Bernanke remarks at the Economic Club of New York on the day that “Stocks Post Biggest Drop Since 1987 Crash as Retail Sales Fall, Commodities Sink and Investors Worry About Hedge Funds”
A motivation of this blog is capturing a small fragment of history as it is expressed on the World Wide Web. The Credit Crisis has been a main focus for the last 14 months due to its impact on capitalist society, especially in relationship to Globalization. Ben Bernanke’s speech yesterday is an excellent consolidation of events and actions by the Fed, the Administration, and Congress. First, let’s look at economic news from the Wall Street Journal on the day of the speech to sketch the economic climate. I will bold items in the article for skimming.
From the Wall Street Journal “Economic Fears Reignite Market Slump”:
Fears of a deep recession sparked the worst drop in the Dow Jones Industrial Average in 21 years, as retail sales tumbled, demand for commodities sank and bank earnings fell.The latest data suggest the U.S. economy is poised to fall into its deepest recession since the early 1980s. That news, coupled with renewed signs of trouble in the all-important markets for credit, reignited the sell-off in stock markets, all but wiping out the huge gains that shares had made in Monday’s rally.
The Dow dropped 733.08 points, or 7.9%, to 8577.91 as recession fears and continuing doubts about the world financial system’s prospects shook investors. Wednesday’s decline marked the Dow’s largest percentage drop since October 1987 and the second-biggest point drop ever. The index is down 21% this month and almost 40% from its record close a year ago.
Other indexes plunged, too, including the Standard & Poor’s 500 stock index, which fell 9.03%. Overall, investors lost about $1.1 trillion in U.S. stock-market value on Wednesday, the second day in history that they have lost more than $1 trillion in one day.
In Asia Thursday morning, markets were down sharply, including Tokyo’s Nikkei Stock Average, off 9.7% in early trading.
In another sign of economic weakness, demand for the most important raw materials continued to slide, with oil and copper prices falling sharply.
With the big drop in stocks, many investors fled into safe-haven instruments like the two-year Treasury bond, which rose in price, sending its yield down to 1.6%, while the 10-year bond price rose slightly to yield 4%.
The stock market was unnerved late in the day by new fears of instability in the financial system, this time in the hedge-fund industry. Traders heard talk that hedge fund Citadel Investment Group, whose funds are down between 26% and 30% for the year, was facing margin calls. The rumors fed an already anxious market, where investors have grown worried that some big, highly debt-dependent hedge funds could fail, causing more market declines…
Mr. Bernanke subtly left open the possibility of interest-rate cuts in the weeks or months ahead, noting inflation pressures have receded as a result of falling commodities prices.
But it’s far from clear how much effect further rate cuts would have. Investors have been demanding huge premiums — known on Wall Street as spreads — over benchmark interest rates to make loans to businesses and households. As long as these spreads remain large, the benefits of rate cuts are diminished. A big priority for now remains calming the fear that has swept through financial markets.
Evidence is mounting that the U.S. is likely to experience a far worse downturn than the 2001 or 1990-91 recessions. Job losses started at the beginning of this year but started deepening last month, even before the worst of the credit crisis struck. The degree of the declines is sapping consumer incomes after a decade showing few earnings gains for most Americans…
The Commerce Department said its broad gauge of retail sales dropped 1.2% last month, a much sharper decline than in July and August. The figures followed weak September sales reports last week by major retailers, and confirmed that the economy was softening before this month’s market turmoil, suggesting deeper declines in the coming months. Consumer spending, which accounts for more than 70% of the U.S. economy, is likely to record declines in the third and fourth quarters of this year.
Retail sales slipped in almost every sector. Auto sales fell 3.8%, while furniture, electronics, clothing and food stores also declined.
The troubles are weighing heavily on the global economy. Weak prospects around the world are pushing commodity prices sharply lower, a sign that strong demand — which led to huge price surges earlier this year — has abated with the economic turmoil. Crude-oil prices tumbled $4.09, or 5.2%, to $74.54 a barrel, its lowest settlement price this year.
Meanwhile, the continuing turmoil in credit markets is likely to hit the banking sector hard in the coming months. J.P. Morgan Chase & Co. and Wells Fargo & Co., two of the nation’s strongest banks, on Wednesday said their consumer operations are likely to worsen for months amid weaker performance of mortgages, credit cards and auto loans. J.P. Morgan, which is one of the nation’s largest credit-card issuers, said charge-offs — reflecting loans considered to be uncollectible — represented 5% of its card portfolio compared with 3.64% in the third quarter of 2007. That’s expected to grow to 6% in the beginning of next year and 7% by the end of 2009, the bank said.
The Federal Reserve’s latest “beige book” report, a summary of regional economic conditions, showed weakness across the nation into early October. Consumer spending declined, manufacturing activity dropped and several regions reported lower capital spending or reductions in capital spending plans “due to the high level of uncertainty about the economic outlook or concerns over the availability of credit.” Among the few bright spots were agriculture and other natural resources, though drops in commodity prices since the reports were compiled could hurt those sectors.
Job losses, which started at the beginning of this year, are expected to worsen as businesses feel the credit pinch. The effects of the worsening economy were on display at retail outlets around the country.
After years of conspicuous consumption, many middle- and upper-income Americans are morphing into cautious shoppers. The change in mood could have a dramatic effect on consumer spending on everything from cars and travel to electronics, fashion and jewelry, especially heading toward the holiday season. That’s a radical change from the 2001 economic slowdown when many people shopped to feel better.
In Chicago, Fanchon Simons, an avid 60-year-old shopper, says she couldn’t bring herself to buy a $360 blouse that she tried on at a designer-clothing boutique last week. Ms. Simons says she hasn’t bought much for herself in the past couple weeks — and not because she can’t afford it. Buying “is not that important to me right now because of the climate,” she says. “Maybe it’s a way to be in sympathy with the rest of the people…or maybe it’s that I don’t really need anything.”
High-end consumers aren’t the only ones pinching pennies or turning to window-shopping. Synetha Chambers, a 31-year-old single parent from Cedar Hill, Texas, who makes $25 an hour as a service representative for AT&T, says she has pared her grocery list to the necessities — milk is a must, but she no longer buys soda and chips. “And I will be honest with you, Christmas is no longer a necessity in my household,” Ms. Chambers says.
In recent weeks, a slew of forecasters have predicted that holiday spending this year is likely to be at the lowest level in nearly two decades. The National Retail Federation plans to release a survey Thursday reporting that U.S. consumers plan to spend an average of $832.36 on holiday-related shopping, up 1.9% from a year earlier. It is the lowest increase in planned consumer spending since the survey began in 2002. The survey was conducted Sept. 30 to Oct. 7.
Here is a pod cast from the PBS Online NewsHour with a perspective on the days events.
Now lets look at Bernanke’s Remarks which is a concise history and well articulated. The full speech is below the break by Federal Reserve Chairman Ben S. Bernanke before the Economic Club of New York, delivered on October 15, 2008. First, here is the edited and annotated transcript for skimming.
Bernanke Remarks on the Crisis and Stabilization
On what caused the Credit Crisis:
As in all past crises, at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets. The crisis will end when comprehensive responses by political and financial leaders restore that trust, bringing investors back into the market and allowing the normal business of extending credit to households and firms to resume…This financial crisis has been with us for more than a year. It was sparked by the end of the U.S. housing boom, which revealed the weaknesses and excesses that had occurred in subprime mortgage lending. However, as subsequent events have demonstrated, the problem was much broader than subprime lending. Large inflows of capital into the United States and other countries stimulated a reaching for yield, an underpricing of risk, excessive leverage, and the development of complex and opaque financial instruments that seemed to work well during the credit boom but have been shown to be fragile under stress. The unwinding of these developments, including a sharp deleveraging and a headlong retreat from credit risk, led to highly strained conditions in financial markets and a tightening of credit that has hamstrung economic growth.
What the Fed did as an initial response in 2007 and the Spring of 2008:
• First, following classic tenets of central banking, the Fed has provided large amounts of liquidity to the financial system to cushion the effects of tight conditions in short-term funding markets.• Second, to reduce the downside risks to growth emanating from the tightening of credit, the Fed, in a series of moves that began last September, has significantly lowered its target for the federal funds rate. Indeed, last week, in an unprecedented joint action with five other major central banks and in response to the adverse implications of the deepening crisis for the economic outlook, the Federal Reserve again eased the stance of monetary policy.
Yet, the credit crisis continued:
Notwithstanding our efforts and those of other policymakers, the financial crisis intensified over the summer as mortgage-related assets deteriorated further, economic growth slowed, and uncertainty about the financial and economic outlook increased. As investors and creditors lost confidence in the ability of certain firms to meet their obligations, their access to capital markets as well as to short-term funding markets became increasingly impaired, and their stock prices fell sharply.
Perspective on normal policy and justification for the strong intervention which began in September 2008:
The Federal Reserve believes that, whenever possible, the difficulties experienced by firms in financial distress should be addressed through private-sector arrangements–for example, by raising new equity capital, as many firms have done; by negotiations leading to a merger or acquisition; or by an orderly wind-down. Government assistance should be provided with the greatest reluctance and only when the stability of the financial system, and thus the health of the broader economy, is at risk. In those cases when financial stability is broadly threatened, however, intervention to protect the public interest is not only justified but must be undertaken forcefully and without hesitation.
Comments illuminating the Fed’s perspective on Freddie Mac, Fannie Mae, Lehman Brothers and AIG:
Fannie Mae and Freddie Mac present cases in point. To avoid unacceptably large dislocations in the mortgage markets, the financial sector, and the economy as a whole, the Federal Housing Finance Agency put Fannie and Freddie into conservatorship, and the Treasury, drawing on authorities recently granted by the Congress, made financial support available.The difficulties at Lehman and AIG raised different issues. Like the GSEs, both companies were large, complex, and deeply embedded in our financial system. In both cases, the Treasury and the Federal Reserve sought private-sector solutions, but none was forthcoming. A public-sector solution for Lehman proved infeasible, as the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman’s acquisition by another firm. Consequently, little could be done except to attempt to ameliorate the effects of Lehman’s failure on the financial system.
In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure would have severely threatened global financial stability and the performance of the U.S. economy. We also judged that emergency Federal Reserve credit to AIG would be adequately secured by AIG’s assets. To protect U.S. taxpayers and to mitigate the possibility that lending to AIG would encourage inappropriate risk-taking by financial firms in the future, the Federal Reserve ensured that the terms of the credit extended to AIG imposed significant costs and constraints on the firm’s owners, managers, and creditors.
The Financial Crisis spreads to the real economy, threatening catastrophic consequences unless the government intervened even more deeply. Commercial Paper in this instance = direct link from financial market crisis to the real economy:
AIG’s difficulties and Lehman’s failure, along with growing concerns about the U.S. economy and other economies, contributed to extraordinarily turbulent conditions in global financial markets in recent weeks. Equity prices fell sharply. Withdrawals from prime money market mutual funds led them to reduce their holdings of commercial paper–an important source of financing for the nation’s nonfinancial businesses as well as for many financial firms. The cost of short-term credit, where such credit has been available, jumped for virtually all firms, and liquidity dried up in many markets. By restricting flows of credit to households, businesses, and state and local governments, the turmoil in financial markets and the funding pressures on financial firms pose a significant threat to economic growth.
Treasury and the Fed are compelled in September and October of 2008 to take deeper action:
• To address illiquidity and impaired functioning in commercial paper markets:
- The Treasury implemented a temporary guarantee program for balances held in money market mutual funds to help stem the outflows from these funds.
- The Federal Reserve put in place a temporary lending facility that provides financing for banks to purchase high-quality asset-backed commercial paper from money market funds, thus reducing their need to sell the commercial paper into already distressed markets.
- Moreover, we soon will implement a new, temporary Commercial Paper Funding Facility that will provide a backstop to commercial paper markets by purchasing highly rated commercial paper directly from issuers at a term of three months when those markets are illiquid.• To address ongoing problems in interbank funding markets, the Federal Reserve has significantly increased the quantity of term funds it auctions to banks and accommodated heightened demands for temporary funding from banks and primary dealers.
• Also, to try to mitigate dollar funding pressures worldwide, we have greatly expanded reciprocal currency arrangements (so-called swap agreements) with other central banks.
• Indeed, this week we agreed to extend unlimited dollar funding to the European Central Bank, the Bank of England, the Bank of Japan, and the Swiss National Bank. These agreements enable foreign central banks to provide dollars to financial institutions in their jurisdictions, which helps improve the functioning of dollar funding markets globally and relieve pressures on U.S. funding markets.
It bears noting that these arrangements carry no risk to the U.S. taxpayer, as our loans are to the foreign central banks themselves, who take responsibility for the extension of dollar credit within their jurisdictions.
These steps are helping the bank system:
The expansion of Federal Reserve lending is helping financial firms cope with reduced access to their usual sources of funding and thus is supporting their lending to nonfinancial firms and households.
“Nonetheless, the intensification of the financial crisis over the past month or so made clear that a more powerful, comprehensive approach involving the fiscal authorities was needed to address these problems more effectively”:
• The Emergency Economic Stabilization Act (the Administration, with the support of the Federal Reserve, asked the Congress for a new program aimed at stabilizing our financial markets): provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy. The act allows Treasury to buy troubled assets, to provide guarantees, and to inject capital to strengthen the balance sheets of financial institutions. The act also raises the limit on deposit insurance from $100,000 to $250,000 per account, effectively immediately.
• The Troubled Asset Relief Program (TARP) authorized by the Emergency Economic Stabilization Act will allow the Treasury, under the supervision of an oversight board that (Bernanke) will head, to undertake two highly complementary activities.
- First, the Treasury will use the TARP funds to help recapitalize our banking system by purchasing non-voting equity in financial institutions. Details of this program were announced yesterday. Initially, the Treasury will dedicate $250 billion toward purchases of preferred shares in banks and thrifts of all sizes. The program is voluntary and designed both to encourage participation by healthy institutions and to make it attractive for private capital to come in along with public capital. We look to strong institutions to participate in this capital program, because today even strong institutions are reluctant to expand their balance sheets to extend credit; with fresh capital, that constraint will be eased. The terms offered under the TARP include the acquisition by the Treasury of warrants to ensure that taxpayers receive a share of the upside as the financial system recovers. Moreover, as required by the legislation, institutions that receive capital will have to meet certain standards regarding executive compensation practices.
- Second, the Treasury will use some of the resources provided under the bill to purchase troubled assets from banks and other financial institutions, in most cases using market-based mechanisms. Mortgage-related assets, including mortgage-backed securities and whole loans, will be the focus of the program, although the law permits flexibility in the types of assets purchased as needed to promote financial stability. Removing these assets from private balance sheets should increase and liquidity and promote price discovery in the markets for these assets, thereby reducing investor uncertainty about the current value and prospects of financial institutions. Unclogging the markets for mortgage-related assets should put banks and other institutions in a better position to raise capital from the private sector and increase the willingness of counterparties to engage. With time, the provision of equity capital to the banking system and the purchase of troubled assets will help credit flow more freely, thus supporting economic growth.
These measures are moves towards a more stable Financial System in the future.
Yet, there is still “the immediate problem of lack of trust and confidence.” The Administration, Congress and the Fed have taken the above measures, yet that does not mean a return of credit to markets. Looking at LIPOR and the TED, the banks are hoarding capital to keep their books solvent in the future instead of taking on the risk of lending to opaque institutions whose books may or may not be toxic:
Accordingly, also announced yesterday was a plan by the Federal Deposit Insurance Corporation (FDIC) to provide a broad range of guarantees of the liabilities of FDIC-insured depository institutions, including their associated holding companies. The guarantee covers all newly issued senior unsecured debt, including commercial paper and interbank funding, and it will also cover all funds held in non-interest-bearing transactions accounts, such as payroll accounts. This broad guarantee will be effective immediately, and fees for coverage will be waived for 30 days. After the 30-day grace period, banks may continue to participate in the guarantee program by paying reasonable fees.
Articulating what the Tax Payer has invested in and what their risk is to the Tax Payer now that the Federal Government has deeply intervened into the Financial Markets:
…(T)he taxpayers’ interests were very much in our minds and those of the Congress when these programs were designed.
• The costs of the FDIC guarantee are expected to be covered by fees and assessments on the banking system, not by the taxpayer.
• In the case of the TARP program, the funds allocated are not simple expenditures, but rather acquisitions of assets or equity positions, which the Treasury will be able to sell or redeem down the road.
• Indeed, it is possible that taxpayers could turn a profit from the program, although, given the great uncertainties, no assurances can be provided.
• Moreover, the program is subject to extensive controls and to oversight by several bodies.
• The larger point, though, is that the economic benefit of these programs to taxpayers will not be determined primarily by the financial return to TARP funds, but rather by the impact of the program on the financial markets and the economy. If the TARP, together with the other measures that have been taken, is successful in promoting financial stability and, consequently, in supporting stronger economic growth and job creation, it will have proved itself a very good investment indeed, to everyone’s benefit.
“Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away.” These measures alone do not correct the trajectory of the economy towards growth.
Conditions restraining the economy:
• Economic activity had been decelerating even before the recent intensification of the crisis.
• The housing market continues to be a primary source of weakness in the real economy as well as in the financial markets
• We have seen marked slowdowns in consumer spending, business investment, and the labor market. • Credit markets will take some time to unfreeze.
• With the economies of our trading partners slowing, our export sales, which have been a source of strength, very probably will slow as well.
The restraining influences are currently being off set somewhat:
• by the favorable effects of lower prices for oil and other commodities on household purchasing power
The big factor according to Bernanke effecting the economy
Ultimately, the trajectory of economic activity beyond the next few quarters will depend greatly on the extent to which financial and credit markets return to more normal functioning.
So far Bernanke has been commenting on the first of his two tier initiatives–supporting economic growth. His second initiative is to control inflation:
• Inflation has been elevated recently, reflecting the steep increases in the prices of oil, other commodities, and imports that occurred earlier this year, as well as some pass-through by firms of their higher costs of production.
• However, expected inflation, as measured by consumer surveys and inflation-indexed Treasury securities, has held steady or eased
• Prices of imports now appear to be decelerating.
• These developments, together with the recent declines in prices of oil and other commodities as well as the likelihood that economic activity will fall short of potential for a time, should lead to rates of inflation more consistent with price stability.
Globalisation measures. “This past weekend, the finance ministers and central bank governors of the Group of Seven industrialized countries met in Washington.”
• We committed to work together to stabilize financial markets and restore the flow of credit to support global economic growth.
• We agreed to use all available tools to prevent failures that pose systemic risk.
• We affirmed we will ensure our deposit insurance programs instill confidence in the safety of savings.
• We agreed to ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources.
• We further agreed that we would take all necessary steps to unfreeze interbank and money markets, and that we will act to restart the secondary markets for mortgages and other securitized assets.
• Finally, we recognized that we should take these actions in ways that protect taxpayers and avoid potentially damaging effects on other countries.I believe that these are the right principles for action, and I see the steps announced by our government yesterday as fully consistent with them.
What Bernanke said in closing:
I have laid out for you today an extraordinary series of actions taken by policymakers throughout our government and around the globe. Americans can be confident that every resource is being brought to bear to address the current crisis: historical understanding, technical expertise, economic analysis, financial insight, and political leadership. I am not suggesting the way forward will be easy, but I strongly believe that we now have the tools we need to respond with the necessary force to these challenges. Although much work remains and more difficulties surely lie ahead, I remain confident that the American economy, with its great intrinsic vitality and aided by the measures now available, will emerge from this period with renewed vigor.
The full speech is below the break
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• “…(Congress) seemed alternately grateful and resentful of the new power couple in Washington. Some referred to “President Paulson” and others groused about an unelected central bank chairman doling out hundreds of billions of dollars…
In the end, what left so many lawmakers and economists frustrated was the sense that no one had a better idea. So they waited for Mr. Paulson and Mr. Bernanke to give them more details about what they wanted to do.” – from A Professor and a Banker Bury Old Dogma on Markets
• “(T)he prospect that the government is preparing to wade in deep — perhaps sparing families from foreclosure and banks from insolvency — has muted talk of the most dire possibilities: a severe shortage of credit that would crimp the availability of finance for many years, effectively halting economic growth.
“The risk of ending up like Japan, with 10 years of stagnation, is now much lessened,” said Nouriel Roubini, an economist at the Stern School of Business at New York University. “The recession train has left the station, but it’s going to be 18 months instead of five years.”
If the plan works, it will attack the central cause of American economic distress — the continued plunge in housing prices. If banks resumed lending more liberally, mortgages would become more readily available. That would give more people the wherewithal to buy homes, lifting housing prices or at least preventing them from falling further. This would prevent more mortgage-linked investments from going bad, further easing the strain on banks. As a result, the current downward spiral would end and start heading up.
“It’s easy to forget amid all the fancy stuff — credit derivatives, swaps — that the root cause of all this is declining house prices,” Mr. Blinder said. “If you can reverse that, then people start coming out of their foxholes and start putting their money in places they have been too afraid to put it.”…
…(Financial) institutions are deeply intertwined with the American economy. When the financial system is in danger, it stops investing and lending, depriving ordinary people of financing for homes, cars and education. Businesses cannot borrow to start up and expand…
…The economy has shed roughly 600,000 jobs since the beginning of the year. If healthy companies cannot get their hands on financing, they will not be able to expand and hire.
“What we’re looking at now is simply an amplified version of what we’ve been in since last August,” Mr. Bernstein added. “You’re witnessing a sudden death instead of a slow bleed.”
The impact of the pullback among banks was evident in the interest rates banks pay other banks to borrow money short-term. Traditionally, banks charge one another a little more than 0.2 percentage point over the rate on the safest investment, United States Treasury bills. But on Friday that spread was more than two percentage points, meaning a bank must pay an enormous premium to persuade another to part with its money.
And still no one knows the extent of the carnage. The financial system has acknowledged roughly $400 billion in losses so far, Mr. Roubini estimates, yet as much as another $1.1 trillion may be lying in wait.
As the government steps in to take over bad debts, it is aiming to clear away the detritus and lift the uncertainty, emboldening banks to lend anew.
Whether it will work in the long term is a question that awaits reaction from investors. But even the most skeptical economists say this is the path the government must take for confidence to crystallize that a genuine fix is under way…” – from But Will It Work?
$700 Billion Is Sought for Wall Street in Massive Bailout
New York Times
September 21, 2008 (found on the NYT.com web site one day before publishing)
By DAVID M. HERSZENHORNWASHINGTON — The Bush administration on Saturday formally proposed to Congress what could become the largest financial bailout in United States history, requesting unfettered authority for the Treasury Department to buy up to $700 billion in mortgage-related assets.
The proposal, not quite three pages long, was stunning for its stark simplicity. It would raise the national debt ceiling to $11.3 trillion. And it would place no restrictions on the administration other than requiring semiannual reports to Congress, granting the Treasury secretary unprecedented power to buy and resell mortgage debt.
Staff members from Treasury and the House Financial Services and Senate banking committees immediately began meeting on Capitol Hill, where negotiations were likely to be complicated but quick. Democratic Congressional leaders have pledged to approve legislation by the end of this week.
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This post includes:
• US takes control of Fannie and Freddie
While the Bush administration stopped short of using the word “nationalisation”, analysts said the moves amounted to a de facto government control. Fannie and Freddie have $5,400bn in outstanding liabilities and guarantee three-quarters of all new US mortgages.
“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” Hank Paulson, Treasury secretary, said. Mr Paulson said the intervention would “accelerate stabilisation in the housing market” by bringing down the cost of home loans.
• A delicate balance in the Freddie and Fannie action
The levees in New Orleans held fast as hurricane Gustav landed last week, sparing the city from the physical devastation experienced under Katrina. And had the levees fallen, the human tragedy would have been significantly reduced as most of the population had already been evacuated from the city.
This situation stands in stark contrast to the devastation that a deleveraging hurricane continues to wreak in the US and other parts of the world. Unlike New Orleans, the levees of the global economy have broken, one after another.
• Cost of US loans bail-out emerging
With the stock market tumbling, the non-partisan Congressional Budget Office said the government takeover of Fannie and Freddie meant the companies should no longer be regarded as outside the public sector.
Peter Orszag, CBO director, said: “It is the CBO view that Fannie Mae and Freddie Mac should be directly incorporated into the federal budget.”…
The CBO bombshell came as it raised its baseline estimate for the US budget deficit to $407bn this year and a record $438bn next year owing to falling revenues and higher spending, some of it related to the fiscal stimulus.
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Now for the Lehman Brothers story: “Lehman is the fourth biggest investment bank in the US. Its assets are larger than Bear’s were and it is involved in many different financial markets, all of which could be disrupted by its failure…Lehman’s problems are only an extreme version of the problems confronting all stand-alone investment banks, which now face not only losses on credit securities but existential questions about their future business models too. If Lehman’s debtholders suffer losses in a failure or takeover, the cost of funds for other investment banks could go up. Letting Lehman go would represent a policy decision that the market must decide whether the sector has a future.”
• Poser for Paulson: the US Treasury chief wants a halt to public bail-outs
The US Treasury secretary began the week with a multi-billion dollar rescue of Fannie Mae and Freddie Mac, twin pillars of the country’s mortgage market, only to end it digging in against calls for a second bail-out, to help save Lehman Brothers, the investment bank.
After deploying public funds in the Fannie and Freddie deal, and earlier to help rescue Bear Stearns in March, it will not be easy for Mr Paulson to refuse to support a Lehman takeover. Yet by late on Friday, that was what he appeared determined to do…
His message: regulators were prepared to be pragmatic to help facilitate a deal but there would be no repeat of the Bear Stearns model, in which the government sweetened the bank’s takeover by JPMorgan Chase by taking on all but the first $1bn (£559m, €706m) of losses on a $30bn portfolio of mortgage-backed securities. This time Mr Paulson has been determined to take the back seat. While pushing hard for a rescue takeover, he has appeared willing to countenance the risk that one might not be forthcoming and Lehman could fail.
In Mr Paulson’s eyes there are big differences between Lehman and Fannie and Freddie. The mortgage giants were vastly more important to the global financial system – their total liabilities are $5,400bn, a large chunk of which is held by foreign central banks whose support for the dollar is crucial. Fannie and Freddie were also much more important for the US economy, since they account for about three-quarters of all new US mortgages.
Moreover, their problems were rooted in their hybrid structure as “government-sponsored” private companies. Mr Paulson believed that the US government had caused this problem and was obliged to deal with it in a way that kept faith with the world’s investors. “Because the US government created these ambiguities, we have a responsibility to both avert and address the systemic risk,” he said last Sunday.
Mr Paulson also sees big differences between the situation at Lehman today and at Bear Stearns in March. The Treasury chief always insisted that he had intervened in March not to help Bear or its investors but to contain the systemic risks raised by its imminent failure. He sees the situation today as different for two main reasons: the markets have had six months to prepare for the possibility that Lehman could fail, and a new Fed facility ensures that it cannot suddenly run out of liquidity in the way that Bear did…
Mr Paulson does not wish to fuel any further a growing bail-out culture in the US, which has already led the troubled automotive industry to seek billions of dollars in loan guarantees.
• No Fed bail-out this time round
“Several Washington-based experts have argued Lehman did not endear itself to the authorities by walking away from earlier rescue proposals because it felt the prices on offer were too low.
“Lehman may be the poster child for enough-is -enough,” says a senior executive at a private equity firm that has been in talks with Lehman in regard to possible asset sales.
Policymakers want to get away from the notion there was a standard formula for resolving financial crises – ie. deploy public money to keep the debt whole once the equity is all but wiped out – knowing this has sponsored specific destabilising trades in financial markets.
The US government may judge that – with a record budget deficit looming next year and Fannie and Freddie’s $5,400bn of liabilities now in public hands – its fiscal ammunition is not limitless, and it may be wise to keep some in reserve for what may prove to be many more such crises further down the road.”
• Lehman Heads Toward Brink as Barclays Ends Talks
Unable to find a savior, the troubled investment bank Lehman Brothers appeared headed toward liquidation on Sunday, in what would be one of the biggest failures in Wall Street history.
The fate of Lehman hung in the balance as Federal Reserve officials and the leaders of major financial institutions continued to gather in emergency meetings on Sunday trying to complete a plan to rescue the stricken bank.
But Barclays, considered the leading contender to buy all or part of Lehman, said Sunday that it could not reach a deal without financial support from the federal government or other banks, making a liquidation more likely…
…how a liquidation might proceed. One option that was discussed on Saturday would have major banks and brokerage firms continue to do business with Lehman as it unwinds its assets and liquidates over a period of months, according to several people briefed on the discussions. That would buy Lehman time to sell those assets in an orderly way and avoid a fire sale that could depress prices of similar assets held by other banks.
The overarching goal of the weekend talks was to prevent a quick liquidation of Lehman, a bank that is so big and so interconnected with others that its abrupt failure would send shock waves through the financial world. Of deep concern is what impact a Lehman failure would have on other securities firms, insurance companies and banks, notably the American International Group, both of which have come under mounting pressure in the markets…
…Both Barclays and Bank of America expressed interest in buying Lehman and were negotiating hard, initially insisting that the government provide financial support. But federal officials were adamant that no public money be used — a big point of contention because many of the top Wall Street executives believe that their banks, which have each written down tens of billions of dollars in assets, do not have the capacity to lead the rescue on their own.
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• Rush Is on to Prevent Big Insurer From Failing : American International Group
As the credit storm has raged in recent months, insurance companies like A.I.G. have been better positioned than the nation’s banks and brokerage firms to weather it because accounting rules do not require insurers to mark the investments held in their long-term portfolios to market. Insurance companies like A.I.G. can hold their investments until they mature, riding out the ups and downs in the market for those assets.
But the moment it began trying to raise capital, A.I.G. had to open its books to potential investors who were likely to take a sharp pencil to the company’s portfolio values, analysts said. And with Lehman Brothers last week providing investors with a valuation for the same types of assets held by A.I.G., subprime and Alt-A mortgage securities, the investment bank’s marks can now be applied to the big insurer’s books.
As of the most recent quarter, for example, A.I.G. had $20 billion of subprime mortgages marked at 69 cents on the dollar and $24 billion in Alt-A securities valued at 67 cents on the dollar.
But Lehman officials on a conference call with investors last week said it was valuing similar subprime mortgage securities to those held by A.I.G. at 34 cents on the dollar; its mark on the Alt-A holdings was 39 cents. Those valuations suggest almost a $14 billion decline in A.I.G.’s holdings, after taxes, an amount representing 18 percent of the company’s book value…
…A.I.G., which is based in New York, has also been under pressure from the derivatives contracts that its London-based financial products unit sold in connection with complex debt securities. Those contracts, called credit default swaps, acted as a type of insurance on the debt securities, making them more attractive to buyers. The swaps also gave speculators an opportunity to bet on the debt securities’ overall creditworthiness, which has declined in response to the turmoil in the housing markets.
When A.I.G.’s financial products unit sold the credit default swaps, it effectively promised to compensate buyers of the debt securities if the mortgages underlying them got into trouble. At the time, the securities were rated AAA, so it seemed at first that A.I.G. was not taking on inordinate risk.
But that picture changed as the housing crisis took hold and homeowners began to default. A.I.G. wrote down the value of its swap portfolio by $25 billion, telling investors that the markdowns did not represent a cash loss of that magnitude. It estimated possible cash payouts on the swaps of between $5 billion and $8 billion.
But because the debt securities covered by the swaps are so complex and opaque, it has been hard for investors to verify A.I.G.’s numbers on their own, and investors have grown impatient as A.I.G. reported big losses they did not expect in the last two quarters.
A.I.G. also said recently that it might have to post collateral to its swap counterparties, heightening concerns that the company would have to raise capital in tight markets. A.I.G. said in a filing with the Securities and Exchange Commission that if its own credit were downgraded one notch by Moody’s and Standard & Poor’s, its swap contracts would require it to post collateral of about $13 billion.
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This post could easily be broken into several separate posts, yet the stark reality of these three issues occurring in the same week, over one year after the Credit Crisis began to take shape publicly, shows that the financial institutions are not yet in a position to begin creating credit opportunities for the American Economy. In other words, there are serious fundamental problems with the American Economy and the way it was managed (or deregulated therefore not managed) over the last 28 years.
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US takes control of Fannie and Freddie
By Krishna Guha, Chris Giles, Saskia Scholtes and Joanna Chung
Published: September 7 2008 19:07 | Last updated: September 8 2008 00:29
The US government on Sunday seized control of the troubled Fannie Mae and Freddie Mac mortgage groups in what could become the world’s biggest financial bail-out.
The government’s move, its most dramatic since the start of the credit crisis, is aimed at ensuring the two groups’ woes do not cripple the country’s housing market or worsen to the point that they fail and send shockwaves through global markets.
While the Bush administration stopped short of using the word “nationalisation”, analysts said the moves amounted to a de facto government control. Fannie and Freddie have $5,400bn in outstanding liabilities and guarantee three-quarters of all new US mortgages.
“Fannie Mae and Freddie Mac are so large and so interwoven in our financial system that a failure of either of them would cause great turmoil in our financial markets here at home and around the globe,” Hank Paulson, Treasury secretary, said. Mr Paulson said the intervention would “accelerate stabilisation in the housing market” by bringing down the cost of home loans.
In a sign of the magnitude and historic nature of the decision, Mr Paulson briefed presidential contenders Barack Obama and John McCain, as well as President George W. Bush and senior members of Congress before the announcement.
As regulators took charge of the companies, the government said it had agreed to inject up to $100bn in each of them as needed to ensure they meet their debts. In addition, it would buy mortgage bonds backed by these companies starting with an initial $5bn purchase, and provide an unlimited liquidity facility to them until the end of next year.
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First, a note I was writing to someone who said that their local economy was uneffected: “You say that the economy is good there. Have you checked the food banks and other resources for those having hard times? Here is a link to Bill Moyer’s Journal and a link to the video which is focusing on Denver since the Democratic convention is there”
Here is a big chunk of highlights from the Bill Moyer post:
BILL MOYERS: Working Americans, and that’s most people, are experiencing the “big squeeze.” In fact, they’re trying to survive one of the most profound social and economic changes in our history. The middle class is disappearing, facing a decline in standards of living. So you’d hope that the Democrats in Denver next week and the Republicans in St. Paul the following week would confront this crisis head on and not just serenade struggling families with a chorus of sympathetic but meaningless sound bites.
This week, we go to the city of the hour - Denver, the site of the Democratic National Convention. Nearly 75,000 people will gather in the Mile High City as Barack Obama makes history by becoming the first African American to be nominated by a major party for president.
But outside the convention center doors, history of a different, more prosaic sort is being made. This year oil hit a record high - $147 a barrel when last year, it was less than half that - around $68. A loaf of bread is up 14% from last year, a dozen eggs is up 33%, and pizza makers have seen the cost of their cheese soar from $1.30 to $1.76. Flour used to make the dough has tripled in price. As these prices soar, the value of homes is sinking. One in three home buyers since 2003 now owe more than their property’s estimated worth. Not only has home equity plummeted, so has the value of other holdings, like stocks and bonds and pensions, the investments families count on as a cushion during hard times.
So America’s middle class, our “fearful families” as some people call them, is taking it on the chin. The history-making nominations aside, all the rhetoric from all the speakers at next week’s Democratic Convention will be so much hot air above the Rockies unless the party comes to grip with how people are living and hurting today.
Just imagine what might happen if instead of going to all the shindigs being paid for by all the wealthy donors and corporations next week, the Democratic faithful - and their candidates - spread out across Denver’s neighbors, and listened to people caught in the big squeeze. That’s what our producer Betsy Rate and correspondent Rick Karr did just the other day.
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I’ve been working a ton over the last 13 business days so this leaves the weekend to catch up. Last weekend I went to the beach so today I was looking forward to capturing some interesting turn of events in our world. Boy oh howdy, a weekend could get full fast:
Exxon again sets US profits record
The run-up in oil and natural gas prices in the second quarter led ExxonMobil to report the highest profit by a US company, in spite of falling production, lower refining and chemical margins and rising operating costs…
The company urged the US to open protected areas. “The challenge is that some of the most promising areas onshore and offshore are off-limits, not only to us, but to the industry,’’ said Exxon.
Yet the company beat back a shareholder revolt this year, launched by the Rockefeller family, to force it into alternative energies.
Poverty, Inc.
Bill Moyer’s broadcasted a video that followed up a BusinessWeek’s report on predatory lending and the mechanism of turning health care debt into consumer debt. Here are a couple of lines from each article:
Inside U.S. companies’ audacious drive to extract more profits from the nation’s working poor
In recent years, a range of businesses have made financing more readily available to even the riskiest of borrowers. Greater access to credit has put cars, computers, credit cards, and even homes within reach for many more of the working poor. But this remaking of the marketplace for low-income consumers has a dark side: Innovative and zealous firms have lured unsophisticated shoppers by the hundreds of thousands into a thicket of debt from which many never emerge.
and
As doctors and hospitals turn to GE, Citigroup, and smaller rivals to finance patient care, the sick pay much more
In a lucrative new form of fiscal alchemy, a growing number of hospitals, working with a range of financial companies, are squeezing revenue from patients with little or no health insurance. April Dial’s dealings with Hot Spring County Medical Center in Malvern, Ark., illustrate how the transformation of medical bills into consumer debt means quicker cash for medical providers but tougher times for many patients of modest means.
The Big Freeze
Analysis of the Credit Crisis from the past year by the Financial Times.
From “Big Freeze part 1: How it began”:
On the contrary, as markets that were crucial for raising funds started to dry up last August, a network of financial vehicles slid into crisis, causing the price of many debt securities to collapse. That started a chain reaction that created liquidity and solvency crises at US and European banks – on a scale last seen in Japan almost exactly a decade ago.
A year later, there is still no sign of an end to these problems. Instead, the sense of pressure on western banks has risen so high that by some measures this is now the worst financial crisis seen in the west for 70 years.
War in Georgia
• Here is some background for OPB Newshour: article or video
• The first article from the New York Times “Europe” section as fighting erupted: article or photos
• Day Two “Georgia and Russia Nearing All-Out War; Moscow Broadens Its Air Campaign; Bush Calls for Halt” : article or photos
• US policy under pressure : In Georgia Clash, a Lesson on U.S. Need for Russia
The image of President Bush smiling and chatting with Prime Minister Vladimir V. Putin of Russia from the stands of the Beijing Olympics even as Russian aircraft were shelling Georgia outlines the reality of America’s Russia policy. While America considers Georgia its strongest ally in the bloc of former Soviet countries, Washington needs Russia too much on big issues like Iran to risk it all to defend Georgia.
Economy indicators
• Oil went down and stock went up this week in dramatic fashion: article
Wall Street stocks rallied strongly on Friday, and made their first consecutive weekly gains since May, after a dip in oil prices offset weak results and a dividend cut from Fannie Mae, the embattled mortgage agency.
Crude oil fell more than $4 a barrel to a three-month low on Friday, taking its tally for the week to a 5.7 per cent decline.
Oil-sensitive stocks rallied strongly on the news. General Motors advanced 2.9 per cent to $10.03 and Ford rose 7.6 per cent to $5.23. Retailers Macy’s and JC Penney climbed 9.5 per cent to $20.73 and 6.6 per cent to $35.75 respectively. An index of airline stocks added 8.2 per cent and the consumer staples and discretionary sectors advanced 2.3 per cent and 5.2 per cent respectively.
• Oil also dipped on the dollar getting stronger : article
Mounting optimism that the US economy would outperform the rest of the developed world pushed the dollar to multi-month highs against leading currencies this week as the oil price resumed its downward path, providing support for equity markets.
On the foreign exchanges, the dollar enjoyed its best one-day advance against the euro for eight years as the single currency fell briefly below the $1.50 level. The dollar also hit a 21-month high against sterling and a seven-month peak against the yen.
The trigger for the greenback’s rally – and a sharp rise in European government bonds – came from comments by Jean-Claude Trichet, the president of the European Central Bank, following Thursday’s decision to leave eurozone interest rates unchanged.
The yield on the two-year German bond hit its lowest since May 20.
Mr Trichet acknowledged that economic growth in the region was weakening – in effect taking further ECB rate rises off the table and underscoring the bleak message provided by a series of weak data releases, most notably from Germany. His remarks compounded increasingly gloomy outlooks in the UK and Japan.
“Over the past quarter, sentiment on growth prospects in the eurozone, Japan and the UK has deteriorated incredibly rapidly and most now accept that recession has already begun in all these three regions,” said Albert Edwards, global strategist at Société Générale.
The Olympics kicks off in China
The New York Times has a section dedicated to the 2008 summer games along with some images from opening night ceremonies.
Life
One of my favorite topics!
How does an egg cell divide and direct its progeny to turn into each of the many types of cell needed by the adult? Researchers led by Richard A. Young of the Whitehead Institute in Cambridge have been chipping away at this central question in biology. This graphic, from an article by Alexander Marson, Stuart S. Levine and others in the Aug. 7 issue of the journal Cell, presents the Young lab’s latest version of the genetic circuitry that controls embryonic cells.
The principal players in a cell’s governance are proteins called transcription factors, which control the activity of genes. The transcription factors bind to short stretches of DNA called promoters and set in motion the process of translating the gene’s information into protein. The promoters sit just upstream on the DNA strand of the gene they control. One transcription factor can control many genes — all that have the kind of promoter it binds to.
Four transcription factors control the embryonic cell. They are Oct4, Sox2, Nanog and Tcf3 (shown as blue circles on left). This gang of four binds to the promoters (red rectangles next to the circles) of their own genes, keep the genes constantly active, and thus perpetuate their own rule.
The four factors also bind to promoters (red rectangles to right) that control lower-level transcription factors and to promoters (purple hexagons) for another kind of control factors called micro-RNAs. The lower-level transcription factors each control major cell functions (black type at right).
Embryonic cells must do two things: divide like crazy, and then direct groups of cells to morph into different cell types. The promoters in the top half of the central column control transcription factors (orange circles) that govern all functions that the cell must invoke to divide and multiply.
The promoters in the lower half govern cell fate; they tell each cell which of the major tissue types it is destined to become. But as long as the cell remains in the embryonic state, the action of all these promoters is held in arrest by a protein called a polycomb (green circle). Only when polycomb’s hold is lifted can the embryonic cells differentiate.
One of the gang of four, Tcf3, is influenced by signals from the cell’s environment. It may be a change in Tcf3 that upsets the gang of four’s rule and sends the mass of embryonic cells cascading down the cell lineages that lead to adulthood.
Nightly Business Report
Friday July 25, 2008
RICK NEWMAN, CORRESPONDENT, US NEWS & WORLD REPORT: If you haven’t heard the news about the American dream, please sit down while I tell you because the American dream is dead. I keep reading the obituaries.
In the old days, when the AD was thriving, people worked hard to improve their lives. They started small businesses that sometimes got bigger. They bought homes and cars and upgraded to nicer homes and cars once they had more money. They had savings accounts in case something went wrong.
Now it’s all ruined. And here’s who did it: CEOs, for starters. Because they take most of the companies’ money for themselves and there’s hardly anything left for employees who used to get 5 percent raises every year as long as they didn’t get fired.
Bankers put a stake in the American dream, too, by giving mortgages to people who couldn’t afford them. Even worse, now these bankers will only give loans to people who can prove they’ll pay the money back.
The Mexicans and Salvadorans and Indians and Chinese have robbed us, too, because they’ve taken a lot of jobs that Americans are fully capable of doing, for more money. What’s the point of working hard, if somebody else is willing to work even harder, for less?
The Saudis and Kuwaitis are part of the cabal, refusing to pump more oil so we can afford to fill our SUVs.
And the biggest villain, of course, is our own government. Where are the gasoline subsidies or the tax breaks that will incentivize us to work harder? How about a bigger mortgage interest deduction, to make owning a home worth all the trouble? Come to think of it, why doesn’t the government just send us all some more money, to help restore our work ethic and our quality of life? Now that’s what we really need: an American dream backed by the full faith and credit of the United States government.
I’m Rick Newman.
I found this paragraph from an article on the New York Times:
After moving into virtually every occupation, women are being afflicted on a large scale by the same troubles as men: downturns, layoffs, outsourcing, stagnant wages or the discouraging prospect of an outright pay cut. And they are responding as men have, by dropping out or disappearing for a while.
Personally I’ve felt like doing some disappearing and I have been withdrawing. I think it is this perspective as a worker–I am a freelance graphic designer so I’m always starting new jobs and leaving them–that informs my political perspective.
For instance, I don’t like all of the mindset of Free Traders who see zero ‘Moral Hazard’ in laying off thousands at a time yet they get in a tizzy of ‘Moral Hazard’ belching at the Fannie and Freddie decisions by the US Government. Leaders who talk about retraining workers through job programs without talking about the significant disruptions and personal trauma that workers go through when they are sacked, have no place as a leader in a Democracy. They are the mouth piece of ownership, they are the voice of intrenched special interest who seek profit for themselves without accountability to the community.
“Fannie Mae has been a government-sponsored wealth generator for its executives. That is wonderful … except for the small fact that this private wealth was gained by public support.”
NPR.org
by Dick Meyer
July 17, 2008 ·
I know the prospect of reading a column about Fannie Mae, the mortgage crisis and government bailouts is as appealing as a bowl of cough syrup. So let’s consider the latest news about the giant company something young parents today call a “teaching moment.”
The lesson is about this old and ignored government truism: The worst scandals are the ones that are perfectly legal.
The electorate and its press corps can get into an outraged lather about whether John McCain improperly took a ride on a crony’s Gulfstream or whether Barack Obama is too close to a shady real estate operator. Congressional staffers are trained to know whether a gift basket of walnuts is kosher, and the difference between legal finger food and an illegal sandwich.
Fannie Mae is different. It is what is called a government-sponsored enterprise. It was established by Congress in the New Deal to buy mortgage loans from banks so they could unload some of the risk and make loans to homebuyers more safely. Wonderful.
So Fannie Mae was allowed to borrow money more cheaply than private mortgage security businesses and allowed to keep less emergency capital in the safe than competitors. As if that weren’t enough, Fannie was made exempt from state and local taxes. Imagine if Goldman Sachs didn’t have to pay New York City taxes.
There are strong arguments that Fannie Mae should have government backing to make home buying easier. There are strong arguments that the government should help stabilize Fannie Mae right now. I am agnostic on both points.
The ethical, as opposed to economic, fight is about whether the government-sanctioned benefits Fannie Mae has enjoyed should have been used to create the executive largess it did.
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From the New York Times…tells of the downfall of Marie, the winsome daughter of a middle-class merchant of fancy goods, at the hands of a series of lecherous, duplicitous soldiers who flatter her, abuse her and drive her into prostitution.
So why does this appear on a politics blog? If the answer is self evident to you:
Art is allowed to express the darker side of humanity while the political arena is full of people who express a positive face in public while in secret express darker faces–like lying about the reasons to invade Iraq. This image above reminds me of Orwell’s “Animal Farm” where the pig Capitalist’s, after running farmer Jones off the farm and take control, move into farmer Jones home. Then at the end the pigs take on the characteristics of the human being as they hold power over all the other animals on the farm.
Including this post in context of the category “Bush Administration”, “Ethics”, and “Wealth” seemed so perfect of a mirror for those who support the Bush Administration to stare into so that they can see themselves more clearly and for those who work within the frame work of American Capitalism–myself included. You see, nothing has changed in the picture Capitalist’s make of themselves since George Orwell penned his stories “Animal Farm” and “1984”. Too bad too many humans are still more like sheep’s and pig’s rather than ascending to the more divine images of restraint and stewardship–or should it be said that humans may be able to understand the pursuit of ascending to these divine images yet they would rather languish as a sheep and pig while those in power would rather keep them there to suck the life out of them in order to create profit.
The case is Chamber of Commerce v. Brown, 06-939.
Washington Post
The Associated Press
Thursday, June 19, 2008; 10:58 AM
WASHINGTON — The Supreme Court on Thursday struck down a California law that blocked use of state money for anti-union activities.
The court ruled on the state’s first-in-the-nation law that bars employers from using state money to influence employees’ views on unions in their workplace.
The justices decided by a vote of 7-2 that federal labor law bars California from regulating union-related activities.
The U.S. Chamber of Commerce, backed by the Bush administration, said the state was trying to silence employers from weighing in on organizing efforts. Federal labor law allows employers to be involved as long as they don’t threaten reprisals.
Justice John Paul Stevens, writing for the court, agreed that the state ventured into territory that belongs to the federal government. Congress already has rejected “California’s policy judgment that partisan employer speech necessarily ‘interferes with an employee’s choice about whether to join or be represented by a labor union’” Stevens said.
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