A Triple-A Punt

Treasury's reform plan gives the credit raters a pass.
If world-class lobbying could win a Stanley Cup, the credit-ratings caucus would be skating a victory lap this week. The Obama plan for financial re-regulation leaves unscathed this favored class of businesses whose fingerprints are all over the credit meltdown.
The government-anointed judges of risk at Standard & Poor's, Moody's and Fitch inflicted upon investors the AAA-rated subprime mortgage-backed security. They also inflicted upon the world's nest eggs the even more opaque AAA-rated collateralized debt obligation (CDO). Without the ratings agency seal of approval -- required by SEC, Federal Reserve and state regulation for many institutional investors -- it would have been nearly impossible to market the structured financial products at the heart of the crisis. Yet Team Obama suggests only that regulators reduce the agencies' favored role "wherever possible."
It's a revealing phrase, implying that there are situations when it's appropriate to rely on ratings from the big three instead of actually analyzing a potential investment. Can anyone name one? Probably not, which makes one wonder how the ratings-agency lobby could be so effective.
The truth is that the strongest defenders of this flawed system are mutual funds, state pension administrators and the federal regulators now managing the various bailout programs. Digging into the underlying assets in a pool of mortgages or judging the credit risk in a collection of auto loans is hard work. But putting taxpayer or investor money in something labeled "triple-A" is easy. Everyone is covered if the government's favorite credit raters have signed off.
The Obama plan also calls for regulators to "minimize" the ability of banks to use highly-rated securities to reduce their capital requirements when they have not actually reduced their risks. Minimize, not eliminate? Does the Treasury believe that some baseline level of fakery is acceptable in bank financial statements? To review, a critical ingredient in the meltdown was the Basel banking standards pushed by the Federal Reserve. Among other problems, Basel allowed Wall Street firms to claim that highly-rated mortgage-backed securities on their books were almost as good as cash as a capital standard.
The Obama plan does make plenty of vague suggestions, similar to those proposed by the rating agencies themselves, to improve oversight of the ratings process and better manage conflicts of interest. The Obama Treasury has even adopted the favorite public relations strategy of the ratings agency lobby: Blame the victim. "Market discipline broke down as investors relied excessively on credit rating agencies," says this week's Treasury reform white paper. After regulators spent decades explicitly demanding that banks and mutual funds hold securities rated by the big rating agencies, regulators now have the nerve to blame investors for paying attention to the ratings.
Even the Fed, which until recently would accept as collateral only securities that had been rated by S&P, Moody's or Fitch, has lately acknowledged the flaws in this approach. The New York Fed has anointed two more firms, DBRS and Realpoint, to judge the default risk of commercial mortgage-backed securities eligible for the Term Asset-Backed Securities Loan Facility (TALF). Since the passage of a 2006 law intended to promote competition, the SEC has also approved new firms to rate securities that money market funds and brokerages are required to hold.
But inviting more firms to become members of this exclusive club isn't the answer. As long as government requires investors to pay for a service, and then selects which businesses may provide it, it's unlikely investors will get their money's worth. History says it's more likely that investors who use the agencies' "investment-grade" ratings as a guide will be exposed to severe losses -- ask people who went long on Enron and WorldCom.
It's time to let markets decide how to judge creditworthiness. One lesson of the crisis is that the unregulated credit default swap (CDS) market provided a more accurate measurement of the risk of financial firms than the government's chosen ratings system. Apparently even the largest provider of these government-required ratings, S&P, has taken this lesson to heart. The company recently introduced a new "Market Derived Signals" model that incorporates the prices of CDS contracts "to create a measure that facilitates the interpretation of market information."
This looks like a signal that even the prime beneficiaries of a government policy believe that the policy failed. So why won't the Obama Administration embrace real reform?

Pensions Crisis

This is future of pensions:

http://www.ft.com/cms/s/0/e82a672e-4ab4-11de-87c2-00144feabdc0.html?nclick_check=1

The end of Dollar in China

In a survey of major Chinese economists, more than two-thirds are reportedly bearish on the prospect of China increasing its holdings of US government bonds, and believe instead the nation should putting more of its hard-earned into gold.

According to a China Business News survey of 70 Chinese economists (including one foreign economist), the exact figure is 71.4% anti-bonds and pro-gold.

The use of China's huge foreign exchange reserve is a topic of concern and controversy. The remaining 28.6% of those polled believe China should continue to buy U.S. Treasury bonds. 38.6% think that China should not continue to buy, but also should not to sell US bonds. 32.8% believe that China should unload the bonds, 22.8% of whom think we should have a slight sell-off, while 10% think China should drop them like a bad habit.

All this is against a backdrop of China surpassing Japan to become America's largest US bond holder and of the ever-widening global financial kerfuffle.

The survey also brings to light the question of whether China’s gold reserves should be increased. Recent gold futures prices broke through US$1000/ounce, making gold the most outstanding asset in the financial turmoil. One economist thinks China’s current gold reserve of 600 tons is an unnecessary load and that the opportunity should be grasped to sell off a bunch of it at a good price.

21.4% of economists said that the gold reserve level was fine and leave it alone.

But 75.7% of the economists asked believe that China should increase its holdings of gold, with 48.6% opting for a slight increase while 27.1% think China should pile in.

Will The Dollar Collapse?

Today, in what we hope will be a regular feature, we bring you a post from our very good friend “Hunter at Distressed Debt Investing,” a pen-name for a financial professional who has asked us to keep his or her identity secret. For his very first column, he introduces us to an important analysis about the potential for inflation and deflation.

When I set out to start a distressed debt investing blog, I promised myself I would focus on bottoms-up investing and analysis. Bankruptcy, valuation, and fundamental analysis is where I get my edge.

That being said, sometimes I read articles, blog posts, or emails sent to me from colleagues or friends that need to be shared with a larger audience because they are just that insightful and informative. I bet every single one of us would have liked to hear John Paulson's thoughts on the U.S. Housing Market and the Securitization Market in 2005 - and then we all would have subsequently made billions of dollars shorting subprime.

Today, I received an email from Sahm Adrangi, who I met at Monish Pabrai's annual meeting a few years back. Sahm used to work at a large distressed debt hedge fund before striking out on his own and forming his own investment advisory firm. I would recommend everyone that enjoys what follows to email Sahm (sadrangi [at] kerrisdalecap [dot] com) and get on his Bi-Weekly email distribution list. Incredibly inciteful stuff (including A LOT of commentary on distressed debt investing). You will not be disappointed.

I think there are a lot of interesting investment ideas that come out of this commentary (especially with distressed companies that have the ability to raise prices), we will talk about those in a future post. Without further ado...

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The Dollar Crisis

Quick Synopsis:

* Abandoning the gold standard in 1971 has resulted in large global trade imbalances and a massive buildup of foreign currency reserves
* These trade imbalances and buildup of foreign reserves have resulted in frequent booms and busts since 1971
* The Japanese bust of 1989, the Asian economic crisis of 1997, and the current US credit market collapse have resulted from the post-1971 paper money monetary system
* Abandoning the gold standard has gradually resulted in a very overvalued US dollar, and that the dollar is headed for disaster
* “The dollar standard is inherently flawed and increasingly unstable. Its collapse will be the most important economic event of the 21st century.”

This week, I’m doing another book review, this time on “The Dollar Crisis” by Richard Duncan. Before I begin, I’ll make a prediction, since I’m an investor and my job is to predict. I increasingly believe that the dollar will collapse, and its ramifications could be as violent as when the credit markets cracked in July 2007. Currency collapses are nothing new, just as the bursting of a credit market bubble was nothing new. A dollar collapse could very well lead to carnage in domestic asset markets, whether it be the stock market, bond market, etc. Also, US imports and the overvalued dollar are fueling many of the export-oriented economies abroad, so a dollar collapse could wreak havoc on foreign asset markets as well. And once it happens, we’re going to view the collapse of the dollar as an obvious event that we should have long seen coming. Just as we now view the subprime wreckage and bursting of the real estate bubble as an event we should have easily predicted.

The problem is timing. Does the dollar collapse in 2009, or 2015? And is it a slow depreciation, or a sudden 50% fall? Those are tougher questions. Richard Duncan predicted the dollar’s demise in 2002. His error of timing discredited an otherwise brilliant book.

In a sentence, “The Dollar Crisis” is about how the world changed in 1971. That was when Richard Nixon dropped the gold standard (or its close cousin, the Bretton Woods international monetary system). Here’s the youtube video: Youtube Bretton Woods. The end of the gold standard ushered in a new era of large trade imbalances and the buildup of foreign currency reserves, and these trade imbalances and large foreign currency reserves have had significant impacts on the global economy that many people don’t realize. Huge trade imbalances and large foreign reserves didn’t really exist during the gold standard. During the gold standard, a country’s money supply was determined by the amount of gold it had. Banks’ reserves were either gold or indirectly tied to gold, and so the amount of money they could lend, and that the nation could print, was backed by the nation’s gold reserves. To see the implications of that sort of monetary system on trade imbalances, let’s take a hypothetical United States and China, where the US is buying lots of goods from China. The US gets goods; China gets dollars. China takes its excess dollars, gives them to the US, and gets gold in exchange. The US gold reserves would decline, causing credit contraction in the US. This would lead to recession; prices would adjust downwards; and falling prices would enhance the trade competitiveness of the US. The US would stop exporting so many goods from China as China’s costs of production begin rising relative to the United States’. The US would stop being a net importer; gold would flow back in; and equilibrium on the balance of payments would be re-established.

Under the gold standard, trade imbalances were unsustainable and self-correcting.

Today, in the system of fiat money, that’s no longer the case. The US gets goods; China gets dollars. China takes its excess dollars, and invests them back in the US, whether in the form of treasury bonds, Freddie Mac mortgage-backed securities, or US corporate bonds. The US takes those dollars and buys more Chinese goods. China gets more excess dollars and reinvests in the US. The US buys more Chinese goods. And on and on, until the US credit market debt as a % of GDP goes from 150% in 1970 to 350% in 2008. Just as reference, that number was 130% in 1950. During the gold standard, debt-to-GDP hardly grew. Under fiat money, it has soared. America isn’t awash in debt because we’re inherently greedy, profligate consumers. It’s because money is no longer backed by gold. China and Japan eagerly reinvest their dollars back in the United States so as to keep their currencies low relative to the US dollar. American consumers and companies happily borrow the money foreigners are throwing their way. The party lasted until 2007, when Americans finally began having trouble paying their enormous debts.

Duncan’s book discusses the implications of the large trade imbalances and buildup of foreign reserves that resulted from the new paper money system introduced in 1971. The book is lengthy and detailed and this email will not do it justice. But I’ll discuss some of my favorite topics from it.

First, the massive Japanese stock market and property bubble in the 1980s, and subsequent decade-long recession in the 1990s, was the product of its large trade surplus and massive buildup of foreign currency reserves. To understand this, we need to see how trade surpluses are analogous to money creation and asset inflation. When a country has a trade surplus, its reserve assets increase, and this essentially leads to credit creation. If a dollar comes into Japan due to a trade surplus, two things can happen. First, it can go into a Japanese bank, increasing the total amount of reserves that bank can lend off of, and thus resulting in credit creation. Or it can be bought by the central bank with newly printed currency, which again is new money entering the Japanese bank, again leading to credit creation. The only way the Japanese central bank can prevent this credit creation is by issuing enough bonds to soak up an equivalent amount of the new money that’s just entered the banking system as a result of the trade surplus. If they don’t, the result will be massive credit creation. And credit creation leads to asset inflation, because the new money has to be invested somewhere. That somewhere is usually stocks, property and debt.

Japan’s total reserves minus gold rose from around $5bn in 1970 to $100bn in 1989. Its money supply (including M2 and CDs) grew from 50 trillion yen to 450 trillion yen by 1989. Without the gold standard, Japan’s trade surplus persisted, leading to massive reserve buildups and huge credit creation. All this newfound credit had to find a home, and it went into the Japanese stock market and property markets. The Japanese stock market went up by more than 12 times from 1970 to 1989, with the Nikkei index trading at more than 60x PE before it crashed (today, it’s under 10x PE). Domestic credit as % of GDP went from 140% to more than 250%. Ultimately, incomes could not rise fast enough to catch up with the tremendous asset inflation that was occurring. In 1989, the Japanese stock market and property bubbles popped as debtors couldn’t pay their creditors; the Japanese banking system became flush with bad loans; and a painfully long recession ensued.

Second, Duncan paints a similar story for the Asian financial crisis that occurred in 1997. He shows how foreign reserves multiplied dramatically from 1988 to 1997 in Indonesia, Korea, Malaysia, and Thailand, rising 3 to 6 times over that period depending on which country you’re looking at. Their reserves buildup was due to Japan relocating its manufacturing capacity to the rest of Asia in response to a sharply appreciating yen. Foreign capital entered the banking system and resulted in excessive credit creation. Like Japan, those economies experienced rapid economic growth and rapid asset price inflation. Overcapacity resulted, and ultimately, the bubble popped, leaving a lot of bad loans in its wake.

Third, he discusses how the original Great Depression in the US was also the result of reserve buildups. During World War I, governments dropped the gold standard in order to print enough money to finance the wars. The result: huge trade imbalances resulted, leading to credit creation in the US. Specifically, the United States was the producing the goods that the Allies were using to fight the war. US gold reserves rose 64% from 1914 to 1917 as Europe exchanged its gold for American goods. The US also began accepting government debt from the Europeans. The Europeans had to drop the gold standard, because Europe couldn’t afford to suffer the recession and credit contraction that would result from their fast-depleting gold reserves. In the US, the increase in reserves led to a doubling of the credit base from 1914 to 1920, which led to a boom in industrial production. When the real economy was no longer able to profitably invest the available liquidity in new plant and equipment due to overcapacity and falling prices, increasing amounts of money were shifted into the stock market. Ultimately, the bubble popped, share prices plunged, credit contracted and a banking crisis developed. Duncan’s thesis: it wasn’t infectious greed that caused the Roaring 20s and subsequent Great Depression. It was excessive credit creation that resulted from trade balances during and after World War I, which in turn resulted from the gold standard being temporarily dropped during World War I.

Duncan also makes an interesting comment about just how much more frequent banking crises have been since 1971. He quotes a Bank of England study in 2001 that referenced a historical study by Bordo, Eichengreen, Klingebiel and Martinez-Peria that said that only 1 major banking crisis occurred in the quarter of a century after 1945, but 19 since. During the Bretton Woods period, systemic banking failures were not common because international reserve assets grew slowly. But when the world’s monetary base began expanding exponentially, they became pandemic.

After recounting various examples of how trade imbalances that were not sustainable under the gold standard have created boom-bust cycles post-1971, Duncan discusses the unsustainability of the current dollar standard that has replaced the Bretton Woods system. Over the last 30 years, the United States has been transformed from the world’s largest creditor into the world’s most heavily indebted debtor. The dollar standard has incentivized countries with trade surpluses to reinvest their dollars back into US dollar-denominated assets, because that’ll keep their currencies low and fuel their export-oriented growth economies. The problem is this: at some point, the US will reach a point where it can’t pay its debts. So at some point, surplus countries will be forced to convert their dollar currencies into their own currencies, causing a sharp appreciation in their currencies and a sharp decline in the dollar. That shift will restore equilibrium to the US balance of payments, but it will also throw the major exporting nations into recession (or exacerbate current recessions) as their exports to the United States collapse (or further collapse).

Duncan has a fascinating chapter called “Global Recession: Why, When and How Hard”. When you pick up the book, turn to page 175. Written in 2002, the chapter is stunningly prophetic. When Duncan’s book came out in 2003, it was soon discredited, because the boom from 2004 to 2007 appeared to prove him dead-wrong. But his ability to predict the events of the past two years in gory detail, back in 2002, is somewhat mind-numbing. For instance, he has a subchapter titled “When?”, with the following sentence reading “When the U.S. property bubble pops. In 2002, the global economy is being supported by an American shopping spree that is being financed by a bubble in the U.S. property market…. The housing bubble is the main explanation for the resilience of the American consumer. Sadly, bubbles pop… In August 2002, the 30-year fixed-rate mortgage fell to a record low of 6.13%. Rarely has global prosperity relied so heavily on one number.” Sounds like obvious stuff nowadays. But written back in 2002? Neat. He also discusses the securitization markets, and accurately predicts the implosion of the asset-backed securities markets. And the collapse of Freddie Mac and Fannie Mae. And the massive banking failures currently sweeping across the nation. His problem was an issue of timing – Duncan was too early in his forecast, and didn’t sufficiently account for governments’ abilities to temporarily reflate their economies by lowering interest rates and pumping money into the world. But these sorts of temporary solutions could only last so long – at some point, a country with rapidly expanding debts becomes no longer able to pay those debts.

There’s one final topic I want to address. One of the more complicated ideas of the book, for me, was his discussion of inflation / deflation. Duncan explains how the global credit creation that resulted from abandoning Bretton Woods has led to global overcapacity. This overcapacity has led to disinflation / deflation, since there is too much global supply in the world relative to global demand, resulting in low prices. Overinvestment causes excess capacity, and excess capacity causes deflation. Second, trade imbalances have allowed export-oriented economies to keep their currencies low relative to the dollar (the currency of the world’s largest consumer), which has also been disinflationary / deflationary. It’s an interesting discussion, because it addresses a question I’ve always had: If we’ve had such strong economic growth from 1982 to 2007, why was there so little inflation (at least until 2004 to 2007, when commodities began surging). Duncan’s answer is (i) ‘global overcapacity’ and (ii) ‘trade imbalances + free trade’. When the world goes into recession, these deflationary forces should only accelerate. He also questions fiscal and monetary policies in this deflationary recessionary environment. He writes “Monetary policy works through credit expansion. When the government wishes to expand the money supply, it buys assets (such as government bonds) from the banks, increasing their liquidity. In theory, the banks, in turn, lend more to businesses… thereby eventually stimulating consumption and the economy overall. In a post-bubble economic environment, characterized by excess capacity, bankrupt corporations, and overly indebted consumers, monetary policy does not work… there are neither a sufficient number of creditworthy borrowers to lend to… nor a sufficient number of clients who want to borrow, due to the lack of money-making investment opportunities left in the gutted marketplace. Consequently, the increased money supply never reaches the consumers and personal consumption does not revive.”

So today, we’re in the following situation: (i) global overcapacity and declining demand; (ii) governments printing money; and (iii) potential collapse of the dollar due to the trade imbalance. The question is: are we heading for deflation or inflation? Duncan seems to admit that he doesn’t really know. In the 2005 edition of his book, he appends an additional chapter discussing how the US and Japanese central banks revived the global economy in 2003 to temporarily stretch out the disequilibria several years longer. He ends that final part, and the book, with a chapter titled “Bernankeism: Anticipating the Policy Response to Global Deflation”. He lays out various scenarios by which the temporary boom can end (the ultimate scenario ended up being a combination of scenarios #2 and #3 (#2 was “A US asset price bubble that drives property prices so high they can’t be financed even at very low interest rates” and #3 “A meltdown of the under-regulated US$200 trillion derivatives market”). He discusses how the dollar will collapse under any one of the scenarios.

Then he writes: “the only option left to stimulate aggregate demand would be to drop paper money from helicopters. That too would fail, however, for who would accept paper dropped from helicopters in exchange for real goods and services? Hyperinflation would quickly set in. Economic transactions would then be conducted through barter rather than via the medium of a debased script. Eventually, a gold standard would re-emerge… Exactly how these events will unfold is impossible to forecast; nevertheless, the eventual outcome is within sight. The dollar standard is inherently flawed and increasingly unstable. Its demise is imminent. The only question is, will it be death by fire – hyperinflation – or death by ice – deflation? Fortunes will be made and lost, depending on the answer to that question.”

Spanish banks pass the Stress Test without problems

By STEPHEN FIDLER and NEIL SHAH

The U.S. government's stress tests are fueling concerns that European banks could be falling behind in their efforts to bolster their own finances.

Unlike in the U.S., there has been no major policy initiative to force banks in Europe to increase capital cushions, and governments have intervened only on a piecemeal basis. Meanwhile, as U.S. banks pile in with efforts to raise capital from investors, European banks aren't taking advantage of a stock rally to do the same.

Getty Images

The Bank of Ireland and five other financial institutions would need billions of dollars more to meet some capital standards used in the U.S. stress testing of its banks, one analysis found.

"Compared to the U.S., the European banking system is rapidly being left behind," said Philip Finch, bank analyst at UBS AG. "If anything, the rally that has taken place has allowed complacency to come back at the bank level and at the policy level."

European banks have raised only about 40% of the $1 trillion they need to cover losses since the beginning of the financial crisis and maintain healthy capital levels, according to the latest estimates from the International Monetary Fund.

By contrast, U.S. banks have raised or announced plans to raise about two-thirds of the $666 billion the IMF believes they need.

The divergence partly reflects a different attitude toward how to scrutinize battered banks. The U.K., one of a handful of European countries to stress-test its banks, never disclosed the parameters or detailed results.

A spokeswoman for the Committee of European Bank Supervisors said national authorities are carrying out stress tests of their domestic banking systems, with results due by September. The examinations are aimed at assessing the European financial system's resilience to shocks, not the capital needs of individual banks. The findings and methodology won't be disclosed publicly.

Reuters

Some bankers prefer the discreet approach. The U.S. strategy was "not the way to instill confidence in the process," Stephen Green, chairman of HSBC Holdings PLC, said in an interview Monday, noting the haggling between banks and regulators. But that openness boosted the credibility of the U.S. stress tests -- and last week's results -- in the eyes of some analysts and investors.

One reason European banks are behind those in the U.S. in raising capital: The economic downturn took as much as a year to ripple across the Atlantic Ocean. That delayed the pain for most banks, except a small number of European financial institutions that invested in shaky U.S. assets or U.K. banks hurt by a decline in real-estate values.

European banks now face potential losses from risk-taking that U.S. banks largely avoided, such as investments in Eastern Europe, which is suffering from a severe recession. Banks in Europe also are more vulnerable to skittish wholesale money markets because of their higher ratios of loans to deposits.

Weakened banks in Europe have a potentially bigger economic impact than U.S. financial institutions do, since some 80% of lending to companies in Europe is through banks, compared with only one-fifth in the U.S. If replenishing capital levels causes European banks to pull back on lending, it could slow economic recovery.

Of the $600 billion in additional capital still needed by European banks, financial institutions in the 16-nation euro zone need $375 billion, followed by $125 billion in the U.K. and $100 billion elsewhere on the Continent, according to the IMF. The IMF's figures are larger than other estimates, partly because they include all banks. In Germany, many of the so-called Landesbanks owned by individual German states are seen as needing more capital.

The U.K. has injected £80 billion ($121.88 billion) of new capital into its banks and is insuring some £562 billion of bank assets under a government program aimed at putting a lid on losses.

Analysts at investment firm Keefe, Bruyette & Woods Ltd. who attempted to replicate the U.S. stress tests for European banks came up with what they called a "broadly positive" result. Six banks with widely traded shares, including Commerzbank AG and Danske Bank AS, would need to raise a total of only about €8 billion ($10.9 billion) in capital to meet the 4% equity Tier 1 capital ratio used in the U.S. tests.

In reality, the European banks probably would want to raise a lot more capital -- as much as €60 billion -- to maintain investor and customer confidence under a bad scenario similar to one used by the U.S. government, said Andrew Stimpson, a KBW analyst.

Tonny Thierry Andersen, finance chief at Danske Bank, said the Danish bank raised about 26 billion kronor ($4.76 billion) in early May, making it the best-capitalized bank in the Nordic region. A representative for Commerzbank said the German bank is "capitalized adequately."

New Zapatero's stimulus plan

Spain's prime minister on Tuesday unveiled new rescue measures to help bring the economy out of recession, including tax cuts for small businesses, aid to encourage car purchases and a plan to reduce a huge stock of unsold new homes.

Jose Luis Rodriguez Zapatero, who presented the package before Parliament in the yearly State of the Nation debate, faced hostile opposition parties, with some lawmakers questioning the measures' benefits as well as the premier's credibility.

Announcing the latest of a string of rescue plans the government says has cost it €50 billion ($67.87 billion) so far, Mr. Zapatero sought to stay on the offensive on economic matters as his party prepares to go before voters in European Parliament elections on June 7.

"The government aims to give a new push to its action against the crisis. It will do so with a twin goal in the coming months: curbing job losses and preparing economic recovery with a new growth model," Mr. Zapatero said.

Spain was once one of Europe's biggest success stories with more than a decade of solid expansion. But the economy has soured dramatically over the past year or so, as a boom fueled by torrid housing construction and consumer spending collapsed.

Spain now has the European Union's highest unemployment rate, at 17.4%, and some forecasts say it will hit 20%. The government had officially forecast the economy will contract 1.6% this year but now says that figure will be even worse, while the International Monetary Fund says it will shrink by 3%.

To aid the housing sector, stuck with an estimated 650,000 unsold homes, Mr. Zapatero said the government wants to encourage purchases now by eliminating tax breaks for all but low-income earners starting in 2011.

After that, home buyers making more than €24,000 a year will no longer be able to deduct the interest they pay on their mortgage. The break will stand for those who bought homes before then.

The prime minister also announced €25 billion in funding to encourage environmental and sustainable economic development projects, aiming to wean Spain from its dependence on bricks and mortar.

In the auto sector, where Spain is Europe's third largest manufacturer although sales have plummeted amid the recession, Mr. Zapatero announced a plan to provide €2,000 in direct aid to people who buy new cars. Half would come from manufacturers, and Spain's central and regional governments will provide the rest.

Zapatero also said taxes will go down 5 percentage points for the next three years for companies that have 25 or fewer employees and do not lay off anyone in 2009.

The debate was to last through Wednesday, with opposition leaders also slated to speak. No vote on the new measures is planned yet.

Fed study puts ideal US interest rate at -5%

By Krishna Guha in Washington April 2009

The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve’s last policy meeting.

The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation.

A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent.

Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150bn (€885bn, £788bn) increase policymakers authorised at the last meeting, which included $300bn of Treasury purchases.

The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week’s policy meeting.

The Fed is not likely to embark on any substantial new programmes at this meeting, in large part because it will not have downgraded its economic forecasts since the last meeting. Indeed, Fed officials may see the risks to the economy as a little more balanced than they were in March, though policymakers probably still see these risks as overall weighted to the downside.

This could set the stage for a more detailed discussion of the framework that will ultimately govern the Fed’s exit strategy.

There is, though, a small but intriguing possibility that the Fed could follow the Bank of Canada in setting out an explicit timeframe over which it expects to keep short-term rates at virtually zero.

While this novel strategy is likely to at least provoke debate within the US central bank, which has shown itself willing to adopt measures first deployed elsewhere, many policymakers would probably be wary of adopting the Canadian approach, following their own unsatisfactory experience in providing guidance on interest rates after the dotcom bubble burst.

Others may feel the Canadian approach would be ineffective as it may not be seen as credibly binding the central bank’s future decisions.

Still, many Fed officials expect they may well keep rates near zero for another 18 months to two years and some might see value in making this more explicit.

Ben Bernanke, chairman, sees the massive expansion of bank reserves caused by the Fed’s unconventional operations as already providing a way to assure the market that the Fed will not be in a position to raise rates for quite some time to come.

The last meeting saw the Fed buy long-term treasuries for the first time in decades. The large initial impact of the move on markets is no longer visible, but officials think the policy was reasonably successful.

Previous staff analysis suggested the $300bn purchase would reduce the yield on 10-year treasuries by 25-35 basis points, and officials think the rate today is about this much lower than it would have been if they had not started buying.

Further purchases are possible, particularly if the Fed again downgrades its economic forecasts. The staff analysis comparing unconventional operations to interest rate cuts suggests more might be needed anyway.

However, policymakers are likely to watch how financial conditions respond to the already-authorised interventions before deciding whether to step up much further.

Moody's Spanish Senior Vice President

Today Carlos Winzer was in ICADE speaking about the agency ratings. It is a very good opportunity to know what he thinks about credit crunch: they are guilty or victim?

Moody's said rating AAA only said that there is no possibility of default (ok, only 0.4%) , but this is true...or not?:

- Lehman Brothers Institutional Funds Government Portfolio -- Aaa
- Lehman Brothers Prime MMF - Aaa
- Lehman Brothers Sterling Liquidity Fund -- Aaa
- Lehman Brothers Institutional Liquidity Funds Prime - Aaa
- Lehman Brothers National Municipal Money Fund - Aaa
- Lehman Brothers Tax Free Money Fund - Aaa
- Lehman Brothers Prime Reserve Fund -- Aaa
- Lehman Brothers Euro Liquidity Fund -- Aaa
- Lehman Brothers US Dollar Liquidity Fund --Aaa
- Lehman Brothers Institutional Liquidity Funds Treasury - Aaa

Another question is about the possibility to spread the business of agencies rating: Right now they are a Oligopoly with a huge power able to create the opinion in one day that a country have to file for the bankruptcy . In US and Europe there are antitrust laws so it's not a remote possibility that the government obligates to split the rating agencies

The end of low-tax countries

Low-tax countries hit at US crackdown plan

By Vanessa Houlder in London and Michael Steen in,Amsterdam. Financial Times

The proposed US crackdown on corporate tax avoidance has provoked an angry response from low-tax countries used heavily by the multinationals that are the target of the Obama administration's reforms.

The US administration, in unveiling the plan on Monday, highlighted the Cayman Islands, Bermuda, the Netherlands and Ireland. The US moves are also likely to be felt in Luxembourg, Switzerland and Singapore where profits reported by US subsidiaries often appear disproportionately high, given the size of those countries.

"We're not happy," said Jan Kees de Jager, the Netherlands' finance secretary. "We have a very transparent policy and we'll work with the US. I expect there'll be a clarification [from the US administration] and we'll not end up on lists like this in future, between Bermuda and Ireland."

Officials and tax experts pointed to the "very average" corporate tax rates in the Netherlands, which has corporation tax of 25.5 per cent, and noted that the country had successfully attracted foreign investors partly because of its location and educational achievements.

However, the Netherlands has no taxes on capital gains and low taxes on dividends, which can make it an attractive location for the subsidiary holding companies of foreign firms.

The Cayman Islands warned that the proposed changes could have unintended consequences. Alden McLaughlin, a minister, defended the islands' role in creating "efficiencies" that benefited business. "Blocking access to the Cayman Islands may have very real unintended negative consequences for international trade and the economies of large countries," he said.

Paula Cox, Bermuda's finance minister, said the announcement was not unexpected but added: "Bermuda will continue to put forth its views in an appropriate manner and at the appropriate level with decision-makers on Capitol Hill."

Critics of President Barack Obama's proposed reforms said the move would impede US multinationals' ability to compete abroad, as most other countries exempt foreign profits from tax. Companies also stepped up their lobbying against the plan by warning that US multinationals could become more vulnerable to takeovers by foreign competitors.

The reduced attraction of the US as a base for multinationals could make them more likely takeover targets, if the acquirer restructured the business to remove foreign subsidiaries from the US tax net, some tax experts said.

Catherine Schultz of the National Foreign Trade Council, which represents multinationals, said: "If there's a reasonable business and strategic reason for the investment anyway, taxes may very well be the factor that speeds the transaction along."

Dave Camp, the lead Republican on the House ways and means committee, said: "Ironically, what the president proposes will make it more likely that American companies will be bought by their foreign competitors."

The attention of international businesses focused on changes designed to "level the playing field" by restricting what the US administration described as tax advantages for creating jobs overseas. This would tighten up the system that allows US multinationals to defer paying US taxes on profits made on overseas investments. Under the reforms, multinationals would no longer be able to claim tax deductions on most foreign expenses, such as interest costs, until it repatriated earnings.

The reforms would also close loopholes that allow businesses to inflate tax credits for foreign taxes that can be deducted against US tax bills, and reform the "check the box" rules that allow entities to elect whether to be taxed as corporations or partnerships.

We Can't Subsidize the Banks Forever

Government has to show it can handle major insolvencies

Matthew Richardson and Nouriel Roubini | May 5, 2009

The results of the government's stress tests on banks, to be released in a few days, will not mark the beginning of the end of the financial crisis. If we are to believe the leaks, the results will show that there might be a few problems at some of the regional banks and Citigroup and Bank of America may need some more capital if things get worse. But the overall message is that the sector is in pretty good shape.

Chad Crowe

This would be good news if it were credible. But the International Monetary Fund has just released a study of estimated losses on U.S. loans and securities. It was very bleak -- $2.7 trillion, double the estimated losses of six months ago. Our estimates at RGE Monitor are even higher, at $3.6 trillion, implying that the financial system is currently near insolvency in the aggregate. With the U.S. banks and broker-dealers accounting for more than half these losses there is a huge disconnect between these estimated losses and the regulators' conclusions.

The hope was that the stress tests would be the start of a process that would lead to a cleansing of the financial system. But using a market-based scenario in the stress tests would have given worse results than the adverse scenario chosen by the regulators. For example, the first quarter's unemployment rate of 8.1% is higher than the regulators' "worst case" scenario of 7.9% for this same period. At the rate of job losses in the U.S. today, we will surpass a 10.3% unemployment rate this year -- the stress test's worst possible scenario for 2010.

The stress tests' conclusions are too optimistic about the banks' absolute health, although their relative assessment is more precise, because consistent valuation methods were used. Still, with Thursday's announcement of the results, it shouldn't be a surprise when the usual suspects emerge. We fear that we are back to bailout purgatory, for lack of a better term. Here are some suggestions for how to extricate ourselves.

First, while Treasury Secretary Timothy Geithner's public-private investment program (PPIP) to purchase financial firms' assets is not particularly popular, we hope the government doesn't give up on it. True, the program offers cheap financing and free leverage to institutional investors, which will lead to the investors overpaying for the assets. But it does promote price discovery and remove the assets from the bank's balance sheets -- necessary conditions to move forward.

And to minimize the cost to taxpayers, banks must not be allowed to cherry-pick which legacy assets to sell. All the risky loans and securities banks were never meant to hold should be on the block. With enough investors participating in the PPIP program, the prices of the assets should be competitive, and there should be no issue of fairness raised by the banks.

Second, the government should stop providing capital, loan guarantees and financing with no strings attached. Banks should understand this. When providing loans to troubled companies, they place numerous restrictions, called covenants, on what these firms can do. These covenants generally restrict the use of assets, risk-taking behavior, and future indebtedness. It would be much better if the government focused on this rather than on its headline obsession with bonuses.

For example, consider the fact that the government, while providing aid to banks, did not restrict their dividend payments. A recent academic study by Viral Acharya, Irvind Gujral and Hyun Song Shin (www.voxeu.org) notes that banks only marginally reduced dividends in the first 15 months of the crisis, paying out a staggering $400 billion in 2007 and 2008. While many banks have been reducing their dividends more recently, bank bailout money had been literally going in one door and out the other.

Consider also recent bank risk-taking. The media has recently reported that Citigroup and Bank of America were buying up some of the AAA-tranches of nonprime mortgage-backed securities. Didn't the government provide insurance on portfolios of $300 billion and $118 billion on the very same stuff for Citi and BofA this past year? These securities are at the heart of the financial crisis and the core of the PPIP. If true, this is egregious behavior -- and it's incredible that there are no restrictions against it.

Third, stress tests aside, it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway.

And we shouldn't hear one more time from a government official, "if only we had the authority to act . . ."

We were sympathetic to this argument on March 16, 2008 when Bear Stearns ran aground; much less sympathetic on Sept. 15 and 16, 2008 when Lehman and A.I.G. collapsed; and now downright irritated seven months later. Is there anything more important in solving the financial crisis than creating a law (an "insolvency regime law") that empowers the government to handle complex financial institutions in receivership? Congress should pass such legislation -- as requested by the administration -- on a fast-track basis.

The mere threat of this law could be a powerful catalyst in aligning incentives. As the potential costs of receivership are quite high, it would obviously be optimal if the bank's liabilities could be restructured outside of bankruptcy. Until recently, this would have been considered near impossible. However, in 2008 there was a surge in distressed exchanges of debt for equity or preferred equity.

Still, the recent negotiations with Chrysler's creditors suggest large obstacles. The size and complexity of large banks' capital structures make debt-for-equity exchanges an even taller task, particularly because creditors will want to hold out for a full bailout along the lines they have been receiving.

The government should be able to dangle an insolvency law as an incentive to cooperate. This will result in a $1 trillion game of chicken. But given the size of the stakes, and the alternative of the taxpayers continuing to foot the bill, it's the best way forward.

Messrs. Richardson and Roubini are professors at New York University's Stern School of Business.

From Wall Street Journal

Merril Lynch Sellers

I'm very surpresed. I discover the sellers work in Private Banking. They know something about finance, they have a good speech and that all.

Merril Lynch sellers try to get new clients with a UVA rays tanned skin and nothing to create nothing to commit theyself...crisis is a good test for Merry Lynch and ML has lost.

Conspiracy Theory, Exposed

by Matthew Malone

With Goldman emerging from the financial crisis battered but still on top, the Street is seeing something more insidiously silly: a bona fide Goldman conspiracy. “A lot of people think that they must have gotten where they are because of some unfair advantage,” hedge fund manager Bill Fleckenstein says. Read "The Usual Suspects" for more background on the whispers on Wall Street.

1. Bear Stearns

The news: In March, Bear Stearns’ stock plummeted, and clients questioned the firm’s viability. J.P. Morgan, with government assistance, agreed to buy Bear for $10 a share.

The facts: Rumors appeared in print that traders in Goldman’s London unit tried to drive Bear’s stock down.

The conspiracy theory: Goldman Sachs and other Wall Street firms have held a grudge against Bear since 1998 when the company refused to join in the $3.6 billion bailout of hedge fund Long-Term Capital Manage­ment. By spreading fear about Bear, Goldman stood to pick up some lucrative new clients. (Goldman’s response: “We went out of our way to be supportive of Bear Stearns.”)

2. Merrill Lynch Sale

The news: On the weekend that the government allowed Lehman to fail, Merrill Lynch, led by C.E.O. John Thain, sold itself to Bank of America for a tidy premium. Days later, the Britain-based bank Barclays agreed to buy Lehman’s core assets for pennies, wiping out Lehman’s shareholders.

The facts: Thain was a frequent adviser to Tim Geithner, who was then president of the New York Fed. Thain also worked as Goldman’s co-president under Paulson.

The conspiracy theory: To protect Thain’s sterling reputation (and Goldman’s too), Geithner and Paulson urged him to find a buyer immediately. If he hadn’t, Merrill would have followed Lehman Brothers into oblivion.

3. A.I.G. Bailout

The news: Officials agreed to extend A.I.G. an $85 billion loan—later upped to $123 billion—to prevent its collapse. Goldman C.E.O. Lloyd Blankfein was (albeit briefly) the only investment-banking chief at a key meeting to discuss the deal.

The facts: Paulson installed Goldman vice chairman Ed Liddy as A.I.G.’s new C.E.O.

The conspiracy theory: Had the insurance giant failed, Goldman would have lost big. It’s said to have $20 billion in A.I.G. exposure. (Goldman says any exposure is offset by collateral and hedges.) Liddy was put in to protect Goldman’s interests. When asked why A.I.G. was bailed out but not Lehman, Dick Fuld, Leh­man’s C.E.O., told Congress, “Until the day they put me in the ground, I will wonder.”

4. Billions for the Banks

The news: The government injected $250 billion into U.S. banks as part of its bailout plan.

The facts: Before its collapse, Lehman Brothers was looking for a capital infusion of roughly $6 billion. Unable to raise the money, the company filed for bankruptcy. The government’s bailout plan, which included $10 billion for Goldman, came in October, just three weeks after Lehman was allowed to fail.

The conspiracy theory: The government let Lehman go under to eliminate one of Goldman’s biggest competitors. Though ­Goldman’s write-downs were tiny relative to those of its competitors, it was nonetheless granted the $10 billion in the bailout to preserve its advantage.

5. Bank Holding Companies

The news: In September, with markets swooning, Goldman Sachs applied to become a bank holding company. The Federal Reserve quickly approved the move, allowing Goldman (and Morgan Stanley, which had also applied for the change) to take deposits backed by the F.D.I.C.

The facts: Over the summer, Lehman C.E.O. Dick Fuld considered converting Lehman to a bank holding company. After discussions with the Fed, Lehman didn’t apply for the change.

The conspiracy theory: Goldman was thrown a lifeline by its many friends in government. Said a former Lehman swaps trader: “They were a lot more connected in government than Fuld was. At the end of the day, that cost Lehman.”

6. Short-Selling Ban

The news: On September 19, S.E.C. Commissioner Christopher Cox announced a month-long ban on the short-selling of stocks in 799 financial companies.

The facts: Executives at Bear and Lehman had long complained to regulators about traders’ irresponsibly shorting their stocks and stoking investor panic. The S.E.C. short-selling ban was implemented after both firms failed and Goldman’s stock dropped 20 percent over three days.

The conspiracy theory: When Goldman’s competitors felt pressure from the shorts, regulators acted timidly. Once the short-sellers turned their attention to Goldman, the company used its influence to push through a ban.

7. Rescuing Citigroup

The news: In November, after Citigroup’s stock dropped more than 60 percent in one week, the government injected $20 billion into the company—adding to the $25 billion it had already committed. The government also agreed to backstop the company’s losses once they surpass $29 billion.

The facts: Citigroup adviser and Goldman alum Robert Rubin mentored Geithner at Treasury and was one of Paulson’s contemporaries at Goldman.

The conspiracy theory: Geithner and Paulson came to the rescue of their friend. The bailout preserved Rubin’s big gig—he made more than $62 million from 2004 to 2007—despite claims he championed some of Citi’s riskiest strategies.

8. The Obama Presidency

The news: Barack Obama was elected the 44th president of the United States.

The facts: As a group, Goldman Sachs employees were among the largest donors to the Obama presidential campaign, giving more than $884,000. Former Goldman hotshots, including Rubin and New Jersey Governor Jon Cor­zine, were reportedly candidates to become Obama’s Treasury secretary. Geithner was eventually picked.

The conspiracy theory: Obama’s victory and Geith­ner’s appointment are the completion of Goldman’s meticulously crafted plan to become a superpower. The firm now has the clout to impose its will on the financial markets—and the world.

What is credit crunch?

Two comics speaking about the credit crunch like investement bankers do:

http://www.dailymotion.com/video/x684wa_the-last-laugh-george-parr-subprime


The best video that I found to understand the actual crisis:

http://www.youtube.com/watch?v=Q0zEXdDO5JU&feature=related