By Matthew Garrahan in Los Angeles
Published: March 28 2008 20:38 | Last updated: March 28 2008 20:38
It has been almost 160 years since the first California gold rush but, with prices hitting record highs, prospectors are once again flocking to the state’s rivers and deserts in search of the precious metal.
Gold’s ascent – prices crossed the $1,000 an ounce barrier this month and remain well above $900 – has sent sales of mining equipment soaring.
“There’s been a dramatic change . . . our sales have risen four-fold in the last three months,” said Harrigan McGregor, owner of GoldFeverProspecting.com, an equipment retailer in northern California.
“This is the second big California gold rush. We’ve had a lot of phone calls from people who are quitting their jobs and prospecting full-time.”
The growth of prospecting by individuals has been accompanied by a sharp increase in commercial mining activity. Commercial claims, most of which involve gold mining, rocketed to 2,274 in the first quarter of this year, up from 132 in the same period of 2005, the Bureau of Land Management says.
Roger Haskins, senior specialist for mining law at the BLM, said the high price of gold was “obviously driving [mining] activity up tremendously”.
“We have a market imbalance at the moment and there’s more demand than supply,” he added. “Gold sits in a little niche because it’s speculative . . . People buy it as a hedge for the future.”
Membership in the Gold Prospectors Association of America “has tripled in a very short space of time”, said Corey Rudolph, an official of the southern California-based group, which organises events for recreational miners.
The hotspot is a 320km strip known as the Gold Belt, or “Motherlode”, which runs near Highway 49 (named for prospecting “49ers” of the 19th century) and the Sierra Nevada mountains. Mr Rudolph said 5-10 per cent of available gold had been mined. “There’s still a lot of gold out there for the smart guys.”
The market in second-hand gold is also booming, with southern California pawnshops reporting increased trade as people sell unwanted gold items. Depending on the quality, these items can be refined and resold.
However, Mr McGregor said raw gold can fetch even higher prices. “If you find a nugget larger than your pinkie finger, it could sell for up to 30 per cent more than the spot price.”
Saturday, March 29, 2008
Friday, March 28, 2008
Fed offers $100 billion more to banks: Why not, it's only money!
By MARTIN CRUTSINGER, AP Economics Writer
32 minutes ago
WASHINGTON - The Federal Reserve announced Friday it will auction another $100 billion in April to cash-strapped banks as it continues to combat the effects of a credit crisis.
The central bank said it would make $50 billion available at each of two auctions, on April 7 and April 21.
Through the end of March, the Fed has provided $260 billion in short-term loans to commercial banks through the innovative auction process. It also has employed Depression-era provisions to provide money to investment banks.
All the moves have been designed to cope with a serious financial crisis that has roiled U.S. and global markets and caused the near-collapse of Bear Stearns Cos., the nation's fifth largest investment bank.
The Fed has been holding auctions every two seeks since December to provide short-term loans to commercial banks. It started with auctions of $20 billion, then pushed the level to $30 billion, and in early March raised the auction amount to $50 billion as the credit shortage grew more severe.
In announcing the move to $50 billion last month, the Fed said it would continue the auctions for at least the next six months, unless credit conditions show they are no longer needed.
The auctions are just one of a series of unorthodox steps the Fed has taken to battle the current crisis. The biggest of those moves was an announcement that it was allowing investment banks to borrow directly from the Fed. Previously, only commercial banks, which face tighter regulations, had that privilege.
The Fed also said it would make available $30 billion in financing to support the sale of troubled Bear Stearns to JP Morgan Chase & Co., hoping to prevent a bankruptcy that could have rocked Wall Street.
The Fed's auctions have drawn criticism from some that the central bank, and ultimately U.S. taxpayers, could be financing a bailout for big Wall Street firms that had engaged in risky lending practices.
Fed Chairman Ben Bernanke will fact questions about the Fed's recent moves when he testifies on Wednesday before the congressional Joint Economic Committee.
32 minutes ago
WASHINGTON - The Federal Reserve announced Friday it will auction another $100 billion in April to cash-strapped banks as it continues to combat the effects of a credit crisis.
The central bank said it would make $50 billion available at each of two auctions, on April 7 and April 21.
Through the end of March, the Fed has provided $260 billion in short-term loans to commercial banks through the innovative auction process. It also has employed Depression-era provisions to provide money to investment banks.
All the moves have been designed to cope with a serious financial crisis that has roiled U.S. and global markets and caused the near-collapse of Bear Stearns Cos., the nation's fifth largest investment bank.
The Fed has been holding auctions every two seeks since December to provide short-term loans to commercial banks. It started with auctions of $20 billion, then pushed the level to $30 billion, and in early March raised the auction amount to $50 billion as the credit shortage grew more severe.
In announcing the move to $50 billion last month, the Fed said it would continue the auctions for at least the next six months, unless credit conditions show they are no longer needed.
The auctions are just one of a series of unorthodox steps the Fed has taken to battle the current crisis. The biggest of those moves was an announcement that it was allowing investment banks to borrow directly from the Fed. Previously, only commercial banks, which face tighter regulations, had that privilege.
The Fed also said it would make available $30 billion in financing to support the sale of troubled Bear Stearns to JP Morgan Chase & Co., hoping to prevent a bankruptcy that could have rocked Wall Street.
The Fed's auctions have drawn criticism from some that the central bank, and ultimately U.S. taxpayers, could be financing a bailout for big Wall Street firms that had engaged in risky lending practices.
Fed Chairman Ben Bernanke will fact questions about the Fed's recent moves when he testifies on Wednesday before the congressional Joint Economic Committee.
Thursday, March 27, 2008
South Korean Pension Fund to Shun US Treasurys! Well if you can't fool your friends, where do you go?
By Reuters | 27 Mar 2008 | 07:05 PM ET Font size:
South Korea's National Pension Service, the world's fifth-biggest pension fund, said on Thursday it was shying away from U.S. Treasurys because of falling yields and the weakening dollar.
The move by the NPS could signal a big shift by financial institutions away from U.S. government debt into higher-yielding assets, the Financial Times said.
The fund, which expects its assets to rise to 250 trillion won by the end of 2008, holds about 17.4 trillion won (US$17.63 billion) worth of foreign bonds of which U.S. Treasurys account for 94 percent. Those figures would suggest NPS holds about 16.4 trillion won in U.S. Treasurys.
"We sees the attractiveness of U.S. Treasurys falling," NPS spokeswoman, Chi Younghye, said. "The overall size of foreign bonds this year will be similar to last year's. There will be little net increase in our holding of foreign bonds for a while." She said if yields are more attractive later, the NPS would start buying again.
NPS holdings in U.S. Treasurys are a fraction of the $4,500 billion Treasury market, the FT noted.
"It is difficult to buy more U.S. Treasurys because the portion of our Treasury investment is already too big and Treasury yields have fallen a lot," the newspaper quoted Kwag Dae-hwan, the head of global investments at the pension fund, as saying.
Yields on 2-year treasury notes have dropped sharply since the middle of last year as investors have bought the government debt as a safe-haven from the global credit crisis.
The 2-year note yielded more than 5 percent in June, but currently it returns around 1.68 percent. The 10-year Treasury yield has dropped to just under 3.5 percent from about 5.3 percent over the same period.
South Korea's National Pension Service, the world's fifth-biggest pension fund, said on Thursday it was shying away from U.S. Treasurys because of falling yields and the weakening dollar.
The move by the NPS could signal a big shift by financial institutions away from U.S. government debt into higher-yielding assets, the Financial Times said.
The fund, which expects its assets to rise to 250 trillion won by the end of 2008, holds about 17.4 trillion won (US$17.63 billion) worth of foreign bonds of which U.S. Treasurys account for 94 percent. Those figures would suggest NPS holds about 16.4 trillion won in U.S. Treasurys.
"We sees the attractiveness of U.S. Treasurys falling," NPS spokeswoman, Chi Younghye, said. "The overall size of foreign bonds this year will be similar to last year's. There will be little net increase in our holding of foreign bonds for a while." She said if yields are more attractive later, the NPS would start buying again.
NPS holdings in U.S. Treasurys are a fraction of the $4,500 billion Treasury market, the FT noted.
"It is difficult to buy more U.S. Treasurys because the portion of our Treasury investment is already too big and Treasury yields have fallen a lot," the newspaper quoted Kwag Dae-hwan, the head of global investments at the pension fund, as saying.
Yields on 2-year treasury notes have dropped sharply since the middle of last year as investors have bought the government debt as a safe-haven from the global credit crisis.
The 2-year note yielded more than 5 percent in June, but currently it returns around 1.68 percent. The 10-year Treasury yield has dropped to just under 3.5 percent from about 5.3 percent over the same period.
Mark-to-market (FT)
Published: March 27 2008 19:46 | Last updated: March 27 2008 19:46
It is an alluring idea: solve the credit crunch at a stroke of the accountant’s pen. But suspending mark-to-market accounting would only hide banks’ losses – which would only add to suspicion about their solvency. The problem is not mark-to-market as such, it is the use of mark-to-market accounting to underpin pro-cyclical bank capital requirements, and it is the capital regime that should be reviewed.
Under traditional historic cost accounting, bonds that a bank bought for $1m would sit on the balance sheet at $1m until the bank sold them, at which point any profit or loss would be recognised. Under mark-to-market accounting – which became widespread in the 1990s – the value of the bonds is constantly adjusted to reflect the price at which they could currently be bought or sold.
Provided there is a market price to mark to, this kind of accounting is far more useful to investors: it tells them what a bank’s assets are worth today, not what they were worth 10 years ago or what they might be worth in normal economic times. It forces banks to confront problems rather than deny them – and given that uncertainty about which banks have suffered losses is an important reason why they will not lend to each other, covering up losses will not solve the credit crunch, but rather make it worse.
The problem, however, is that mark-to-market accounting is not simply a tool to inform investors. It underlies the balance sheet, and so generates the fundamental number with which a bank is regulated: its capital ratio.
The standard Basel requirement is that a bank’s target ratio of capital to risk-weighted assets should be 8 per cent. Under historic cost accounting, falling market prices had no immediate effect on capital adequacy, but under mark-to-market they create losses, which force banks either to raise more funds or to cut back on lending. There should be a thorough review of the Basel II capital regime, which has other features that make banks cut lending as market prices fall.
Mark-to-market is not perfect. The dozens of assumptions used to value assets with no market price – so-called marking to model – must be thoroughly audited if historic cost accounting is not to be preferable. There may also be the perverse result of banks choosing to hold more illiquid assets in future if they conclude that holding liquid bonds risks mark-to-market losses.
Hiding losses would destroy confidence, not create it, so suspending mark-to-market is not the answer to the credit squeeze. But the capital rules that make mark-to-market a problem cannot be changed overnight and, in the meantime, falling bank capital could create a downward spiral of less lending and further falls in asset prices. The banks either need to raise more capital or they must temporarily be allowed to operate with less.
Copyright The Financial Times Limited 2008
It is an alluring idea: solve the credit crunch at a stroke of the accountant’s pen. But suspending mark-to-market accounting would only hide banks’ losses – which would only add to suspicion about their solvency. The problem is not mark-to-market as such, it is the use of mark-to-market accounting to underpin pro-cyclical bank capital requirements, and it is the capital regime that should be reviewed.
Under traditional historic cost accounting, bonds that a bank bought for $1m would sit on the balance sheet at $1m until the bank sold them, at which point any profit or loss would be recognised. Under mark-to-market accounting – which became widespread in the 1990s – the value of the bonds is constantly adjusted to reflect the price at which they could currently be bought or sold.
Provided there is a market price to mark to, this kind of accounting is far more useful to investors: it tells them what a bank’s assets are worth today, not what they were worth 10 years ago or what they might be worth in normal economic times. It forces banks to confront problems rather than deny them – and given that uncertainty about which banks have suffered losses is an important reason why they will not lend to each other, covering up losses will not solve the credit crunch, but rather make it worse.
The problem, however, is that mark-to-market accounting is not simply a tool to inform investors. It underlies the balance sheet, and so generates the fundamental number with which a bank is regulated: its capital ratio.
The standard Basel requirement is that a bank’s target ratio of capital to risk-weighted assets should be 8 per cent. Under historic cost accounting, falling market prices had no immediate effect on capital adequacy, but under mark-to-market they create losses, which force banks either to raise more funds or to cut back on lending. There should be a thorough review of the Basel II capital regime, which has other features that make banks cut lending as market prices fall.
Mark-to-market is not perfect. The dozens of assumptions used to value assets with no market price – so-called marking to model – must be thoroughly audited if historic cost accounting is not to be preferable. There may also be the perverse result of banks choosing to hold more illiquid assets in future if they conclude that holding liquid bonds risks mark-to-market losses.
Hiding losses would destroy confidence, not create it, so suspending mark-to-market is not the answer to the credit squeeze. But the capital rules that make mark-to-market a problem cannot be changed overnight and, in the meantime, falling bank capital could create a downward spiral of less lending and further falls in asset prices. The banks either need to raise more capital or they must temporarily be allowed to operate with less.
Copyright The Financial Times Limited 2008
Is This the Big One?
Is This the Big One?
This article is adapted from Jeff Faux's new book, Why We're Liberals: A Political Handbook for Post-Bush America (Viking).
For more than a decade, we Americans have been living on an economic San Andreas fault--a foundation of fracturing competitiveness covered by unsustainable consumer spending with money borrowed from foreigners. A financial earthquake was inevitable. We don't know how high on the recession Richter scale the current crisis will take us, but it increasingly looks like, as they say in San Francisco, "The Big One."
Since the last Big One, the Great Depression of the 1930s, we have had eleven small to medium recessions, lasting an average of ten months. The most severe--two back-to-back downturns that began in 1979--drove price increases and the unemployment rate to double digits.
We're not at those levels yet. But the structural supports underneath our shop-till-we-drop economy are considerably weaker. For starters, we have a historic depression in the housing market. Americans' total mortgage debt now exceeds their home equity, for the first time since 1945. Housing prices have dropped 10 percent since last spring, followed by record foreclosures. Most economists expect them to drop at least another 10 percent, which could leave more than 14 million households--at least 16 percent of the total--better off if they just walked away from their homes. Prices could go even lower.
Until last year, housing prices in most places had risen rapidly since the 1990s. This enabled middle-class homeowners with stagnant wages and maxed-out credit cards to keep spending by refinancing their mortgages. The housing boom also spawned the now infamous subprime mortgage--a scheme devised by Main Street realtors and Wall Street bankers to finance home buying with loans that let the borrower buy in with little money down but carried high interest rates. The expensive payments would be made later by refinancing the mortgage as prices continued to rise. These subprimes were sold to middle-class strivers upgrading to McMansions as well as to the working poor.
The increased demand pushed housing prices further into the stratosphere--until, inevitably, they fell back to earth. When the subprime borrowers could no longer make their payments, foreclosure signs went up, lowering the value of other houses in the neighborhood. The refinancing spigot shut off, retail sales sputtered and by January the economy was shedding jobs.
But it is not the squeeze on homeowners that is giving our central bankers nightmares. It is the blowback of housing deflation on the country's massively overleveraged financial markets, which has seriously constricted the flow of credit--the lifeblood of the world's largest debtor economy.
In a typical deal, subprime mortgages were sold to investment companies, where they were commingled with prime mortgages to back up new securities that could be touted as both safe and high-yielding. This new debt paper was then peddled to investors, who used it as collateral for "margin" loans to buy yet more stocks and bonds. At each change of hands, fees and underwriting charges added to the total claims on the original shaky mortgages. The result was a frenzied bidding up of prices for a bewildering maze of arcane securities that neither buyers nor sellers could accurately value.
Giant Ponzi scheme? Not to worry, responded the Wall Street geniuses. By spreading risks among more people, the miracle of "diversity" was actually turning bad loans into good ones. Anyway, banks were buying insurance policies against default, which in turn were transformed into a set of even murkier securities called "credit default swaps" and marketed to hedge funds, pension managers and in some cases back to the banks that were being insured in the first place. At the end of 2007 the market for these swaps was estimated at $45.5 trillion--roughly twice as large as all US stock markets combined.
This huge pyramid of debt was made possible by thirty years of relentless deregulation of financial markets, culminating in the 1999 repeal of the Glass-Steagall Act, which had prohibited banks from dealing in high-risk securities. In effect, Washington regulators became passive enablers to Wall Street's financial binge drinkers. When they crashed--for example, in the savings-and-loan and junk-bond debacles of the 1980s, the Long-Term Capital Management collapse of 1998 and the Enron and dot-com crashes of the early 2000s--the government cleaned up the mess with taxpayers' money and let them go back to the bar.
So here we go again. When subprime homeowners stopped paying, the prices of the mortgage-backed securities used as collateral fell. Banks demanded that their borrowers pay up or cover their margins. Panicked selling by borrowers further lowered the securities' prices, triggering more margin calls and more defaults. Massive losses piled up at places like Citigroup, Countrywide, Merrill Lynch and Morgan Stanley, and cascaded back into the insurance companies. At the end of February, the huge insurer American International Group reported the largest quarterly loss, $5 billion, since the company started in 1919.
After some delay, the Federal Reserve Board last summer started lowering interest rates on loans to the banks. But in a phrase from the bank crisis of the 1930s, it was like "pushing on a string." The bankers' problem was not that money was too expensive to lend out; it was that they were afraid they wouldn't get their money back. When they did lend, they jacked up the rates to compensate for the higher perceived risks--even to solid customers. The Port Authority of New York and New Jersey suddenly had to borrow money at 20 percent. The State of Pennsylvania couldn't finance its college student loan program. Fannie Mae, the fund created by the federal government to support perfectly sound middle-class housing, struggled to sell its bonds.
In mid-March, after anguished discussions between Federal Reserve officials and Wall Street moguls, the Fed agreed to provide $400 billion in new cash loans to banks and investment firms. Days later came the shock of eighty-five-year-old Bear Stearns going belly up. In an unprecedented deal, the Fed immediately lent JPMorgan Chase the money to buy Bear Stearns, taking suspect mortgage-backed paper as collateral. Bear's stockholders had already taken a hosing when the stock crashed. The big winners were the company's creditors and insurers, who were saved from the consequences of their bad business judgment.
We are now staring into the abyss. The Bear Stearns bailout has created a presumption of a safety net under any major stockbroker, in addition to any major bank. Rumors are that Lehman Brothers and Citigroup may be next. The Fed could handle a Lehman crash. But the collapse of Citigroup, the world's largest bank, would be catastrophic, bankrupting businesses, other banks and consumers and cutting off credit for state and local governments. And it could stretch the Fed to the limit of its resources.
There is a widespread assumption that there is no bottom to the pockets of the Federal Reserve. Not quite. The Fed has a finite amount of actual assets--mostly Treasury obligations backed by the "full faith and credit" of the government, which is a commitment to raise taxes if necessary to pay the debt. These assets total about $800 billion, some $400 billion of which have been obligated to back up loans. If the loans default, the Fed has to sell the Treasury notes in order to settle. If there are enough of these failures, the Fed could exhaust its assets. It would then have to resort to really "printing money"--issuing promissory notes not backed up by anything--or get bailed out by the Treasury, putting taxpayers further in the hole. Long before the Fed is down to the last of its stash of Treasury notes, more skittish domestic and foreign investors will flee the dollar. Interest rates would balloon and prices of oil and other imports would skyrocket. Credit would freeze, investment would plummet and tens of millions of Americans would be out on the street, with neither a job nor a roof over their heads.
Unlikely? Yes, still. Unthinkable? Not anymore. Estimates of Wall Street's losses already run well up to $500 billion. A 20 percent drop in housing prices would translate into a $4 trillion drop in the value of housing assets. A large chunk of that loss would destroy the value that underlies the mortgage-backed securities the Fed has now agreed to guarantee.
But well short of such a worst-case scenario, the country seems headed for major economic damage that will severely test whatever we have left of safety nets. It took five years from the time the recovery began in 1983 for the unemployment rate to return to pre-recession levels. Once we reach the bottom of this trough, it could be a very long time before American consumers, whose spending accounts for some 70 percent of our economy, crawl out of the debt hole and back into the shopping mall. The Japanese have still not recovered from their similar housing/debt crash in the early 1990s.
Virtually everyone who has studied Japan in the 1990s and the United States in the 1930s concludes that in both cases the government acted too late with too little in order to stop the debt dominoes from tumbling through the entire economy.
But the American political system seems as seized up as the credit markets. As the Federal Reserve tries desperately to put an overdosed Wall Street on life support, President Bush remains dizzily detached, periodically repeating his moronic mantra against government intervention in the free market. At a press conference that is impossible to parody, Treasury Secretary Henry Paulson announced the Administration "plan" to safeguard the nation against a future crisis. It boiled down to a hope that the finance industry would do a better job of policing itself and that individual states would see to any new laws that might be needed. In what the New York Times dryly reported were his "most extensive comments to date about the credit and market problems," Paulson, formerly co-chair of the investment firm Goldman Sachs, firmly told reporters that he was not interested in finding "scapegoats." No kidding.
In response to pressure from Democrats, the White House at the end of January did reluctantly agree to a fiscal stimulus. But Bush demanded that it be limited to the only economic policy he understands: tax cuts. Democrats caved, and the government started printing up $160 billion in a one-time rebate to consumers and businesses, which will be sent out in May. Too little, too late, and likely to be spent paying down debt and buying more Chinese imports.
Senate majority leader Harry Reid has proposed a second round of stimulus--this time through public investment, putting people to work rebuilding bridges, schools and other infrastructure. But no one is talking about a level of fiscal injection needed to counterbalance the drop in consumer and business spending.
If we use the 1979-83 experience as a guide, we'd need some $600 billion to $700 billion in deficit spending. But in those days, the United States was still a creditor nation. Thanks to three decades of trade deficits, topped by the costs of the Iraq War, we now depend on foreign lenders, increasingly worried about the value of their US bonds. As Lee Price, chief economist of the House Appropriations Committee, put it, "We need as big a stimulus as our foreign lenders will allow us to get away with."
To give some relief to those at the bottom of this tottering financial edifice, Barney Frank and Chris Dodd, chairs of, respectively, the House Financial Services and Senate Banking committees, are proposing updated versions of a Depression-era housing rescue program. The government would furnish $300-$400 billion to buy up existing home mortgages at prices marked down to reflect the current lower values. The plan could refinance 1-2 million homes. It may not be enough, but it probably represents the outer limit of what is possible in the twilight year of a White House whose economic competence is in the twilight zone.
Given the way Washington works, the Frank/Dodd proposal would need business support. Yet despite the fact that it would bring desperately needed trust back to the system, the capos of the Wall Street mob are unenthusiastic. Being forced to acknowledge losses on their books could toss a few more of them out of their jobs at a time when the supply of golden parachutes may be getting thin. Better to hunker down and whimper for more welfare from the Fed.
Some are already getting direct bailouts from big government. But it's not coming from the US government. Foreign-government-owned "sovereign wealth funds" are now buying sizable equity shares to shore up battered firms. Citigroup, where the Saudis are already the chief stockholder, sold roughly $20 billion of itself to Abu Dhabi, Singapore and Kuwait. The Chinese just bought 10 percent of Morgan Stanley, and Merrill Lynch sold a 9 percent stake to Singapore. With oil above $100 a barrel, more of Wall Street is certain to wind up owned in the Middle East. Some members of Congress still warn that these countries are looking for political influence in America's financial heart, rather than optimizing their rate of return. They are probably right, but the nationalist fires that flared up against Dubai ownership of US ports in 2006 have largely been banked. Beggars can't be choosers.
Another hope is that the Europeans, the Chinese, whoever, will take over our role as the world's consumer of last resort. As the recession slows US imports, countries that have grown fat on exports to us will certainly have to shift more of their growth to their own domestic market. But to expect that the leaders of other nations would put their own economies at risk by running up trade deficits in order to save us Americans from the consequences of our own folly seems stunningly naïve.
So if this is not The Big One, it is likely to be A Big One--and a long one.
We could still get lucky, of course. Republicans facing re-election might persuade Bush to support a big fiscal stimulus and housing rescue. Home prices may miraculously stabilize. Tomorrow, bankers may wake up like Scrooge on Christmas morning and just start lending. The Chinese may start importing American-made cars...
Otto von Bismarck once remarked, "There is a Providence that protects idiots, drunkards, children and the United States of America." Let's hope it's still true.
This article is adapted from Jeff Faux's new book, Why We're Liberals: A Political Handbook for Post-Bush America (Viking).
For more than a decade, we Americans have been living on an economic San Andreas fault--a foundation of fracturing competitiveness covered by unsustainable consumer spending with money borrowed from foreigners. A financial earthquake was inevitable. We don't know how high on the recession Richter scale the current crisis will take us, but it increasingly looks like, as they say in San Francisco, "The Big One."
Since the last Big One, the Great Depression of the 1930s, we have had eleven small to medium recessions, lasting an average of ten months. The most severe--two back-to-back downturns that began in 1979--drove price increases and the unemployment rate to double digits.
We're not at those levels yet. But the structural supports underneath our shop-till-we-drop economy are considerably weaker. For starters, we have a historic depression in the housing market. Americans' total mortgage debt now exceeds their home equity, for the first time since 1945. Housing prices have dropped 10 percent since last spring, followed by record foreclosures. Most economists expect them to drop at least another 10 percent, which could leave more than 14 million households--at least 16 percent of the total--better off if they just walked away from their homes. Prices could go even lower.
Until last year, housing prices in most places had risen rapidly since the 1990s. This enabled middle-class homeowners with stagnant wages and maxed-out credit cards to keep spending by refinancing their mortgages. The housing boom also spawned the now infamous subprime mortgage--a scheme devised by Main Street realtors and Wall Street bankers to finance home buying with loans that let the borrower buy in with little money down but carried high interest rates. The expensive payments would be made later by refinancing the mortgage as prices continued to rise. These subprimes were sold to middle-class strivers upgrading to McMansions as well as to the working poor.
The increased demand pushed housing prices further into the stratosphere--until, inevitably, they fell back to earth. When the subprime borrowers could no longer make their payments, foreclosure signs went up, lowering the value of other houses in the neighborhood. The refinancing spigot shut off, retail sales sputtered and by January the economy was shedding jobs.
But it is not the squeeze on homeowners that is giving our central bankers nightmares. It is the blowback of housing deflation on the country's massively overleveraged financial markets, which has seriously constricted the flow of credit--the lifeblood of the world's largest debtor economy.
In a typical deal, subprime mortgages were sold to investment companies, where they were commingled with prime mortgages to back up new securities that could be touted as both safe and high-yielding. This new debt paper was then peddled to investors, who used it as collateral for "margin" loans to buy yet more stocks and bonds. At each change of hands, fees and underwriting charges added to the total claims on the original shaky mortgages. The result was a frenzied bidding up of prices for a bewildering maze of arcane securities that neither buyers nor sellers could accurately value.
Giant Ponzi scheme? Not to worry, responded the Wall Street geniuses. By spreading risks among more people, the miracle of "diversity" was actually turning bad loans into good ones. Anyway, banks were buying insurance policies against default, which in turn were transformed into a set of even murkier securities called "credit default swaps" and marketed to hedge funds, pension managers and in some cases back to the banks that were being insured in the first place. At the end of 2007 the market for these swaps was estimated at $45.5 trillion--roughly twice as large as all US stock markets combined.
This huge pyramid of debt was made possible by thirty years of relentless deregulation of financial markets, culminating in the 1999 repeal of the Glass-Steagall Act, which had prohibited banks from dealing in high-risk securities. In effect, Washington regulators became passive enablers to Wall Street's financial binge drinkers. When they crashed--for example, in the savings-and-loan and junk-bond debacles of the 1980s, the Long-Term Capital Management collapse of 1998 and the Enron and dot-com crashes of the early 2000s--the government cleaned up the mess with taxpayers' money and let them go back to the bar.
So here we go again. When subprime homeowners stopped paying, the prices of the mortgage-backed securities used as collateral fell. Banks demanded that their borrowers pay up or cover their margins. Panicked selling by borrowers further lowered the securities' prices, triggering more margin calls and more defaults. Massive losses piled up at places like Citigroup, Countrywide, Merrill Lynch and Morgan Stanley, and cascaded back into the insurance companies. At the end of February, the huge insurer American International Group reported the largest quarterly loss, $5 billion, since the company started in 1919.
After some delay, the Federal Reserve Board last summer started lowering interest rates on loans to the banks. But in a phrase from the bank crisis of the 1930s, it was like "pushing on a string." The bankers' problem was not that money was too expensive to lend out; it was that they were afraid they wouldn't get their money back. When they did lend, they jacked up the rates to compensate for the higher perceived risks--even to solid customers. The Port Authority of New York and New Jersey suddenly had to borrow money at 20 percent. The State of Pennsylvania couldn't finance its college student loan program. Fannie Mae, the fund created by the federal government to support perfectly sound middle-class housing, struggled to sell its bonds.
In mid-March, after anguished discussions between Federal Reserve officials and Wall Street moguls, the Fed agreed to provide $400 billion in new cash loans to banks and investment firms. Days later came the shock of eighty-five-year-old Bear Stearns going belly up. In an unprecedented deal, the Fed immediately lent JPMorgan Chase the money to buy Bear Stearns, taking suspect mortgage-backed paper as collateral. Bear's stockholders had already taken a hosing when the stock crashed. The big winners were the company's creditors and insurers, who were saved from the consequences of their bad business judgment.
We are now staring into the abyss. The Bear Stearns bailout has created a presumption of a safety net under any major stockbroker, in addition to any major bank. Rumors are that Lehman Brothers and Citigroup may be next. The Fed could handle a Lehman crash. But the collapse of Citigroup, the world's largest bank, would be catastrophic, bankrupting businesses, other banks and consumers and cutting off credit for state and local governments. And it could stretch the Fed to the limit of its resources.
There is a widespread assumption that there is no bottom to the pockets of the Federal Reserve. Not quite. The Fed has a finite amount of actual assets--mostly Treasury obligations backed by the "full faith and credit" of the government, which is a commitment to raise taxes if necessary to pay the debt. These assets total about $800 billion, some $400 billion of which have been obligated to back up loans. If the loans default, the Fed has to sell the Treasury notes in order to settle. If there are enough of these failures, the Fed could exhaust its assets. It would then have to resort to really "printing money"--issuing promissory notes not backed up by anything--or get bailed out by the Treasury, putting taxpayers further in the hole. Long before the Fed is down to the last of its stash of Treasury notes, more skittish domestic and foreign investors will flee the dollar. Interest rates would balloon and prices of oil and other imports would skyrocket. Credit would freeze, investment would plummet and tens of millions of Americans would be out on the street, with neither a job nor a roof over their heads.
Unlikely? Yes, still. Unthinkable? Not anymore. Estimates of Wall Street's losses already run well up to $500 billion. A 20 percent drop in housing prices would translate into a $4 trillion drop in the value of housing assets. A large chunk of that loss would destroy the value that underlies the mortgage-backed securities the Fed has now agreed to guarantee.
But well short of such a worst-case scenario, the country seems headed for major economic damage that will severely test whatever we have left of safety nets. It took five years from the time the recovery began in 1983 for the unemployment rate to return to pre-recession levels. Once we reach the bottom of this trough, it could be a very long time before American consumers, whose spending accounts for some 70 percent of our economy, crawl out of the debt hole and back into the shopping mall. The Japanese have still not recovered from their similar housing/debt crash in the early 1990s.
Virtually everyone who has studied Japan in the 1990s and the United States in the 1930s concludes that in both cases the government acted too late with too little in order to stop the debt dominoes from tumbling through the entire economy.
But the American political system seems as seized up as the credit markets. As the Federal Reserve tries desperately to put an overdosed Wall Street on life support, President Bush remains dizzily detached, periodically repeating his moronic mantra against government intervention in the free market. At a press conference that is impossible to parody, Treasury Secretary Henry Paulson announced the Administration "plan" to safeguard the nation against a future crisis. It boiled down to a hope that the finance industry would do a better job of policing itself and that individual states would see to any new laws that might be needed. In what the New York Times dryly reported were his "most extensive comments to date about the credit and market problems," Paulson, formerly co-chair of the investment firm Goldman Sachs, firmly told reporters that he was not interested in finding "scapegoats." No kidding.
In response to pressure from Democrats, the White House at the end of January did reluctantly agree to a fiscal stimulus. But Bush demanded that it be limited to the only economic policy he understands: tax cuts. Democrats caved, and the government started printing up $160 billion in a one-time rebate to consumers and businesses, which will be sent out in May. Too little, too late, and likely to be spent paying down debt and buying more Chinese imports.
Senate majority leader Harry Reid has proposed a second round of stimulus--this time through public investment, putting people to work rebuilding bridges, schools and other infrastructure. But no one is talking about a level of fiscal injection needed to counterbalance the drop in consumer and business spending.
If we use the 1979-83 experience as a guide, we'd need some $600 billion to $700 billion in deficit spending. But in those days, the United States was still a creditor nation. Thanks to three decades of trade deficits, topped by the costs of the Iraq War, we now depend on foreign lenders, increasingly worried about the value of their US bonds. As Lee Price, chief economist of the House Appropriations Committee, put it, "We need as big a stimulus as our foreign lenders will allow us to get away with."
To give some relief to those at the bottom of this tottering financial edifice, Barney Frank and Chris Dodd, chairs of, respectively, the House Financial Services and Senate Banking committees, are proposing updated versions of a Depression-era housing rescue program. The government would furnish $300-$400 billion to buy up existing home mortgages at prices marked down to reflect the current lower values. The plan could refinance 1-2 million homes. It may not be enough, but it probably represents the outer limit of what is possible in the twilight year of a White House whose economic competence is in the twilight zone.
Given the way Washington works, the Frank/Dodd proposal would need business support. Yet despite the fact that it would bring desperately needed trust back to the system, the capos of the Wall Street mob are unenthusiastic. Being forced to acknowledge losses on their books could toss a few more of them out of their jobs at a time when the supply of golden parachutes may be getting thin. Better to hunker down and whimper for more welfare from the Fed.
Some are already getting direct bailouts from big government. But it's not coming from the US government. Foreign-government-owned "sovereign wealth funds" are now buying sizable equity shares to shore up battered firms. Citigroup, where the Saudis are already the chief stockholder, sold roughly $20 billion of itself to Abu Dhabi, Singapore and Kuwait. The Chinese just bought 10 percent of Morgan Stanley, and Merrill Lynch sold a 9 percent stake to Singapore. With oil above $100 a barrel, more of Wall Street is certain to wind up owned in the Middle East. Some members of Congress still warn that these countries are looking for political influence in America's financial heart, rather than optimizing their rate of return. They are probably right, but the nationalist fires that flared up against Dubai ownership of US ports in 2006 have largely been banked. Beggars can't be choosers.
Another hope is that the Europeans, the Chinese, whoever, will take over our role as the world's consumer of last resort. As the recession slows US imports, countries that have grown fat on exports to us will certainly have to shift more of their growth to their own domestic market. But to expect that the leaders of other nations would put their own economies at risk by running up trade deficits in order to save us Americans from the consequences of our own folly seems stunningly naïve.
So if this is not The Big One, it is likely to be A Big One--and a long one.
We could still get lucky, of course. Republicans facing re-election might persuade Bush to support a big fiscal stimulus and housing rescue. Home prices may miraculously stabilize. Tomorrow, bankers may wake up like Scrooge on Christmas morning and just start lending. The Chinese may start importing American-made cars...
Otto von Bismarck once remarked, "There is a Providence that protects idiots, drunkards, children and the United States of America." Let's hope it's still true.
Accountants KPMG accused of professional negligence
KPGM helps with accounting fraud!
Andrew Clark in New York
guardian.co.uk, Thursday March 27 2008 Article history
The accounting firm KPMG has been accused of professional negligence and of acquiescing to a "difficult" client as auditor to New Century Financial, an American mortgage company that collapsed under the weight of sub-prime loans.
An independent report commissioned by the US justice department has suggested that creditors could seek compensation from the European-based accountancy group for allowing and even aiding New Century to understate its liabilities.
The report says a KPMG partner, John Donovan, brushed aside concerns about contentious accounting practices in an impatient email because he feared losing New Century as a client. "I am very disappointed we are still discussing this," wrote Donovan. "As far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off."
The sudden bankruptcy of New Century last April was among the early signs of the looming credit crunch brought on by defaults in the US home-loans market.
New Century was a big player in sub-prime loans, providing $60bn (£30bn) of mortgages a year. The securities and exchange commission is investigating its demise and it is the subject of class-action lawsuits by shareholders and ex-staff.
The bankruptcy examiner who compiled the report, Michael Missal, found that New Century had a "brazen obsession" with increasing the size of its loan portfolio, quadrupling its new mortgages over four years. There was little consideration over whether customers could afford repayments — instead, the firm's main criteria was whether it could sell on loans.
New Century ran into trouble when investors began to reject its loans on the secondary debt markets, sending them back as so-called "kickouts". It failed to make sufficient provision for these liabilities and, the report finds, KPMG did not exercise proper scrutiny.
"KPMG failed to question or test certain important assumptions in a rigorous manner," says the report. "The KPMG engagement team acquiesced in New Century's departures from prescribed accounting methodologies and often resisted or ignored valid recommendations."
It says KPMG's auditors were intimidated by New Century's financial controller, Dave Kenneally — a KPMG alumnus himself who the report describes as "difficult, condescending and quick tempered". But KPMG rejected the findings. It said: "We strongly disagree with the report's allegations concerning KPMG and we believe that an objective review of the facts and circumstances will affirm our position."
Andrew Clark in New York
guardian.co.uk, Thursday March 27 2008 Article history
The accounting firm KPMG has been accused of professional negligence and of acquiescing to a "difficult" client as auditor to New Century Financial, an American mortgage company that collapsed under the weight of sub-prime loans.
An independent report commissioned by the US justice department has suggested that creditors could seek compensation from the European-based accountancy group for allowing and even aiding New Century to understate its liabilities.
The report says a KPMG partner, John Donovan, brushed aside concerns about contentious accounting practices in an impatient email because he feared losing New Century as a client. "I am very disappointed we are still discussing this," wrote Donovan. "As far as I am concerned we are done. The client thinks we are done. All we are going to do is piss everybody off."
The sudden bankruptcy of New Century last April was among the early signs of the looming credit crunch brought on by defaults in the US home-loans market.
New Century was a big player in sub-prime loans, providing $60bn (£30bn) of mortgages a year. The securities and exchange commission is investigating its demise and it is the subject of class-action lawsuits by shareholders and ex-staff.
The bankruptcy examiner who compiled the report, Michael Missal, found that New Century had a "brazen obsession" with increasing the size of its loan portfolio, quadrupling its new mortgages over four years. There was little consideration over whether customers could afford repayments — instead, the firm's main criteria was whether it could sell on loans.
New Century ran into trouble when investors began to reject its loans on the secondary debt markets, sending them back as so-called "kickouts". It failed to make sufficient provision for these liabilities and, the report finds, KPMG did not exercise proper scrutiny.
"KPMG failed to question or test certain important assumptions in a rigorous manner," says the report. "The KPMG engagement team acquiesced in New Century's departures from prescribed accounting methodologies and often resisted or ignored valid recommendations."
It says KPMG's auditors were intimidated by New Century's financial controller, Dave Kenneally — a KPMG alumnus himself who the report describes as "difficult, condescending and quick tempered". But KPMG rejected the findings. It said: "We strongly disagree with the report's allegations concerning KPMG and we believe that an objective review of the facts and circumstances will affirm our position."
Fed Auctions Billions in Securities
WASHINGTON (AP) — Big investment houses took the Federal Reserve up on its first-time offer Thursday to let them borrow Treasury securities, the latest effort to ease a painful credit crisis.
The Federal Reserve auctioned $75 billion worth of Treasury securities. Bidders paid an interest rate of 0.330 percent. Demand was high. The Fed received bids of $86.1 billion worth of the securities.
It was the first time the Fed conducted an auction of this kind. The next one will be held April 3.
The program, dubbed the Term Securities Lending Facility, was announced earlier this month by the Fed and is intended as a booster shot for financial institutions and for the troubled mortgage market. The Fed said it would make as much as $200 billion worth of Treasuries available through weekly auctions that started Thursday.
Big Wall Street investment firms could borrow much-in-demand Treasury securities from the Fed and put up more risky investments, including certain shunned mortgage-backed securities as collateral for the 28-day loans.
The new program is designed to make investment houses more inclined to lend to each other. It also is aimed at providing relief to the distressed market for mortgage-linked securities. Questions about their value and dumping of these securities have driven up mortgage rates, aggravating the housing crisis. Since the Fed's announcement of this new program, rates on some mortgages have eased somewhat.
Federal Reserve Governor Randall Kroszner, in a speech Thursday, said curbing shady lending practices that contributed to the housing and credit debacles should help revive the badly shaken confidence of the public and investors.
"Effective consumer protection can help to restore confidence in the mortgage markets and help to preserve the flow of capital to consumers who wish to purchase a home," Kroszner said.
Under fire from Congress for being too lax in its oversight, the Fed has proposed a sweeping rule to protect homeowners from dubious lending practices. Subprime borrowers — those with tarnished credit histories or low incomes — have been hurt the most, although problems have spread to more credit-worthy borrowers.
The Fed has a proposal that would: restrict lenders from penalizing risky borrowers who pay loans off early; require lenders to make sure these borrowers set aside money to pay for taxes and insurance; and bar lenders from making loans without proof of a borrower's income.
It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the home's value. The proposal would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers.
The Federal Reserve auctioned $75 billion worth of Treasury securities. Bidders paid an interest rate of 0.330 percent. Demand was high. The Fed received bids of $86.1 billion worth of the securities.
It was the first time the Fed conducted an auction of this kind. The next one will be held April 3.
The program, dubbed the Term Securities Lending Facility, was announced earlier this month by the Fed and is intended as a booster shot for financial institutions and for the troubled mortgage market. The Fed said it would make as much as $200 billion worth of Treasuries available through weekly auctions that started Thursday.
Big Wall Street investment firms could borrow much-in-demand Treasury securities from the Fed and put up more risky investments, including certain shunned mortgage-backed securities as collateral for the 28-day loans.
The new program is designed to make investment houses more inclined to lend to each other. It also is aimed at providing relief to the distressed market for mortgage-linked securities. Questions about their value and dumping of these securities have driven up mortgage rates, aggravating the housing crisis. Since the Fed's announcement of this new program, rates on some mortgages have eased somewhat.
Federal Reserve Governor Randall Kroszner, in a speech Thursday, said curbing shady lending practices that contributed to the housing and credit debacles should help revive the badly shaken confidence of the public and investors.
"Effective consumer protection can help to restore confidence in the mortgage markets and help to preserve the flow of capital to consumers who wish to purchase a home," Kroszner said.
Under fire from Congress for being too lax in its oversight, the Fed has proposed a sweeping rule to protect homeowners from dubious lending practices. Subprime borrowers — those with tarnished credit histories or low incomes — have been hurt the most, although problems have spread to more credit-worthy borrowers.
The Fed has a proposal that would: restrict lenders from penalizing risky borrowers who pay loans off early; require lenders to make sure these borrowers set aside money to pay for taxes and insurance; and bar lenders from making loans without proof of a borrower's income.
It also would prohibit lenders from engaging in a pattern or practice of lending without considering a borrower's ability to repay a home loan from sources other than the home's value. The proposal would curtail misleading ads for many types of mortgages and bolster financial disclosures to borrowers.
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