Monday, March 30, 2009

We're in Danger of Being Blinded by Market Bottom Predictions

Yesterday morning I read a brilliant article analyzing the market bottom: “Markets Have Hit a Bottom, But Is It THE Bottom?” by Eric Coffin, a contributor to Seeking Alpha, where I saw the article posted. Coffin does a great job taking a look at various economic fundamentals from the price of copper to the actions of the Fed.

He comes to the conclusion that although there are some positive signs out there, too much volatility remains to make any firm predictions about whether the market has hit a true bottom or not. I agree with him, but I also have a major problem with the value of his predictions. In fact, virtually every day I read articles on Seeking Alpha that are similarly brilliant and argue either for or against the market bottom and direction. Each makes a similar mistake.

The Quality Of Any Market Analysis Is Directly Related To The Scope Of The Analysis Beyond Economic And Market Factors.

I have thought for some time that the current global crisis in its most basic terms is not attributable to economic and market factors but to cultural factors. Every segment of our society, from construction worker to web designer to lawyer, investors, bankers, home buyers - all of this society - lived with certain standards and motivations that took us straight to where we ended up.

In most basic terms, it was a consumer society where the most important activity was to buy: buy newer, bigger, better, more expensive, higher tech, but buy even if it is with money you do not have.

Yes, that had clear economic consequences, but it had other consequences in terms of lifestyle. That lifestyle may be replicated again at some point in the future, but it will probably take a generation or two.

If my premise is correct, that this crisis is basically due to cultural issues, then it would also be correct to assume that the crisis will result in cultural changes. Some of them are likely to have a dramatic impact on the economy and the stock market, both in terms of degree and quickness.

Among the most dramatic possibilities is the prospect of political upheaval. For example, I discussed the political issues that will swirl around the G20 in an article that was also published by Seeking Alpha, and also in a detailed look at protests of the middle/working class around the world.

Political volatility is not a part of Mr. Coffin’s analysis of the market bottom, but what would happen to the market if riots broke out within a few days of each other in various locations throughout the world? How will the world (consumers, investors, bankers …) react to those headlines? I am not predicting that those headlines will occur, but I find it hard to dismiss the prospect that they could occur. To ignore that when trying to determine a market bottom is to have a basic flaw in the analysis.

Similarly, an analysis that considers the possibility of improved earnings driving a market recovery needs to include some consideration of how the consumer might change culturally. For example, in his column in yesterday’s New York Times, (”Darkness Down The Road“), David Leonhardt raises this fundamental question: “There is no doubt that the economy is in terrible shape. The overall volume of loans is, in fact, falling. But is that because banks won’t lend? Or because businesses and families don’t want to borrow?”

To come to an answer, Leonhardt focuses on one industry: the rental car business. In addition to an analysis of the balance sheets of the major industry players that is revealing, he notes: Overall industry purchases are down 63 percent relative to early last year, and all three companies have also laid off workers. Why?

Because the economy is in terrible shape. Fewer people are traveling and renting cars. The companies already own too many cars, thanks to the sweetheart deals that Detroit offered in recent years to clear out its bloated inventory. ’From our standpoint, there is no liquidity crisis,’ says Patrick Farrell, an Enterprise vice president. ‘We’re buying fewer cars because we need fewer cars.’”

Interesting. To what degree will the lesser use of rental cars become a cultural legacy of the current crisis that will extend beyond the crisis itself? Have all the industries been identified that are going to be impacted even to some degree by cultural changes? In very real terms, this crisis is just starting to be absorbed by the public; so can we even start to predict how they will change? The certainty of a prediction about the bottom of the market is directly related to the uncertainty of cultural changes yet to come. I think there are a great deal.

Then there is the direction of the political philosophy of the U.S. We do not know yet just how far towards a more centralized government we will go. I do not think a market bottom can be predicted without taking into account what the role of the government will be two or three years from now.

I do believe there is great value in analysis of economic and market conditions and trends. But, I am increasingly convinced - and concerned - that non-economic and non-market factors will have a dramatically greater impact than most people currently factor into their predictions.

Friday, March 27, 2009

Markets Have Hit a Bottom, But Is It THE Bottom?

The spring in the financial sector’s step last week has some wondering if bottoms are finally forming in for the equities market. This is based on an assumption that weak banks couldn’t get much cheaper and that, to Wall Street’s way of thinking, a “real” bull rally has to be led by financials. Certainly it's true there is much less $ (or £, or €) value that can be chopped off them than has already been. Early year profits indicated by some of the larger and weaker US banks, and comment by US Fed Chairman Bernanke that the recession could be over by year’s end if the banking sector stabilizes, also helped the cause.

Of course this enthusiasm does ignore that going from anywhere to 0 is a 100% loss so financials are not exactly risk free. Concern about whether some banks need to be nationalized in order to induce some true stability is not yet off the table.

The detail of the early year profitability is yet to be laid out, and it came with cautions that Q1 still has a month to go. Banks’ operating profits can build through a quarter only to be lost on booking off capital requirements and write downs. Wall Street views too much that looks bad as a one time event that shouldn’t be included in “real” earnings. Losses are losses where we come from.

The big news of last week was Bernanke finally pulling the trigger and starting a program of quantitative easing, or money printing as they call it in the old country. Things have gotten to the point that Helicopter Ben will be second guessed on every move he makes.

We think that you have to start with the assumption that the Fed has some data in hand that we mere peons are not privy to. Given that he made the decision after equity markets had already put in a substantial rally, this was not the Fed coming to Wall Street’s rescue. It was the Fed coming to the bond market’s rescue.

Yields on the 10 year Treasuries had been creeping inexorably upwards for over a month. As we have noted several times in the past few months, the Fed has to find ways to allow the Treasury to sell a mountain of paper without driving up interest rates at the worst possible time. Buying Treasuries will serve the dual purpose of pulling down rates and pumping money into the US economy. The announcement helped create the biggest one week loss for the US$ ever. As we note below, traders fear this makes an inflationary endgame all but assured when the economy really starts to recover.

After a 15% move, the major markets look ready to take a breather. We’d like to think we have seen the bottom in the markets but there is still a lot of bad news to get through. Earnings season starts in two weeks. No one expects good numbers. The real question is how much of the bad stuff is priced in. No one will know the answer to that question until we see how traders react but we are still holding to the belief that a bottom is likely to come during the summer doldrums.

It may not be much lower than this month’s but another revisit of the lows seems the most likely course of events. We also can’t help but wonder if the Fed’s move means there is another shoe left to drop that the rest of us don’t know about yet. It’s hard to imagine there are any new sources of bad news left, but it hasn’t paid to make that assumption for two years.

Despite the improved credit markets we are still in a cash-driven market. China and other creditor economies are right to insist on seeing the rot dug out of the system before doing any more to help fix it. China already has a large cash infusion moving into its economy, and indicates it expects a loss on its plans to buy more US treasury paper.

It has also made it clear it sees no reason to expand its spending plans, at this point. It, and others with functioning banking sectors, will increasingly refocus on workarounds to avoid western banking.

The issue that would be of most concern to us seems, right now, to be the least contentious. There appears to be agreement to avoid hampering global trade, at least overtly. Protectionist measures were one of the worst problems of the dirty 30s, and so far governments are shying away from them. Hopefully that continues. Markets will react badly if it doesn’t.

China’s government has been replenishing its stockpile of copper, which has helped reduce warehoused copper available through the LME by 10% in two weeks. The warehouse offerings have been reduced in part because copper users themselves are more willing to hold inventory. China’s buying helps, but so does an easing of credit conditions that makes cash generation less urgent. Since we are cautious about unfinished debt-crisis business in the financials sector, we also have to remain cautious about the strengthening copper price. Current LME copper warehouse stock levels are still 45% above the start of this year, and 300% of last year’s lows after all.

With a shift away from the greenback, we could well see more copper price gains regardless of changes to warehouse stocks. These would be real in so far as copper should reflect the inflationary pressures in the US that are inherent to a $ weakening. However, we would still like to see continued reductions to commercial stocking levels support any price gain for the red metal, rather than simply its return to the currency system.

It’s worth noting that if China adds the amounts rumoured (700,000-1,000,000 tonnes) to its government stocks and leaves it there, this year’s expected copper surplus will disappear. The Chinese buyers are not fools. They were the ones selling $4.00 copper to hedge funds, after all. We think their statement of intent is real but that doesn’t mean they will either chase or drive the price higher.

Announcement of a move by the US Fed to buy the long end of its bond market also had the expected impact on the gold price. Having consolidated to the US$900 per ounce level, we think it likely it will now be a “currency of choice” in a move away from the US. Gold (and most other commodities) have gone back to their anti-dollar status. After moving with the Dollar since the start of the year, correlations have again reversed.

There are many who place undue faith in the ability of the Fed to reverse the sort of trades it is about to start. It’s common for the Fed to undertake small scale refi activity and reverse it later. The difference this time is the operations will be several orders of magnitude larger. Even assuming the Fed wanted to reverse them (a big if at this point), it can’t do it in the midst of the Treasury’s funding campaign without blowing up interest rates.

A more important question is how other central banks will react to these moves. More of them may feel compelled to follow the US lead if only to help maintain competitiveness of local products. To the extent that commodities continue to be viewed as currency proxies that cannot be created out of thin air this should help metals and energy prices. It will however make price changes more unpredictable. While the situation is clearly bullish, don’t think that these latest Fed moves have made gold or anything else a straight one way trade. There is no reason to expect volatility to fade away any time soon.

Wednesday, March 25, 2009

United States - 10 Reasons Why We Still Haven't Hit Bottom?

Don’t get me wrong, I love this bear market rally. It makes me feel good. Makes me feel wealthier. Makes me feel more confident. But is it warranted? Even if it isn’t, sometimes just thinking the worst has passed helps the market recover more quickly than previously thought possible. But remember, bear market rallies are usually the largest. And if you look into it, not much has changed but psychology. Here are my top ten reasons for why the worst may still be to come.

1) People are searching for the bottom

Most bottoms occur when no one thinks it is. The bottom doesn’t occur when people think the worst is over, but when everyone wants to get out. It’s the point that there just aren’t enough sellers anymore, and the market starts to guide higher. I think that since so many people suspect this to be the bottom, it is yet to come.

2) Liquidity still hasn’t returned

Even though recent Fed moves may increase liquidity in the future, many companies are still struggling with debt loads and cash problems. Even if the sun is on the horizon, many companies will be forced into bankruptcy, delaying the bottom's appearance temporarily.

3) This is a real recession

This isn’t some made up bear market like the tech-bubble, this recession is affecting peoples lives and their habits. Comparing this recession to the tech-bubble isn’t even reasonable. I hate to say it, but this time it’s different, like it always is. Real people will be affected. Every company will be affected.

4) People think they can’t win anymore

I’ll say it, buy-and-hold is dead. In no sense am I saying it doesn’t work, but people think it doesn’t work. They’ve been handing their money over to the ‘professionals’ for years, and they don’t have much to show for it. I think the return of capital coming into the market could be light as more and more people see the stock market as rigged.

5) Valuations still need to be cut and revised

Every valuation method we use to evaluate the ‘cheapness’ of stocks is worthless. P/E’s are only valuable when you know the forward P/E’s. PEG’s need to be revised because future growth may be slower. Earnings estimates still need to be guided lower, causing inevitable hits on the stock market's performance.

6) Technicals don’t work

Isn’t that crazy, technical analysis doesn’t work anymore! Tell me one technical analyst who foresaw the recent stock market crash. The answer is zero, because you actually had to know fundamentals and things that were going on to call it.

The time where people can look at charts and decide what’s going to happen is over. People will need to be more involved and maybe, just maybe, know what the company they are investing in actually does. I think the slowing participation of technical traders will decrease volatility and delay the eventual rebound.

7) America may not be invincible

Ever ask yourself the question “What happens if no one wants our debt anymore?” Some possibilities: currency crisis, war, treasury bond default, massive sell off by Russia, Japan and China of dollar reserves, bank runs, food shortages, civil unrest, snowballing bankruptcies, systemic financial meltdown; skyrocketing interest rates and inflation when foreign central banks stop buying those little pieces of paper that promise them 3% interest paid out of our children’s future earnings. This is exactly the type of environment that makes these things possible. Throw away your arrogance, America isn’t invincible, we are just as prone to these things as any other modern country.

8) People hate each other

We hate the companies that steal our money (AIG) and we hate the people that are trying to save them (congress). It strikes me as odd that the worst run bank in the world (the US government) is trying to tell other companies how to run themselves efficiently. How about a pay-cut for our congress representatives for losing us so much money? Anyway, our children will be spending a huge part of their labor to pay interest on debt created by the profligacy of our generation. The long-term horizon is fairly bleak as well if we don’t get our act together.

9) We are in a downward spiral

Lower spending equals lower employment equals lower confidence equals lower productions equals lower spending equals lower employment equals lower confidence…..
If we had been saving during the sunny times for the rainy days, this would just be a recession. Too bad everyone’s broke. Even if they wanted to save now, where’s the money coming from?

10) Everything is 10 times worse than you think

Discretionary income falls by a multiple of wealth destruction. In other words, if you lose 25% of your household income, discretionary spending can fall 80%. You do the math. Unfortunately, this type of logic applies to too many other economic factors. And I’m the biggest bull of all.

Monday, March 23, 2009

UK To Remain In Deflation Trap Until 2012, Economists Warn.

LONDON, Britain will be mired in a deflation trap for years despite the radical efforts of the Bank of England to pump extra cash into the economy, economists have warned. The forecast, by a team at BNP Paribas, states that prices in Britain will keep falling for at least another two-and-a-half years, as Britain suffers an apparently intractable bout of debt deflation.

The warning comes only days before official figures confirm this Tuesday that the Retail Price Index has dipped into negative territory for the first time in almost half a century.

It also follows a warning from the Bank itself that the UK is now exhibiting early signs of becoming stuck in debt deflation; the combination of falling prices and rising debt burdens that afflicted the US during the Great Depression.

But while many assume the combination of near-zero interest rates and a heavily-devalued pound will help prevent falling prices from becoming entrenched, and may stoke inflation, the BNP Paribas economists said they expected deflation to persist all the way until 2012.

Furthermore, the fall in prices would be broad-based across the economy, pushing into the red not only the RPI but also the Consumer Price Index, which the Bank's Monetary Policy Committee targets Alan Clarke, UK economist at BNP Paribas, said: "Our revised economic forecasts for the UK are the most pessimistic in the market.

We expect GDP to contract by more than 4 per cent this year and by a further 1 per cent in 2010. We expect deflation to set in during 2011, even earlier were it not for the VAT hike [which will follow the temporary cut in the tax this year]."

"Over the medium term, we expect the unemployment rate to surge to above10 per cent; well above neutral. This will exert significant downward pressure on inflation, turning negative in 2011." The forecast is based largely on the bank's prediction that the unemployment rate will soar to 10.4 per cent of the workforce by 2011, depressing the wider economy and underlines the disparity between economists' expectations for the coming years.

The Office for National Statistics will on Tuesday announce that the annual rate of change in the RPI has dropped beneath zero for the first time since February 1960, most likely falling to -0.6pc. It is also likely to say that CPI inflation has fallen to around 2.5 per cent. The CPI does not include the effects of either house prices or mortgage interest payments, and so has been less affected by the falls in property values over the past year. - Daily Telegraph

Friday, March 20, 2009

Major Banks Slash Southeast Asian Growth Forecasts

SINGAPORE: Major investment banks slashed growth forecasts for Southeast Asian economies, with one predicting an 8 per cent contraction in Singapore, as the weakening global economy hits the region's key export industry. Goldman Sachs now expects Singapore's gross domestic product (GDP) to fall 8 per cent this year from a previous forecast for a 4 per cent contraction hurt also by a slowing real estate market and shrinking investment.

It also cut its GDP forecasts for 2009 for four other Southeast Asian economies. Among them, its sharpest downward revision was for Malaysia to shrink 3.5 percent from growth of 1.7 percent previously, while it saw Thai GDP slipping 4 per cent from a 0.8 per cent drop previously.

Indonesia's economy was expected to grow at a slower pace of 2.5 per cent from 3 percent previously, and the Philippine economy was expected to shrink 0.5 per cent from a growth forecast of 1.8 per cent previously, Goldman said in a note.

"We reiterate our view that Singapore has one of the highest exposures to weakness in external demand, because of its high ratio of exports to GDP and the high portion of exports-driven domestic demand," it said. HSBC lowered growth forecasts for Singapore to -7 per cent and for Malaysia to -3.5 per cent, from -5 per cent and +0.5 per cent previously.

Credit Suisse saw a 6.5 per cent contraction for Singapore, a 5.2 per cent contraction for Japan as frozen trade hits exporters, but 8 per cent growth for China given its policy stimulus. Goldman's forecast on Singapore is the most bearish among private economists, although Singapore's most powerful politician, Lee Kuan Yew, told a Reuters seminar the economy could contract by as much as 10 per cent in 2009 if exports continued to slide in the second quarter.

A poll of analysts by Reuters on Wednesday put the average forecast for Singapore at a 4.9 per cent contraction, in line with the government's official forecast and a survey of economists by the central bank. Goldman saw the Singapore dollar at 1.64 to the US dollar within 3 months while HSBC sees a 2-3 per cent one-off shift downwards in the band, with scope to ease policy again. - Reuters

Article from Business Times.com

Wednesday, March 18, 2009

KNM's Lee May Lead Buyout If Banks Can Provide Funding

KNM Group Bhd (7164) managing director Lee Swee Eng said he will consider leading a management buyout of the Malaysian oil and gas services provider as long as banks can raise the funds.Investment bankers have approached Lee, who owns 25 per cent of KNM, and suggested he buy the remaining shares, though none has made a proposal that includes financing, he said.

KNM has lost 71 per cent in the past six months in Kuala Lumpur trading, cutting its market value to RM1.31 billion. "We are very undervalued," Lee, who set up Selangor-based KNM in 1990, said in an interview on March 13. "The opportunity for privatisation is a good opportunity, but it's the source of funding.

There's no offer on the table. "Lee, 53, has seen the value of his stake plummet as the global recession, tumbling oil prices and a sell-off by foreign investors combined to make KNM the second-worst performer on Malaysia's benchmark index in 2008.

He said he probably needs between RM1 billion and RM2 billion to fund any takeover. KNM share prices closed around 34.0 sen. The shares reached a record RM2.48 in January 2008. Cashflow at the Selangor-based company would be sufficient to service any borrowings after a buyout and associated cost cuts, Lee said. Annual profit at KNM has climbed every year since 2004. "With our earnings, we should be able to handle that," he said.

"I don't think that would be an issue." Banks worldwide have restricted lending during the financial crisis, and Malaysia's government last week pledged RM25 billion in guaranteed funds to help businesses obtain credit and raise money on the bond market. Even so, Lee said it's not clear whether banks, foreign or domestic, would be willing to lend funds for a management buyout.

KNM's business prospects are tied to the price of crude oil because exploration projects, for which producers hire companies such as KNM, become less viable as prices fall. KNM has had to reduce its bids for most of the projects up for tender, Lee said. The company, with an order book of RM3.9 billion, won about RM300 million of orders between December and January, Lee said.

The revised value of all the contracts that KNM is seeking is RM18 billion, he said. "The business has been a bit slow because of the volatility of the price of oil," Lee said. "We're expecting the second quarter onwards to be better.

Most of the rebidding has taken place. We will sail through this with flying colours. "Crude oil for April delivery still hovers around USD 44.00 to USD 48.00 a barrel in after-hours electronic trading on the New York Mercantile Exchange after the Organisation of Petroleum Exporting Countries decided against deeper output cuts. Crude slumped 70 per cent from its July record. - Bloomberg

Monday, March 16, 2009

Rage Mounts Over AIG’s Rewarding Of Culprits

WASHINGTON, March 16 – A large portion of the taxpayer money spent to rescue insurer AIG was passed on to Goldman Sachs and several European banks, who were among the major beneficiaries of more than USD 90 billion in payments in the first three-and-a-half months of the government bailout, AIG disclosed on Sunday.

The revelation was another public relations nightmare, coming on the same weekend that the Obama administration expressed outrage over American International Group Inc’s plan to pay massive bonuses to the people in the very division that destroyed the company by issuing billions of dollars in derivatives insuring risky assets.

AIG, an embattled insurance giant that has received federal bailouts totalling USD 173 billion and is now paying USD 165 million in employee bonuses, is at the heart of a global financial crisis that President Barack Obama is trying to address with plans for trillions of dollars in spending. As part of those efforts, Obama will announce steps on Monday to make it easier for small business owners to borrow money, officials said.

But the revelations that billions of US taxpayer dollars were funnelled through AIG to Goldman Sachs – one of Wall Street’s most politically connected firms – and to European banks including Deutsche Bank, France’s Societe Generale and the UK’s Barclays was likely to stoke further outrage at the entire US bank bailout.

While the payments were not illegal, the fact that billions of dollars given to prop up giant insurer AIG were then transferred to European banks and Wall Street investment houses could raise new doubts about whether the rescue was really economically necessary. Goldman Sachs, formerly led by Henry Paulson who was treasury secretary at the time of the original AIG bailout, could not immediately be reached for comment. Deutsche Bank and Barclays declined to comment.

As it seeks to ease the credit crunch that was the original target of the Troubled Assets Relief Program (TARP), the Treasury will also offer more details this week about the workings of proposed public-private partnerships to take toxic assets off banks’ books, including a timeframe, a senior department official said on Saturday.

“No taxpayer in these arrangements is going to lose money until the investor who put up the money has lost 100 per cent,” said Chief White House economic adviser Lawrence Summers. Treasury officials have said the fund, or funds, would be a vehicle to provide as much as USD 1 trillion in financing for buying bad assets – particularly mortgages gone bad as a result of the US housing bust. The Federal Reserve and Federal Deposit Insurance Corp would participate. As more Americans lose their jobs and homes, Obama’s new administration is under heavy pressure to show that the rescue plan for AIG and major banks is working to free up lending and rein in the riskier excesses of Wall Street.

The payments to AIG counterparties include the provision of collateral to back up credit default swaps, a form of financial insurance that AIG’s London office was writing, the purchase of the collateralised default obligations, a type of complex debt security that underlay that insurance, and payments to counterparties of a securities lending program.

Through three separate types of transactions, Goldman received an aggregate USD 12.9 billion. Among European banks, SocGen was the biggest recipient at USD 11.9 billion, Deutsche got USD 11.8 billion and Barclays was paid USD 8.5 billion. The list of counterparties was made public by AIG amid growing pressure on the insurer to come clean about the true beneficiaries of the bailout ahead of a congressional hearing on Wednesday at which AIG chief executive Edward Liddy is slated to testify.

Summers – speaking before the payments to banks were made public – called the AIG bonuses “outrageous” but said contracts must be honoured, even though Treasury Secretary Timothy Geithner had “negotiated very forcefully” with AIG and done all that was “legally permissible” to limit the payments.

“We’re not a country where contacts just get abrogated willy nilly,” Summers, a former treasury secretary, said on CBS’s “Face the Nation” program. “What the lesson is, is this: We don’t really have a satisfactory regulatory regime in place.” News of the AIG bonuses sparked outrage beyond political circles and was equally apparent on news Web sites and among ordinary Americans.

To help small businesses, officials said Obama intends to provide USD 730 million from the congressionally approved USD 787 billion economic stimulus program to cut lending fees, boost loan guarantees and expand other programs. “We know that small businesses are the engine of growth,” Christina Romer, who chairs the White House Council of Economic Advisers, said on NBC’s “Meet the Press.”

“We absolutely want to do things to help them.” As part of the financial rescue, the Obama administration expects private investors to bolster government funds to help cleanse the banking system of bad assets, said Austan Goolsbee, a member of the Council of Economic Advisers. “That is a key component to the plan but that is not the only key component,” Goolsbee told “Fox News Sunday,” stressing that the first step had to be a “thorough examination of what situation the banks are in.”

“It’s better to do this jointly with private capital,” said Goolsbee. “I believe there is a reasonable expectation that people will participate.” The idea of offering financing support from the government for private investors willing to buy the toxic assets was first put forward by Geithner in February but the lack of detail has disappointed financial markets. Mark Zandi, chief economist at Moody’s Economy.com, said private investors were ready to join the government in buying up toxic assets – “if it is organised well enough.”

“They’re waiting to understand what this program is all about,” Zandi told Fox. “I don’t think stimulus by itself is the answer. In fact, the most important thing is shoring up the banking system.” AIG’s Liddy said in a letter to Geithner the giant insurer was legally obligated to make 2008 employee retention payments but had agreed to revamp its system for future bonuses after the Obama administration objected.

“There are a lot of terrible things that have happened in the last 18 months, but what’s happened at AIG is the most outrageous,” Summers said. Representative Barney Frank, the Democratic chairman of the powerful House of Representatives Financial Services Committee, said the government must see if the bonuses can be recovered, adding that the timing of AIG’s commitment was important.

“We can’t just violate law, legal obligations,” Frank told Fox. “I understand that. But I do want to find out at what point these illegal obligations were incurred.” Mitch McConnell, the Republican minority leader in the Senate, called the AIG situation an “outrage” and said the nature of the contracts needed to be checked.

“Did they enter into these contracts knowing full well that, as a practical matter, the taxpayers of the United States were going to be reimbursing their employees? Particularly employees who got them into this mess in the first place?” McConnell said on ABC’s “This Week.” – Reuters

Saturday, March 14, 2009

The Next Big Bailout Decision: Insurers

The tumbling financial markets are dragging down the life-insurance industry, an important cog in the U.S. economy, as mounting losses weaken the companies' capital and erode investor confidence. A dozen life insurers have pending applications for aid from the government's USD 700 billion Troubled Asset Relief Program, and the industry is expecting an answer to its request for a bank-style bailout in the coming weeks. The government so far hasn't said whether insurers will be eligible for the program.

Life insurers have taken a beating in recent weeks. The Dow Jones Wilshire U.S. Life Insurance Index has fallen 59% since the beginning of the year, leaving it down 82% since its May 2007 all-time high. The Dow Jones Industrial Average has lost 21% year to date, off 51% since its October 2007 record.

Some of the hardest-hit companies are century-old names that insure the lives of millions of Americans. Shares of Hartford Financial Services Group Inc., which already received a capital injection from German insurer Allianz, are down 93% as of Wednesday's close from their 52-week high. MetLife Inc. and Prudential Financial Inc. are both suffering as the value of their vast investment portfolios declines.

Some life insurers are faring better than others, and some of the nation's giants retain triple-A ratings, including Massachusetts Mutual Life Insurance Co., New York Life Insurance Co., Northwestern Mutual Life Insurance Co. and TIAA-CREF. But as the economy buckles, analysts say many insurers face losses that can eat away at the capital cushions regulators require them to maintain.

Long-time experts say the industry is going through its most tumultuous period in recent memory. "It's a pretty scary scenario right now," said Pete Larson, an analyst at Gradient Analytics, a Scottsdale, Ariz., research group.

Some state regulators have lately extended relief from certain capital requirements. But insurers haven't received the kind of injections banks got in recent months. That's partly because insurers didn't gobble up risky assets, and also because as long-term investors, they generally don't have to recognize on the bottom line short-term dips in values of their assets.

Ratings agencies and stock investors are growing concerned about how long the industry can avoid reckoning with the distressed assets on their books. Rating agencies Moody's Investors Service, Standard & Poor's and A.M. Best have cut the ratings of more than a dozen insurers in recent weeks.

The ramifications of a weakened life-insurance industry for the overall economy are significant. Life insurers are among the biggest holders of the nation's corporate debt. Together, they own about 18% of all corporate bonds outstanding, according to the American Council of Life Insurers, or ACLI, an industry trade group.

If life insurers stop buying bonds, the capital markets may not fully recover, say insurance industry representatives and analysts. Already, their buying activity has slumped. In the fourth quarter of 2008, life insurers agreed to buy USD 3.3 billion in stocks and bonds through private transactions, down 63% from the previous quarter, according to a survey by the ACLI. Insurers have been putting more cash into safe havens such as Treasury bonds.

Any sign of vulnerability among life insurers could further erode confidence and make jittery consumers reluctant to buy insurance products, analysts and financial advisers say. "I get as many emails from subscribers who worry about their policies as they do about their stock," said Morningstar analyst Alan Rambaldini, who covers life-insurance companies. Though life-insurance and variable-annuity sales fell industrywide in the fourth quarter of 2008, analysts say it is too soon to trace declines to consumer concerns about the stock action.

Ratings firms and Wall Street analysts say another problem for some life insurers is obligations for variable annuities, a retirement-income product that often guarantees minimum withdrawals or investment returns. As stock markets plunge to fresh lows, life insurers need to set aside additional funds to show regulators that they can meet their obligations, further crimping spare capital.

The industry has several things in its favor. Life insurers will likely continue to generate cash from the premiums on their policies, some analysts and executives say. And unlike investment banks and many other financial firms, life insurers don't need to routinely raise money in the capital markets to fund daily operations. Few of the biggest ones have any sizable debt of their own maturing in 2009. Many insurers have built up big cash chests in recent months, by hoarding their incoming premiums.

For now, the Treasury Department hasn't said whether life insurers will be eligible for TARP funds. Industry group ACLI expects Treasury to decide whether insurers will be eligible for federal aid some time later this month. "We don't have a clear picture of which way that clarification would tend to go," said ACLI representative Gary Hughes.

The Treasury Department didn't return calls for comment made late in the day. One stumbling block is that the industry is overseen by state regulators, not a single federal agency. That means there's no group of federal officials responsible for it or with a deep understanding of its challenges.

The problems plaguing life insurers aren't the same as those at insurance giant American International Group Inc., which has received a USD 173 billion aid package. Its losses stemmed largely from derivatives, primarily credit default swaps, tied to complex securities that turned sour in the credit crunch.

Life insurers' woes have come largely from investment-grade corporate bonds, commercial real estate and mortgages, regulatory filings show. Many insurers ended 2008 with high levels of losses that, due to accounting rules, they haven't had to record on their bottom lines. MetLife, the nation's biggest life insurer by assets with USD 380.84 billion in its general account, had USD 29.8 billion in unrealized losses at the end of 2008.

MetLife says it is amply capitalized, with more than USD 30 billion in cash, and that it doesn't expect to realize significant losses from its investment portfolio. "We strongly believe that the way we've looked at our unrealized gains and losses is appropriate for our liabilities and for the most part that these [investments] will pay off," said MetLife spokesman John Calagna.

Hartford Financial had USD 14.6 billion in unrealized losses at year's end. Prudential, the second-largest insurer by assets, had nearly USD 11.3 billion in unrealized losses, up USD 5.4 billion in the fourth quarter from the previous quarter. Hartford didn't respond to requests for comment. A Prudential spokesman said, "We believe that we are adequately capitalized based on our objective of a double-A rating."

—Jessica Holzer and Michael R. Crittenden contributed to this article.

Friday, March 13, 2009

Is Warren Buffett Wrong? Four Reasons the Recession May Be Easing

Nouriel Roubini is known as Dr. Doom, but Warren Buffett is giving the dour economist a run for his money. President Obama’s favorite deal maker has offered more morose pronouncements on the recession. You might recall that in April 2008, after the fall of Bear Stearns, Buffett predicted the recession would be worse than feared.

This week, he upped the ante, calling the recession “an economic Pearl Harbor,” and suggesting it would last for five more years, or longer than World War II. (Of course, Buffett may be going by the old saw that a recession is when your neighbor loses your job and a depression is when you lose yours; the Oracle lost over $5 billion last year in the worst performance in his 44 long years in the business.)

We haven’t seen any shantytowns spring up or people pushing wheelbarrows full of money to buy bread, so, feeling in a generous mood, Deal Journal brainstormed four reasons why Buffett could be, this time, entirely too bearish.

The Pain Already Feels Deep:

The market is always looking for something called “capitulation.” Even though Dow 5,000 isn’t out of the question, Doug Kass, founder of Seabreeze Capital Management, thinks a market bottom was hit March 2, writing, “My contention…is that the serious problems have been more than fully discounted in the world’s equity markets. Moreover, while many have grown increasingly impatient with the new Administration’s piecemeal strategy toward addressing the banking industry’s toxic assets, a cohesive deal, under the leadership of Lawrence Summers, will soon be forthcoming and will be effective.”

The Administration Knows What the Problem Is:

In the Great Depression and in Japan in the 1990s, economies suffered when leaders tried different tacks to solve their problems but committed too little capital to solving the underlying causes. But to judge from Treasury Secretary Timothy Geithner’s appearance on Charlie Rose last night, the administration knows the depth and causes of the issue: “What typically happens is people understate the severity of it. They wait too late to act.

When they act, they do too little. And that makes the crisis deeper, causes more damage, makes fiscal problems worst, deficits larger in the longer term, causing more damage than necessary, and ultimately, costs more to fix it. So the basic strategy underlying what the president is doing is to move as quickly, with as much force as comprehensibly as possible.” More importantly, the run of disasters seems to have slowed down, which means solutions don’t have to take just 48 hours.

The Tide Is Turning Against the Biggest Bugaboo in Finance:

Mark-to-market accounting has lost its last friend on Wall Street in James Dimon. Many Wall Streeters have blamed their woes on accounting rules that require banks to take new hits on troubled assets every quarter–and, in the words of Shakespeare’s Macbeth, the line of such assets stretches out to the crack of doom. Proponents of such accounting dismiss such complaints, believing they are the equivalent of, say, thinking that it is in looking in mirrors that causes pimples.

In a speech today, Dimon said the accounting rule had been taken “to a ridiculous point.” His compatriots running banks would agree: Wall Street has argued that it is meaningless to take troubled assets and “mark to market” if there’s no market. In October, Congress eased the rules by giving banks some leeway in determining the values of these assets, but no bank wants to be in a gray area. The drumbeat for a repeal started last fall. Dimon, the CEO of a bank that has suffered less than others, has an opinion that carries weight. In addition, Ben Bernanke suggested easing accounting rules yesterday.

The Bond Markets Are Healthier:

Looking at every major bond index, “in every case the credit markets are in better shape than five months ago when the S&P was 30% higher,” Kass says. The TED spread, a key indicator of the bond markets that compares three-month Libor yields to three-month T-bills, has shrunk to 1.10 percentage point from 4.63 in October.

The High-Yield Spread — which compares the yields on 10-year junk bonds to 10-year Treasurys–has pulled back to 16.25 points from 19.08 points in October. The corporate bond markets saw record issuance in January and near-record in February, marking the most active months for investment-grade corporate bond issuance among American companies since 1995, according to Dealogic data, with a total of around $300 billion raised.

Dimon, too, sees a recovery on the way. What’s behind Dimon’s optimism? The bond markets, for one thing. Deal Journal has chronicled the resurgence of the bond markets in January and February, and our Dow Jones Newswires colleagues Joe Bel Bruno has this update. “There are modest signs of recovery and healing out there,” Dimon said. It makes sense: if the crash was based on the loss of credit lines, the fact that some, at least, are being extended should be an encouraging sign.

Article from The Wall Street Journal

Wednesday, March 11, 2009

Bernanke: Some Banks Really Are Too Big to Fail


Throughout the ongoing credit crisis, pundits and skeptics alike have alluded to “too big to fail” — the idea that some financial institutions, however irresponsible, had become too fat, too large, and too systemically important to the global financial machine to be allowed by regulators to fail.

U.S. Federal Reserve chief Ben Bernanke admitted in a speech Friday morning that the notion of “too big to fail” was correct, and suggested that Federal regulators were moving to ensure that some of the nation’s largest banks would not be allowed to fail.

In remarks delivered to the Council on Foreign Relations in Washington D.C., Bernanke said that “reforms to the financial architecture” were needed to prevent this sort of crisis in the future — but said that some firms were too large to be allowed to fail. Read the full speech.

“We must address the problem of financial institutions that are deemed too big–or perhaps too interconnected–to fail,” Bernanke said. “Given the highly fragile state of financial markets and the global economy, government assistance to avoid the failures of major financial institutions has been necessary to avoid a further serious destabilization of the financial system, and our commitment to avoiding such a failure remains firm.”

In other words: I don’t like it, but, yes, some firms really are too big to fail. Bernanke suggested the U.S. needed to prop up ailing financial giants like Citigroup, Inc. (C) and American International Group Inc (AIG), while also suggesting that a new regulatory framework be put into place to prevent “too big to fail” from being an issue in the next financial crisis.

“It is imperative that policymakers address this issue by better supervising systemically critical firms to prevent excessive risk-taking and by strengthening the resilience of the financial system to minimize the consequences when a large firm must be unwound,” Bernanke said.
AIG was clearly on Bernanke’s mind here, as well: “The United States also needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm, including a mechanism to cover the costs of the resolution.”

The ailing insurer has received more than USD 160 billion in direct Federal assistance to keep it afloat as bets of credit default swaps and other derivative contracts — including mortgage-related bets — have soured.

The Fed chief also suggested that the recession could be over by the end of 2009, if policymakers and regulators are able to right the ship of the U.S. and global financial machine. Doing so quickly, however, might be a tall order; as Bernanke noted in his speech, addressing this crisis will require a coordinated global response.

Pundits have suggested for months now that Wells Fargo & Co.’s (WFC) acquisition of troubled Wachovia Corp. last year was the result of the bank’s desire to remain “too big to fail” in the eyes of regulators; a similar strategy was cited behind Bank of America’s (BAC) purchase spree, which included troubled mortgage originator Countrywide Financial Corp. and Merrill Lynch. Whether he intended to or not, Bernanke’s speech Friday clearly gives some strong credence to such thoughts.

Tuesday, March 10, 2009

Who Got AIG's Bailout Billions?

NEW YORK (Reuters) - Where, oh where, did AIG's bailout billions go? That question may reverberate even louder through the halls of government in the week ahead now that a partial list of beneficiaries has been published.

The Wall Street Journal reported on Friday that about USD 50 billion of more than USD 173 billion that the U.S. government has poured into American International Group Inc since last fall has been paid to at least two dozen U.S. and foreign financial institutions.

The newspaper reported that some of the banks paid by AIG since the insurer started getting taxpayer funds were: Goldman Sachs Group Inc, Deutsche Bank AG, Merrill Lynch, Societe Generale, Calyon, Barclays Plc, Rabobank, Danske, HSBC, Royal Bank of Scotland, Banco Santander, Morgan Stanley, Wachovia, Bank of America, and Lloyds Banking Group.

Morgan Stanley and Goldman Sachs declined to comment when contacted by Reuters. Bank of America, Calyon, and Wells Fargo, which has absorbed Wachovia, could not be reached for comment. The U.S. Federal Reserve has refused to publicize a list of AIG's derivative counterparties and what they have been paid since the bailout, riling the U.S. Senate Banking Committee.

Federal Reserve Vice Chairman Donald Kohn testified before that committee on Thursday that revealing names risked jeopardizing AIG's continuing business. Kohn said there were millions of counterparties around the globe, including pension funds and U.S. households. He said the intention was not to protect AIG or its counterparties, but to prevent the spread of AIG's infection.

The Wall Street Journal, citing a confidential document and people familiar with the matter, reported that Goldman Sachs and Deutsche Bank each got about USD 6 billion in payments between the middle of September and December last year. Once the world's largest insurer, AIG has been described by the United States as being too extensively intertwined with the global financial system to be allowed to fail.

The Federal Reserve first rode to AIG's rescue in September with an USD 85 billion credit line after losses from toxic investments, many of which were mortgage related, and collateral demands from banks, left AIG staring down bankruptcy. Late last year, the rescue packaged was increased to USD 150 billion. The bailout was overhauled again a week ago to offer the insurer an additional USD 30 billion in equity.

AIG was first bailed out shortly after investment bank Lehman Brothers was allowed to fail and brokerage Merrill Lynch sold itself to Bank of America Corp. Bankruptcy for AIG would have led to complications and losses for financial institutions around the world doing business with the company and policy holders that AIG insured against losses.

Representative Paul Kanjorski told Reuters on Thursday that he had been informed that a large number of AIG's counterparties were European. "That's why we could not allow AIG to fail as we allowed Lehman to fail, because that would have precipitated the failure of the European banking system," said Kanjorski, a Democrat from Pennsylvania who chairs the House Insurance Subcommittee.

TOXIC ASSETS/TOXIC WASTE

As part of its business, AIG insured counterparties on mortgage-backed securities and other assets. The collapse of the U.S. subprime mortgage market, which triggered a global financial crisis, left the insurer and some of its policy holders facing possible ruin as the value of assets declined.

U.S. regulators failed to recognize how much risk AIG was piling on in credit-default swaps, and by the time they understood, they had no choice but to pour in billions of public dollars, Kohn and other officials told the Senate panel.

Senators were outraged by the lack of details about where the bailout money has gone.
"That we find ourselves in this situation at all is ... quite frankly, sickening," said Senator Christopher Dodd, the Democrat who chairs the committee. "The lack of transparency and accountability in this process has been rather stunning."

Eric Dinallo, superintendent of New York State's Insurance Department, railed on Friday against AIG's failed business model, likening its insuring credit-default swaps as gambling with somebody else's money. "It's like taking insurance on your neighbor's house and even maybe contributing to blowing it up," he said at a panel sponsored by New York University's Stern School of Business.

U.S. lawmakers have said they are running out of patience with regulators' refusal to identify AIG's counterparties. On Thursday, Richard Shelby, the top Republican on the banking committee, said: "The Fed and Treasury can be secretive for a while but not forever."

Monday, March 9, 2009

BUY OR SELL-Will HSBC, the 'Big Elephant', dance again?

HONG KONG, March 9 (Reuters) - Faced with a multi-billion dollar cash call, HSBC (HSBA.L) (0005.HK) investors are torn between the bank's relative strength and the headwinds still ravaging global financial companies.

HSBC, dubbed the "big elephant" in Hong Kong because of its mammoth market capitalisation and powerful share market performance, has shed $37 billion in market value since last Monday when it outlined plans to raise $17.7 billion in a deeply discounted rights issue.

While the rights issue will enhance the bank's capital ratio by 150 basis points and raise its tier 1 ratio to 9.8 percent, restoring its capital advantage over most rivals, the spectre of further writedowns in the bank's U.S. and European businesses has made investors wary. HSBC's Hong Kong-listed shares plunged 24 percent on Monday alone as large investors shorted the stock on hopes of buying it back after the rights issue.

HOUSEHOLD PROBLEMS HAUNT

Despite the selldown, the stock is still seen as expensive by some, with its estimated 2009 price to book ratio at 0.8 times, compared with 0.6 times for Standard Chartered (2888.HK) (STAN.L), another UK-based lender with a focus on emerging markets.

"With no improvement in the news and data we have been getting, the outlook on the U.S. is an important determinant for an HSBC buy or sell," said Winson Fong, fund manager who helps manage $2 billion with SG Asset Management.

After making a loss of $16.5 billion on its U.S. business in 2008, compared with $1.1 billion a year ago, HSBC said it would shut most of its U.S. consumer lending business. But worries persist over its $62 billion in outstanding loans at its HSBC Finance arm in the United States at the end of the fourth quarter and rising provisions in the bank's UK business.

"Fundamentally we are concerned from the top down these (US and UK) economies are still worsening and those two economies account for 75 percent of the loan base," said CLSA's Daniel Tabbush. Tabbush, who predicted HSBC's massive cash call, slashed his target price on the stock to HK$28 last week after cutting his earnings estimates for 2010 and 2011 by $2 billion to $3 billion.

Dora Hui, an office assistant in Hong Kong who sold her shares in HSBC a few years ago and has been waiting to buy the stock since it dropped below HK$100, said she is not on board this time around. "They say HSBC is not the same old HSBC anymore ... and with Citibank (C.N) shares below $1 now, could this be the way HSBC is headed?," she said.

STILL BEST OF THE PACK

But HSBC, unlike many other global lenders, turned a profit in 2008 and some company watchers said its newly bolstered balance sheet will equip the bank to acquire new businesses as other competitors pull back.

"The downsizing of the business in HFC (Household Finance Company) is a positive move," said Lee Shau Kee, an influential Hong Kong tycoon whose Shau Kee Financial Enterprises is a sub-underwriter on the HSBC rights issue for up to HK$2.34 billion.

"HSBC has a strong financial base ... the subscription price of approximately HK$28 per share is very cheap," the Hong Kong billionaire, who is also the chairman of Henderson Land Development (0012.HK), said in a statement on Monday. The bank's focus on more resilient emerging markets including China and a strong influx of deposits stands it in good stead, said analysts.

HSBC is expected to slash its 2009 dividend by half after having reduced its 2008 payout by 29 percent, but given the bank's strong capital position and liquidity there seems little reason not to expect the dividend to start growing again by 2010, Citigroup argued in a note.

Also, the bank's estimated 2009 dividend yield of 6.5 percent looks even more attractive as the financial maelstrom rages on, the Citigroup note said. "It's all about investor appetites. If you are a long-term investor, if you can hold the stock for three to five years, there a high chance of economic recovery all over the world and I expect the share price to rebound," said Steven Chan, banking analyst at Daiwa.

Saturday, March 7, 2009

Financial Crisis And Bailouts

Recently Tun Dr Mahathir Mohamad posted an article about our world financial crisis. The article that he wrote was quite good. Let us enjoy reading the article.

1. I was in England recently and the newspapers were full of dismal reports on bank and business failures, the closure of well-known businesses like Woolworths and Baratt, the increases of unemployment rate with some 700,000 professionals among the 2 million laid off or unable to get jobs. And there were lots more bad news.

2. The British Government is busy bailing out banks and companies with hundreds of billions of pounds but the economy seemed to have gone into recession despite all these efforts. There is no sign that the crisis is on the mend.

3. Malaysia can feel vindicated because all the things we did in the 1997 - 98, crisis, which were condemned by the economists of Europe and America, are now being done by them blatantly and on a massive scale. They talk about trillions of dollars and hundreds of billions of pounds in bailouts. Where the money is coming from is not revealed. Have they been keeping these huge sums for such an emergency?

4. I am not a financier or even an economist. But somehow I think the bailouts are not going to work although they worked in our case.

5. This is because the banks and businesses we bailed out did not get into trouble because they abused the systems or indulged in fraud. They were forced into that situation because the currency was devalued by currency traders and they found themselves unable to meet their commitments. Once they gained access to funds through bailouts they were able to do business again and to repay the money they had received.

6. They were able to do this because, although Malaysia was in recession, the rest of the world was not. There was much less constraint in doing business.

7. The situation today is very different.

8. The collapse of the economies of the rich countries is due to extensive abuses of the financial and monetary systems so much so that the systems broke down completely. I doubt (not being an expert I can only doubt) that the trillions of dollars to bail out the failed banks and financial institutions will enable them or their economies to recover.

9. This is because their huge losses were due to fraud and they cannot recover the billions they had lost through ordinary business, i.e. through the financing of the production of goods and services. Only through doing the same things that had brought them down, i.e. through sub-prime loans, through investments in derivatives and hedge funds, through massive loans to currency traders etc. can they make the billions to return the money they had received through bailouts. Obviously they cannot be allowed to indulge in their old abuses. Through ordinary business it would take years and years to recover the money they had lost. In the meantime all these banks, financial institutions and businesses will belong to the bailor, the Government, i.e. they have effectively been nationalised. And that will spell the end of capitalism and the free market.

10. It should be noted that the East Asian countries have not yet recovered from the 1997 - 98 crisis. Their currencies have not regained their strength to the pre-crisis levels. They have all become poorer, or at least not as rich as they could be had there been no financial crisis.

11. It will be the same with the rich countries. Their GDP and per capita pre-crisis will not be restored despite the trillions they are spending on their bailouts. They are poorer now and will remain relatively poor even after they have put their houses in order.

12. I may be wrong of course. Maybe by more trillions of dollars of bailouts the rich would achieve recovery. But I have my doubts.

13. Unfortunately the poor countries will also become poorer.

Friday, March 6, 2009

Worst Job Losses In 60 Years Expected

(MarketWatch) -- Based on the old rule of thumb that a recession is when you lose your job and a depression is when I lose mine, 650,000 families fell into a depression in February, according to the latest forecasts.

The Labor Department will release its latest snapshot of the job market on Friday at 8:30 a.m. Eastern. Economists are predicting nonfarm payrolls fell by 650,000 in February, the largest one-month job loss in almost 60 years as the recession tightened its grip on the economy.

The unemployment rate probably rose to 8%, the economists said, up from 7.6% in January and up 1.8 percentage points in the past six months, the fastest increase in more than 30 years. It would mean that a record 4.2 million jobs will have been lost since the recession began in December 2007, with no end in sight.

February could mark the worst month of job losses in the recession, even if the losses continue at a slower pace for months. Payroll growth typical lags behind any pickup in the economy.
The consensus of private forecasters is for the unemployment rate to get close to 9% next year, with some forecasters looking for a 10% rate. The Federal Reserve doesn't expect the unemployment rate to fall below 7% until 2011.

And remember: These forecasts assume the Fed will slowly be able to get credit flowing again, and that the recently approved fiscal stimulus will give a significant boost to the economy.
With output still falling at a dizzying rate, most companies are shedding unneeded workers and cutting back the hours of those remaining.

Strapped by debt and seeing their paper wealth evaporating, many consumers are spending as little as they can. At the same time, companies are postponing plans to buy equipment to expand production until the storm passes. "Even when demand does stabilize, production will likely lag as companies seek to trim unwanted stocks" of unsold goods, wrote Richard Berner, chief U.S. economist for Morgan Stanley.

Horrendous payroll numbers.

If the economy did shed 650,000 jobs in February as expected, it would be the third largest monthly loss on record, dating back to 1939. The record was set in September 1945, when nearly 2 million people lost their jobs after the Allies won the most destructive war in history and industry was retooling for peacetime, sending "Rosie the Riveter" back to her knitting.

In October 1949, 834,000 jobs were lost when almost all the nation's steelworkers went on strike in the final month of a brutal but short recession. Of course, the size of the workforce is much larger today than it was in 1949 or 1956. But as a proportion of the workforce, job losses during this recession have been staggering. If February's losses are as expected, it would be the fourth straight month of job losses of more than 0.4% of payrolls, matching the longest such stretches in the post-war era.

If 650,000 jobs were lost in February, it would bring total losses in this recession to about 3.1% of payrolls, matching the losses in recessions of 1949, 1954 and 1982. Next on the list: 4% in 1958 and 6.9% in 1945.

Behind the forecasts.

The main evidence for a worsening job market has been the rise in unemployment benefits. First-time claims have risen decisively over 600,000, nearly double the level at the beginning of the recession. Continuing claims are at an all-time high. Consumer surveys also show extreme pessimism about finding a job.

The employment index in the Institute for Supply Management survey fell to a record low in February. While some forecasters think job losses in February stayed in the ballpark of about 590,000, others think the labor market got much worse in February and are expecting losses of 650,000, 700,000, or in one case, even 800,000.

"February was the worst month yet," said Global Insight's Brian Bethune and Nigel Gault, who are predicting payroll losses of 750,000 and an employment rate of 8%. Others have a slightly less dire view, if a loss of 625,000 could be considered upbeat. "Our sense, admittedly based mostly on anecdotes, is that labor market conditions remain dismal but are not necessarily accelerating to the downside," wrote Stephen Stanley, chief economist for RBS Greenwich Capital.

Economists expect the number of hours worked to continue plunging as more workers are forced into part-time shifts. In January, 7.8 million workers wanted to work full time but could only get part-time work, a number that's risen by 3.2 million since the recession began.

Thursday, March 5, 2009

The Collapse Of Manufacturing

The financial crisis has created an industrial crisis. What should governments do about it?

USD 0.00, not counting fuel and handling: that is the cheapest quote right now if you want to ship a container from southern China to Europe. Back in the summer of 2007 the shipper would have charged USD 1,400. Half-empty freighters are just one sign of a worldwide collapse in manufacturing.

In Germany December's machine-tool orders were 40% lower than a year earlier. Half of China's 9,000 or so toy exporters have gone bust. Taiwan's shipments of notebook computers fell by a third in the month of January. The number of cars being assembled in America was 60% below January 2008.

The destructive global power of the financial crisis became clear last year. The immensity of the manufacturing crisis is still sinking in, largely because it is seen in national terms-indeed, often nationalistic ones. In fact manufacturing is also caught up in a global whirlwind.

Industrial production fell in the latest three months by 3.6% and 4.4% respectively in America and Britain (equivalent to annual declines of 13.8% and 16.4%). Some locals blame that on Wall Street and the City. But the collapse is much worse in countries more dependent on manufacturing exports, which have come to rely on consumers in debtor countries.

Germany's industrial production in the fourth quarter fell by 6.8%; Taiwan's by 21.7%; Japan's by 12%-which helps to explain why GDP is falling even faster there than it did in the early 1990s . Industrial production is volatile, but the world has not seen a contraction like this since the first oil shock in the 1970s-and even that was not so widespread. Industry is collapsing in eastern Europe, as it is in Brazil, Malaysia and Turkey. Thousands of factories in southern China are now abandoned. Their workers went home to the countryside for the new year in January. Millions never came back.

Factories floored

Having bailed out the financial system, governments are now being called on to save industry, too. Next to scheming bankers, factory workers look positively deserving. Manufacturing is still a big employer and it tends to be a very visible one, concentrated in places like Detroit, Stuttgart and Guangzhou. The failure of a famous manufacturer like General Motors (GM) would be a severe blow to people's faith in their own prospects when a lack of confidence is already dragging down the economy.

So surely it is right to give industry special support? Despite manufacturing's woes, the answer is no. There are no painless choices, but industrial aid suffers from two big drawbacks. One is that government programmes, which are slow to design and amend, are too cumbersome to deal with the varied, constantly changing difficulties of the world's manufacturing industries.

Part of the problem has been a drying-up of trade finance. Nobody knows how long that will last. Another part has come as firms have run down their inventories (in China some of these were stockpiles amassed before the Beijing Olympics). The inventory effect should be temporary, but, again, nobody knows how big or lasting it will be.

The other drawback is that sectoral aid does not address the underlying cause of the crisis-a fall in demand, not just for manufactured goods, but for everything. Because there is too much capacity (far too much in the car industry), some businesses must close however much aid the government pumps in. How can governments know which firms to save or the "right" size of any industry? That is for consumers to decide.

Giving money to the industries with the loudest voices and cleverest lobbyists would be unjust and wasteful. Shifting demand to the fortunate sector that has won aid from the unfortunate one that has not will only exacerbate the upheaval. One country's preference for a given industry risks provoking a protectionist backlash abroad and will slow the long-run growth rate at home by locking up resources in inefficient firms.

Nothing to lose but their supply chains

Some say that manufacturing is special, because the rest of the economy depends on it. In fact, the economy is more like a network in which everything is connected to everything else, and in which every producer is also a consumer. The important distinction is not between manufacturing and services, but between productive and unproductive jobs.

Some manufacturers accept that, but proceed immediately to another argument: that the current crisis is needlessly endangering productive, highly skilled manufacturing jobs. Nowadays each link in the supply chain depends on all the others. Carmakers cite GM's new Camaro, threatened after a firm that makes moulded-plastic parts went bankrupt. The car industry argues that the loss of GM itself would permanently wreck the North American supply chain.

Aid, they say, can save good firms to fight another day. Although some supply chains have choke points, that is a weak general argument for sectoral aid. As a rule, suppliers with several customers, and customers with several suppliers, should be more resilient than if they were a dependent captive of a large group.

The evidence from China is that today's lack of demand creates the spare capacity that allows customers to find a new supplier quickly if theirs goes out of business. When that is hard, because a parts supplier is highly specialised, say, good management is likely to be more effective than state aid.

The best firms monitor their vital suppliers closely and buy parts from more than one source, even if it costs money. In the extreme, firms can support vulnerable suppliers by helping them raise cash or by investing in them. If sectoral aid is wasteful, why then save the banking system? Not for the sake of the bankers, certainly; nor because state aid will create an efficient financial industry.

Even flawed bank rescues and stimulus plans, like the one Barack Obama signed into law this week, are aimed at the roots of the economy's problems: saving the banks, no matter how undeserving they are, is supposed to keep finance flowing to all firms; fiscal stimulus is supposed to lift demand across the board. As manufacturing collapses, governments should not fiddle with sectoral plans. Their proper task is broader but no less urgent: to get on with spending and with freeing up finance.

Article by Jesper Lee - Cimb

Wednesday, March 4, 2009

When Will The Armageddon End For World Financial Crisis ?

When will the end of the world end? This week opened with an apocalyptic bang, as the Dow Jones Industrial Average hit an intraday low of 6,705.63 -- the index's lowest level since Oct. 28, 1997. It fell Monday, then fell again on Tuesday. In response, pundits everywhere went picking through their tea leaves one shred at a time, looking for the definitive sign that Armageddon is over, so we can all go back to making money again.

What history shows, however, is that the road to recovery from a catastrophic bear market can be distressingly long. Friday, finance professor Elroy Dimson of London Business School will publish his periodic update of long-term investment returns, which is eagerly awaited each year among the propeller-heads of the investing world.

Along with his colleagues Paul Marsh and Mike Staunton, Prof. Dimson compiles vast amounts of reliable data on 17 stock markets around the world all the way back to 1900. Naturally, the report this year focuses on bear markets. The results shocked even me, and I don't startle easily. Consider this: Prof. Dimson estimates that we'll have to wait nine more years before the Dow average, including dividends, has a 50% chance of hitting its 2007 highs.

The report also challenges the conventional wisdom that a run of bad results in the past must be followed by good returns in the future. Following the worst years, stocks outperformed cash over the next five years by an annual average of 7.1 percentage points. But after the best years, stocks outperformed by 6.8 percentage points annually -- a statistical dead heat.

"If you were trying to find a rule buried in this as to what investors should do to make money," says Prof. Dimson, "it's kind of hopeless." The report hammers home another uncomfortable truth. The belief that stocks become virtually riskless if you just hold onto them long enough -- popularized a decade ago in books like Jeremy Siegel's "Stocks for the Long Run" and James Glassman and Kevin Hassett's "Dow 36,000" -- has been shattered by reality.

No matter how long your investing horizon may be, the risk of owning risky assets can never go to zero.Since 1900, there have been four global bear markets in which stocks have fallen by at least 40%, adjusted for inflation. Two have occurred in the past nine years alone. Stocks are risky not merely because their returns are variable, but because they can wipe you out at various points along the way.

That's the price you must pay -- often at the worst possible time, and never with a moment's notice -- for the hope of higher returns in the end. That hope is real and valid. It is also uncertain. "More people are realizing that equities are still risky even over long horizons," Prof. Dimson says. "So I think some of the reasons that people were willing to pay a high price for risky securities have been curtailed."

It may be a long time before investors are again willing to value stocks at much higher than the long-term average of 15 times earnings. That's important. Expectations can be a major factor in stock valuations for years; you don't always get what you foresee. In 1900, for example, many investors were in a triumphal mood, buoyed by the trend toward peace and prosperity. But over the next five decades, all hell broke loose, and global stock markets returned an annual average of just 3.5% after inflation.

In 1950, Cold War pessimism was the order of the day, and many doubted whether humanity itself would survive the years to come. But progress prevailed; global stock markets gained 9% a year, adjusted for inflation, over the next five decades. The mood today is probably closer to the pessimism of 1950 than to the optimism of 1900, which is itself a hopeful sign for the longer term.

Nor are Prof. Dimson's findings quite as discouraging as they sound at first. If there's an even chance that the Dow will nearly double in nine years, that implies a total return of 7.1% per year, which isn't exactly chicken feed. Since 1900, U.S. stocks have averaged a 6% annual return after inflation. If you knew nothing else -- and none of us do -- then that should be your forecast of the return on U.S. stocks over the long term. That's measured in decades.

In the short run, as just about every investor now realizes, anything can happen. So now is the time to give your entire portfolio a liquidity test. By "entire portfolio," I mean not just your stocks, bonds and mutual funds, but all your assets and liabilities. Do you have enough cash to support yourself (and your family) for six to 12 months if you lose your job? Can you comfortably cover any big expenses (tuition, a house down payment, a wedding) that must be paid in the next few years?

Do illiquid assets like real estate or a private business constitute less than half your wealth? If your answer to any of those questions is no, then you should think twice before sinking more money into stocks. That was true, by the way, even before the bear market. If, however, you aren't yet retired and can answer yes to each of those questions, you should have no hesitation about staying in stocks.

In fact, you should buy more -- especially if your job security isn't contingent on the health of the stock market. Say, you're a tenured teacher, a member of the clergy, a prison administrator, a funeral director or an Internal Revenue Service agent. As Prof. Dimson puts it, "If your children will have a wedding in the near future and you absolutely must pay for it, keep your money risk-free.

But if you want the chance of giving them a wonderful wedding instead of just feeding a few guests, then you should take the risk of investing in equities. "Abraham Lincoln liked to tell the story of a king who ordered his wise men to come up with a single sentence that would never be false. Their solution, which Lincoln called both "chastening" and "consoling," covered all possible contingencies: "And this, too, shall pass away."

My dad, no slouch in the wisdom department, once shared with me his version of the way to encompass all possible futures: "Hope for the best, but expect the worst." Those, it seems to me, are good watchwords for investors, regardless of whether or not the end of the world has ended.

Tuesday, March 3, 2009

Buffett's Worst Year

NEW YORK (Fortune) -- Berkshire Hathaway reported today that its net worth fell in 2008 by $11.5 billion, a decline reducing its per-share book value by 9.6%. That was Berkshire's worst result in the 44 years that Chairman Warren Buffett has run the company and, in fact, only the second decline in that period. The other drop was 6.2% in 2001, a year hurt by 9/11 and other problems in Berkshire's insurance operations.

Per-share book value changes are the customary way that Buffett reports the company's results because this method incorporates all of Berkshire's capital gains and losses whether they are realized or not. A large decline in the value of Berkshire's stock holdings was indeed the central reason that Berkshire reported a down year.

Under the more commonly used yardstick, earnings (which do not reflect unrealized gains or losses), Berkshire reported profits of $3,224 per share for 2008 against $8,548 in 2007. Berkshire's profits stemmed mainly from interest and dividends on its investments and the earnings of its 70 operating subsidiaries. Berkshire has extensive holdings in two industries, insurance and utilities, whose earnings are not closely correlated with those of the general economy.

Even so, the total pretax earnings of all Berkshire's operating businesses (not including insurance for this calculation) fell by a bit, from just over $4,000 per share to just under that figure. The decline reflected the sagging results of the many Berkshire operations that are being hurt by a sour economy, among them those in housing-related businesses (Johns Manville, Shaw Industries) and retail (including furniture, jewelry, and candy companies).

Berkshire's (BRKA, Fortune 500) shares have taken a beating. The A stock dropped from $142,000 at yearend 2007 to $96,600 a year later, and in 2009 it has fallen further, closing at $78,600 yesterday. From its top of $151,000, hit in late 2007, the stock is down 48%.

In his chairman's letter, Buffett states that 2008 had good points mixed in with the bad. But in an unusual admission for the opening pages of the letter (a point easily recognizable by this writer because she has edited Buffett's letter for 32 years) he says bluntly, "During 2008 I did some dumb things in investments."

The dumbest, he said, was buying a large amount of ConocoPhillips stock when oil prices were near their peak and in no way anticipating the dramatic drop in prices that subsequently occurred. Buffett said he still thinks the odds are good that oil will sell in the future at much higher prices than the $40 to $50 per barrel now prevailing. But even if prices should rise, he said, "the terrible timing" of the Conoco purchase has cost Berkshire several billion dollars. Berkshire data show that the company entered 2008 with 17.5 million Conoco (COP, Fortune 500) shares and ended with nearly five times that many, 84.9 million shares.

At yearend, when Conoco stock was about $52, Berkshire's unrealized loss on all its shares (both those bought in 2008 and earlier) was $2.6 billion. But the stock closed yesterday at $37.40. If Berkshire still owns all its Conoco shares, the unrealized loss has grown to $3.8 billion. That hammering may psychically bother Buffett the most -- he detests making faulty judgments about stock prices -- but Berkshire's biggest financial blows in 2008 came from two of the company's long-time holdings: The market value of Berkshire's American Express (AXP, Fortune 500) shares fell by $5 billion, and its Coca-Cola (KO, Fortune 500) stake sank by $3 billion.

Berkshire's huge position in Wells Fargo (WFC, Fortune 500) suffered very little in 2008, but has been hammered this year. The 304 million Wells shares that Berkshire owned at yearend 2008 have lost well over half their market value, falling from $9 billion to $3.65 billion. Berkshire's stake in U.S. Bancorp (USB, Fortune 500) is down by around $800 million.

The good points about 2008 for Berkshire? Well, Buffett had been long looking for places to invest the company's bulging granary of cash, and the tumbling prices in 2008 provided him opportunities (a word obviously not fitting the Conoco purchase).

In the fall, inking a deal announced earlier in the year, he put $6.5 billion into Wm. Wrigley Co., by means of 11.45% subordinated notes (that was $4.4 billion of the investment) and preferred stock that pays a 5% dividend ($2.1 billion) and carries upside possibilities that have not been disclosed. The investments helped finance Mars Inc.'s purchase of Wrigley. The preferred stock opportunities expanded after the financial world fell apart in September.

On October 1, Berkshire bought $5 billion of Goldman Sachs preferred paying a 10% dividend and acquired warrants -- exercisable for five years -- to purchase 43.5 million common shares for $5 billion, a price per share of $115. Goldman has been well under that price most of the time since and closed yesterday at $91.

In a similar deal, carried out on October 16, Berkshire purchased $3 billion of General Electric 10% preferred and acquired warrants -- again, good for five years -- to buy 134.8 million common shares of GE for $3 billion, a price per share of $22.25. GE's stock, weighed down by GE Capital (which, in loans, is effectively the fifth-largest bank in the nation), has been a general disaster since and closed yesterday at around $8.50.

To finance all those purchases, store up for a $5 billion acquisition of utility Constellation Energy that fell through, and keep Berkshire's operations well supplied with cash, Buffett felt obliged, he said in his letter, to sell some portions of holdings that he would have preferred to keep. Principally, he said, the stocks sold were Procter & Gamble, Johnson & Johnson, and Conoco. Berkshire's positions in all three were established in the last few years, though the P & G holding materialized when that company merged in 2005 with Gillette, whose stock Berkshire had owned since the early 1990s.

The paradox of Buffett's investment year will be evident: To put Berkshire's pile of cash to work at prices he considered attractive -- "I like those preferreds," he said recently -- he had to endure a terrible stock market that savaged many of the stocks the company already held. He has always declared, though, that he is perfectly content to see Berkshire's stocks fall in price, because that allows him to buy more of them cheaply.