naked capitalism

Links 7/11/09

2009-07-11T03:18:00.001-04:00

Speedy cheetahs put through paces BBC

Government honours veterans of Bletchley Park at last V3. Cryptonomicon fans take note.

Sarah Palin is resigning over money, says Levi Johnston Telegraph. Makes more sense than any reason I have heard thus far.

NYT Totally Flubs Story on Mortgage Market Dean Baker

Surprise fall in factory prices puts pressure on Bank Independent

The recession is slowing household formation Bubble Meter

Statement of Professor James K. Galbraith1 to the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services On the Fed as systemic risk regulator.

SEC May Gain Expanded Powers to Prohibit Broker Pay, Wrongdoers Bloomberg

Goldman Sachs profit bonanza could stoke anger Reuters. Duh!

Failure of a Fail-Safe Strategy Sends Investors Scrambling Wall Street Journal

Haiku Economics Mark Thoma. Um, this is economists simply doing an older and therefore more upscale version of Twitter. Although I actually do like haiku.

Did a productivity slowdown cause the financial crisis? David Brackfield, Joaquim Oliveira Martins VoxEU. Any readers who want to have fun with this, be my guest.

On Wall Street: Credit crisis is far from over Aline van Duyn, Financial Times

‘Secretive’ firms dominate US share trading Financial Times. How long has Tyler Durden been on this story? Months? Now the FT notices? And thanks only the the Goldman software theft.

A couple of Bloomberg videos (hat tip reader ComparedToWhat?) Mohamed El-Erian on the new normal and a good radio interview with Shiller and Roubini.

Creditors oppose extending Lehman plan deadline Reuters. If you read our long Lehman post yesterday, we went after Alvarez & Marsal, the bankruptcy consultant, for its clearly conflicted position (it was advising the board before the BK, and since has issued reports that have the effect of exculpating the board, and therefore themselves). The post also pointed to an article from the FInancial Times, which described how A&M was spending time on a nutty scheme to coordinate the BK actions in 27 (maybe more) jurisdictions. Nice in theory, unworkable in practice, and more important, a patently obviously effort to enlarge and extend its involvement. Now get a load of this:

The committee's filing also criticized a fee structure that it says encourages restructuring advisers, Alvarez & Marsal, to drag out the time it spends managing Lehman. Alvarez & Marsal has so far earned fees of about $115 million.

That is in addition to legal fees of $263 million. More dirt in the article.

Antidote du jour:

Geithner to Scold Mortgage Servicers Later This Month

2009-07-11T02:31:00.001-04:00

Lordie, the theater is beginning to look like a Punch and Judy show, where everything is staged and no one gets hurt.

Joe Nocera has a not-too bad piece on the latest comedy of errors, except he takes the Adminstration's PR way too seriously:

Remember that infamous meeting last October at the Treasury Department, the one where then-Secretary Henry Paulson locked the chief executives of the nation’s nine largest financial institutions in a room, and wouldn’t let them out until they agreed to accept billions of dollars in government bailout money — whether they wanted it or not?

O.K., that’s a bit of an exaggeration. But I was reminded of that meeting on Thursday night when I was shown a letter that the administration had just sent out calling for yet another big meeting at Treasury with yet another sector of the financial industry. Signed by Treasury Secretary Timothy Geithner and Shaun Donovan, the housing and urban development secretary, the letter demanded that representatives from the top 25 mortgage servicers assemble in Washington on July 28. It is likely to be every bit as painful for them as that Paulson meeting last October was for the bank C.E.O.’s.

Yves here. Geithner beat up on the banks? Please. This notion comes from an alternative universe. One thing that Paulson was good at was muscling people. This has never been in Geithner's skill set. If Larry Summers were a participant, I might take the Nocera scenario seriously, but this is pure fantasy.

Nocera then tells us why servicers are not set up to do mods and gets to the punch line:

In truth, servicers and banks don’t yet have powerful enough incentives to do large-scale mortgage modifications. The servicers and modification experts I spoke to this week all agreed that the $1,000-per-modification being dangled by the government was pretty meaningless, given the amount of time, money and effort they require.

So now that the carrot hasn’t worked especially well, the government is taking out the stick. That letter the administration sent out on Thursday did not mince words. It demanded that the servicers begin “adding more staff than previous planned, expanding call centers beyond their current size, providing an escalation path for borrowers dissatisfied with the service they have received, bolstering training of representatives, developing extra online tools, and sending out additional mailings to borrowers who may be eligible for the program.”

And the laggards? Starting next month, the government plans to begin publishing data showing which servicers are doing well and which are doing poorly,

Do you, dear readers, think that is going to make an iota of difference? Manifest unhappiness about bankster pay hasn't had much impact either, now has it?

It is a bit surprising that Nocera regards the failure of this program as news. We were skeptical when it was launched:

But I have my doubts that it will work. First, despite the bribes to servicers, I don't see strong reasons for them to play ball. These mods will be costly, I am not certain the comp is adequate, and mortgage securities holders may sue.

Second, the redefault rate on mortgage mods that do not have significant principal reduction in the first six months now is high. The New York Times reports that payment reductions are expected to be "hundreds of dollars" a month. Is that really going to make a difference with most borrowers, particularly since the interest portion is tax deductible and these mortgages are recent (ie, the interest component is a high proportion of the total payment).

Third, the program qualifies people based on mortgage payments relative to total income. Some consumers are so up to their eyeballs in debt that a mortgage mod is merely rearranging the deck chairs on the Titanic. So in this version of the program, borrowers with high levels of overall debt (55%= to income) get debt counseling! Let me tell you, someone in that fix is probably beyond hope. In the old days of easier credit, someone paying 29% on credit cards could get a somewhat less punitive rate via debt consolidation. I doubt there is much of that sort of credit on offer right now.

Fourth, second mortgage holders don't have reason to play ball

So I wonder if this is again grandstanding, to make it abundantly clear that the Administration is washing its hands of the problem and fobbing full responsibility for the problem back on the banks.

The best solution was to have had judges be able to modify loans in bankruptcy. But Team Obama does not throw its weight behind many of the things it in theory favors (it backs down and calls it "compromise:" at the drop of a hat) and did not have BK mods as high on its list of priorities.

White House Sorta, Kinda Thinkin' 'Bout Using TARP Money for Small Business Loans as Small Business Lenders Go Bust

2009-07-11T01:28:00.002-04:00

The Washington Post has a pretty bizarre story up tonight. The Administration is thinking about releasing TARP funds as loans to small businesses.

Stress the thinking part. As in big-time thinking. As in long way from action. Which begs the question as to why this is a news story. Since I am of the view that pretty much every news story is a plant or a leak, at least if any semi-well run entity is involved, one then must ponder the purpose in having such an early-stage idea come to light. Is it to flush out support, or to give opponents a chance to rally?

Key bits of the Washington Post article. At the beginning, the confident tone makes it sound as if the program is on the runway, ready for takeoff:

The Obama administration is developing an initiative to take money from the $700 billion rescue program for the banking system and make it available to millions of small businesses, which officials say are essential to any economic recovery because they employ so many people, according to sources familiar with the plan.

The effort would represent a striking shift from the rescue program's original mandate, since it would direct billions of bailout dollars toward a plan that aims more at saving jobs than at righting the financial system. Some economists estimate that small businesses, defined as firms with fewer than 500 workers, employ most of the country's workforce.

A proposal being floated by senior Treasury Department officials calls for using the bailout funds to expand a government program that helps small companies borrow from banks at low rates to keep their businesses going, the sources said. These "working-capital" loans would come with few restrictions and could be used to buy inventory, hold on to employees and pay off short-term debt.

The initiative would bulk up the Small Business Administration's most popular lending program, called 7(a). Lines of credit for small companies could greatly increase in size. If a firm failed despite receiving this help, the government would cover most of the losses on the federal loan, perhaps as much as 90 percent. Lines of credit act like the credit cards for companies -- short-term, revolving debt used to pay a variety of immediate expenses.

But then, four paragraphs further down, we get to this:

Administration officials said discussions are in the early stages and that no plan is expected before the fall. Concepts now on the table may evolve or be scrapped altogether, they said. No dollar figure has been set.

But discussions about the plan have reached the highest levels of the government. In a meeting at the White House last week, Treasury Secretary Timothy F. Geithner expressed support for the proposal, but National Economic Council Director Lawrence H. Summers was more skeptical. Neither has made up his mind, officials said...

The debate over the proposal has centered on whether taxpayers would be protected and whether banks that make these loans to small firms would lower their lending standards if the government promises to cover loans that go bad, according to participants present or briefed on the discussions.

Yves here. Hhm. We didn't hear much on worries about losses when it came to propping up housing prices. Clearly the National Association of Realtors and of course the banks are better at lobbying than small businessmen, who are not exactly a force to be reckoned with on K Street. Back to the story:

Administration officials want to prevent small businesses from closing and adding their workers to the growing ranks of the unemployed. Some officials say small companies are key to reversing the soaring unemployment rate, which has hit 9.5 percent, the highest since the early 1980s. Small businesses employ 60 percent to 80 percent of all workers, according to some economists, though others say those figures are too high.

Yves again. It is a little late to be waking up to that concern. We pointed out that American Express had entirely shut two small business lending programs last December and this January, when it was the first credit card issuer to target small businesses and had a good sized program. Banks have been cutting credit lines on credit cards, a key source of small business funding, for what, at least a year? Advanta, focused solely on small business credit cards, shut down all credit extension as of June. The damage of credit curtailment is swift for businesses that need it. Yes it is better to do something late than never. but fall (even assuming this gets up and running in the fall, fall was the timetable for merely moving this forward) is way way too late. Many small businesses have large Christmas sales, which requires them to commit to inventory in advance. which (I presume) is summer at the latest for manufacturers, fall for retailers. The failure to consider timing suggests the designers have limited real-world input, which is not a good sign.

The further you get into the story, the more apparent it becomes that this program will never see the light of day, or if it does, it will be more PR than substance:

Aiding small businesses could be a gamble because they have a poorer record than large corporations when repaying loans; it would be the riskiest government investment so far under the bailout plan. Officials are trying to design the program to exclude companies that are likely to fail even if they received federal aid, people with knowledge of the discussions said.

Some administration officials hoped to present several proposals to President Obama last week. But the meeting has been put on hold indefinitely while the Treasury conducts a deeper analysis of the problems afflicting small companies.

Yves here. I cannot believe we have this "corporations have a better odds of repayment" twattle. Did they put AIG and Citi in their sample?

This story at the Wall Street Journal. "Major Lender Faces Crunch." may explain why this not-likely-to-be-a-program idea is being put forth now. CIT, which lends to nearly 1 million small businesses, is going down for the count. Let's see, how many people might those businesses employ? And how many really need that credit from CIT?

From the Journal:

CIT Group Inc., a lender to almost a million mostly small and midsize businesses across the country, is preparing for a possible bankruptcy filing after so far failing to win a government guarantee to help it borrow, said people familiar with the matter....

The mere hiring of bankruptcy counsel doesn't mean a company will actually make a bankruptcy filing. CIT has been pressing its case "with increased urgency to the government,"...

CIT has a $1 billion payment due in mid-August and it is unclear the company "will be able to handle that,".... if CIT did file, the consequences could be considerable, because the 101-year-old company, as of March 31, had $68 billion of liabilities...

The New York-based lender has been stuck for months in a bureaucratic tangle over government assistance. It received $2.3 billion from the federal Troubled Asset Relief Program in December, after winning approval to become a bank holding company. But CIT has so far been unable to access another federal program, one that helps banks and thrifts sell debt with government guarantees. Access to that program would enable CIT, which has a below-investment-grade, or "junk," credit rating, to sell bonds at a low interest rate....

A bankruptcy filing by CIT could affect thousands of small borrowers, from Dunkin' Donuts franchisees to restaurant owners and clothing retailers. "If CIT were to go away, it would take a financing option away from franchisees who want to buy stores or expand their networks," said Kate Lavelle, chief financial officer of Dunkin' Brands, the which owns Dunkin' Donuts and has had a 50-year relationship with CIT....

The FDIC has been considering CIT's application for a federal debt guarantee since January and hasn't reached a decision. The agency is concerned about CIT's deteriorating financial position and operating losses.

Yves here. At the very end of the piece comes the real issue:

One problem with getting more aid is that the government has made it clear it doesn't see the company as a systemic risk to the financial system. The people familiar with the matter said the government feels that other lenders, such as J.P. Morgan Chase & Co. or Deutsche Bank AG, can handle many of the same loans that CIT specializes in, such as loans to small retailers or rail-car leasing firms.

I am not saying CIT should be saved. But can someone tell these clowns that increasing the concentration at the big end of the financial system increases systemic risk?

Dodd, Frank Do 180 Degree Turn on Mark to Market

2009-07-11T01:20:00.001-04:00

This from an attentive (and well known) investor. I'd provide a link except the press release is not yet posted on Dodd's website

United States Congress
For Immediate Release
July 10, 2009
Contact: Kirstin Brost/Justine Sessions, Dodd, 202-224-7391
Steve Adamske, Frank, 202-225-7141

Dodd, Frank Ask Regulators to Address 2nd Mortgages Valuation Problems that Discourage Loan Modifications
Honest Accounting Key to Effort to Help Families Keep Their Homes & Stabilize the Housing Market

WASHINGTON - Today Senate Banking Committee Chairman Chris Dodd (D-CT) and House Financial Services Chairman Barney Frank (D-MA) sent a letter to the heads of the bank regulatory agencies asking them to address whether banks are inflating the value of 2nd mortgages on their balance sheets, thereby discouraging proactive efforts to modify and restructure mortgage loans and crippling programs designed to prevent foreclosures.

Across the country housing prices have dropped and many Americans owe far more on their mortgages than their homes are worth. Because they are "underwater," these homeowners are unable to refinance, leaving them unable to make payments. The HOPE for Homeowners program was designed to help Americans stay in their homes by adjusting their mortgages to 90% of the assessed value of their property while helping mortgage companies prevent larger losses they would face if the homes simply went into foreclosure.

The tough reality is that in areas where housing prices have dropped dramatically, 2nd mortgages may be virtually worthless. Regrettably, many banks are still unwilling to update their balance sheets to show these assets have dropped in value, and inflated values have made it virtually impossible for HOPE for Homeowners to work. These companies would rather deny reality today, even if it means more people losing their homes and the banks losing more money down the road with a further explosion of foreclosures.

Below/attached, is the letter:

Trust me, the letter does not add much.

Of course, this is not a complete change for these solons on the issue of mark to market, merely a reversal where the banks are clearly being pigs. The second mortgages often have no value in these cases, but the second mortgage holder nevertheless will use his blocking position to try to squeeze blood from a turnip. My impression is all this does is kill refis rather than yield them cash, but they seem unable to get past their reflexes.

Bloomberg is coming down hard on Goldman

2009-07-10T09:44:00.001-04:00

Submitted by Edward Harrison of Credit Writedowns.

The video linked below is a must-see piece of journalistic skepticism. The duo at Bloomberg News are discussing the recent alleged theft of trading code by a former Goldman employee Sergey Aleynikov who moved to a hedge fund called Citadel. Their commentary is incredulous. Their tone seems to ask: “Is the Government working for Goldman now?”

Here are a few gems:

“What is Goldman Sachs doing with this trading code that could manipulate the markets?”
“And Goldman got on the phone to the Justice Department and got them so fast to nail this guy, it’s almost - you wonder if they have a red line to the government.”
“It is amazing within one day of Goldman calling they had FBI agents at his driveway doing surveillance. The next day they arrested him…”
“It’s interesting that the prosecutor from the testimony that I’ve read, it almost sounds as if he’s working at Goldman Sachs.”

More here

Goldman Sachs Loses Grip on Its Doomsday Machine: Jonathan Weil - Bloomberg

Guest Post: Jersey's Jitters: An Omen For Public Plans?

2009-07-10T04:13:00.006-04:00

Submitted by Leo Kolivakis, publisher of Pension Pulse.

From Big Blue's pension blues, we go to public sector pension blues. Bloomberg reports that New Jersey's pension asset value dropped 19% last fiscal year:

New Jersey’s pension assets fell 19 percent during the fiscal year that ended June 30, the board overseeing the funds said.

The decline in asset value, to $63 billion on June 30 from $78.2 billion a year earlier, adds stress to a retirement account that was underfunded by about $34 billion at the start of the fiscal year. The fund covers about $6 billion in benefit payments each year.

“Tough year,” William Clark, director of the Division of Investment, told members of the State Investment Council today. Clark said the losses are not as severe as those suffered by other public pension funds. “At the end of the day, our numbers will come out at the top of the range for public funds,” he said.

Actuaries who calculate the health of the fund each year assume the state’s investments will earn 8.25 percent annually. Taxpayers eventually are required to make up any difference between actual earnings and that assumed rate. In the fiscal year that ended June 30, the investments posted a negative return of 14 percent, Clark said.

Last year was the second in a row that the fund’s assets declined in value. The fund’s losses came even after gains since February, when the value reached a low of $56.4 billion.

The investment losses are compounded by a decline in pension contributions by the state and local governments.

Governor Jon Corzine, grappling with a growing budget deficit, cut pension payments to $263 million last fiscal year and plans to contribute about $150 million this year. Actuaries said the state needed to contribute $4.7 billion over those two years to keep pace with the funds’ rising expenses.

In addition, the state this year allowed local governments to postpone up to $584 million in payments they were scheduled to make into the fund in April.

As you can see, the health of public plans isn't any better than that of private plans. The only difference is that taxpayers are on the hook for public plans.

Moreover, New Jersey isn't the only one with that ridiculous 8.25% required actuarial return. Governor Corzine, an ex-Goldman Sachs alumni, knows that in a deflationary world such rosy projections are pure pipe dreams.

Are Jersey's jitters an omen for public plans? You bet they are. Governments around the world are grappling with seriously underfunded public and private pension plans and there are no real solutions to deal with global pension tension.

As I write, there is a mini heat wave going on in Greece, but I am more concerned with the rising temperature of the pension pandemic. Oh well, back to swimming, tanning, eating amazing Cretan food, and reading Henry Miller's novels. Not sure if I am coming back to Montreal.

Links 7/10/09

2009-07-10T03:38:00.001-04:00

JFK runway shut for crossing turtles, delaying flights for over an hour Telegraph (hat tip reader Barbara)

Dieting Monkeys Offer Hope for Living Longer New York Times

Humans may give swine flu to pigs in new twist to pandemic PhysOrg. Doesn't this increase the odds of mutation? Let's hope it is the inconsequential kind.

Third of breast cancer 'harmless' BBC. This is not news, but this information is not given to women in order to keep them coming for mammograms. They are a lousy diagnostic, good at picking up slow growing cancers that will not kill you, and bad at getting the fast moving lethal kind. Manual exams are actually better at picking up the deadly type, as is newer tech (thermal imaging), but people prefer the seemingly more scientific approach of a mammogram, and doctors have an installed base of equipment.

Journalism Scandal at News Corp Columbia Journalism Review

Netanyahu's paranoia extends to 'self-hating Jews' Emmanuel and Axelrod Ha'aretz

Markets need rules Rolfe Winkler, Reuters. A beltated congrats to Rolfe on joining Reuters! They are also letting him keep his Options Armageddon branding.

If Goldman Sachs Reports Record Profits, How Will That Affect U.S. Markets? John Lounsbury. Reader Michael D points out that the real punch line of this story, that Goldman expects its richest pay year ever, got virtually airbrushed out of initial MSM reports. Loundsbury gives it long form treatment.

AIG to pay more executive bonuses July 15: source Reuters. I'd hyperventilate about this, but it clearly does no good. No one question the way top of cycle pay is now treated as the new normal, even in a bloodbath.

Citi reshuffles senior management Financial Times. The inaptly named Ned Kelly, who performed quite poorly in his initial public appearance, has been replaced as CFO after a mere four months.

Japan's wholesale prices mark record drop in June MarketWatch (hat tip DoctoRx)

**FLASH** Goldman Code Theft BOMBSHELL? Karl Denninger. The allegation is that the purloined code allowed Goldman to front run on a massive scale. Plus Denninger Goes On Air, One Minute Twenty Seconds Of Airtime Ensues Tyler Durden

Markets mayhem puts spin on statistics Martin Sandbu Financial Times. Parsing the trade stats.

The clearinghouse that saved foreign exchange trading from the crisis Richard M. Levich, VoxEU

The Stimulus Trap Paul Krugman

Global Banking Economist Warned of Coming Crisis Der Spiegel. Today's must read.

Antidote du jour:

So Where, Exactly, Did Lehman's $130 Billion Go?

2009-07-10T03:02:00.000-04:00

The Lehman demise refuses to go away.

It has come out that the losses appear likely to be $130 billion on what was a roughly $660 billion balance sheet. That is an insanely high level.

What has caught my attention from the get-go is that blame was very quickly pinned on the disorderly bankruptcy. While I am sure that is a major factor, it is now being played up in the press as if it was the sole cause. I find it curious that Bryan Marsal, the president of Lehman and more important, co-chief executive officer of Alvarez & Marsal, the restructuring consultant for US bankruptcy, is taking the time to tell this story, per the CNBC clip below. There happens to be a piece in the Financial Times: tonight on Lehman (hat tip reader Don B) as well as this video from last week via reader Hubert, which says there might be a bit of a PR effort afoot.

Blogger was rejecting the CNBC embed code, and I fixed the supposed broken link, but if you have trouble, try here.

Marsal sticks with the "disorderly bankruptcy" message, and invokes Public Enemy Number Two: derivatives (Number One is credit default swaps). And he maintains that the bank was felled by a liquidity, not a solvency problem.

Why is this all a tad convenient? Raising the issue of dubious accounting now, which is fraud, opens up a whole new can of worms. That would seem to be enough of a reason.

But it seems pretty likely that dubious asset valuations played a role. Remember, David Einhorn was very critical of the Lehman's accounting; it was very highly levered. Not much would have to be wrong for the bank to be bust. An ex-Lehman employe also has doubts:

I've always thought the fixed income portfolio was a much more promising source to look for the shortfall...they took no writedowns whatsoever on the portfolio through the fall/winter, despite a larger (relative to size) mix of mortgage and other toxic waste (leveraged finance, bridge to nowhere loans) than MER, C, etc. The Level 3 bucket grew substantially, until investors began to catch on & focus on that metric...at which time they moved a bunch of the Level 3 stuff off balance sheet (through setting up JV's like One William, R3, etc)...all to avoid marks that would have created a bigger capital hole than they felt they could fill.

Another indicator that things might not be what they seem: the UK administrator says that there were 100 companies in that operation, and was stunned by its complexity. In a separate development described in the FT, Alvaraz & Marsal is trying to come up with a global plan, which seems peculiar given the national nature of bankruptcy regimes. And the UK administrator, which is overseeing the biggest non-US piece (and may also have a bone of contention, given how $8 billion was drained by the parent from the UK at the 11th hour) is having none of it:

Now, however, the liquidator to the parent company, Lehman Brothers Holdings Incorporated, is trying to change this mentality among the affiliates. Alvarez & Marsal, US restructuring experts, want to recreate some ghost version of the deceased bank through the global protocol, which aims to encourage each affiliate to focus on maximising the size of the overall pie rather than focusing only on their slice.

To that end, they have drawn up an agreement with seven administrators representing 27 Lehman companies – with more expected to sign. This promises much closer co-operation, the development of a single system for adjudicating internal claims and more sharing of data....

Crucially, however, not all the administrators are on board. PwC, in charge of Lehman’s main London-based European operations, known as Lehman Brothers International (Europe) and the most pivotal operation outside the US, has flatly refused to sign up.

Tony Lomas, head of the PwC team, is a veteran of cross-border corporate collapses from Robert Maxwell’s media empire to failed carmaker MG Rover and the European arm of Enron, the energy company. “My experience tells me [the protocol] is aspirational and lacks practicality,” he says. “It is sometimes not even practical to reduce an agreement between just two insolvency practitioners in different estates to writing.”

Back to the main plot, the $130 billion that went poof.

Lehman had $6 trillion of derivatives. But if they included credit default swaps, they were presumably hedged with offsetting positions, so the notional amount would way overstate real exposures. And another portion was probably plain vanilla stuff like interest rate swaps, which would not have a lot of latitude for pricing disputes.

If Lehman was done in by adverse market conditions and dirty tricks by the rest of the banking industry to the tune of $130 billion, wouldn't the counterparties to Lehman's losing positions be showing gains?

Where this might come back is via the repos used to fund derivative positions. I will confess to not haivng tracked down Lehman's final 10-Q, but a normal I-Bank is funded roughly 50% by repos, so say $330 billion. Let us make generous assumptions, that Lehman was using 40% structured credits as collateral. And remember, thanks to the 2005 bankruptcy laws, the counterparties can grab collateral. They don't have to go into the bankruptcy queue.

Collateral haircuts went through the roof when Lehman went down:

But even with a 20% spike in repo haircuts, we get only to $26 billionish. Even if the Lehman counterparties were jerks and upped the haircuts by 30%, it still only gets you to around $40 billion.

The reason I am particularly suspicious of Alvarez & Marsal is their role is badly conflicted. If you listen to the recording, Marsal argues that Lehman was not handled properly, and stresses that the board was shockec by the result. They had assumed an "ordelry transiotn" meaning a sale, or bailout like Fannie.

The problem is that Alvarez & Marsal was advising the Lehman board before the bankruptcy. So Marsal's statement is tantamount to an admission that his firm advised the board badly.

And even more peculiarly, in January A&M issued a report for the board in December contending that the "chaotic" bankruptcy was the cause (by implication the sole cause) of the big losses. But then they pegged the damage resulting from the disorder at only $50 to $75 billion. No wonder they are out doing the PR circuit. They want everyone to forget that earlier $50 to $75 billion range.

Here is a section from a December Wall Street Journal article:

As much as $75 billion of Lehman Brothers Holdings Inc. value was destroyed by the unplanned and chaotic form of the firm's bankruptcy filing in September, according to an internal analysis by the company's restructuring advisers.

A less-hurried Chapter 11 bankruptcy filing likely would have preserved tens of billions of dollars of value...An orderly filing would have enabled Lehman to sell some assets outside of federal bankruptcy-court protection, and would have given it time to try to unwind its derivatives portfolio in a way that might have preserved value, the study says.

We now have the interesting question, :"if the board was told as much as %75 billion was due to the chaos, pray tell where did the other $55 billion go?" And the assertion that Chapter 11 would have produced a vastly better outcome is questionable. As we pointed out then:

Here is where readers are encouraged to correct me if I have something wrong or a bit askew. I was under the very strong impression that securities firms do not decay in an orderly fashion, but instead collapse rapidly once certain triggers are breached, making it well-nigh impossible to contain the unwind. In fact, you'd need pretty substantial changes in both bankruptcy law and the way that trading counterparties deal with each other to have the sort of managed process that the A&M reports argues should have taken place.

Specifically:
1. Once a firm is downgraded beyond a certain threshold, any counterparties that trade with it will be downgraded due to their exposures. And when other firms stop being willing to enter into repos (which do involve a credit exposure) a securities firm is toast. Liquidity is the life blood of a trading firm. And a bankruptcy filing has the same effect. From Jim Bianco:
If Lehman does file, Moody’s has to downgrade their counter-party rating to junk. This forces everyone to stop doing business with Lehman. If you do business with a junk counter-party, you risk your rating falling to junk as well (you are only as good as your shakiest counter-party). Most buy-side accounts have fiduciary rules that bar them from doing business with a junk rated counter-party. Recall that this was the trigger that buried Bear.

No way that Moody's will agree to keep a bankrupt broker with an investment grade counter-party risk rating.

2. The A&M report appears to have ignored the 2005 bankruptcy law changes that rendered the claim made above, that Lehman could have blocked the unwind of its derivatives book via a Chapter 11 filing, incorrect. From the Financial Times:
Wall Street unwittingly created one of the catalysts for the collapse of Bear Stearns, Lehman Brothers and American International Group by backing new bankruptcy rules that were aimed at insulating banks from the failure of a big client, lawyers and bankers say.

The 2005 changes made clear that certain derivatives and financial transactions were exempt from provisions in the bankruptcy code that freeze a failed company’s assets until a court decides how to apportion them among creditors.

The new rules were intended to insulate financial companies from the collapse of a large counterparty, such as a hedge fund, by making it easier for them to unwind trades and retrieve collateral.

However, experts say the new rules might have accelerated the demise of Bear, Lehman and AIG by removing legal obstacles for banks and hedge funds that wanted to close positions and demand extra collateral from the three companies.

“The changes were introduced to promote the orderly unwinding of transactions but they ended up speeding up the bankruptcy process,” said William Goldman, a partner at DLA Piper, the law firm. “They wanted to protect the likes of Lehman and Bear Stearns from the domino effect that would have ensued had a counterparty gone under. They never thought the ones to go under would have been Lehman and Bear.”...

The changes in the code expanded the scope and definition of financial transactions not covered by bankruptcy rules to include credit default swaps and mortgage repurchase agreements – products used widely by Lehman, Bear and AIG....

Lawyers said the 2005 exemptions also could apply to non-financial companies, potentially complicating the bankruptcy process of any company that uses derivatives. Stephen Lubben, professor at Seton Hall University School of Law, said: “These provisions affect a non-financial firm, such as a car company or an airline, because they also engage in derivatives trading.”.

Now perhaps the Wall Street Journal summary does the A&M report a disservice, and they did correctly parse out any that might have been spared the 2005 bankruptcy law changes. But the FT article gives the impression these changes included most if not all derivatives.

And there is another issue. Chapter 11 filings require debtor-in-possession financing (you need to keep paying bills while holding the creditors at the time of filing at bay). Lehman would have been a very big DIP. The financial community is a really small pond. Word of Lehman attempting to line up a big enough DIP would have lead to an immediate run on the firm. No counterparty wants to risk having trading assets frozen for months, perhaps longer.

So if the logic above is correct, the A&M report looks like a costly ass-covering exercise to protect the board from lawsuits. And the Journal did the board a favor by giving it reasonably prominent placement.

We were not alone in our skepticism. From Independent Accountant:

How interesting. A&M was hired before LEH's bankruptcy. What if anything did A&M tell LEH before filing? Is A&M's report designed to protect A&M from a malpractice suit for failure to warn LEH's board of this at least, reasonably possible result? If A&M did not anticipate this $50+ billion disaster, why listen to A&M now? What does "value was destroyed" mean? Did an "Act of God" cause it? Aren't derivatives a "zero-sum" game? If so, counterparties gained at LEH's expense! Should LEH's bankruptcy estate sue them? Or is A&M protecting these counterparties by saying value "destruction", not transfer? Has LEH preference payments or fraudulent transfers to pursue? Does A&M recognize LEH's counterparties may give it future referrals with nothing more to gain from LEH, a "repeat player advantage"? A better title for the WSJ article, "Lehman's Chaotic Bankruptcy filing Destroyed Billions in Value", would have been "Lehman's Consultant Claims ... ". The WSJ accepted A&M's claims at face value. "Preserved value" or cost counterparties more? "This also terminated contracts". Did the "Three Musketeers", Henry Paulson (HP), Zimbabwe Ben (ZB) and Chris Cox (CC) know this on the night of 14 September?...

No matter, LEH's board should not have filed on 15 September if it was not in the interest of LEH's shareholders and creditors. PERIOD! Did Marsal discuss these "fundamental rules" with LEH's board on the night of 14 September? If not, why not? Where was Harvey Miller (HM), LEH's bankruptcy counsel on the night of 14 September? Should LEH sue HM for malpractice? The WSJ headline is revealing. Creating chaos may conceal bankruptcy fraud so intentional acts appear to result from oversight or mistake. Did that happen here? Is the SDNY US Attorney's Office looking into this? The WSJ might have used this title, "Lehman Counterparties Screw Unsecured Creditors Out Of $50 Billion".

Zero Hedge and Independent Accountant have also criticized A&M for incurring charges in the BK that look hard to justify, yet also taking the easy way out and skipping steps that would have increased recoveries for creditors.

Another example: in the video, Marsal mentions that his firm hired some 400 ex Lehman staffers to help unwind the trades, and threw out a $500,000 salary and a $500,000 bonus if recovery targets were met as a representative figure.

The world happens to be awash in unemployed structured credit types these days, I would bet at least 300 of those 400 jobs could have been filled at much lower cost. But Alvarez & Marsal has no incentive to do that. Paying more makes it easier to hire people, and also makes their fees look more reasonable. And say "derivatives" and a BK judge will buy in, even if the skills required may not be all that high level. In the LTCM bankruptcy, Myron Scholes worked for a mere $250,000 a year, which in today's dollars is about $330,000. Am I to believe in that there is good reason to pay more than the equivalent of $500,000 all in for a successful job? Well, sadly yes, pay escalated with perilous little justification, since most of the money supposedly made turned out to be smoke and mirrors, but those high water marks are still holding.

If readers have any idea where the $130 billion went, we'd be very curious to know. Please comment or ping us at yves@nakedcapitalism.com.

Chinese Money Growth Producing Mixed Signals, Limited Real Economy Results

2009-07-10T01:56:00.001-04:00

China has had two failed bill auctions this week, due to fears the government, which has started to raise rates, will continue down that path to curb money supply growth. Yet with growth flagging (anything under 8% is inadequate to absorb new workers), choking off stimulus now does not seem well timed. From Bloomberg:

China failed to attract enough bidders in a government debt sale for a second time this week on speculation that policy makers will rein in money supply to avoid any pickup in inflation.

The Ministry of Finance sold 25.1 billion yuan ($3.7 billion) in bills of the 35 billion yuan it had sought...

The People’s Bank of China has been pushing up money-market rates in the past two weeks, seeking to choke off the supply of funds used to speculate on stocks and real estate without derailing a 4 trillion yuan economic stimulus plan. Chinese banks extended 1.53 trillion yuan of new loans in June, more than double the amount in May, the central bank said on July 8.

“The central bank’s open-market operations suggest concerns that the rapid surge in new bank lending in the first half of this year could fuel inflation,” said Tommy Xie, an economist at Oversea-Chinese Banking Corp. in Singapore. “Market players have also started to worry about early tightening risk.”...

China bond yields “have not tracked the V-shape move in U.S. Treasury yields” as the global credit crisis eased, Tim Condon, Singapore-based head of Asia research at ING Groep NV, wrote in a research note today. “Over the next six to 12 months we expect monetary tightening to drive the five-year Treasury bond yield back to 4 percent.”

China’s bond market swelled in size to about $2.2 trillion at the end of March, compared with $1.9 trillion a year earlier, paced by corporate bond sales, according to the Asian Development Bank. Demand has been waning in recent weeks. An auction of 28 billion yuan of five-year government securities on July 3 drew bids for 1.42 times the debt on offer, compared with a 1.65 bid-to-cover ratio in a sale of 28 billion yuan of 10- year notes on June 17.

The government failed to complete a bond sale on July 8 for the first time in almost six years, selling 27.5 billion yuan of the 28 billion yuan in one-year notes it auctioned.

Reader Michael explains the underlying dynamics, that money growth has not produced much real economy stimulus. From Cajing:

The People's Bank of China, or the central bank, should shift from its moderately loose policy stance and signal clearly that it will stabilize money supply in the second half as inflationary fears return, a government researcher said.

Xia Bin, a director at the Development Research Center of the State Council, said on June 4 that M2, the broadest measure of money supply, typically grows at 14 percent to support a 10 percent expansion in gross domestic product. However, he said, money supply growth is currently far above 20 percent.

Central bank figures show M2 grew 25.7 percent year-on-year in May to 54.9 trillion yuan.

As Michael noted:

Given that they are probably going to grow ~7%, these stats goes to show how dire the underlying economy in china really is…their stimulus can’t go on forever…

Well, technically, it could, but at the risk of even more diminished results per amount of money thrown at the problem.

Banks Get a Break, Buy TARP Warrants Back on the Cheap

2009-07-10T00:17:00.001-04:00

Another day, another banking industry subsidy. From MarketWatch (hat tip reader Marshall):

A panel that oversees a $700 billion bank bailout package said Friday that financial institutions buying out warrants they gave the government in exchange for capital injections are now buying back those stakes at well below their fair value.

The Congressional Oversight Panel, which is charged with overseeing the Troubled Asset Relief Program, or TARP, said in a report that a group of 11 small banks that have repurchased government warrants in exchange for taxpayer-funded assistance, have bought-out the stakes at 66% of their face value.

The C.O.P., which employed three Harvard University valuation experts to conduct the analysis, said that taxpayers would have received $10 million more had the warrants been sold back to the banks at their face value.

The report argues that liquidity discounts are a key factor for why the warrants were purchased at such low prices. Should a similar discount be a major factor for warrant repurchases at larger institutions buying out government stakes, the shortfall to taxpayers could be as much as $2.1 billion,...

The panel employed three valuation experts from Harvard Business School -- Robert Merton, Daniel Bergstresser and Victoria Ivashina -- to conduct the review....

The report also raises the question of whether banks should be repaying TARP funds at all at this stage in the economic recovery. The C.O.P.'s next report will examine this question.

"Any exit from the TARP system implicates an important policy question: If the banks give up federal support prematurely, will the economy suffer as a result? The panel has not reached a consensus on whether it is wise policy to release banks from the TARP program at this time, but our June report on the bank stress tests raised key questions about whether we know enough about the banks' overall health," the report said.

Boy, are the banks trying to spin this one, and the Wall Street Journal is a taker. See "J.P. Morgan to Send Warrants to Market":

Several Wall Street firms seeking to buy back warrants held by the government as part of the $700 billion financial bailout are complaining that the Treasury Department is demanding too high a price, according to people familiar with the matter.

The Treasury has rejected the vast majority of valuation proposals from banks, saying the firms are undervaluing what the warrants are worth, these people said. That has prompted complaints from some top executives. J.P. Morgan Chase & Co. Chief Executive James Dimon raised the issue directly with Treasury Secretary Timothy Geithner, disagreeing with some of the valuation methods that the government was using to value the warrants.

The inability to agree on a price has already prompted J.P. Morgan to take the next step in a complex process to remove the warrants from the hands of the government. The bank has waived its right to buy the warrants and will allow the Treasury to auction them in the public market, which bank executives say will result in an actual market price.

Citigroup: AIG Equity May Be Worth Zero

2009-07-09T12:42:00.001-04:00

While recent news reports have tried to put a cheery face on the AIG bailout as asset sales are moving forward haltingly, the end game appears no better than it did some months ago, at least according to Citigroup. Note that the amount authorized for bailout is $180 billion,"only" $134 billion has been committed to date. The Citigroup analyst suggests the taxpayer may just get out whole on the loans, but one has to wonder whether he is merely steering clear of voicing an opinion on the debt, since that is not his beat anyhow. Regardless, this report raises doubts about full recovery of the funds, much the less any supposed upside.

From Reuters (hat tip reader Joe C):

American International Group Inc, the insurer rescued by a series of federal bailouts, may have zero equity value due to the risk of more credit default swap losses and the disposal of key assets at low valuations, Citigroup said.

Shares of the company fell 22 percent to $10.22 in early trade Thursday on the New York Stock Exchange. The shares have lost more than 90 percent of their value in the last year.

Potential markdowns in AIG Financial Product unit's regulatory CDS portfolio may result in collateral calls that would again put pressure on AIG's liquidity, Citigroup analyst Joshua Shanker said.

Yves here, If I am not mistaken, those "regulatory CDS" are the infamous $300 billion provided to allow European banks to lower required regulatory capital, and if so, the article puts a lower value on it, suggesting writedowns have already occured. Some readers have said those were used to hedge AAA rated structured paper, like CDOs (eek). I am not sure of how this trade worked (Basel II arcana, needless to say) but I believe unhedged AAA was treated as needing only 20% as much equity as riskier credits (A or BBB equivalent?). UBS was big in this practice, and the CDS may have been the reason the bank was able to carry only 1% equity against assets.

Any readers who know details, please elaborate or correct. If you prefer, you can e-mail me at yves@naekdcapitalism.com and I will amend the post as needed. Back to Reuters:
"Such collateral calls could also pressure rating agencies to lower their credit ratings for the company, leading to a similar

cycle to the one that the company experienced prior to the massive government intervention in the third quarter," Shanker wrote in a research note.

Last month, AIG revised its 2008 annual report to add a new risk factor that shows it may recognize valuation losses on a CDS portfolio if credit markets continue to deteriorate.

At issue is a super senior CDS portfolio held by AIG Financial Products with a notional value of $192.6 billion as of March 31, 2009....

The analyst said while AIG may be able to repay U.S. investment and some debt with core asset sales, the remaining businesses may be those that generate lower return on equity, handicapped by a high debt burden.

In June, the federal government agreed to accept $25 billion of preferred stock in two AIG businesses as partial repayment of debt.

AIG had said the agreement positions its two businesses -- American International Assurance Co Ltd (AIA) and American Life Insurance Co (Alico) -- for initial public offerings, depending on market conditions.

Shanker said it expects AIG to carve out its commercial property and casualty business in the form of an initial public offering in 2010.

The analyst, however, said there is high probability that selling off all operations just to cover debt will leave the holding company with little or no equity.

AIG had already agreed to sell a 98 percent stake in its Russian consumer finance business to Banque PSA Finance SA, a unit of France's Peugeot SA (Paris:PEUP.PA - News), and is selling its credit card business in Taiwan to Far Eastern International Bank.

AIG's bid to sell its Taiwan insurance unit, Nan Shan LIfe, attracted bids from global investors Carlyle and Primus, among others and could fetch more than $2 billion.

More on why big capital markets players are unmanageable

2009-07-09T11:13:00.005-04:00

Submitted by Edward Harrison of Credit Writedowns.

Yves had a very good post yesterday called “Why Big Capital Markets Players Are Unmanageable” on banks: the former i-banks and commercial banks. The biggest takeaway for me came from her statements regarding the level of responsibility that a junior level employee in an investment bank can have. She says:

What makes capital markets businesses different from any other form of enterprise I can think of is the amount of discretion given of necessity to non-managerial employees, meaning traders, salesmen, investment bankers, analysts. In pretty much any other large scale business, decisions that have a meaningful bottom line impact (pricing, new sales campaign, investment decision) are deliberate affairs, ultimately decided at a reasonably senior level. The discretion that customer-facing staff have in pretty much any business in limited. At what level does someone have the authority to negotiate a contract? And even then, how many degrees of freedom do they have?

That is a very significant factor in investment banking that makes it risky. Think about the blow-ups that have occurred in trading enterprises from SocGen to Sumitomo to Barings Bank. In most enterprises, most junior-level employees don’t have the decision-making authority necessary to allow these mistakes to happen.

But, Yves’ post got me to thinking a bit more about investment banking itself and the change in emphasis within firms. John Gapper at the FT had a revealing post yesterday on just this subject. He writes:

There is excited talk of investment bankers reclaiming the power and mystique that veteran rainmakers such as Joe Perella, Robert Greenhill and Roger Altman (all of whom now ply their trade at boutiques) once enjoyed at big banks, rather than being trained as technicians and treated as such.

How seriously should we take this? Not as seriously as the bankers do, it is safe to say. There will always be a place in the boardroom for a few senior advisers with the skills and temperament to give thoughtful and unbiased advice to chief executives facing big, risky decisions.

“Sometimes a chief executive needs a surgeon to operate but sometimes he needs a GP who understands people and politics and governance. The best banker can rise above the short-term deal,” says one.

But, valuable as that job may be to the client, it is a niche activity for large banks. Investment banking – advisory work and underwriting – brought in less than a tenth of Goldman Sachs’ net revenues in the first quarter and was dwarfed by trading and principal investing.

When a bank can earn $30m for making a lending commitment to a company that is acquiring another and only $5m for advising on the merger, it tends to value the former over the latter. Advisory work brings prestige, while financing and lending bring in the big bucks.

Did you see where Gapper says only one-tenth of the earnings comes from traditional advisory work? Today’s investment banks look nothing like their brethren of yesteryear. For all intents and purposes, banks today are giant hedge funds – at least in comparison to what they once were. It is sales & trading that is dominant at today’s firms and that has great significance regarding risk and compensation.

A brief history

Before I get into what things look like today, let me give you a (very) brief history of Wall Street’s structure from the 1920s onward. Back in the roaring 20s, the United States had the Universal banking model. JP Morgan was the king of the hill, with a huge advisory, lending and international operation (The House of Morgan is a good book detailing the history). JPMorgan was so big that the firm and the man literally saved the street during the Panic of 1907 (also chronicled in a book aptly titled The Panic of 1907). It was this event that got us a central bank in America because no one wanted another 1907 and no one wanted the whole system dependent on one private citizen.

Now, the Universal banking model has a few problems that created huge conflicts of interest in the 1920s. Many believe the excess wrought by these conflicts contributed to the Depression. So, we got a fix via Glass-Steagall in 1933, whereby commercial banking and merchant/investment banking activities were separated. In the case of JP Morgan, it was split into three: JP Morgan, a commercial bank, Morgan Stanley, an investment bank, and Morgan Grenfell, a British merchant bank (and also former employer of mine). Other banks had to split too: Bank of Boston – First Boston, for example. Others exited one business or another (Goldman got rid of commercial banking).

As before, money center banks like National City (now Citigroup), Chase, Chemical Bank, Bankers Trust and JP Morgan dominated the wholesale market while other smaller banks concentrated on retail banking, what most of us see on the high street. JP Morgan and Bankers Trust, in fact, had no retail banking whatsoever.

By the 1980s, these banks were chomping at the bit to get into investment banking because the retail banking had been disintermediated and was much less profitable. As a result, there was a relaxation of Glass-Steagall whereby commercial banks were permitted to earn up to 25% of their revenue from investment banking activities like trading and advisory work. The money center banks, already having significant business relationships through their huge wholesale businesses, jumped in. At some point, the 25% restriction became onerous for the bankers as they bumped up against the ceiling. JPMorgan was the bank that was most affected by this rule as it developed a very large advisory and trading business.

By the 1990s, the slippery slope made it inevitable that Glass-Steagall was to be repealed. After all, no one blew up due to the 25% rule. Granted Bankers Trust permanently damaged their franchise in the early 1990s with a huge derivatives scandal. But, the bank lobby was still pushing for Glass-Steagall to be repealed.

Of course, it was eventually repealed in order to retroactively allow the Citigroup-Travellers merger to occur. The rest of the history you know.

Moving into trading

What is not evident in this history is that investment banks used to be dominated by dealmakers. The advisory work was considered the main focus. Look at any Wall Street book before “Liar’s Poker.” Almost none of them talks about trading. Sales & trading as considered the bucket shop department where guys whose knuckles were dragging the floor worked. These men – invariably from Brooklyn and sporting ethnic names – were looked down upon by the white shoe investment bankers.

Back when Wall Street was run by partnerships, there was a bulge bracket of firms whose names came fist on any prospectus for bond or equity offerings. This group consisted of Goldman Sachs, Morgan Stanley, Lehman Brothers, Dillon Read, and First Boston. Names not on that list were Salomon Brothers (too much trading), Merrill Lynch (too much retail client focus), and Drexel Burnham (not classy enough). Clearly, the hierarchy was white shoe Investment Bankers first, knuckle dragging traders and middle brow retail shops last.

This all changed, starting in the 1980s. There are a number of factors why, but the change in focus brought Salomon, Merrill and Drexel into the big leagues. As time went on trading became more and more dominant. In my view, a lot of this had to do with economies of scale. Yves says:

So the scale of operation required to be competitive is too large for it to be managed by player-coaches who had deep expertise, and like the Dimon example, were more expert than the people working for them. But the normal corporate/commercial banking management structure, with more managerial layers, and the top brass having broader spans of control, was devised in earlier stages of industrial organization, when you had factories or service business with a great deal of routinization of worker and middle manager tasks. Traditional commercial banks are on the same factory format.

Now, she is focusing on why commercial banks differ from investment banks. I would use this same paragraph to also highlight the difference between an OTC derivatives operation at JPMorgan Chase and the advisory work at a firm like Greenhill or Lazard, the former bread and butter of I-banks. The sales and trading operations benefit from scale in a way advisory work does not. And what that means, given Yves’ quote is that you have a lot of junior people making big decisions.

What’s more is the fact that banks are not acting as passive conduits who ‘make markets,’ their traditional function. They are now taking risks with their own capital. One reason Goldman bounced back from the crisis so well is that it has a large proprietary trading operation that was able to make a lot of money, not through facilitating transactions, but through making trades for Goldman’s own account. In essence, Goldman Sachs is today as much a hedge fund as it is a bank.

The problem with this model, moving from advisory work to trading and from facilitator to principal, is that it is riskier. The reason this past crisis was so devastating has much to do with the move to the bank-trading-as-principal-actor business model. And since scale is a large part of why this works, these firms are not just risky, they are also enormous – which makes them a systemic risk.

Going forward, I hope we see regulators address this problem. Banks of today look nothing like banks of just twenty-five years ago. And investment banking today looks nothing like it did a generation ago either. In both cases, the operations are larger and riskier, a situation which must be addressed if we are to avoid another crisis of this magnitude.

Sources

Big banks look to rainmakers again – John Gapper, FT

Nationwide brings back 125% LTV mortgages

2009-07-09T07:43:00.001-04:00

Submitted by Edward Harrison of Credit Writedowns.

The Nationwide, the world’s largest building society, is now bringing back the dreaded 125% mortgage. While the lender claims these mortgages are a “niche product” designed for customers of Nationwide in negative equity, the Financial Services Authority (FSA) is looking to ban this type of lending.

From the BBC:

It will only be available to existing customers in negative equity who want to move house.

Negative equity means that the value of someone's home is less than the amount they owe on their mortgage.

Nationwide said the deal was a very "niche offer" and that not everyone in negative equity would qualify.

The Financial Services Authority is considering limiting mortgage loans to 100% of a property's value.

'No more risk'

The Nationwide only offers new customers mortgages worth 85% of the value of the home they want to buy.

Under its new arrangement, borrowers would take out a loan for 95% of the value of their new house at a fixed rate of 6.73% for three years or 7.48% for five years.

They would then be able to add on the negative equity from their old home, up to another 30% of the value of the new property, at a higher fixed rate of 7.23% for three years or 7.98% for five years.

Now, this is a different product than the one being sponsored by the U.S. government ( see posts on that here and here). In the U.S., the 125% mortgage only applies to the refinancing of mortgages of existing properties. Here, the Nationwide is offering to fund 95% of the new house purchase, plus up to 30% negative equity from a previous residence.

While I am sceptical about the rationale for this product, it is quite innovative. First, the negative equity portion carries a higher rate than the 95% mortgage. Moreover, loan exposure for Nationwide probably won’t increase because these deals are for existing customers. And, Nationwide seems to have found a way to get more house transactions in a climate where prices have been declining.

To my mind, the 125% product offered by this building society shows how innovative the financial services industry can be in any investing or economic climate. However, products like these operate on the fringe of what should be considered prudent. I see it as further evidence that the financial services industry needs strong oversight to prevent lenders from taking on too much risk and creating the kind of financial crises we have experienced.

Related articles
Nationwide offers 125pc mortgage to home owners trapped in negative equity – The Telegraph
Nationwide brings back 125% mortgage – The Guardian

Guest Post: Big Blue's Pension Blues Spreading?

2009-07-09T05:21:00.007-04:00

Submitted by Leo Kolivakis, publisher of Pension Pulse.

The Independent reports that IBM is ready to close its UK final salary pension scheme:

IBM has become the latest company planning to turn its back on final salary pension payouts. The computer systems group is consultung staff about proposals to close its UK scheme, which would affect 5,000 employees.
Brendon Riley, the general manager of IBM in the UK and Ireland, said in a memo to staff that the "rising costs and liabilities" had forced it to consider moving existing members of the IBM scheme – about a quarter of the workforce – to a defined contribution scheme.
Staff will be consulted for 60 days from 5 August and a decision will be made following the feedback. Mr Riley said he understood the situation would be "sensitive and difficult for many". He added: "The rapidly rising costs and liabilities associated with the provision of defined benefit pensions is placing pressure on our long-term ability to invest for future growth and operate in an intensely competitive global market."
IBM confirmed the move, saying it was "taking action to maintain competitiveness in the marketplace and introduce greater predictability to long-term pension provision costs". IBM's final salary pension scheme was closed to new members several years ago.
Tesco, Shell, Diageo and Cadbury are the only FTSE 100 companies that still have final salary pension schemes open to new employees. Five years ago, about 40 per cent of businesses offered such an incentive, but company pension schemes have fallen out of favour as interest rates and the equity markets have slumped and life expectancy has risen.
This summer, three blue-chip companies have closed their final salary schemes, which base their payouts on a worker's earnings at retirement and their
length of service. The Morrisons supermarket chain closed its scheme for existing members last month, and Barclays Bank also said it was closing its scheme. Earlier that week, BP announced that it was closing its scheme to new recruits from April.

IBM is the latest large firm contemplating to cut its penion scheme. I suspect many more will follow in the era of pensions apartheid. The pension crisis is exposing one of the biggest flaws of the private sector, namely, how to secure a stable retirement income for all those hard-working folks who are now discovering their pensions are in jeopardy.

On that note, I am heading out to the big blue seas of Crete to swim and read my Henry Miller books.

Links 7/9/09

2009-07-09T03:29:00.001-04:00

As you can see, the want of my own posts tonight is not due to a failure to look for material!

Dolphin 'superpod' spotted off Wales BBC

Monkeys show language recognition Science News Examiner

Prince Charles: next generation faces 'living hell' unless climate change tackled Telegraph

White House Ponders Bernanke's Future Wall Street Journal. Looking at the alternatives, we are probably better off with the devil we know. Summers? Dear God. Roger Ferguson? I know him from McKinsey, and let's put it this way: everyone to a person was stunned when he got his earlier Fed appointment. But then he went to head a fancy financial products group at Swiss Re, which was doing stuff he and they did not understand, and in short order lost about a billion dollars. That qualifies him to be a systemic risk regulator? Christiina Romer is also on the list (oh dear) plus Janet Yellen and Alan Blinder.

Pakistani president Asif Zardari admits creating terrorist groups Telegraph (hat tip reader Paul S)

Swiss Government/UBS-Versus-The USA and Me Bruce Krasting and Bern to block UBS record transfer to US Financial Times

Home Prices Post First Quarterly Gain Since 2006 Housing Wire

CHART OF THE DAY: We've Wiped Out All The New Jobs Of The 21st Century Clusterstock. Eeek.

McKinsey Quarterly on State Capitalism (hat tip Zero Hedge)

S&P Increases 2005-07 Subprime and Alt-A Loss Assumptions Research Recap

RMB 1.5 trillion in new Chinese lending — can we turn this thing off? Michael Pettis

The Money Multiplier Mark Dow

Yen: Safe Haven, But for How Much Longer? Ben Bitroff

What, Me Worry?: Few Expected Green Shoots in the Bond Market Brad DeLong.

Global Financial Stress Menzie Chinn, Ecnobrowser

Shipping flashes early warning signals again Ambrose Evans-Pritchard, Telegraph

Apartment Vacancy Rate Hits 22-Year High Wall Street Journal (hat tip reader Don B)

IMF Sees Stronger Global Rebound From ’09 Recession Bloomberg

Who gets the credit? And does it matter? Household vs. firm lending across countries Thorsten Beck. Berrak Buyukkarabacak. Felix Rioja, and Neven Valev, VoxEU

U.S. Treasury Opens Distressed-Debt Program Without Pimco Bloomberg (hat tip DoctoRx)

Antidote du jour. Fans around the world watched the Michael Jackson tribute:

Subprime Foreclosure Woes: More on Securitization Creating Bad Incentives

2009-07-09T00:40:00.000-04:00

One of our pet peeves is that the powers that be are desperate to recreate status quo ante, as far as the financial crisis is concerned, when that is what created the mess in the first place. And the tinkering being done around the margins is not sufficient to remedy many of the shortcomings.

Take mortgage securitizations. It is now blindingly obvious that they led to lower quality borrower due diligence. Why bother if you are reselling the loan? And in keeping, while just about every other innovation has a historical precedent (the first derivatives and mutual fund was in Ur, 1788 BC, for instance), loans apparently were never traded prior to our brave new world of banking. That suggests it might not be such a hot idea. Aside from the initial screening, another activity that was once intrinsic to banking was monitoring the borrower. That too goes out the window with securitization.

We've seen some attention to the first set of problems, the incentives for the originator to simply cut costs, which means as little screening as he can conceivably get away with and still unload the paper. The idea of having the party that sourced retain 5% simply is not enough to make a difference in behavior; making it easier for investors to sue in case of deficient originator due diligence would probably do more promote the desired response. But regardless, the priority is to restart the securitization machine, not fix the problems with the process.

One of the obvious, oft-discussed ones is the near impossibility of mortgage mods. In down real estate markets far less bad tahn this one, lenders would try to keep viable borrowers in the house. Since they at least knew the community, and had decent loan files from the initial screening, they could decide what to do on an individual basis. Aside from not being in a position to make informed decisions about particular borrowers, servicers are not set up to do anything on an individual basis. They are factories, with standard procdures for most activities. And of course, most servicing agreements limit or bar mods.

Now we have a new side effect of securitization: trusts dumping foreclosed houses. This looks to be a tragedy of the commons. While it seems rational for owners of foreclosed houses to liquidate inventory and move on (in theory, price discovery and market clearing are a good thing), the servicers are selling in bulk. If you have a lot of sellers dumping inventory at the same time, that is likely to produce an overshoot of housing price declines below historical levels in terms of relationship to rental prices and incomes.

The Wall Street Journal profiles the development in Atlanta, and Georgia has one of the fastest foreclosure timetables in the country, so this trend will be coming to your market soon.

From the Wall Street Journal:

The U.S. housing market is facing new downward pressure as holders of subprime-mortgage bonds flood the market with foreclosed homes at prices that are much lower than where many banks are willing to sell.

While nationwide figures are scarce, a review of thousands of foreclosures in the Atlanta area shows that trusts managing pools of securitized mortgages sold six times as many properties as banks during the six months ended March 31. And homes dumped by subprime bondholders sold for thousands of dollars less on average than bank-owned properties, the data show.

Yves here. That does not prove conclusively that the servicers are truly getting worse prices. The banks presumably were able to offload the best homes, and what is left will probably sell at deeper discounts. Back to the story:

Experts say this is a bad omen for residential real-estate prices and homeowners trying to sell or refinance, because the fire sales, many to cover soured subprime loans, put downward pressure on the value of nearby homes. All of this undermines federal efforts to stabilize the housing market and revive the broader economy....

In the Atlanta area, hit hard by foreclosures and declining home values in the past two years, mortgage-backed securitization entities completed 6,260 foreclosures in last year's fourth quarter and the first quarter of 200...

Of those foreclosures, securitization entities sold 2,963 homes during the same period for an average of 62% of the original loan amount. Banks unloaded just 442 of the homes they foreclosed upon, with an average selling price of 69% of the original loan amount.

There still is much more inventory that mortgage-servicing firms are racing to sell for securitization trusts. Such entities tend to sell in bulk so that they can cut losses, finding it more cost-efficient to move homes through foreclosure and subsequent sale than to try to restructure the mortgage with the borrower...

According to Karen Weaver, global head of securitization research at Deutsche Bank AG, the steepest losses are on subprime loans, where lenders generally are recovering just 26% of the original loan amount....

Yves here. Read that last sentence again. Stunning. But that also says you could do ridiculously deep principal reductions and still come out ahead.

In March, the mortgage-processing firm that works on behalf of a Goldman Sachs Group Inc. mortgage trust sold a house in southwest Atlanta for $17,000 -- a markdown of 87% from the original loan value. A Goldman spokeswoman declined to comment.

In the fourth and first quarters, Bear-issued trusts sold 29 properties in Fulton County, which includes Atlanta, for a total of $3.5 million. That was 60% of the combined original loan amounts of $5.8 million.

The loans were pooled in the vehicle during a period of Bear securitizations that were sold to investors prior to the firm's sale to J.P. Morgan Chase & Co. a little more than a year ago.

A J.P. Morgan spokesman said the depressed prices are representative of a housing market correcting itself in a period that is vastly different from a few years ago. Many of the regions facing the largest declines in value are the same ones that soared and saw a frenzy of construction during the housing boom.

In comparison, Countrywide Financial Corp., now owned by Bank of America Corp., completed the sale of 23 properties in Fulton for $3.7 million, or 86% of the original loan amount during the same time period, the real-estate records analyzed by Data Intelligence show.

A Bank of America spokesman said prices being fetched in the Atlanta area for the Countrywide portfolio reflect a reluctance to dump properties far below prevailing market values. The bank is getting an average of 99% of the appraised value of homes on an average sale, while selling within one year 99% of the properties that end up on its books.

Financial Alchemy at Morgan Stanley: Greywolf A3 CDOs now Aaa bonds

2009-07-08T15:01:00.001-04:00

Submitted by Edward Harrison of Credit Writedowns.

The Online Merriam-Webster Dictionary describes alchemy as “a power or process of transforming something common into something special” or “aiming to achieve the transmutation of the base metals into gold.” Well, it seems Morgan Stanley is engaging in some financial alchemy because it is about to trade near-junk rated paper for Aaa gold-standard bonds (hat tip Max Keiser and Stacy Herbert).

Morgan Stanley plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings in the first transaction of its kind, said two people familiar with the sale.

Morgan Stanley is selling $87.1 million of securities that it expects to receive top AAA ratings and $42.9 million of notes graded Baa2, the second-lowest investment grade by Moody’s Investors Service, according to marketing documents obtained by Bloomberg News. The bonds were created from Greywolf CLO I Ltd., a CDO arranged in January 2007 by Goldman Sachs Group Inc. and managed by Greywolf Capital Management LP, an investment firm based in Purchase, New York.

Here’s the problem. In June, Moody’s downgraded the Aaa tranche of this CDO six notches to A3 because the default rate for loans in the tranche soared to 7 percent. So, now, Morgan Stanley has been able to re-package this paper, and…voila this debt is Aaa again. Everybody’s doing this repackaging. Goldman plans to sell over $200 million of repackaged Commercial mortgage-backed paper very soon.

So, when earnings start coming in this quarter and you are wondering how these banks aren’t writing down huge losses due to events like this and this, you now have one more reason why. Here are two more reasons here and here. The question is whether investors will be fooled.

ps. – I am sure Morgan Stanley added credit enhancement, collateral, reduced the poorly performing assets, etc, etc. But, nevertheless, you have to wonder how this stuff gets a Aaa rating when substantially the same loan pool was just downgraded six notches.

Source

Morgan Stanley Plans to Turn Downgraded Loan CDO Into AAA Bonds - Bloomberg

Links 7/8/09

2009-07-08T05:43:00.000-04:00

'Time to ditch climate policies' BBC

Is this really a great global recession? Rebel Economist. Looks at an unusual metric.

Amplifying the Drumbeat on the “Overdraft Protection” Racket Columbia Journalism Review

Meriwether Said to Shut JWM Hedge Fund After Losses Bloomberg. Whacked in a crisis yet again. Wonder if he was short vol this time around.

Japan Machine Orders Unexpectedly Fall, Exports Slump Bloomberg (hat tip DoctoRx)

In Summer Hideaway for the Rich, Slump Is Visiting, Too New York Times

How Long Before the Fed's Days Are Numbered? Michael Panzner

Pope condemns capitalism’s ‘failures’ Financial Times

Antidote du jour:

Why Big Capital Markets Players Are Unmanageable

2009-07-08T05:04:00.000-04:00

John Kay comes perilously close to nailing a key issue in his current Financial Times comment, "Our banks are beyond the control of mere mortal" in that he very clearly articulates the problem very well but then draws the wrong conclusion:

At Oxford university, I often hear people say there is nothing wrong with the system: the problem is the vice-chancellor/master/bursar/ university officials. And, in a sense, they are right. If the vice-chancellor had the wisdom of Socrates, the political skills of Machiavelli and the leadership qualities of Winston Churchill, not to mention the patience of Job, he or she would be very likely to be able to fulfil the conflicting demands of the post. But such paragons are few and far between. In the meantime we must try to find structures that can be operated by ordinary mortals.

In the same way, the claim that the fault with the banking system lies not with the structure of banks but with the boards and executives that claimed to run them is both correct and absurd...if the failures are both as widespread and as persistent as it appears, the problem is in the job specification rather than with the incumbent. If you employ an alchemist who fails to turn base metal into gold, the alchemist is certainly a fool and a fraud but the greater fool is the patron.

The bank executives pilloried by the UK’s Treasury select committee of MPs were all exceptional people. The vilified Sir Fred Goodwin was an effective manager who had slashed through the National Westminster bureaucracy and revived a failing institution – a task that had defeated many able men before him. His chairman, Sir Tom McKillop, offered experience and ability that met every possible specification for such a role in a big international corporation. As chairman of HBOS, Lord Stevenson was Britain’s supreme networker. This skill is a particularly valuable attribute in an environment where the essence of banking is to extract very large sums of taxpayers’ money while giving as little as possible in return. His chief executive, Andy Hornby, was criticised for being a retailer. But Halifax, half of HBOS, needed retail expertise. The only thing it needed to know about complex securitised products was that there was no good reason to buy them.

Like Sir Fred, Sir Tom, Lord Stevenson and Mr Hornby, most of the people who sat on the boards of failed banks were individuals whose services other companies would have been delighted to attract...

The hapless four were criticised for their lack of banking expertise but it is, in fact, not clear what modern banking expertise is. The world of modern banking requires all the skills of these gentlemen, plus some others, and no one can expect to have all these attributes.

It has been said of Jamie Dimon (who does not have a banking qualification) that his dominance exists because at every meeting all the participants know that he could do each of their jobs better than they could. But the business world cannot operate at all if it can operate only with individuals of the calibre of Mr Dimon. Better, as so often, to follow an aphorism of Warren Buffett’s: invest only in businesses that an idiot can run, because sooner or later an idiot will.

Our banks were not run by idiots. They were run by able men who were out of their depth. If their aspirations were beyond their capacity it is because they were probably beyond anyone’s capacity. We could continue the search for Superman or Superwoman. But we would be wiser to look for a simpler world, more resilient to human error and the inevitable misjudgments. Great and enduringly successful organisations are not stages on which geniuses can strut. They are structures that make the most of the ordinary talents of ordinary people.

The problem is Kay is applying traditional managements structures to investment banking, Even though these entities may have substantial retail arms and bank charters, the area that poses the management challenge is the capital markets businesses. And he makes a dangerous, erroneous assumptions: that mere mortals, meaning generalists, can run these businesses. That is bogus.

What makes capital markets businesses different from any other form of enterprise I can think of is the amount of discretion given of necessity to non-managerial employees, meaning traders, salesmen, investment bankers, analysts. In pretty much any other large scale business, decisions that have a meaningful bottom line impact (pricing, new sales campaign, investment decision) are deliberate affairs, ultimately decided at a reasonably senior level. The discretion that customer-facing staff have in pretty much any business in limited. At what level does someone have the authority to negotiate a contract? And even then, how many degrees of freedom do they have?

By contrast, think how many decisions traders and salesmen in capital market firms make in a day, and their potential bottom line impact (though experiment: how much damage could a truly vindictive trader do in a day or a week, if he decided to blow up his employer?) Investment bankers work over longer time frames, and like many normal businesses, have a lot of things routinized so as to make them more efficient, but it also limits their latitude (standard forms for many types of client agreements, standard pitch book formats, etc). However, unlike "normal" businesses, a frequent activity in investment banking is creating new products, often in a very ad-hoc way, with teams with relevant skills thrown together to try to push something through. The politics are often sharp-elbowed, but people are too pragmatic to let turf issues interfere with getting a new deal launched).

The approach for managing these businesses in the days of partnerships, when the owners were personally liable for losses, was to have small units with partners running them who knew the business and could oversee it properly. Effectively you had four layers: associate/analyst (the college kids, the analysts, did pretty much the same stuff the associates did, who usually had MBAs, except the MBAs got to go to client meetings more often), VPs, and partners, but some of the more senior partners were department heads in units that also had partners (who'd manage either people on their desks, if traders of salesmen, or if in investment banking, had accounts and various VPs and associate types working on each client). But those department heads had also grown up in the business, and were still active in it. Heads of significant departments in turn would be on an executive committee, a part-time role.

The problem with this model is it starts to come under strain when the partner group gets too large. And OTC markets have strong network effects, so having bigger market share confers a competitive advantage. And now there are high minimum scale requirements for being in the business. You need to be in all major times zones with a pretty broad product array. all kinds of back office support, all kinds of IT for risk management, communications, position management...

So the scale of operation required to be competitive is too large for it to be managed by player-coaches who had deep expertise, and like the Dimon example, were more expert than the people working for them. But the normal corporate/commercial banking management structure, with more managerial layers, and the top brass having broader spans of control, was devised in earlier stages of industrial organization, when you had factories or service business with a great deal of routinization of worker and middle manager tasks. Traditional commercial banks are on the same factory format. They handle large volumes of very simple, standard transactions with a high degree of control and oversight. That's a big reason why it took commercial banks over 15 years to make meaningful headway against investment banks. Although regulations were an issue, the bigger barrier was the radical difference between the two management cultures. There was no regulatory barrier to commercial banks offering mergers & acquisitions, for instance, but they were lousy at that for a very long time.

So Kay is effectively asking for a traditional commercial banking model, businesses "that make the most of the ordinary talents of ordinary people". There are businesses like that in banking, but they are mainly in retail banking and corporate lending. If you want that world, you need a far more radical change in the industry than anyone is contemplating now. You'd need to go to the world that Taleb advocates, From a list of his ten suggestions:

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning . Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

If we can't shut down credit default swaps, which the more I dig, the more I see they had a very direct role in the meltdown CDS on subrprime mortgages started in 2004, and there is a longer form gloss as to how that played a major role, if not the key role, in the superheated demand for "product" particularly subprime, in the manic phase of the credit bubble), we will never get to a world like the one Kay wants to see, or at least not until we hopelessly break the one we have now.

Guest Post: Pensions Thriller?

2009-07-08T04:39:00.009-04:00

Submited by Leo Kolivakis, publisher of Pension Pulse.

Off vacationing in Crete so I will keep it short and sweet. Noticed stocks got hammered again on Tuesday. I would be buying those dips, especially on solars (LDK and YGE).

A few pension articles for you. The Toronto Star reports that pension panic subsiding. The Financial Post reports that improved Canadian equity markets sends solvency ratio up.

The CBC reports that Canada Pension Plan loses assets but not hope. We are in the early stages of the pension crisis so I wouldn't lose hope yet but it will get much uglier if the status quo is the only solution policymakers can come up with.

Finally, broadcasts of Michael Jackson hits and skyrocketing sales of the late pop icon's discs after his death have given a boost to Dutch pension fund ABP, which in 2008 bought the rights to several of his songs. Good move for ABP but the pensions thriller will continue long after the King of Pop's death.

Trade Update: Container Shipping "A Black Hole of Losses"

2009-07-08T02:42:00.001-04:00

Even though the Baltic Dry Index, which measures freight rates rates for bulk transport, is well off its lows, other indicators of shipping activity are less encouraging. Containers shipment, which handles higher value added goods, is still falling and is expected to remain low in 2010.

From the Los Angeles Times (hat tip DoctoRx):

Trade at international ports is on track to drop more than 10% this year, one of the steepest declines ever...

Cargo ships will carry 27 million fewer containers by year's end than they did in 2008 -- a reduction roughly equivalent to all of the cargo containers handled by the five busiest U.S. seaports in a typical year, according to London-based Drewry Shipping Consultants' Container Forecaster Report.

"There has never been a decline like this before. We have never seen numbers like these," said Neil Dekker, editor of the Drewry report. "The container industry is looking at a $20-billion black hole of losses. We can expect a lot of casualties."...

"The forecasts for 2010 call only for a very moderate recovery in trade volume. This is a long-term problem. It will take several years for us to get back to the trade levels we saw in 2006 and 2007," Kyser said.

At the Port of Long Beach, the nation's second-busiest container port behind Los Angeles', trade volumes have been knocked back all the way to 2003 levels, according to spokesman Art Wong, wiping out all of the trade gains recorded during the boom years of 2004 through 2007. Similar results can be found at many of the major U.S. ports...

The continuing global recession has run so deep that it has caused Moody's Investors Service to downgrade its outlook to negative overall for the 53 U.S. ports whose credit ratings it tracks.

But there is a bright spot for Los Angeles and Long Beach..."Los Angeles-Long Beach are the two most highly rated ports in the U.S. Two of the primary drivers are their strong financial situations and their competitive market positions," said Baye Larsen, an analyst and assistant vice president at Moody's. "Both are a key advantage for those ports. They will be among the first to benefit when the recovery does come."..

There are few indications that the turnaround will begin any time soon. The trade route that had been the most resilient in the face of the global recession -- between Asia and Europe -- has now succumbed to the downturn as well. So far this year, the last three years of growth in trade between Asia and Europe have been erased, Dekker said....

Freight rates for transpacific trade, the amount that shipping lines can charge for a typical 40-foot container for cargo moving between Asia and the West Coast of the U.S., have plummeted to $920 from $1,400 at the beginning of the year, according to the Drewry report.

The continued slump has dashed the hopes of many in the industry, who had come to believe that the recession had bottomed out and that a recovery was beginning.

"At this moment we can't see anything particularly positive around the corner," Dekker said. "We don't want to be overly negative. That is just the reality."

Google to Launch PC Operating System

2009-07-08T02:20:00.000-04:00

Wow, I never thought I'd see the day when a company made a frontal assault on Microsoft's core business. Google goes where the DOJ failed to penetrate (more accurately, Judge Thomas Penfield Jackson managed to steal defeat from the jaws of victory by making some remarks between the decision and the sentencing phase of the Microsoft antitrust case that got him removed from the case, and installed a particularly clueless judge, Colleen Kollar-Kotelly. as a replacement, who meted out vastly weaker sanctions that Jackson would have administered).

While competition is presumably a good thing, I'm not sure having one monopolist replace another is a great improvement. Google is already playing the FUD card (fear, uncertainty, and doubt) by putting this info out well in advance of launch (a product for low-end portable PCs, due out second half 2010. I wonder if this is part of a strategy to bridge computers and communications devices. Apple has a full OS of sorts in its iPhone, but this announcement says the ultimate aim is the PC market). Admittedly, part of FD was also announcing vaporware, while Google has much higher odds of delivering a real product on its timetable.

Having been a Google customer via Blogger, their customer service is non-existent. As a matter of policy, you cannot get a live person, hence you cannot get a problem resolved. When this blog was shut down (it was incorrectly tagged as a spam blog) I was lucky enough to know the brother of a C-level executive. Any other level of contact, and I would not have gotten any resolution. Trust me, I am better at getting past gatekeepers than most people, and the Google switchboard might as well be Fort Knox.

Google simply does not get the first rule of customer service: the perception of customer service is based not on the error rate, but the quality of problem resolution. People want a company that will admit to its errors, fix them quickly, and be pleasant about it. That does not seem to be how Google defines its product (not that Microsoft understand that either, mind you).

I'd be curious as to what the tech experts think (as a Mac person I can watch the blood sport with indifference), but Google presumably recognizes that Microsoft has a hugely bloated OS that it no longer even fully comprehends. That means the OS is inherently insecure. Linux has made inroads, but more in the corporate/institutional market, where it is easier to organize user support (although the irony is that one of the things that helps keep Microsoft going is that it is a tech support full employment act. Linux and Macs require vastly less support than Windows).

From the Wall Street Journal:

Google Inc. is preparing to launch an operating system for personal computers, a direct assault on the turf of software giant Microsoft Corp..... It said the software, which will initially target low-end portable PCs called netbooks, would be based on its Chrome Web browser and available to consumers in the second-half of 2010.

The post--by Google's Sundar Pichai, vice president of product management, and Linus Upson, its engineering director -- said the operating system would be "lightweight" and optimized for running Web-based applications. Google's goal, they said, is to address shortcomings of PCs -- including security problems and lengthy delays while computers boot up, the Google executives wrote.

"We hear a lot from our users and their message is clear — computers need to get better," they wrote.

Eventually, Google hopes to scale the software to full-scale PC's as well, they wrote.

The effort marks the latest attack by Google on Microsoft, which dominates the market for operating system software that powers computer applications. The Mountain View, Calif., company, which makes 97% of its revenue from online advertising, has been trying to compete with Microsoft and other software makers by offering more software that runs in a Web browser and isn't downloaded directly to computers. Now it appears to be broadening its approach, in a move that could give it greater distribution of its own online software services, including word-processing and email software.

But whether it can chip away at Microsoft's dominance in the market remains unclear. In the months since its launch, Chrome has done little to challenge Microsoft's lead in the browser software. And some hardware companies have been slow to adopt Google software -- like its Android operating system, which is targeted at running applications on mobile phones -- arguing it isn't robust enough to handle many tasks.

The Google blog post stresses that the Chrome operating system is a separate effort from Android -- though, like Android, it will be "open source," meaning other developers can have access to and modify the code.

The software is designed to work on PCs running x86 chips -- the design used by Intel Corp. and Advanced Micro Devices Inc. used in most conventional PCs -- as well as chips based on designs from ARM Holdings PLC that are the standard in cellphones and are expected to be used in netbooks later this year, the executives said.

Though the software will be based on the core of Linux, its "kernel" in programming parlance, the Chrome OS, as it is called, will add a new layer of windowing software to manage what a user sees on a display screen. Instead of requiring programmers to write programs specifically for the operating system -- an uphill battle, at a time developers have many choices about where to focus their efforts -- the Google engineers said that the Chrome operating system will simply run programs written for the Web.

"And of course, these apps will run not only on Google Chrome OS, but on any standards-based browser on Windows, Mac and Linux thereby giving developers the largest user base of any platform," the Google executives wrote.

Google's incursion into operating systems could galvanize its critics, including privacy groups and competitors, who argued that the online search company already collects vast amounts of information about consumers' Internet use.

Reality Intrusion

2009-07-07T14:19:00.002-04:00

Rob Parenteau, CFA, serves as an economic and investment strategy consultant at MacroStrategy Edge, and edits the monthly Richebacher Letter. He also serves as a research associate at the Levy Economics Institute.

The Austrian School works with a world where money and finance can have repercussions on the real economy, primarily through the effects of financial signals and credit flows on the allocation of productive resources. So too did J.M. Keynes and Hy Minsky, and so too did Dr. Kurt Richebacher. It is a world most of us would recognize as part of our actual experience in the economy.

Contemporary macroeconomics has little room for money and finance to matter. General equilibrium theory, the intellectual pinnacle of the profession, has no room for money. Real business cycle theory has no room for finance – negative shocks to productivity, virtually from out of the blue, are the stated source of recessions. The Taylor rule, which ostensibly guides central bank policy rate setting, has an interest rate but no room for either money or finance, unless it is packed away in the error terms of the canonical equations. Recently, the Henry Kaufman Professor of Financial Institutions at Columbia University and his co-authors concluded the US housing bubble had little effect on consumer spending patterns. Huh?

Investors clobbered repeatedly by financial crises have good reason to search beyond conventional economic analysis. Much of the mainstream approach to economics has made itself irrelevant or at least foreign to our actual experience. Indeed, there is an argument to be made that the representation of human behavior in mainstream economics has approached qualities that would more likely be associated with people struggling with various degrees of autism (you will find this notion, which actually deserves to be taken more seriously, developed in greater detail at www.paecon.net: a quick glance at the quotes from contemporary economists in the left column will convince you that some members of the profession know there is a problem).

Apparently, repeated episodes of financial instability may also be getting through to not just investors, but policy makers as well. Much to our surprise, the latest World Economic Outlook published by the IMF reveals a macro framework that we believe those pursuing the unconventional insights of the Austrian School, Keynes, Fisher, Minsky, Dr. Richebacher and many others would largely recognize. In discussing the distinct characteristics of business cycles that involve a major financial crisis, the IMF staff discovered the following:

“…expansions associated with financial crises may be driven by overly optimistic expectations for growth in income and wealth. The result is overvalued goods,
services, and, in particular, asset prices. For a period, this overheating appears to confirm the optimistic expectations, but when expectations are eventually disappointed, restoring household balance sheets and adjusting prices downward toward something approaching fair value require sharp adjustments in private behavior. Not surprisingly, a key reason recessions associated with financial crises are so much worse is the decline in private consumption.”

While not as precise as the models developed by heterodox economists over the decades here the IMF recognizes the end of an expansion has something to do with falsified income expectations and mispriced financial assets. When financial signals promote misallocation of productive resources, profit income expectations are likely to be falsified as malinvestment or overinvestment is revealed. With earnings expectations falsified, equity and corporate bond prices are likely to fall toward “fair” or intrinsic value. As product and financial markets react to profit disappointments, households face layoffs leading to further income disappointments, as well as falling wealth, and consumer spending growth contracts. All of this should sound very familiar.

What about the recovery profile from recessions accompanied by major financial crises? Here, summarizing the results of the “Big Five” financial crisis episodes identified by economists Reinhart and Rogoff - which include Finland (1990–93), Japan (1993), Norway (1988), Spain (1978–79), and Sweden (1990–93) – the IMF has found some notable differences from the typical recovery trajectory.

“What do these observations tell us about the dynamics of recovery after a financial crisis? First, households and firms either perceive a stronger need to restore their balance sheets after a period of overleveraging or are constrained to do so by sharp reductions in credit supply. Private consumption growth is likely to be weak until households are comfortable that they are more financially secure. It would be a mistake to think of recovery from such episodes as a process in which an economy simply reverts to its previous state.

Second, expenditures with long planning horizons—notably real estate and capital investment—suffer particularly from the after-effects of financial crises. This appears to be strongly associated with weak credit growth. The nature of these financial crises and the lack of credit growth during recovery indicate that this is a supply issue. Further…industries that conventionally rely heavily on external credit recover much more slowly after these recessions.

Third, given the below-average trajectory of private demand, an important issue is how much public and external demand can contribute to growth. In many of the recoveries following financial crises examined in this section, an important condition was robust world growth. This raises the question of what happens when world growth is weak or nonexistent.”

Again, these are themes which should sound familiar to you. Professional equity investors were, up until the past month, very eager to count the green shoots sprouting from the monthly flow of economic statistics. Policy makers are eager to get banks to revive loan activity. Both of these constituencies appear to be ignoring that the way out of a recession that was triggered in no small part by an overleveraged US consumer may not be the same as the way in. The IMF staff, in contrast, may be starting to get the joke.

More importantly, the IMF staff seems to understand the unique nature of the challenge this time around. In the five prior recessions they studied with significant financial crises, the way out was not through releveraging of the private sector, but rather through improved trade balances, as global growth successfully floated all boats. If private sector spending is dampened by balance sheet repair and lender caution, then economic recovery prospects become more dependent on fiscal stimulus or foreign demand. This time around, the latter exit, the one the IMF identifies as most frequently employed in such situations, is somewhat blocked as the countries running the largest current account deficits wrestle with the most severe recession in many decades.

Calls for a second round of fiscal stimulus have begun to crop up around the US in recent weeks as fears the green shoots will fade to brown have been fed by a weaker than expected employment result, more signs of debt distress, and the continued ravages of home price deflation. That such calls are arising just weeks after investors were debating the prospects for hyperinflation dynamics taking hold, and bidding up commodity prices while selling Treasury bonds, tells you something about the deep uncertainty that still prevails. We are indeed in uncharted waters. What remains missing is any serious investigation of a new global growth model. The old one, based on consumer debt binges fueled by serial asset bubbles on the one hand, and headlong expansion of productive capacity in low labor cost countries that prefer to accumulate foreign currency reserves in part to manage currency pegs, is impaired enough that even the IMF realizes the scope of the challenges ahead.

On the US side, we know issues of private sector deleveraging, energy independence, water infrastructure, education and health care need to be addressed. Entrepreneurs, investors, policy makers, and economists best train their efforts in these directions to craft a plausible way forward from what is clearly not a garden variety recession with a conventional monetary or fiscal policy fix. If public/private collaboration is required to execute solutions in these areas because investors and creditors remain too short term oriented or too risk averse, then so be it. Reality has intruded on a global growth model that has proven itself unsustainable. Time to drop the delusions and move forward.

Does the US need a second stimulus package?

2009-07-07T10:41:00.001-04:00

Submitted by Edward Harrison of Credit Writedowns.

Laura Tyson, an advisor to President Barack Obama, said in a speech to day in the lead up to the –8 conference that the ground work for a potential second stimulus bill must be laid now. To be sure, the G-8 leaders are expected to recommend continued policy accommodation worldwide. However, Vice President Joe Biden recently suggested that the Obama Administration has no plans for a second stimulus bill on the political TV show Meet the Press (transcript here). So, which is it – stimulus or no stimulus?

The U.S. should consider drafting a second stimulus package focusing on infrastructure projects because the $787 billion approved in February was “a bit too small,” said Laura Tyson, an adviser to President Barack Obama.

The current plan “will have a positive effect, but the real economy is a sicker patient,” Tyson said in a speech in Singapore today. The package will have a more pronounced impact in the third and fourth quarters, she added, stressing that she was speaking for herself and not the administration.

Tyson’s comments contrast with remarks made two days ago by Vice President Joe Biden and fellow Obama adviser Austan Goolsbee, who said it was premature to discuss crafting another stimulus because the current measures have yet to fully take effect. The government is facing criticism that the first package was rolled out too slowly and failed to stop unemployment from soaring to the highest in almost 26 years.

Obama said last month that a second package isn’t needed yet, though he expects the jobless rate will exceed 10 percent this year. When Obama signed the first stimulus bill in February, his chief economic advisers forecast it would help hold the rate below 8 percent.

Unemployment increased to 9.5 percent in June, the highest since August 1983. The world’s largest economy has lost about 6.5 million jobs since December 2007.

Clearly, the economic situation is much worse than Obama’s team predicted back in January. It is leading to rising unemployment and grim statistics on things like consumer default rates. So, if the $787 billion stimulus package was based on a rosy economic scenario that never happened, it goes to reason that this stimulus bill was too small, as Laura Tyson argues.

Yet, some economists like Mark Zandi of Economy.com agree with Biden that we should take a wait and see approach (video below).

Of course, the wait and see modus could be a disaster as stimulus should take six to nine months to kick in. If the economy falters in Q4, say, a stimulus might be forthcoming in Q1 2010 with effects coming on line late in 2010 – not a very good scenario for politicians in Congress looking to get re-elected.

So, which is it: stimulus or no stimulus?

Below are two takes on this question.

The Failure of the Mainstream Model – Stephanie Kelton
Will Obama go for a second stimulus? No … - James Pethokoukis

And, for the record, I don’t think Obama could get a second stimulus bill through Congress if he tried.

Source

Obama Adviser Says U.S. Should Mull Second Stimulus - Bloomberg

Links 7/7/09

2009-07-07T02:51:00.000-04:00

Climate change is shrinking sheep BBC

The laser that can halt blindness and offer hope for millions Mail Online

NiMH Batteries, Chevron Patents and the Future of Plug-in Hybrid Cars SEA (hat tip John D)

How useless is a Chocolate Teapot? Kitchen Science Experiments (hat tip reader Munch Paulson). A follow up to a weekend post.

Jobless Koreans Turn to Manual Labor New York Times

The World Finance Crisis & the American Mission Robert Skidelsky, New York Review of Books. I am very late to this, but it is still worth reading.

"Half of the World's Emissions Came from Just 700 Million People" Mark Thoma

Earnings and PE ratios in the Great Depression Certain Ruin

Debt Burden Quickens Power Shift as G-8 Nations Lose Influence Bloomberg (hat tip DoctoRx). This is a good piece, but misses one key point: there will be defaults, as there were in the 1930s. We may do it via inflation, but there will be debt repudiation.

Debt tripping up Canadians The Star (hat tip DoctoRx)

Under restraint Gillian Tett and Aline Van Duyn, Financial Times. On the less than rosy prospects for the revival of securitization.

Insight: Reservations about the dollar David Woo, Financial Times. Good discussion of the not-so-hot future of the dollar as reserve currency. The punch line:

In the near term, the global economy remains too fragile to absorb the shock of a large and disorderly decline of the dollar. In that respect, the chances for co-ordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years.

Banks Planning "Harry and Louise" Ads Noam Schreiber. Ooh, this makes me ill, but consider: the reason those Harry and Louise ads worked was because people like their doctors, and that extended to their perception of the health care system (even if they know the system is broken, they are afraid of changes to their relationship, even if that isn't in the cards for them. Plus people were not as dissatisfied with health care then as they are now). By contrast, does anyone like or trust their bank?

Antidote du jour: