May 21, 2010
A.I.G.’s Derivatives at European Banks Could Expose It to Debt Crisis
By MARY WILLIAMS WALSH
The waves of financial trouble rippling across Europe could end up splashing at least one American institution: the taxpayer-owned American International Group.
A.I.G. has sought to unwind its derivatives business, which gave it a big exposure to Europe.
After an outcry over details disclosed last year about how the government’s bailout helped a number of European banks, the company intended to rid itself of the derivatives it sold to those institutions to help them comply with their capital requirements.
But its latest quarterly filing with regulators shows that the insurance behemoth still has significant exposure to those banks. A.I.G. listed the total notional value of these derivatives, credit-default swaps, as $109 billion at the end of March. That means if events in Europe turned sharply against A.I.G., its maximum possible loss on these derivatives would be $109 billion.
No one is suggesting that is likely.
Still, it would be a sore spot if A.I.G. once again had to make good on a European bank’s investment losses, even on a small scale. A spokesman for A.I.G., Mark Herr, declined to name the European banks that bought its swaps to shore up their capital.
A.I.G.’s stock has also fallen in recent days amid uncertainty over whether the continuing European debt crisis could set back an important, $35.5 billion asset sale. A.I.G.’s chief executive, Robert Benmosche, announced in March that the company would sell its big Asian life insurance business to Prudential of Britain, raising money to pay back part of its rescue loans.
The transaction needs the approval of 75 percent of Prudential’s shareholders.
Shares of A.I.G. fell seven consecutive trading days to close at $34.81 on Thursday. That was a drop of 23 percent since May 11. The shares recovered slightly on Friday, closing at $35.96.
A.I.G.’s swaps work something like bond insurance. The European banks that bought them could keep riskier assets on their books without running afoul of their capital requirements, because the insurer promised to make the banks whole if the assets soured. The contracts call for A.I.G.’s financial products unit to pay in cases of bankruptcy, payment shortfalls or asset write-downs.
A.I.G. is also required to post collateral to the European banks under certain circumstances, but the company said it could not forecast how much.
It was the collateral provisions of a separate portfolio of credit-default swaps that caused A.I.G.’s near collapse in September 2008. Those swaps were tied to complex assets whose values were hard to track.
The European bank assets now in question consist mostly of pooled corporate loans and residential mortgages. A.I.G. has said they are easier to evaluate and therefore less risky.
A.I.G. had hoped these swaps would become obsolete at the end of 2009, when European banking was to have completed its adoption of a detailed new set of capital adequacy rules, known as Basel II. Since A.I.G.’s swaps were designed to help banks comply with the more simplistic previous regime, the insurer thought they would serve no useful purpose after the changeover and could be terminated without incident.
But international bank regulators have yet to fully adopt Basel II. A.I.G.’s first-quarter report said “it remains to be seen” which capital adequacy rules would be used in different parts of Europe. Mr. Herr said A.I.G. could not comment beyond the information already filed with regulators. In its first-quarter report, the insurer said the banks were holding the loans and mortgages in blind pools, making it hard to know how they would weather Europe’s storm. Some pools have fallen below investment grade.
A.I.G. said the pools of loans and mortgages were not generally concentrated in any industry or country. They have an expected average maturity, over all, of a little less than two years. The company said it was getting regular reports on the blind pools and losses so far had been modest.
http://www.nytimes.com/2010/05/22/business/22aig.html?ref=business
Showing posts with label Credit Default Swaps. Show all posts
Showing posts with label Credit Default Swaps. Show all posts
Saturday, 22 May 2010
Naked Truth on Default Swaps
May 20, 2010
Naked Truth on Default Swaps
By FLOYD NORRIS
Should people be able to bet on your death? How about your financial failure?
In the United States Senate, Wall Street won one this week when the Senate voted down a proposal to bar the so-called naked buying of credit-default swaps. If that were the law, you could not use swaps to bet a company would fail. The exception would be if you already had a stake in the company succeeding, such as owning a bond issued by the company.
On the other side of the Atlantic, Germany announced new rules to bar just such betting — but only if the creditors were euro area governments.
None of this argument would be taking place if regulators had done their jobs years ago and classified credit-default swaps as insurance.
As it happened, however, clever people on Wall Street followed the prescription laid down by Humpty Dumpty in Lewis Carroll’s “Through the Looking Glass:”
“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”
When Alice protested, Humpty Dumpty replied that the issue was “which is to be master — that’s all.”
The word here is “swap.” It used to mean, well, a swap. In a currency swap, one party will win if one currency rises against another and lose if the opposite happens.
Credit-default swaps are, in reality, insurance. The buyer of the insurance gets paid if the subject of the swap cannot meet its obligations. The seller of the swap gets a continuing payment from the buyer until the insurance expires. Sort of like an insurance premium, you might say.
But the people who dreamed up credit-default swaps did not like the word insurance. It smacked of regulation and of reserves that insurance companies must set aside in case there were claims. So they called the new thing a swap.
In the antiregulatory atmosphere of the times, they got away with it. As Humpty would have understood, Wall Street was master. Because swaps were unregulated, calling insurance a swap meant those who traded in them could make whatever decisions they wished.
That decision, perhaps more than anything else, enabled the American International Group to go broke — or, more precisely, to fail into the hands of the American government. Had it been forced to set aside reserves, A.I.G. would have stopped selling swaps a lot sooner than it did.
The decision that swaps were not insurance meant that anyone could buy or sell them — or at least anyone who could find a counterparty.
Had credit-default swaps been classified as insurance, the concept of “insurable interest” might have been applied. That concept says that you cannot buy insurance on my life, or on my house, unless you have an insurable interest.
Gary Gensler, the chairman of the Commodities Future Trading Commission, recently laid out the history of that concept. It did not exist until the 18th century, when many people — not just owners of ships or cargos — began buying insurance against ships sinking.
More ships began sinking, and insurers cried foul.
The British Parliament outlawed such sales of ship insurance in 1746. Ever since, to buy that insurance you had to have an interest in the ship or its cargo. But it was another 28 years before Parliament extended the idea to life insurance.
So should it be illegal for me to buy credit-default swaps on companies even if I have no other interest in the company? And if I have an interest, should I be limited to buying only enough insurance to cover my exposure? That is, if I own $100 million in XYZ Corporation bonds, should I be able to buy $1 billion in insurance against an XYZ default?
To most on Wall Street, the answer is obvious: let markets function. My buying that insurance will probably drive up the price, and serve as a market indication that people are worried about the credit, which is good because it gives a warning to others.
In any case, it is legal to sell stocks short. That, too, is a way to bet that a company will fail. So what’s the difference?
One difference is that many people short stocks because they deem them overvalued, not because they think the company will go broke. They can profit even if the company does well, so long as the stock does turn out to have been overvalued.
Many who despise credit-default swaps argue that they can be used to force companies to fail. The swap market is thin, and even a relatively small purchase can drive up prices. That very movement may make lenders nervous, cause liquidity to dry up and bring on unnecessary bankruptcies.
There is another, little noticed, possible impact of credit-default swaps. They can undermine bankruptcy laws.
Normally, a creditor wants to keep a company out of bankruptcy if there is a decent chance it can survive. If it does go broke, the creditor wants to maximize the value of the company anyway, so that more will be available to pay creditors.
But what happens if a major creditor, who might even control one class of bonds, has a much larger position in credit-default swaps?
Will he not have interests directly at odds with those of other creditors, since he will do better if the company ends up with less to pay its creditors? Might that creditor seek to, and perhaps be able to, sabotage the company’s best hopes for revival?
At a minimum, such things should be disclosed, but that gets tricky when one part of a megabank (the one with the bonds) claims it is run independently from the other (the one with the swaps).
I don’t know whether it is necessary to treat credit-default swaps like insurance and require someone to have an insurable interest before swaps can be purchased.
The financial reform bill now being debated in the Senate has provisions intended to assure that many of the previous swap abuses are not repeated.
But I do think Germany’s decision was ill considered. First, it may have little effect if other countries do not join in. Buying a swap in New York or London, rather than Frankfurt, will not be difficult.
But the more important issue is one of limiting the targets of credit-default swap purchases. If Germany had simply required buyers of credit-default swaps to have an insurable interest, it would have been standing up for a principle.
By limiting the scope to swaps on debt of euro area governments, the German government sends two signals: it is acting in self-interest, and it is still worried that it may have to finance more bailouts.
http://www.nytimes.com/2010/05/21/business/economy/21norris.html?ref=business
Naked Truth on Default Swaps
By FLOYD NORRIS
Should people be able to bet on your death? How about your financial failure?
In the United States Senate, Wall Street won one this week when the Senate voted down a proposal to bar the so-called naked buying of credit-default swaps. If that were the law, you could not use swaps to bet a company would fail. The exception would be if you already had a stake in the company succeeding, such as owning a bond issued by the company.
On the other side of the Atlantic, Germany announced new rules to bar just such betting — but only if the creditors were euro area governments.
None of this argument would be taking place if regulators had done their jobs years ago and classified credit-default swaps as insurance.
As it happened, however, clever people on Wall Street followed the prescription laid down by Humpty Dumpty in Lewis Carroll’s “Through the Looking Glass:”
“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean — neither more nor less.”
When Alice protested, Humpty Dumpty replied that the issue was “which is to be master — that’s all.”
The word here is “swap.” It used to mean, well, a swap. In a currency swap, one party will win if one currency rises against another and lose if the opposite happens.
Credit-default swaps are, in reality, insurance. The buyer of the insurance gets paid if the subject of the swap cannot meet its obligations. The seller of the swap gets a continuing payment from the buyer until the insurance expires. Sort of like an insurance premium, you might say.
But the people who dreamed up credit-default swaps did not like the word insurance. It smacked of regulation and of reserves that insurance companies must set aside in case there were claims. So they called the new thing a swap.
In the antiregulatory atmosphere of the times, they got away with it. As Humpty would have understood, Wall Street was master. Because swaps were unregulated, calling insurance a swap meant those who traded in them could make whatever decisions they wished.
That decision, perhaps more than anything else, enabled the American International Group to go broke — or, more precisely, to fail into the hands of the American government. Had it been forced to set aside reserves, A.I.G. would have stopped selling swaps a lot sooner than it did.
The decision that swaps were not insurance meant that anyone could buy or sell them — or at least anyone who could find a counterparty.
Had credit-default swaps been classified as insurance, the concept of “insurable interest” might have been applied. That concept says that you cannot buy insurance on my life, or on my house, unless you have an insurable interest.
Gary Gensler, the chairman of the Commodities Future Trading Commission, recently laid out the history of that concept. It did not exist until the 18th century, when many people — not just owners of ships or cargos — began buying insurance against ships sinking.
More ships began sinking, and insurers cried foul.
The British Parliament outlawed such sales of ship insurance in 1746. Ever since, to buy that insurance you had to have an interest in the ship or its cargo. But it was another 28 years before Parliament extended the idea to life insurance.
So should it be illegal for me to buy credit-default swaps on companies even if I have no other interest in the company? And if I have an interest, should I be limited to buying only enough insurance to cover my exposure? That is, if I own $100 million in XYZ Corporation bonds, should I be able to buy $1 billion in insurance against an XYZ default?
To most on Wall Street, the answer is obvious: let markets function. My buying that insurance will probably drive up the price, and serve as a market indication that people are worried about the credit, which is good because it gives a warning to others.
In any case, it is legal to sell stocks short. That, too, is a way to bet that a company will fail. So what’s the difference?
One difference is that many people short stocks because they deem them overvalued, not because they think the company will go broke. They can profit even if the company does well, so long as the stock does turn out to have been overvalued.
Many who despise credit-default swaps argue that they can be used to force companies to fail. The swap market is thin, and even a relatively small purchase can drive up prices. That very movement may make lenders nervous, cause liquidity to dry up and bring on unnecessary bankruptcies.
There is another, little noticed, possible impact of credit-default swaps. They can undermine bankruptcy laws.
Normally, a creditor wants to keep a company out of bankruptcy if there is a decent chance it can survive. If it does go broke, the creditor wants to maximize the value of the company anyway, so that more will be available to pay creditors.
But what happens if a major creditor, who might even control one class of bonds, has a much larger position in credit-default swaps?
Will he not have interests directly at odds with those of other creditors, since he will do better if the company ends up with less to pay its creditors? Might that creditor seek to, and perhaps be able to, sabotage the company’s best hopes for revival?
At a minimum, such things should be disclosed, but that gets tricky when one part of a megabank (the one with the bonds) claims it is run independently from the other (the one with the swaps).
I don’t know whether it is necessary to treat credit-default swaps like insurance and require someone to have an insurable interest before swaps can be purchased.
The financial reform bill now being debated in the Senate has provisions intended to assure that many of the previous swap abuses are not repeated.
But I do think Germany’s decision was ill considered. First, it may have little effect if other countries do not join in. Buying a swap in New York or London, rather than Frankfurt, will not be difficult.
But the more important issue is one of limiting the targets of credit-default swap purchases. If Germany had simply required buyers of credit-default swaps to have an insurable interest, it would have been standing up for a principle.
By limiting the scope to swaps on debt of euro area governments, the German government sends two signals: it is acting in self-interest, and it is still worried that it may have to finance more bailouts.
http://www.nytimes.com/2010/05/21/business/economy/21norris.html?ref=business
Saturday, 27 March 2010
Betting on the Blind Side
Michael Burry always saw the world differently—due, he believed, to the childhood loss of one eye. So when the 32-year-old investor spotted the huge bubble in the subprime-mortgage bond market, in 2004, then created a way to bet against it, he wasn’t surprised that no one understood what he was doing. In an excerpt from his new book, The Big Short, the author charts Burry’s oddball maneuvers, his almost comical dealings with Goldman Sachs and other banks as the market collapsed, and the true reason for his visionary obsession.
April 2010
Dr. Michael Burry in his home office, in Silicon Valley. “My nature is not to have friends,” Burry concluded years ago. “I’m happy in my own head.”
A court had accepted a plea from a software company called the Avanti Corporation. Avanti had been accused of stealing from a competitor the software code that was the whole foundation of Avanti’s business. The company had $100 million in cash in the bank, was still generating $100 million a year in free cash flow—and had a market value of only $250 million! Michael Burry started digging; by the time he was done, he knew more about the Avanti Corporation than any man on earth. He was able to see that even if the executives went to jail (as five of them did) and the fines were paid (as they were), Avanti would be worth a lot more than the market then assumed. To make money on Avanti’s stock, however, he’d probably have to stomach short-term losses, as investors puked up shares in horrified response to negative publicity.
“That was a classic Mike Burry trade,” says one of his investors. “It goes up by 10 times, but first it goes down by half.” This isn’t the sort of ride most investors enjoy, but it was, Burry thought, the essence of value investing. His job was to disagree loudly with popular sentiment. He couldn’t do this if he was at the mercy of very short-term market moves, and so he didn’t give his investors the ability to remove their money on short notice, as most hedge funds did. If you gave Scion your money to invest, you were stuck for at least a year.
..
..
“I have heard that White Mountain would rather I stick to my knitting,” he wrote, testily, to his original backer, “though it is not clear to me that White Mountain has historically understood what my knitting really is.” No one seemed able to see what was so plain to him: these credit-default swaps were all part of his global search for value. “I don’t take breaks in my search for value,” he wrote to White Mountain. “There is no golf or other hobby to distract me. Seeing value is what I do.”
....
....
When he’d started Scion, he told potential investors that, because he was in the business of making unfashionable bets, they should evaluate him over the long term—say, five years. Now he was being evaluated moment to moment. “Early on, people invested in me because of my letters,” he said. “And then, somehow, after they invested, they stopped reading them.” His fantastic success attracted lots of new investors, but they were less interested in the spirit of his enterprise than in how much money he could make them quickly. Every quarter, he told them how much he’d made or lost from his stock picks. Now he had to explain that they had to subtract from that number these & subprime-mortgage-bond insurance premiums. One of his New York investors called and said ominously, “You know, a lot of people are talking about withdrawing funds from you.” As their funds were contractually stuck inside Scion Capital for some time, the investors’ only recourse was to send him disturbed-sounding e-mails asking him to justify his new strategy. “People get hung up on the difference between +5% and -5% for a couple of years,” Burry replied to one investor who had protested the new strategy. “When the real issue is: over 10 years who does 10% or better annually? And I firmly believe that to achieve that advantage on an annual basis, I have to be able to look out past the next couple of years.… I have to be steadfast in the face of popular discontent if that’s what the fundamentals tell me.” In the five years since he had started, the S&P 500, against which he was measured, was down 6.84 percent. In the same period, he reminded his investors, Scion Capital was up 242 percent. He assumed he’d earned the rope to hang himself. He assumed wrong. “I’m building breathtaking sand castles,” he wrote, “but nothing stops the tide from coming and coming and coming.”
http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004?printable=true
Saturday, 7 February 2009
Credit Crisis -- The Essentials
Credit Crisis -- The Essentials
Latest Developments: Updated: Feb. 7, 2009
The Obama administration has settled on a plan to inject billions of dollars in fresh capital into banks and entice investors to purchase their most troubled assets. Feb. 6, 2009
Senate Democrats reached an agreement with Republican moderates on Friday to pare a huge economic recovery measure, clearing the way for approval of a package that President Obama said was urgently needed in light of mounting job losses. Feb. 6, 2009
With the economic downturn taking a toll on industries that employ more men, women are close to surpassing men on the nation's payrolls. Feb. 6, 2009
A plan backed by the Obama administration would help desperate homeowners stay in their houses while they renegotiate their debt. Feb. 6, 2009
Overview
By THE NEW YORK TIMES
In the fall of 2008, the credit crunch, which had emerged a little more than a year before, ballooned into Wall Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, mighty investment banks that once ruled high finance have crumbled or reinvented themselves as humdrum commercial banks. The nation’s largest insurance company and largest savings and loan both were seized by the government. The channels of credit, the arteries of the global financial system, have been constricted, cutting off crucial funds to consumers and businesses small and large.
In response, the federal government adopted a $700 billion bailout plan meant to reassure the markets and get credit flowing again. But the crisis began to spread to Europe and to emerging markets, with governments scrambling to prop up banks, broaden guarantees for deposits and agree on a coordinated response.
Origins
The roots of the credit crisis stretch back to another notable boom-and-bust: the tech bubble of the late 1990’s. When the stock market began a steep decline in 2000 and the nation slipped into recession the next year, the Federal Reserve sharply lowered interest rates to limit the economic damage.
Lower interest rates make mortgage payments cheaper, and demand for homes began to rise, sending prices up. In addition, millions of homeowners took advantage of the rate drop to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down.
And turn sour they did, when home buyers had to leverage themselves to the hilt to make a purchase. Default and delinquency rates began to rise in 2006, but the pace of lending did not slow. Banks and other investors had devised a plethora of complex financial instruments to slice up and resell the mortgage-backed securities and to hedge against any risks — or so they thought.
The Crisis Takes Hold
The first shoe to drop was the collapse in June 2007 of two hedge funds owned by Bear Stearns that had invested heavily in the subprime market. As the year went on, more banks found that securities they thought were safe were tainted with what came to be called toxic mortgages. At the same time, the rising number of foreclosures helped speed the fall of housing prices, and the number of prime mortgages in default began to increase.
The Federal Reserve took unprecedented steps to bolster Wall Street. But still the losses mounted, and in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase for a price that was less than the worth of Bear’s Manhattan skyscraper.
Sales, Failures and Seizures
In August, government officials began to become concerned as the stock prices of Fannie Mae and Freddie Mac, government-sponsored entities that were linchpins of the housing market, slid sharply. On Sept. 7, the Treasury Department announced it was taking them over.
Events began to move even faster. On Sept. 12, top government and finance officials gathered for talks to fend off bankruptcy for Lehman Brothers. The talks broke down, and the government refused to step in and salvage Lehman as it had for Bear. Lehman’s failure sent shock waves through the global banking system, as became increasingly clear in the following weeks. Merrill Lynch, which had not been previously thought to be in danger, sold itself to the Bank of America to avoid a similar fate.
On Sept. 16, American International Group, an insurance giant on the verge of failure because of its exposure to exotic securities known as credit default swaps, was bailed out by the Fed in an $85 billion deal. Stocks dropped anyway, falling nearly 500 points.
The Government’s Bailout Plan
The bleeding in the stock market stopped only after rumors trickled out about a huge bailout plan being readied by the federal government. On Sept. 18, Treasury Secretary Henry M. Paulson Jr. publicly announced a three-page, $700 billion proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a move aimed at shoring up balance sheets and restoring confidence within the financial system.
Congress eventually amended the plan to add new structures for oversight, limits on executive pay and the option of the government taking a stake in the companies it bails out. Still, many Americans were angered by the idea of a proposal that provided billions of dollars in taxpayer money to Wall Street banks, which many believed had caused the crisis in the first place. Lawmakers with strong beliefs in free markets also opposed the bill, which they said amounted to socialism.
President Bush pleaded with lawmakers to pass the bill, but on Sept. 29, the House rejected the proposal, 228 to 205, with an insurgent group of Republicans leading the opposition. Stocks plunged, with the Standard & Poor’s 500-stock index losing nearly 9 percent, its worst day since Oct. 19, 1987.
Negotiations began anew on Capitol Hill. A series of tax breaks were added to the legislation, among other compromises and earmarks, and the Senate passed a revised version Oct. 1 by a large margin, 74 to 25. On Oct. 3, the House followed suit, by a vote of 263 to 171.
When the bill passed, it was still unclear how effective the bailout plan would be in resolving the credit crisis, although many analysts and economists believed it would offer at least a temporary aid. Federal officials promised increased regulation of the financial industry, whose structure was vastly different than it had been just weeks before.
The first reactions were not positive. Banks in England and Europe had invested heavily in mortgage-backed securities offered by Wall Street, and England had gone through a housing boom and bust of its own. Losses from those investments and the effect of the same tightening credit spiral being felt on Wall Street began to put a growing number of European institutions in danger. Over the weekend that followed the bailout’s passage, the German government moved to guarantee all private savings accounts in the country, and bailouts were arranged for a large German lender and a major European financial company.
And even as the United States began to execute its bailout plan, the tactics continued to shift, with the Treasury announcing that it would spend some of the funds to buy commercial paper, a vital form of short-term borrowing for businesses, in an effort to get credit flowing again.
Continued Volatility
When stock markets in the United States, Europe and Asia continued to plunge, the world’s leading central banks on Oct. 8 took the drastic step of a coordinated cut in interest rates, with the Federal Reserve cutting its two main rates by half a point.
And after a week in which stocks declined almost 20 percent on Wall Street, European and American officials announced coordinated actions that included taking equity stakes in major banks, including $250 billion in investments in the United States. The action prompted a worldwide stock rally, with the Dow rising 936 points, or 11 percent, on Oct. 13.
But as the prospect of a severe global recession became more evident, such gains were impossible to sustain. Just two days later, after Ben S. Bernanke, the Federal Reserve chairman, said there would be no quick economic turnaround even with the government’s intervention, the Dow plunged 733 points.
The credit markets, meanwhile, were slow to ease up, as banks used the injection of government funds to strengthen their balance sheets rather than lend. By late October, the Treasury had decided to use its $250 billion investment plan not only to increase banks’ capitalization but also to steer funds to stronger banks to purchase weaker ones, as in the acquisition of National City, a troubled Ohio-based bank, by PNC Financial of Pittsburgh.
The volatility in the stock markets was matched by upheaval in currency trading as investors sought shelter in the yen and the dollar, driving down the currencies of developing countries and even the euro and the British pound. The unwinding of the so-called yen-carry trade, in which investors borrowed money cheaply in Japan and invested it overseas, made Japanese goods more expensive on world markets and precipitated a steep plunge in Tokyo stock trading.
Oil-producing countries were hit by a sudden reversal of fortune, as the record oil prices reached over the summer were cut in half by October because of the world economic outlook. Even an agreement on a production cut by the Organization of the Petroleum Exporting Countries on Oct. 24 failed to stem the price decline.
Stock markets remained in upheaval, with the general downward trend punctuated by events like an 11-percent gain in the Dow on Oct. 28. A day later, the Fed cut its key lending rate again, to a mere 1 percent. In early November, the European Central Bank and the Bank of England followed with sharp reductions of their own.
Federal officials also moved to put together a plan to aid homeowners at risk of foreclosure by shouldering some losses for banks that agree to lower monthly payments. Detroit’s automakers, meanwhile, hard hit by the credit crisis, the growing economic slump and their belated transition away from big vehicles, turned to the government for aid of their own, possibly including help in engineering a merger of General Motors and Chrysler.
The leaders of 20 major countries, meanwhile, agreed to an emergency summit meeting in Washington on Nov. 14 and 15 to discuss coordinated action to deal with the credit crisis. The group agreed to work more closely, but put off thornier questions until next year, in an early challenge for the Obama administration.
The Crisis and the Campaign
The credit crisis emerged as the dominant issue of the presidential campaign in the last two months before the election. On Sept. 24, as polls showed Senator John McCain’s support dropping, he announced that he would suspend his campaign to try to help forge a deal on the bailout plan. The next day, both he and Senator Barack Obama met with Congressional leaders and President Bush at the White House, but their efforts failed to assure passage of the legislation, which went down to defeat in an initial vote on Sept. 29, a week before it ultimately passed.
The weakening stock market and growing credit crisis appeared to benefit Mr. Obama, who tied Mr. McCain to what he called the failed economic policies of President Bush and a Republican culture of deregulation of the financial markets. Polls showed that Mr. Obama’s election on Nov. 4 was partly the fruit of the economic crisis and the belief among many voters that he was more capable of handling the economy than Mr. McCain.
As president-elect, Mr. Obama made confronting the economic crisis the top priority of his transition. Just three days after his election, he convened a meeting of his top economic advisers, including the billionaire investor Warren Buffett; two former Treasury secretaries, Lawrence H. Summers and Robert E. Rubin; Paul A. Volcker, a former Federal Reserve chairman; and Eric E. Schmidt, the chief executive of Google. After their Nov. 7 meeting, he called quick passage of an economic stimulus package, saying it should be taken up by the the lame-duck Congressional session, and that if lawmakers failed to act, it would be his main economic goal after assuming office Jan. 20.
Mr. Obama also faced a host of other demands as president-elect, including calls to bail out the auto industry, particularly General Motors, which warned that it would run out of cash by mid-2009. And some economists and conservatives questioned whether, given the economic crisis, he could still meet some of his pledges from the campaign, like rapidly rolling back the Bush tax cuts, which some felt would hurt demand, and pushing ahead with his planned expansion of health care coverage, which could greatly increase a soaring deficit.
Deeper Problems, Dramatic Measures
With credit markets still locked up and investors getting worried about the big banks, Wall Street marked a grim milestone in late November when stock markets tumbled to their lowest levels in a decade. In all, the slide from the height of the stock markets had wiped out more than $8 trillion in wealth. The markets inched back in the weeks that followed as investors looked forward to a new administration and a huge economic stimulus package, but key indicators of the economy only got worse.
In December, an obscure group of economists confirmed what millions of Americans had suspected for months: the United States was in a recession. The economy had actually slipped into recession a year earlier, a committee of economists said, putting the current downturn on track to be the longest in a generation. Unemployment rose to its highest point in more than 15 years. Trade shrank. Home prices fell farther. As inflation virtually halted, economists began to worry about deflation, the vicious cycle of lower prices, lower wages and economic contraction.
Retailers suffered one of the worst holiday seasons in 30 years as worried consumers cut back, raising the likelihood that dozens more would join stores like Sharper Image, Circuit City and Linens 'n Things in bankruptcy.
On Dec. 16, the Federal Reserve entered uncharted waters of monetary policy by cutting its benchmark interest rate to nearly zero percent and declaring that it would deploy its balance sheet and essentially print money to fight the deepening recession and locked credit markets. Investors cheered, sending the Dow up more than 300 points, but many economists began to worry about the world's appetite for hundreds of billions of dollars in new Treasury debt.
Other countries followed the Fed with rate cuts of their own. Britain’s central bank a wave of refinancing that nevertheless skipped many homeowners.
But as Mr. Obama took office, investors were just as worried as ever, as evidenced by Wall Street’s worst Inauguration Day drop ever. The fourth-quarter corporate earnings season was marked by billion-dollar losses and uncertain outlooks for 2009. The economy showed no sign of turning around. And many lawmakers and analysts began to wonder whether the first $350 billion in bailout money had any effect at all. Banks that received bailout funds sat on their money, rather than lend it out to consumers or home buyers.
And bailout recipients such as Citigroup and Bank of America were forced to step forward for additional lifelines, raising one of the most uncomfortable questions a new president has ever had to address: Would the government nationalize the American banking system?
http://topics.nytimes.com/topics/reference/timestopics/subjects/c/credit_crisis/index.html
Latest Developments: Updated: Feb. 7, 2009
The Obama administration has settled on a plan to inject billions of dollars in fresh capital into banks and entice investors to purchase their most troubled assets. Feb. 6, 2009
Senate Democrats reached an agreement with Republican moderates on Friday to pare a huge economic recovery measure, clearing the way for approval of a package that President Obama said was urgently needed in light of mounting job losses. Feb. 6, 2009
With the economic downturn taking a toll on industries that employ more men, women are close to surpassing men on the nation's payrolls. Feb. 6, 2009
A plan backed by the Obama administration would help desperate homeowners stay in their houses while they renegotiate their debt. Feb. 6, 2009
Overview
By THE NEW YORK TIMES
In the fall of 2008, the credit crunch, which had emerged a little more than a year before, ballooned into Wall Street’s biggest crisis since the Great Depression. As hundreds of billions in mortgage-related investments went bad, mighty investment banks that once ruled high finance have crumbled or reinvented themselves as humdrum commercial banks. The nation’s largest insurance company and largest savings and loan both were seized by the government. The channels of credit, the arteries of the global financial system, have been constricted, cutting off crucial funds to consumers and businesses small and large.
In response, the federal government adopted a $700 billion bailout plan meant to reassure the markets and get credit flowing again. But the crisis began to spread to Europe and to emerging markets, with governments scrambling to prop up banks, broaden guarantees for deposits and agree on a coordinated response.
Origins
The roots of the credit crisis stretch back to another notable boom-and-bust: the tech bubble of the late 1990’s. When the stock market began a steep decline in 2000 and the nation slipped into recession the next year, the Federal Reserve sharply lowered interest rates to limit the economic damage.
Lower interest rates make mortgage payments cheaper, and demand for homes began to rise, sending prices up. In addition, millions of homeowners took advantage of the rate drop to refinance their existing mortgages. As the industry ramped up, the quality of the mortgages went down.
And turn sour they did, when home buyers had to leverage themselves to the hilt to make a purchase. Default and delinquency rates began to rise in 2006, but the pace of lending did not slow. Banks and other investors had devised a plethora of complex financial instruments to slice up and resell the mortgage-backed securities and to hedge against any risks — or so they thought.
The Crisis Takes Hold
The first shoe to drop was the collapse in June 2007 of two hedge funds owned by Bear Stearns that had invested heavily in the subprime market. As the year went on, more banks found that securities they thought were safe were tainted with what came to be called toxic mortgages. At the same time, the rising number of foreclosures helped speed the fall of housing prices, and the number of prime mortgages in default began to increase.
The Federal Reserve took unprecedented steps to bolster Wall Street. But still the losses mounted, and in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase for a price that was less than the worth of Bear’s Manhattan skyscraper.
Sales, Failures and Seizures
In August, government officials began to become concerned as the stock prices of Fannie Mae and Freddie Mac, government-sponsored entities that were linchpins of the housing market, slid sharply. On Sept. 7, the Treasury Department announced it was taking them over.
Events began to move even faster. On Sept. 12, top government and finance officials gathered for talks to fend off bankruptcy for Lehman Brothers. The talks broke down, and the government refused to step in and salvage Lehman as it had for Bear. Lehman’s failure sent shock waves through the global banking system, as became increasingly clear in the following weeks. Merrill Lynch, which had not been previously thought to be in danger, sold itself to the Bank of America to avoid a similar fate.
On Sept. 16, American International Group, an insurance giant on the verge of failure because of its exposure to exotic securities known as credit default swaps, was bailed out by the Fed in an $85 billion deal. Stocks dropped anyway, falling nearly 500 points.
The Government’s Bailout Plan
The bleeding in the stock market stopped only after rumors trickled out about a huge bailout plan being readied by the federal government. On Sept. 18, Treasury Secretary Henry M. Paulson Jr. publicly announced a three-page, $700 billion proposal that would allow the government to buy toxic assets from the nation’s biggest banks, a move aimed at shoring up balance sheets and restoring confidence within the financial system.
Congress eventually amended the plan to add new structures for oversight, limits on executive pay and the option of the government taking a stake in the companies it bails out. Still, many Americans were angered by the idea of a proposal that provided billions of dollars in taxpayer money to Wall Street banks, which many believed had caused the crisis in the first place. Lawmakers with strong beliefs in free markets also opposed the bill, which they said amounted to socialism.
President Bush pleaded with lawmakers to pass the bill, but on Sept. 29, the House rejected the proposal, 228 to 205, with an insurgent group of Republicans leading the opposition. Stocks plunged, with the Standard & Poor’s 500-stock index losing nearly 9 percent, its worst day since Oct. 19, 1987.
Negotiations began anew on Capitol Hill. A series of tax breaks were added to the legislation, among other compromises and earmarks, and the Senate passed a revised version Oct. 1 by a large margin, 74 to 25. On Oct. 3, the House followed suit, by a vote of 263 to 171.
When the bill passed, it was still unclear how effective the bailout plan would be in resolving the credit crisis, although many analysts and economists believed it would offer at least a temporary aid. Federal officials promised increased regulation of the financial industry, whose structure was vastly different than it had been just weeks before.
The first reactions were not positive. Banks in England and Europe had invested heavily in mortgage-backed securities offered by Wall Street, and England had gone through a housing boom and bust of its own. Losses from those investments and the effect of the same tightening credit spiral being felt on Wall Street began to put a growing number of European institutions in danger. Over the weekend that followed the bailout’s passage, the German government moved to guarantee all private savings accounts in the country, and bailouts were arranged for a large German lender and a major European financial company.
And even as the United States began to execute its bailout plan, the tactics continued to shift, with the Treasury announcing that it would spend some of the funds to buy commercial paper, a vital form of short-term borrowing for businesses, in an effort to get credit flowing again.
Continued Volatility
When stock markets in the United States, Europe and Asia continued to plunge, the world’s leading central banks on Oct. 8 took the drastic step of a coordinated cut in interest rates, with the Federal Reserve cutting its two main rates by half a point.
And after a week in which stocks declined almost 20 percent on Wall Street, European and American officials announced coordinated actions that included taking equity stakes in major banks, including $250 billion in investments in the United States. The action prompted a worldwide stock rally, with the Dow rising 936 points, or 11 percent, on Oct. 13.
But as the prospect of a severe global recession became more evident, such gains were impossible to sustain. Just two days later, after Ben S. Bernanke, the Federal Reserve chairman, said there would be no quick economic turnaround even with the government’s intervention, the Dow plunged 733 points.
The credit markets, meanwhile, were slow to ease up, as banks used the injection of government funds to strengthen their balance sheets rather than lend. By late October, the Treasury had decided to use its $250 billion investment plan not only to increase banks’ capitalization but also to steer funds to stronger banks to purchase weaker ones, as in the acquisition of National City, a troubled Ohio-based bank, by PNC Financial of Pittsburgh.
The volatility in the stock markets was matched by upheaval in currency trading as investors sought shelter in the yen and the dollar, driving down the currencies of developing countries and even the euro and the British pound. The unwinding of the so-called yen-carry trade, in which investors borrowed money cheaply in Japan and invested it overseas, made Japanese goods more expensive on world markets and precipitated a steep plunge in Tokyo stock trading.
Oil-producing countries were hit by a sudden reversal of fortune, as the record oil prices reached over the summer were cut in half by October because of the world economic outlook. Even an agreement on a production cut by the Organization of the Petroleum Exporting Countries on Oct. 24 failed to stem the price decline.
Stock markets remained in upheaval, with the general downward trend punctuated by events like an 11-percent gain in the Dow on Oct. 28. A day later, the Fed cut its key lending rate again, to a mere 1 percent. In early November, the European Central Bank and the Bank of England followed with sharp reductions of their own.
Federal officials also moved to put together a plan to aid homeowners at risk of foreclosure by shouldering some losses for banks that agree to lower monthly payments. Detroit’s automakers, meanwhile, hard hit by the credit crisis, the growing economic slump and their belated transition away from big vehicles, turned to the government for aid of their own, possibly including help in engineering a merger of General Motors and Chrysler.
The leaders of 20 major countries, meanwhile, agreed to an emergency summit meeting in Washington on Nov. 14 and 15 to discuss coordinated action to deal with the credit crisis. The group agreed to work more closely, but put off thornier questions until next year, in an early challenge for the Obama administration.
The Crisis and the Campaign
The credit crisis emerged as the dominant issue of the presidential campaign in the last two months before the election. On Sept. 24, as polls showed Senator John McCain’s support dropping, he announced that he would suspend his campaign to try to help forge a deal on the bailout plan. The next day, both he and Senator Barack Obama met with Congressional leaders and President Bush at the White House, but their efforts failed to assure passage of the legislation, which went down to defeat in an initial vote on Sept. 29, a week before it ultimately passed.
The weakening stock market and growing credit crisis appeared to benefit Mr. Obama, who tied Mr. McCain to what he called the failed economic policies of President Bush and a Republican culture of deregulation of the financial markets. Polls showed that Mr. Obama’s election on Nov. 4 was partly the fruit of the economic crisis and the belief among many voters that he was more capable of handling the economy than Mr. McCain.
As president-elect, Mr. Obama made confronting the economic crisis the top priority of his transition. Just three days after his election, he convened a meeting of his top economic advisers, including the billionaire investor Warren Buffett; two former Treasury secretaries, Lawrence H. Summers and Robert E. Rubin; Paul A. Volcker, a former Federal Reserve chairman; and Eric E. Schmidt, the chief executive of Google. After their Nov. 7 meeting, he called quick passage of an economic stimulus package, saying it should be taken up by the the lame-duck Congressional session, and that if lawmakers failed to act, it would be his main economic goal after assuming office Jan. 20.
Mr. Obama also faced a host of other demands as president-elect, including calls to bail out the auto industry, particularly General Motors, which warned that it would run out of cash by mid-2009. And some economists and conservatives questioned whether, given the economic crisis, he could still meet some of his pledges from the campaign, like rapidly rolling back the Bush tax cuts, which some felt would hurt demand, and pushing ahead with his planned expansion of health care coverage, which could greatly increase a soaring deficit.
Deeper Problems, Dramatic Measures
With credit markets still locked up and investors getting worried about the big banks, Wall Street marked a grim milestone in late November when stock markets tumbled to their lowest levels in a decade. In all, the slide from the height of the stock markets had wiped out more than $8 trillion in wealth. The markets inched back in the weeks that followed as investors looked forward to a new administration and a huge economic stimulus package, but key indicators of the economy only got worse.
In December, an obscure group of economists confirmed what millions of Americans had suspected for months: the United States was in a recession. The economy had actually slipped into recession a year earlier, a committee of economists said, putting the current downturn on track to be the longest in a generation. Unemployment rose to its highest point in more than 15 years. Trade shrank. Home prices fell farther. As inflation virtually halted, economists began to worry about deflation, the vicious cycle of lower prices, lower wages and economic contraction.
Retailers suffered one of the worst holiday seasons in 30 years as worried consumers cut back, raising the likelihood that dozens more would join stores like Sharper Image, Circuit City and Linens 'n Things in bankruptcy.
On Dec. 16, the Federal Reserve entered uncharted waters of monetary policy by cutting its benchmark interest rate to nearly zero percent and declaring that it would deploy its balance sheet and essentially print money to fight the deepening recession and locked credit markets. Investors cheered, sending the Dow up more than 300 points, but many economists began to worry about the world's appetite for hundreds of billions of dollars in new Treasury debt.
Other countries followed the Fed with rate cuts of their own. Britain’s central bank a wave of refinancing that nevertheless skipped many homeowners.
But as Mr. Obama took office, investors were just as worried as ever, as evidenced by Wall Street’s worst Inauguration Day drop ever. The fourth-quarter corporate earnings season was marked by billion-dollar losses and uncertain outlooks for 2009. The economy showed no sign of turning around. And many lawmakers and analysts began to wonder whether the first $350 billion in bailout money had any effect at all. Banks that received bailout funds sat on their money, rather than lend it out to consumers or home buyers.
And bailout recipients such as Citigroup and Bank of America were forced to step forward for additional lifelines, raising one of the most uncomfortable questions a new president has ever had to address: Would the government nationalize the American banking system?
http://topics.nytimes.com/topics/reference/timestopics/subjects/c/credit_crisis/index.html
Sunday, 30 November 2008
US Subprime: History of the Credit Crunch and Credit Crisis
US Subprime: History of the Credit Crunch and Credit Crisis
Geneva, 3 nov 2008.
In this multi-part series, we uncover the events that led to the subprime credit crunch, and analyze future financial prospects.
Part 1: INFLATING THE BUBBLE
Part 2: BURSTING THE BUBBLE
Part 3: CONFIDENCE
Part 4: UNWINDING
http://www.economywatch.com/us-subprime/History_of_subprime_credit_crunch_part_4.html
What now?
Well, this is difficult to predict as we are in uncharted territory. It has taken time for the severity of the situation to sink in with most governments. If they have been to slow to react, the IMF has given them a shake up this weekend by saying that we could see a major melt down in the world financial system if governments do not take strong action. As I write, more and more governments are coming out to support their banks.
We can be sure we are not at the end yet. There is more bad debt on the books of the banks that has not been fully written off yet. A change in accounting rules may stave off some of this, but there is still a problem. The equity markets are badly shaken and will undoubtedly be very volatile for some time to come.
The shock of it all has triggered a lack of confidence which takes time to be restored and will affect us all. The removal of the credit mountain will cause an economic slowdown, but the worry that ensues will filter down to the consumer, who will stop spending - even if he has the money to spend - and this will push the slowdown into recession. There is much pessimism around and many comparisons to the great depression of the 1930s. You have to remember when assimilating the news that bad news sells papers and keeps people glued to the news channels, far more than good news. Gloomy predictions sell better than optimistic ones. The news channels know this.
America is likely to bear the worst brunt of this, with UK close behind and then Europe. It is harder to predict the effect on the emerging markets. They will undoubtedly slow down as their export markets dry up, but the larger emerging countries have started to develop a domestic market and a new middle class and they do not carry the bad debt of the western banks. China is sitting on over $500 billion of US Treasury Bills. However, China has already started to feel the impact of a slow down with some 20 million jobs being lost already this year, according to the Sunday Times. This sounds a lot, but you have to remember they have population of over 1.3 billion, - more than 4.3 times that of USA.
Geneva, 3 nov 2008.
In this multi-part series, we uncover the events that led to the subprime credit crunch, and analyze future financial prospects.
Part 1: INFLATING THE BUBBLE
Part 2: BURSTING THE BUBBLE
Part 3: CONFIDENCE
Part 4: UNWINDING
http://www.economywatch.com/us-subprime/History_of_subprime_credit_crunch_part_4.html
What now?
Well, this is difficult to predict as we are in uncharted territory. It has taken time for the severity of the situation to sink in with most governments. If they have been to slow to react, the IMF has given them a shake up this weekend by saying that we could see a major melt down in the world financial system if governments do not take strong action. As I write, more and more governments are coming out to support their banks.
We can be sure we are not at the end yet. There is more bad debt on the books of the banks that has not been fully written off yet. A change in accounting rules may stave off some of this, but there is still a problem. The equity markets are badly shaken and will undoubtedly be very volatile for some time to come.
The shock of it all has triggered a lack of confidence which takes time to be restored and will affect us all. The removal of the credit mountain will cause an economic slowdown, but the worry that ensues will filter down to the consumer, who will stop spending - even if he has the money to spend - and this will push the slowdown into recession. There is much pessimism around and many comparisons to the great depression of the 1930s. You have to remember when assimilating the news that bad news sells papers and keeps people glued to the news channels, far more than good news. Gloomy predictions sell better than optimistic ones. The news channels know this.
America is likely to bear the worst brunt of this, with UK close behind and then Europe. It is harder to predict the effect on the emerging markets. They will undoubtedly slow down as their export markets dry up, but the larger emerging countries have started to develop a domestic market and a new middle class and they do not carry the bad debt of the western banks. China is sitting on over $500 billion of US Treasury Bills. However, China has already started to feel the impact of a slow down with some 20 million jobs being lost already this year, according to the Sunday Times. This sounds a lot, but you have to remember they have population of over 1.3 billion, - more than 4.3 times that of USA.
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