This financial crisis is now truly global

This financial crisis is now truly global
The financial crisis has moved from Wall Street to all streets, as the economic shock causes strains and suffering in every part of the world economy.

By Adrian Michaels
Last Updated: 9:11PM GMT 20 Feb 2009

In Florida, a state devastated by tumbling house prices and repossessions, the inhabitants are arming themselves against recession, with requests for concealed weapon permits up 42 per cent in the past 45 days. In Moscow, the murder rate has climbed by 16 per cent. At Tetsuya's – the most exclusive and expensive restaurant in Sydney – the waiting list has shrunk from three months to 24 hours.

Over the past few months, we were told that we were caught in the worst economic crisis for 20 years, then 30, then 80, then 100. It can't be long before someone points out that really, all things considered, the Black Death was comparatively pleasant. But beyond the hyperbole, one thing is clear: what began as a financial problem in certain debt-soaked nations is battering the economies of dozens of others, as well as millions of people working in almost every trade. It will change behaviour and alter the pecking order of the world's economies. There will be social unrest and changes of regime. Received wisdom, whether about the benefits of free trade, globalisation or European integration, may be cast on to a bonfire of recrimination. Estimates of how long the pain will last range from a year to a decade. Bring out your dead.

Among the most significant developments has been the realisation that the most prudent countries – such as Germany, Japan and China – will suffer as badly as the spendthrifts, or even worse. Despite the whiff of hubris that wafted from Berlin when the banks of Britain and America went into meltdown, Germany's economy contracted by two per cent in the last quarter of 2008, compared with 1.5 per cent for Britain's. The problem was that the Chinese and Germans were too thrifty: their countries' growth was reliant on sales of goods to countries that were borrowing. Now that Americans can't afford its products, China's exports have collapsed, down 17.5 per cent in January from a year earlier.

Americans can't spend because their house prices have crumpled, their shares have plummeted and their banks will not – or cannot – lend them any money. Insecurity is also forcing cutbacks: January saw the highest monthly jump in unemployment in 34 years. The equally worried Chinese seem to want to save still more: imports into China fell 43 per cent in January compared with the year before. Yet if no one at home or abroad wants to buy their goods, the result will be massive unemployment: some 20 million people are already said to have lost their jobs. As they head home from the coastal manufacturing belt, their government is trying to force-feed them consumer goods; 80 per cent of all white goods sold in December were subsidised.

As demand dries up, the arteries of global trade are hardening. Lufthansa's air freight division is putting 2,600 staff on short-time working, while cargo ships have so many empty containers that shipping rates are a tenth of what they were at last year's peak. The knock-on effects are complex, but painful. "For Rent" signs dot empty storefronts on the once sought-after stretch of New York's Madison Avenue, where the vacancy rate rose by 50 per cent in 2008. Rents have dropped by a third as the ladies who lunch think twice about coffee at Barneys, or frocks from Versace. This falling appetite for luxury goods helps explain why half of India's 400,000 diamond workers have lost their jobs. More than 40 have committed suicide.

Or take car sales, which Carlos Ghosn, the chief executive of Renault-Nissan, estimates could fall by 21 per cent across the world this year. Car companies are begging governments for handouts – but that won't shift their products from showrooms. Among other things, lower car sales mean fewer catalytic converters, which means that platinum does not need to be mined so intensively. The price of platinum has fallen by half, and the world's largest producer, Anglo Platinum, which operates mostly in South Africa, is axing 10,000 jobs.

And so the rural Chinese are not the only ones heading home. Thanks largely to a construction boom, Spain was responsible for a third of the new jobs created in the eurozone in 2006 and 2007, but is now losing 40,000 a week, and is offering subsidies for migrants to leave (some immigrants are instead digging in, selling home-cooked food at illegal markets around Madrid). Thai factories and farms used to rely on Burmese expats; aid workers report that thousands of them are now being rounded up and sent home. Malaysia has banned the hiring of foreigners in certain sectors, while the Philippines, which has 10 per cent of its population working abroad, is braced for family incomes to tumble. Remittances from overseas are a lifeline for the world's poorest: Africans working in the developed world have been sending back $40 billion a year to support their impoverished relatives, but the World Bank predicts that this could drop substantially this year.

Even when the crisis is not causing outright misery, it is transforming behaviour. In Britain, employers seem to be choosing to fire women rather than men – but in America, more than 80 per cent of those losing their jobs have been male; as a result, women are making up an increasing percentage of the workforce. Of course, not every extraordinary trend or statistic can be blamed on the economic crisis – but it is certainly true that cheap, home-based pursuits are making a comeback, and frippery is out. Australians spent 13 per cent less on eating out in the last quarter of 2008, while a Manhattan dentist is pitching his teeth-whitening services with the phrase "Make me an offer".

The challenge is to come up with a political response that does not make things worse. Western countries used to preach openness, free movement of people, the breaking down of barriers. Now the instinct is to raise the shutters and protect voters' livelihoods. Social unrest is spreading; particularly at risk are the nations of central and eastern Europe, which fervently embraced the free market after the Berlin Wall came down. As their workers headed west, their businesses loaded up on debt to fuel breakneck expansion; now, they can't meet their obligations, especially as the region's biggest banks were sold to Italians and Austrians, who might repatriate cash to focus on domestic demands. "The mess in central and eastern Europe is a clear result of globalisation," says Hans Redeker, a strategist at European bank BNP Paribas. "It should be no surprise to see [Western] banks acting increasingly locally while trying to please domestic governments."

The world's leaders promise to stop protectionism, but their actions speak differently. A joint statement this week from Gordon Brown and Silvio Berlusconi, Italy's prime minister, said: "Protectionist measures reduce worldwide growth, deny us the benefits of global trade and confine millions to poverty." Yet both countries are propping up their car industries. Congress wants to protect the American steel industry; the French government is spending more on newspaper advertising.

However restless they are, electorates need to remember that a lack of protectionism lay behind a huge increase in prosperity for millions of people. That is not easy when jobs are being lost. A cleaned-up banking system is a top priority – but the debate has only just started about how our banks are to look, who will run them and how they will be regulated. "The history of financial crises," warns Michael Pettis, professor of finance at Peking University, "shows a mismanagement of the regulatory framework that comes out of them."

Above all, consumers are somehow going to have to change their behaviour. Americans are certain to be more prudent during the immediate crisis, but they need to maintain that more hostile attitude to debt when it is over. It will be just as hard to persuade the Chinese, Japanese and Germans to start spending, in order to supplement export-led growth with domestic demand. "The world doesn't need more stuff to sell," explains Prof Pettis. "It needs more buyers."

As they mature, Asian economies will in time have better pension and health systems, which will help persuade people that there is a safety net for hard times, and tease money out from under the mattress. "Surplus countries have to spend their income and enjoy themselves," says Charles Dumas, an analyst at Lombard Street Research. "The purpose of an economy is to consume." Right now, though, the main objective is survival.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/4736387/This-financial-crisis-is-now-truly-global.html

Savers withdraw record amount from banks

Savers withdraw record amount from banks
The British Bankers' Association said that customers withdrew £2.3bn in January, the biggest drop since records began.

By Paul Farrow
Last Updated: 5:19PM GMT 24 Feb 2009

The BBA said personal deposits fell by £2.3bn as spending drained cash and savers sought alternative ways of getting a return on their cash. The previous high for falling deposits was £1.5bn in 1997.

David Dooks, BBA statistics director, said: "It is the biggest monthly fall in a decade. A fall in deposits in January reflects a tendency to draw on cash to pay off credit cards after Christmas, or to move into alternative financial products paying a higher return."

With interest rates at record lows savers are having to find other ways to get a return on their money. A recent survey showed that savers are preparing to abandon their tax-free Individual Savings Accounts (ISAs) because of lack of money and falling rates.

The uSwitch survey shows that 4.3 million savers are planning on withdrawing money from their accounts, losing the advantage of the tax-free status. The research suggests that, with the average cash ISA saver having a balance of £2,200, savers are set to withdraw £9.5 billion over the next year.

On the other hand, sales of corporate bond funds, which are paying yields of 5pc or more are proving popular among investors looking for a lower risk investment that pays an income. Bonds funds accounted for two in every three unit trusts bought in December and they continue to attract the lion's share of investors' money in 2009.

Dooks played down suggestions that customers had lost faith in the banks and said that deposits had risen in November and December.


http://www.telegraph.co.uk/finance/personalfinance/savings/4799679/Savers-withdraw-record-amount-from-banks.html

Dr Doom says US govt bonds next bubble to burst

Dr Doom says US govt bonds next bubble to burst

SINGAPORE, Feb 23 – As usual, Dr Marc Faber, the author of The Gloom Boom and Doom Report and contrarian views, did not disappoint the masochist in us as he gave his spiel on the causes of the current economic turmoil at a dialogue on Friday organised by The Business Times in partnership with Julius Baer, one of Switzerland's leading wealth managers.

His topic “Were You Born Before Or After 2007”, that is, before or after the global economies began their steep decline, got nearly 400 bankers and businessmen intrigued enough to spend four-and-a-half hours at the Ritz Carlton Singapore.

Luckily lunch was served before Dr Doom, as Dr Faber is often called, took the floor. The picture he painted was indeed gloomy, with no end in sight of what appears to be a very long tunnel.

The present credit crisis caused by ultra expansionary monetary policies was very serious, he said – as if the audience of bankers and business were not already aware of this.

He went on to add that non-financial credit growth has declined from an annual rate of 16 per cent in late 2006 to between 1 and 2 per cent now.

The deleveraging taking place among financial intermediaries is negative for the American economy that is addicted to credit growth, he pointed out. The United States' trade and current account deficits will shrink further and diminish international liquidity. This is bad for asset prices.

“We had an unprecedented global economic boom between 2002 and 2007. A colossal global economic bust is now following,” he said.

And worse might follow, as he noted: There was still one bubble more to be deflated – US government bonds.

Adding more fuel to his fire of gloom was his warning that regardless of the policies followed by the US government and its agencies, the American consumer was in a recession, which will only deepen.

“Expansionary monetary policies, which caused the current credit crisis in the first place, are the wrong medicine to solve the current problems. They can address the symptoms of excessive credit growth, but not the cause,” he noted.

Expansionary fiscal and monetary policies will, after a bout of deflation, lead to much higher inflation rates, which will have a negative impact on the valuation of equities in real terms, he observed.

“But what options does the Federal Reserve have with a total credit market debt to GDP (Gross Domestic Product) of more than 350 per cent?” he asked rhetorically.

And if that was bad enough, he raised the spectre of war looming on the horizon, noting that geopolitical tensions were on the rise. He predicted that commodity shortages, especially of oil, would lead to increased international tensions and to what he called resource nationalism.

The shortage of oil would be caused not only by increased demand from China and India, but also the Middle East. “Not only do they (the Middle East) produce oil, they produce too many babies,” he said in one of the few light moments of his dialogue.

The good doctor, however, had some upbeat investment advice: In Asia, avoid real estate in financial centres, but look at things such as soft commodities, which, while volatile, are on an upward trend.

There are also opportunities in pharmaceutical and hospital management companies, and in banks, insurance companies and brokers, especially in emerging economies.

Opportunities also abound in plantations and farmlands in Indonesia, Malaysia, Latin America and the Ukraine. He also advised investors to go long on gold and corporate bonds but to dump US government bonds.

However, what was lacking at the talk were solutions to the current crisis. And answers. When can we see the light at the end of the tunnel? How long is the tunnel that we are in? – Today

http://www.themalaysianinsider.com/index.php/business/18977-dr-doom-says-us-govt-bonds-next-bubble-to-burst

The Global Recession

The Global Recession, Graded on a Curve

By FLOYD NORRIS
Published: February 19, 2009
If the economies and stock markets of the world were graded on a curve, the United States would be doing quite well.

Stock prices in the United States have fallen sharply since the end of 2007, but the situation is even bleaker in some other countries.

In the fourth quarter of last year, the American economy shrank at a 3.8 percent annual rate, the worst such performance in a quarter-century. They are envious in Japan, where this week the comparable figure came in at negative 12.7 percent — three times as bad.
Industrial production in the United States is falling at the fastest rate in three decades. But the 10 percent year-over-year plunge reported this week for January looks good in comparison to the declines in countries like Germany, off almost 13 percent in its most recently reported month, and South Korea, down about 21 percent.
Even in the area of exploding mortgages, the United States has done better than some countries, particularly in Eastern Europe. There it is possible now to owe twice what a house is worth — even if the house has not lost much of its value.
Grading on the curve, as any college student knows, requires that a certain proportion of high grades be given out no matter how badly the class as a whole performs. If the best student in the class gets just over half the answers right on a difficult test, that student deserves an A.
The real world, alas, does not score success in that way.
Consider how much money you would have left if you had put $100 into the stocks in the leading market indexes of major countries at the end of 2007, less than 14 months ago.
In the United States, you would now have about $53. That fact — coupled with the reality that more Americans than ever are depending on the stock market to pay for their retirement — has severely depressed sentiment and spending.
But it merits one of the top grades in this world. Among major markets, only Japan, at $59, has done better. In Britain, France, Spain and Germany, the figure would be around $45. In Italy, it would be $37. About a quarter of the money would still be there in countries like Ireland, Greece and Poland.
Remember the BRIC countries, where growth possibilities seemed limitless not long ago? The stars there are Brazil and China, where about $46 or $47 remains. In India, the figure is $35, and in Russia it is $23. At least they have all done a lot better than Iceland, where you would have just $3 left of your hypothetical $100.
All this failure, whether in markets or economies, is feeding upon itself. Imports and exports are falling nearly everywhere. “Our exports have been hurt more by the global recession than their exports have been hurt by our recession,” said Roger Kubarych, an economist at the Unicredit Group in New York.
Nowhere does the situation appear more dire now than in Eastern Europe.
Many of those countries had been running large current-account deficits, just as the United States has been doing. But the United States still has the ability to borrow all the dollars it wants — in part because lenders know the United States can print more of them if it needs to.
Eastern European countries have no such printing presses, and those countries that can borrow show little interest in sharing the bounty.
“Emerging Europe appears to be suffering a ‘sudden stop’ in financing, which could cause the region’s economy to contract by 5 percent to 10 percent this year,” said Neil Shearing, an economist at Capital Economics in London. “Markets in Eastern Europe appear to be in meltdown.” He says the Baltic economies could shrink 20 percent this year.
The latest collapses are both a cause of and a result of worries about the health of banks in the region, many of which are owned by Western European banks. Some of those banks did a fine job of pushing “affordable” mortgages that are turning out to be just the opposite, endangering both borrower and lender.
The details differed from the subprime lending that was a major cause of the destruction of capital in the American banking system. There were no “Ninja” loans (no income, no job or assets) that would produce exploding monthly payments within a couple of years. Instead, the banks pushed mortgages denominated in foreign currencies — largely the euro and the Swiss franc — where interest rates were much lower than in the local currency markets.
The risk was obvious. What if the local currency lost value rapidly? That is just what is happening. The Hungarian forint is down by about a quarter this year against the Swiss franc, and by more than half since last summer.
That means someone who bought a house in Hungary last summer, financing it with a Swiss franc loan, now owes more than twice as many forints as he or she borrowed, and has a monthly payment that has increased by a similar amount. Even if the home’s value has not fallen and the homeowner’s job is safe, he or she may be in desperate straits. In fact, unemployment is rising and house prices are falling.
It has been noted in what Donald H. Rumsfeld called the “old Europe” that the European countries in the direst straits tend to be the ones that accepted American financial advice with the most enthusiasm. Now, however, few Americans seem to be interested.
Part of the Obama plan to revive the American financial system is an expansion of the TALF program, announced but not carried out by the Bush administration. That program — short for Term Asset Backed Securities Loan Facility — is supposed to stimulate financing for things like credit cards and student loans.
But the loans are not for just anybody. At least 95 percent of the money must go to American borrowers. “It is a ‘Lend America’ program,” said Mr. Kubarych.
When world leaders gather, there is a lot of talk about coordinated policies. When the leaders go home, it is every country for itself. Unfortunately, as the United States ought to have learned, doing better than anyone else may not be nearly enough.
Floyd Norris’s blog on finance and economics is at nytimes.com/norris.

http://www.nytimes.com/2009/02/20/business/economy/20norris.html?fta=y

The humble Certificate of Deposit

Your Money
Not All Certificates of Deposit Are Plain Vanilla — or Safe

By RON LIEBER
Published: February 20, 2009
It was bad enough when big banks started going under. Then, money market funds became suspect. But now, even the humble certificate of deposit has become mired in scandal.

This week, the Securities and Exchange Commission accused a Texas financier named Robert Allen Stanford of fraud. Investigators allege that the scheme revolved in large part around the sale of about $8 billion of suspiciously high-yielding C.D.’s through Stanford International Bank.
These C.D.’s were not insured by the Federal Deposit Insurance Corporation. So once again, we’re faced with images of forlorn people trying and failing to extract their life savings.
There’s some question as to whether Stanford ought to have been using the phrase “certificate of deposit.” Most investors who hear “C.D.” immediately assume that it’s safe.
Faulty terminology or not, it’s a bad time for C.D.’s to get a black eye, given that growing numbers of people are looking for secure investments as stocks approach their bear market lows. So now that C.D.’s have been sullied, it makes sense to take a step back and review the basic product as well as other, more exotic C.D.’s that are being offered at banks, brokerage firms and elsewhere.

BASIC C.D.’S

When you buy a C.D. you hand over a pile of money to a bank and agree to keep it there for a certain period of time. In return for the certainty that it can use your funds for that long, the bank pays you interest, usually more interest than it would pay on a normal checking or savings account. Investments in C.D.’s are covered by the F.D.I.C., which currently offers insurance of up to $250,000 per person per bank. Additional coverage may be available depending on how you set up your accounts. (Links to the pertinent part of the F.D.I.C.’s Web site are available from the version of this story at nytimes.com/yourmoney.)
That $250,000 figure will fall to $100,000 for some types of accounts at the end of the year absent any new governmental action, so long-term C.D. investors need to keep that in mind.
There are plenty of places to shop for the best C.D. rates. Bankrate.com is one useful site, while MoneyAisle allows banks to compete for your business in an auction on the Web. Often, the banks offering the best rates are small banks you won’t have heard of or large banks that may be somewhat troubled.
As long as you don’t invest more than the F.D.I.C. limits, you don’t need to worry about losing your money. If the bank that issues your C.D. fails, however, another bank may end up with the failed bank’s deposits and has the right to lower your C.D. rate.
With any C.D., including the more complicated ones I outline below, there are a number of questions you should ask about the terms. Is the interest rate fixed? How long is the term? Is it callable, meaning the bank can give your money back to you before the term is up if it wants to? What sort of penalties exist if you need to take money out before the term is up? If the penalties are large enough, you could end up losing principal if you unexpectedly need the funds early.
You also want to check to see how the interest will be paid. Retirees may want a check, while others may want the money reinvested in the C.D. Also, how often does the bank pay out the interest? And will the bank try to automatically roll the money into a new C.D. when the term is up? Are there any commissions?

BROKERED C.D.’S

These are C.D.’s sold by brokerage firms, both large investment firms like Charles Schwab and small operations that maintain Web sites or try to cold-call you. They generally pool money from investors and then invest it in C.D.’s from F.D.I.C.-insured banks that the brokers find on their own. Sometimes, the banks are willing to pay better rates on brokered C.D.’s if the brokerage firm can bring a large enough pile of money to the bank.
One advantage here, according to René Kim, a senior vice president of Charles Schwab, is that you can keep multiple C.D.’s of different maturities in one account. And if you have a lot of money to put to work, you can place it with different banks to stay under the F.D.I.C. limits. Just be sure that the broker doesn’t place it with a bank where you already have other accounts, if the new money would put you over the F.D.I.C. limits.
Brokerage firms may tell you that there are no fees for early withdrawal of a brokered C.D. The S.E.C. warns, however, that if you want to get your money out early, your broker may need to try to sell your portion of the C.D. on a secondary market. You may not be able to sell it for an amount that will allow you to get all of your principal back.

INDEXED C.D.’S

These C.D.’s, also known as market-linked C.D.’s, generally guarantee that you’ll get your original investment back. They also let you share in the gain of a stock market index, like the Dow Jones industrial average or the Standard & Poor’s 500-stock index. If stocks are up during the term of your C.D., you’ll make some money. If not, you’ll still get your initial investment back, though inflation may have eroded its value.
While this downside protection and upside participation may be tempting at a time like this, these C.D.’s can be complicated. (They’re also a bit scarce at the moment, since stock market volatility makes it more expensive for banks to offer them.) Your return will depend on how the issuer of the C.D. calculates the average return on the index. So ask to see an example.
Also, the bank that offers the C.D. may not credit any of the money you earn until the end of the C.D.’s term, even though you still have to pay taxes each year on your interest.
Finally, while your initial investment may have F.D.I.C. protection, any gain during the term of the C.D. may not be covered if the bank goes under before the C.D.’s term is up, depending on how the interest is calculated and credited. Again, ask about this in advance. Also, don’t assume that your investment comes with F.D.I.C. insurance, because there are similar-sounding investments that may not.

FOREIGN CURRENCY C.D.’S

Here, you’re using American dollars to make a bet. At EverBank, which offers many foreign currency C.D.’s, you earn interest in the currency that you choose and can earn even more money if it appreciates against the dollar. If it moves in the opposite direction, however, you can lose not just your interest but some of the principal, too.
While the F.D.I.C. does insure the principal here, EverBank notes that the coverage is only for failure of the institution, not for fluctuation in currency prices. “Please only invest with money that you can afford to risk, and as part of a broadly diversified investment strategy,” its disclosure says.
The bank might as well say that you should only invest what you can afford to lose, which is not how most people normally think about C.D.’s.
So if you’re trying to stay safe, consider a plain, old-fashioned C.D. instead. And don’t ever assume, as some of the Stanford investors may have done, that F.D.I.C. insurance is automatically part of the C.D. package.
How safe is your C.D.? Write to rlieber@nytimes.com

http://www.nytimes.com/2009/02/21/your-money/21money.html?em

The Index Funds Win Again

Strategies
The Index Funds Win Again

By MARK HULBERT
Published: February 21, 2009
THERE’S yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.

Basic stock market index funds generally aspire to nothing more than matching the returns of a market benchmark. So in a miserable year for stocks, index funds may not look very appealing. But it turns out that, after fees and taxes, it is the extremely rare actively managed fund or hedge fund that does better than a simple index fund.
That, at least, is the finding of a new study by Mark Kritzman, president and chief executive of Windham Capital Management of Boston. He presented his results in the Feb. 1 issue of Economics & Portfolio Strategy, a newsletter for institutional investors published by Peter L. Bernstein Inc.
Mr. Kritzman, who also teaches a graduate course in financial engineering at M.I.T.’s Sloan School of Management, set up his study to accurately measure the long-term impact of all the expenses involved in investing in a mutual fund or hedge fund. Those include transaction costs, taxes and management and performance fees.
He is not the first to try such a measurement. But, he said in an e-mail message, it is surprisingly hard to measure these costs accurately. The bite taken out by taxes, for example, depends on the specific combination of positive years and losing ones, as well as the order in which they occur. That combination and order also affect the performance fees charged by hedge funds.
Mr. Kritzman devised an elaborate method to take such contingencies into account. Then he calculated the average return over a hypothetical 20-year period, net of all expenses, of three hypothetical investments: a stock index fund with an annualized return of 10 percent, an actively managed mutual fund with an annualized return of 13.5 percent and a hedge fund with an annualized return of 19 percent. The volatility of the three funds’ returns — along with their turnover rates, transaction fees and management and performance fees — was based on what he determined to be industry averages.
Mr. Kritzman found that, net of all expenses, including federal and state taxes for a New York State resident in the highest tax brackets, the winner was the index fund.
Specifically, he assumed that long-term capital gains were subject to a 15 percent federal tax and a 6.85 percent state tax; short-term capital gains and dividends were taxed at a combined federal and state rate of nearly 42 percent. The index fund’s average after-expense return was 8.5 percent a year, versus 8 percent for the actively managed fund and 7.7 percent for the hedge fund.
Expenses were the culprit. For both the actively managed fund and the hedge fund, those expenses more than ate up the large amounts — 3.5 and 9 percentage points a year, respectively — by which they beat the index fund before expenses.
IF such outperformance isn’t enough to overcome the drag of expenses, what would do the trick? Mr. Kritzman calculates that just to break even with the index fund, net of all expenses, the actively managed fund would have to outperform it by an average of 4.3 percentage points a year on a pre-expense basis. For the hedge fund, that margin would have to be 10 points a year.
The chances of finding such funds are next to zero, said Russell Wermers, a finance professor at the University of Maryland. Consider the 452 domestic equity mutual funds in the Morningstar database that existed for the 20 years through January of this year. Morningstar reports that just 13 of those funds beat the Standard & Poor’s 500-stock index by at least four percentage points a year, on average, over that period. That’s less than 3 out of every 100 funds.
But even that sobering statistic paints too rosy a picture, the professor said. That’s because it’s one thing to learn, after the fact, that a fund has done that well, and quite another to identify it in advance. Indeed, he said, he has found from his research that only a minority of funds that beat the market in a given year can outperform it the next year as well.
Professor Wermers said he believed that it was “exceedingly probable that any fund that has beaten the market by an average of more than one percentage point per year over the last decade achieved that return almost entirely due to luck alone.”
“By definition, therefore, such a fund could not have been identified in advance,” he added.
The investment implication is clear, according to Mr. Kritzman. “It is very hard, if not impossible,” he wrote in his study, “to justify active management for most individual, taxable investors, if their goal is to grow wealth.” And he said that those who still insist on an actively managed fund are almost certainly “deluding themselves.”
What if you’re investing in a tax-sheltered account, like a 401(k) or an I.R.A.? In that case, Mr. Kritzman conceded, the odds are relatively more favorable for active management, because, in his simulations, taxes accounted for about two-thirds of the expenses of the actively managed mutual fund and nearly half of the hedge fund’s. But he emphasized the word “relatively.”
“Even in a tax-sheltered account,” he said, “the odds of beating the index fund are still quite poor.”
Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch. E-mail: strategy@nytimes.com.

http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html?em

When Consumers Cut Back: An Object Lesson From Japan

When Consumers Cut Back: An Object Lesson From Japan

By HIROKO TABUCHI

Published: February 21, 2009

TOKYO — As recession-wary Americans adapt to a new frugality, Japan offers a peek at how thrift can take lasting hold of a consumer society, to disastrous effect.

Multimedia
Graphic
In Japan, Neither Spending Nor Saving

The economic malaise that plagued Japan from the 1990s until the early 2000s brought stunted wages and depressed stock prices, turning free-spending consumers into misers and making them dead weight on Japan’s economy.
Today, years after the recovery, even well-off Japanese households use old bath water to do laundry, a popular way to save on utility bills. Sales of whiskey, the favorite drink among moneyed Tokyoites in the booming ’80s, have fallen to a fifth of their peak. And the nation is losing interest in cars; sales have fallen by half since 1990.
The Takigasaki family in the Tokyo suburb of Nakano goes further to save a yen or two. Although the family has a comfortable nest egg, Hiroko Takigasaki carefully rations her vegetables. When she goes through too many in a given week, she reverts to her cost-saving standby: cabbage stew.
“You can make almost anything with some cabbage, and perhaps some potato,” says Mrs. Takigasaki, 49, who works part time at a home for people with disabilities.
Her husband has a well-paying job with the electronics giant Fujitsu, but “I don’t know when the ax will drop,” she says. “Really, we need to save much, much more.”
Japan eventually pulled itself out of the Lost Decade of the 1990s, thanks in part to a boom in exports to the United States and China. But even as the economy expanded, shell-shocked consumers refused to spend. Between 2001 and 2007, per-capita consumer spending rose only 0.2 percent.
Now, as exports dry up amid a worldwide collapse in demand, Japan’s economy is in free-fall because it cannot rely on domestic consumption to pick up the slack.
In the last three months of 2008, Japan’s economy shrank at an annualized rate of 12.7 percent, the sharpest decline since the oil shocks of the 1970s.
“Japan is so dependent on exports that when overseas markets slow down, Japan’s economy teeters on collapse,” said Hideo Kumano, an economist at the Dai-ichi Life Research Institute. “On the surface, Japan looked like it had recovered from its Lost Decade of the 1990s. But Japan in fact entered a second Lost Decade — that of lost consumption.”
The Japanese have had some good reasons to scale back spending.
Perhaps most important, the average worker’s paycheck has shrunk in recent years, even after companies rebounded and bolstered their profits.
That discrepancy is the result of aggressive cost-cutting on the part of Japanese exporters like Toyota and Sony. They, like American companies now, have sought to fend off cutthroat competition from companies in emerging economies like South Korea and Taiwan, where labor costs are low.
To better compete, companies slashed jobs and wages, replacing much of their work force with temporary workers who had no job security and fewer benefits. Nontraditional workers now make up more than a third of Japan’s labor force.
Younger people are feeling the brunt of that shift. Some 48 percent of workers age 24 or younger are temps. These workers, who came of age during a tough job market, tend to shun conspicuous consumption.
They tend to be uninterested in cars; a survey last year by the business daily Nikkei found that only 25 percent of Japanese men in their 20s wanted a car, down from 48 percent in 2000, contributing to the slump in sales.
Young Japanese women even seem to be losing their once- insatiable thirst for foreign fashion. Louis Vuitton, for example, reported a 10 percent drop in its sales in Japan in 2008.
“I’m not interested in big spending,” says Risa Masaki, 20, a college student in Tokyo and a neighbor of the Takigasakis. “I just want a humble life.”
Japan’s aging population is not helping consumption. Businesses had hoped that baby boomers — the generation that reaped the benefits of Japan’s postwar breakneck economic growth — would splurge their lifetime savings upon retirement, which began en masse in 2007. But that has not happened at the scale that companies had hoped.
Economists blame this slow spending on widespread distrust of Japan’s pension system, which is buckling under the weight of one of the world’s most rapidly aging societies. That could serve as a warning for the United States, where workers’ 401(k)’s have been ravaged by declining stocks, pensions are disappearing, and the long-term solvency of the Social Security system is in question.
“My husband is retiring in five years, and I’m very concerned,” says Ms. Masaki’s mother, Naoko, 52. She says it is no relief that her husband, a public servant, can expect a hefty retirement package; pension payments could fall, and she has two unmarried children to worry about.
“I want him to find another job, and work as long as he’s able,” Mrs. Masaki says. “We must be ready to fend for ourselves.”
Economic stimulus programs like the one President Obama signed into law last week have been hampered in Japan by deflation, the downward spiral of prices and wages that occurs when consumers hold down spending — in part because they expect goods to be cheaper in the future.
Economists say deflation could interfere with the two trillion yen ($21 billion) in cash handouts that the Japanese government is planning, because consumers might save the extra money on the hunch that it will be more valuable in the future than it is now.
The same fear grips many economists and policymakers in the United States. “Deflation is a real risk facing the economy,” President Obama’s chief economic adviser, Lawrence H. Summers, told reporters this month.
Hiromi Kobayashi, 38, a Tokyo homemaker, has taken to sewing children’s ballet clothes at home to supplement income from her husband’s job at a movie distribution company. The family has not gone on vacation in two years and still watches a cathode-ray tube TV. Mrs. Kobayashi has her eye on a flat-panel TV but is holding off.
“I’m going to find a bargain, then wait until it gets even cheaper,” she says.

http://www.nytimes.com/2009/02/22/business/worldbusiness/22japan.html?em

U.S. Pressed to Add Billions to Bailouts

U.S. Pressed to Add Billions to Bailouts


By EDMUND L. ANDREWS, ANDREW ROSS SORKIN and MARY WILLIAMS WALSH
Published: February 23, 2009

Related
Across the Atlantic, Echoes in R.B.S.’s Lifeline (February 24, 2009)
A Third Rescue Would Give Washington a 40% Stake in Citigroup (February 24, 2009)
New York Financier Picked as Top Adviser on Auto Industry Bailout (February 24, 2009)
Times Topics: Credit Crisis - Bailout Plan


The government faced mounting pressure on Monday to put billions more in some of the nation’s biggest banks, two of the biggest automakers and the biggest insurance company, despite the billions it has already committed to rescuing them.
The government’s boldest rescue to date, its $150 billion commitment for the insurance giant American International Group, is foundering. A.I.G. indicated on Monday it was now negotiating for tens of billions of dollars in additional assistance as losses have mounted.
Separately, the Obama administration confirmed it was in discussions to aid Citigroup, the recipient of $45 billion so far, that could raise the government’s stake in the banking company to as much as 40 percent.
The Treasury Department named a special adviser to work with General Motors and Chrysler, two of Detroit’s biggest automakers, which are seeking $22 billion on top of the $17 billion already granted to them.
All these companies’ mushrooming needs reflect just how hard it is to stanch the flow of losses as the economy deteriorates. Even though the government’s finances are being stretched — and still more aid might be needed in the future — it is being forced to fill the growing holes in the finances of these companies out of fear that the demise of an important company could set off a chain reaction.
The deepening global downturn is dragging down all kinds of businesses, and, with no bottom to the recession in sight, investors sent the Standard & Poor’s 500-stock index down 3.5 percent, to its lowest close since April 1997. The Dow industrials fell 250.89 points, to 7,114.78, a 3.7 percent drop.
In an unexpectedly assertive joint statement after two weeks of bank stock declines, the Treasury Department, the Federal Reserve and federal bank regulatory agencies announced that the government might demand a direct ownership stake in major banks that do not have enough capital to weather a deeper downturn. The government will begin conducting a test of the banks’ financial health this week.
Administration officials emphasized that nationalizing any of the major banks was their least favorite solution to the banking crisis, but they acknowledged that some banks might be both too big to fail and too fragile to endure another round of shocks without substantial help.
The administration is debating how big a role to play in the auto businesses, what concessions the companies should make in return for aid and whether bankruptcy should be considered, though it prefers a private sector solution. On Monday, Steven Rattner, co-founder of the private equity firm Quadrangle Group, was named an adviser to the Treasury on restructuring the auto industry. As the administration takes bigger stakes in companies, the value held by existing shareholders is being diluted, which could make it even harder to attract private money in the future. Timothy F. Geithner, the secretary of the Treasury, recently outlined a bank recovery plan that included a new program to attract a combination of public and private money to buy troubled mortgages and other assets.
A.I.G. serves as a cautionary note about the difficulty of luring private investors when the size of the losses is unknown. In the months since the government initially stepped in last fall to take an 80 percent stake in the insurer, the company has suffered deepening losses and has been forced to post more collateral with its trading partners. The company, according to a person close to the negotiations, is discussing the prospect of converting the government’s $40 billion in preferred shares into common equity.
The prototype could turn out to be Citigroup, which is negotiating with regulators to replace the government’s nonvoting preferred shares with shares that are convertible into common stock.
“We absolutely believe that our private banking system is best off being in private hands and we are trying our best to keep it that way,” said one senior administration official, who spoke on condition of anonymity. But, he continued, the government is already deeply involved in propping up the banking system and may have no choice.
Officials said they were bracing for the possibility of new problems that might indeed require the government to take a more aggressive stance.
“Given our involvement at this particular stage, there is an element, a possibility over time, that we will end up with some ownership of these institutions,” the official said. “This is really about aggressive anticipatory action. It is an acceptance that the future is uncertain, but that we can plan on a certain basis for it.”
Acquiring common stock would give the government more control, but expose it to more risk. Armed with voting shares, government officials would have more power to replace management and change company strategy. But the Treasury would lose its claim to dividend payments, which in Citigroup’s case amount to more than $2.25 billion a year.
A.I.G. declined to provide details of its new financial problems, citing the “quiet period” just before it issues fourth-quarter results. But some people familiar with A.I.G.’s negotiations said it was on the brink of reporting one of the biggest year-end losses in American history.
Such losses lead to a bigger problem. A further credit rating downgrade would force the company to raise more capital, according to a person involved in the negotiations. The losses appeared to be across the board, unlike the insurer’s giant losses of last September, which were confined mostly to the derivative contracts, called credit-default swaps, that A.I.G. had written as insurance on other debts.
A.I.G. has not been writing new credit-default swap contracts, and had tried to put the swaps disaster behind it. In November the company worked out a relief package with the Federal Reserve Bank of New York, in which the most toxic of its swap contracts were put into a kind of quarantine, so they could no longer hurt its balance sheet.
But A.I.G. put only one type of credit-default swaps into the quarantine. It had written several other classes of credit-default swaps, which it has continued to carry on its books.
If the latest round of losses severely weaken A.I.G.’s capital and its creditworthiness, then its swap counterparties may be entitled to demand that A.I.G. come up with a large amount of cash for collateral — precisely the problem that brought the company to its knees last September.
“They stand, unfortunately, to bring others down with them if they go down,” said Donn Vickrey of Gradient Analytics, an independent research firm. Last fall, when A.I.G. received its initial $85 billion from the Fed, he estimated that the total cost of bailing out A.I.G. would eventually mount to $250 billion. “We are moving closer and closer to that prediction,” he said Monday.
The difficulty of shoring up A.I.G. must weigh on the administration at this moment. The administration’s banking statement amounted to a plan of action demonstrating a way to demand a major and possibly a controlling stake in systemically important banks like Citigroup and Bank of America.
“They are desperate to not nationalize the banks,” said Robert J. Barbera, chief economist at ITG. “They know what happened when they took Iraq and they would just as soon not take over the banks, because if you own it, you gotta fix it.”
Eric Dash and Michael J. de la Merced contributed reporting.

http://www.nytimes.com/2009/02/24/business/24bailout.html?_r=1&ref=business

Stocks Slump on Corporate Woes; Indexes Fall by 3.4%

Stocks Slump on Corporate Woes; Indexes Fall by 3.4%
By JACK HEALY 5:17 PM ET

Investors pushed the Dow and S.&P. 500 down to 1997 levels as losses piled up in technology and major industrial companies.

Investors called it another day of water-torture declines on Wall Street: drop, drop, drop.

A broad sell-off sent Wall Street staggering lower in the last hour of trading on Monday as the banking system continued to worry investors. The Dow Jones industrial average was down 250.89 points at the close while the Standard & Poor’s 500-stock index, a broader gauge of the market closed at its lowest level since April 1997.

Losses piled up in technology companies like Apple, Google and I.B.M. and industrial companies like DuPont, Caterpillar and the aluminum maker, Alcoa. But in a reversal, battered shares of Citigroup and Bank of America closed higher, and the financial sector fared better than the broader market.

With worries growing about the stability and solvency of the country’s big banks, the Treasury Department tried to reassure jittery investors with a message supporting the financial system and laying out details of the coming “stress tests” of major banks. The message did not calm anyone.

After a brief rise in early trading, stock markets fell into the red and sank lower throughout the afternoon. The Dow Jones industrial average closed down 3.4 percent to 7.114.78 while the broader S. & P. 500 fell 3.47 percent, or 26.72 points, to 743.33. The technology heavy Nasdaq was down 3.7 percent, or 53.51 points, to 1,387.72 as shares of technology companies turned lower.

Shares of Microsoft, Hewlett-Packard and other technology companies fell amid concerns about how the sector would hold up as the economy spins lower. Companies that make basic materials like steel, chemicals and plastic also sank. Crude oil fell $1.59, to $38.44 a barrel, scaling back some recent gains, and gold prices also fell back slightly to $995 an ounce.

The day’s declines continued the downward momentum of a brutal week that sent the major indexes down more than 6 percent. “In lieu of anything the market sees as positive, it’s going to continue its easiest path, and the path it sees is down,” said Joseph Saluzzi, co-head of equity trading at Themis Trading. “That’s where we’re stuck right now, and who’s going to get out in front of it?”

With America’s banking system facing a round of “stress tests,” the prospect of greater governmental control and an uncertain future, the government tried to assure investors early Monday that it would stand behind the banking system, and that it would provide additional temporary aid to banks.

“The government will ensure that banks have the capital and liquidity they need to provide the credit necessary to restore economic growth,” the Treasury Department, the Federal Deposit Insurance Corporation and other agencies said in an unusual joint statement. “Moreover, we reiterate our determination to preserve the viability of systemically important financial institutions so that they are able to meet their commitments.”

The Treasury statement added that major banking institutions were “well capitalized.”

But analysts said investors remained worried about how America’s biggest banks would deal with the troubled assets on their balance sheets, and their prospects for weathering a prolonged economic contraction. Shares of Wells Fargo, Citigroup and Bank of America stayed positive, but other financial companies like Morgan Stanley and Goldman Sachs turned negative.

Analysts said that after fevered speculation last week about bank nationalization, many investors now expect the government to move in that direction, despite statements from the White House supporting a privately held banking system. Stock markets dropped on Friday amid concerns that a broad government takeover could wipe out financial shareholders.

Now, with the government set to begin the “stress tests” on Wednesday, investors want to know which banks will be deemed healthy and which will not, analysts said. Of most pressing concern are big banks including Citigroup, Bank of America, Wells Fargo and JPMorgan Chase, followed by regional chains.

“We need to know how they stand right now,” said Dave Rovelli, managing director of trading at Canaccord Adams. “The uncertainty of waiting for the results of these stress test is just killing the markets.”

Three weeks ago, stock markets tumbled after the Treasury Department announced plans to form a public-private partnership to take troubled mortgage-related assets off the balance sheets of banks. Investors said the government’s plans were short on details and left too much uncertainty about how those assets would be valued, or how private investors would be enticed to bid on them.

The losses on Wall Street came one week after the Dow sank to its lowest levels in six years on growing fears about banks across Europe and the United States.

By the end of trading on Friday, the Dow had tumbled 6.2 percent for the week, its worst since October, and had sunk to its lowest levels in six years. The S. & P. 500 fell 6.5 percent, dropping below 800, but was still slightly above its bear-market lows of Nov. 20.

“The technicians now have control of this market,” said Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research. “People are saying, ‘Where do we go now? We don’t know what’s next.’ ”

What next for the price of gold?

What next for the price of gold?
While the outlook for the gold price remains positive, Blackrock Gold & General fund manager Graham Birch thinks investors should be wary of losing their perspective on it as part of a balanced portfolio.

By Pascal Dowling, head of research at Financial Express
Last Updated: 12:18PM GMT 23 Feb 2009

The price of gold this year overtook platinum briefly for the first time in a quarter of a century, causing a spike in gold funds. But while the outlook for the gold price remains positive, Blackrock Gold & General fund manager Graham Birch thinks investors should be wary of losing their perspective on it as part of a balanced portfolio.

Gold has rallied strongly in recent months to reach around $970 an ounce last week, close to its peak of more than $1,000 an ounce in March last year, prompting a new spike in the performance of funds with exposure to the metal.

Ruffer Baker Steel Gold has produced a total return of 55pc since the start of November when the price of gold began to rise, while Investec leapt 71pc over the same period. Smith & Williamson Global Gold & Resources fund has seen even greater returns, growing 75pc.

Blackrock Gold & General fund has produced a total return of 70pc – the equivalent of turning £1,000 into £1,700 over the same period, but the story behind this stellar performance is more complicated than it first appears.

Fund manager Graham Birch says the collapse of Lehman Brothers may have had a significant effect on the gold price last year, the implications of which are still being felt.

"You could argue that in the autumn of last year gold shares were too cheap. The price of gold was hit very hard during the Lehman crisis – you have to remember that so many people had money tied up with Lehman, and they were forced to sell whatever they had – including gold – during that period just to raise liquidity."

Gold reached a low in October last year, and has begun to recover. Because gold is priced in dollars and the dollar has strengthened against the pound, British investors with exposure to the precious metal have done particularly well.

Mr Birch claims that the commodity will continue to perform well, as people continue to buy into gold as a way to diversify their portfolios, and hedge their bets against the outcome of the various fiscal and monetary stimuli which governments, here and in the United States especially, are using to reinvigorate the economy.

Unsurprisingly, Adrian Ash, head of research at online gold trading facility www.bullionvault.com , agrees. The cost of holding gold, in terms of risk and lost interest, as opposed to cash, has fallen. To all intents and purposes, neither asset now pays any interest, but there is much concern about the possibility that money itself will be worth less in five years should inflation kick in on the back of these economic stimuli.

Mr Ash said: "The stimulus package which is coming through in the United States, I think a lot of people are seeing as the government heading straight to the dollar printing press. The big question is, in 12 months' time how many more dollars will there be in the world, and how much more gold will there be?"

Mr Birch said: "At the moment conditions are deflationary – money buys more than it used to – but central banks have cut back interest rates to virtually nothing, and once they've done that the next step is to use what they call quantitative easing – which is effectively printing money.

"A lot of people who are buying gold at the moment think that there is some danger that this quantitative easing might end in tears. If you are investing in a 10-year bond, for example, the interest rate is lousy, and it's redeemed in sterling – and you don't know what the effect of this quantitative easing is going to be; it could be that it's inflationary, and if it is that means you don't know what the value of sterling will be when it comes to redemption."

This wariness should support further strength in the gold price, claimed Mr Birch, but investors should not see exposure to the asset as a panacea. He explained: "Gold is not really an asset that helps poor people to get rich. It's an asset that helps rich people to stay rich as part of a diversified portfolio. You must remember that the people who are buying gold don't mind if they lose a bit of money on the gold price, if they are properly diversified, because if the gold price begins to fall, that probably means the conventional equity market is beginning to recover so they're making a bit of money elsewhere."

Gold, and in particular funds that invest in gold equities, should not be viewed as an absolute return option – or an option offering positive returns in any market. A recovery in the stock market would quite likely see poor returns or losses for funds of this type, and Mr Birch said this was important to remember.

"To be honest we would not take much action at all if the gold price did begin to fall. It sounds bad but these are sector funds, so we do not shy away from giving exposure to that sector just because it's begun to fall. We would take it on the chin, and that might mean people sell out of the fund, but that's their choice – we are not making the decision to go for exposure to gold for them, so we would not make the decision to deprive them of it,'' he said.

"It just so happens that exposure to gold has provided a good absolute return in recent years, but our goal is simply to provide exposure to it, and hopefully add some value over the long term."

http://www.telegraph.co.uk/finance/personalfinance/investing/4786021/What-next-for-the-price-of-gold.html

Why did no one see the credit crunch coming?

The Queen's tough question about the credit crunch has not been answered
Why did no one see the credit crunch coming? That was the awkward question Her Majesty the Queen asked on a visit to the London School of Economics last year.

By Peter Spencer
Last Updated: 9:32PM GMT 22 Feb 2009

Comments 18 Comment on this article

It would make a useful addition to many economics and finance examination papers this summer.

I would argue that it was hard to predict simply because nothing like this has ever happened before. History is littered with financial crises, but the collapse of the market in liquidity that lies at the heart of this problem is almost without precedent. The only case I am aware of is the collapse in international trade finance that took place after the assassination of the Archduke Ferdinand in Sarajevo, in the run up to the First World War.

The roots of this collapse lie in the global imbalances that have been building up for decades, making the world economy increasingly vulnerable. Huge savings in Asia depressed world interest and inflation rates and were channelled through the US banking system to western borrowers, reinforced since the millennium by the flow of petrodollars.

That helped drive the boom in UK mortgage and housing markets and the fall in the saving ratio. In 2006 our mortgage lenders were handing out £10bn of mortgages every month – and only getting in £5bn of that from savers. The rest was coming in from overseas banks.

The result was an overseas debt of £740bn between 2000 and 2006 – worth more than half of our gross domestic product – typically with a very short maturity. These dollar inflows had to be converted into sterling, which is why the exchange rate was so strong and exports so weak.

I think we all knew it could not last. It didn't matter whether you looked at the global imbalances; the level of house prices, or the 125pc mortgages that lenders were blithely handing out: this was clearly unsustainable.

People had been predicting a sticky end for years, but the dance just went on and on. Gordon Brown was repeatedly warned of the risk we were running with high levels of borrowing by the OECD, the IMF and other institutions. However, the music was so loud he could not hear.

He was not the only one. The Bank for International Settlements clearly warned of the threat to the global financial system posed by financial engineering and high levels of leverage. However, the markets refused to listen and just carried on dancing.

When it finally came, the end of the credit boom was much more sudden than anyone imagined. Like myself, most economists thought in terms of a gradual rebalancing as the debts built up and house prices became unaffordable, with the brakes applied gently. We expected things to turn round gradually, moving in a cyclical way rather than screeching to a halt. The surprise was that this time the international banking markets simply froze, suddenly halting the inflows into sterling and the credit markets. So what we got was more like a car crash. The economy had to adjust suddenly rather than, as we thought, gradually

Regrettably, very few were wearing seat belts. Now all of those heavy short term debts have to be repaid. Northern Rock was of course the first casualty, and the housing market quickly followed, dragging the rest of the economy into recession. The pound has been another casualty.

As I say, economists usually expect things to turn round gradually rather than abruptly. Financial markets can turn on a sixpence, but they usually remain open for business, even after a stock market crash. As Hyman Minsky observed, credit markets swing from elation and speculation to panic and contraction. But they have not shut down before, at least in peacetime.

Interest rates and financial prices can react violently in a crisis, but usually they manage to get demand back into line with supply. If confidence collapses it may take a big fall in the stock market to tempt bargain hunters back in, but eventually this happens.

Credit markets seem easier to understand than the stock market but are actually much more complex. If the supply of bank finance is cut, interest rates will normally rise to help bring demand into line with supply. But as Joseph Stiglitz pointed out in a famous paper with Andrew Weiss in 1981, this will discourage prudent borrowers who tend to be price sensitive, increasing the proportion of bad risks on the loan book. It is hard to prevent this: bank managers can't really distinguish the bad risks; otherwise they would not get a loan in the first place. Credit risk rises, particularly if a recession results, meaning that a rise in the loan rate can actually reduce the profitability of the loan book.

In this situation, banks tend to ration their customers rather than raising rates any further. A similar effect seems to have shut down the inter-bank and other wholesale credit markets in August 2007. Inter-bank rates naturally moved up as the market began to worry about bank losses on sub-prime loans.

But they reached a point at which they began to raise questions about the borrower's ability to repay. Any bank that was prepared to pay 1pc or so over the odds clearly had a liquidity problem. It might also have a solvency problem, especially if it was relying on high cost wholesale funds to fund a historic portfolio of low cost mortgages. So any banks that did have surplus cash simply hoarded it rather than risking it.

Of course there was more to it than that. Once Northern Rock failed, it became clear that wholesale depositors could not rely on the bank regulators to monitor the banks properly.

This also raised doubts about the Bank of England's ability to help out banks without stigmatising them, even if they just had a temporary problem with their liquidity.

Moreover, when the credit markets dried up it was no longer possible to place a market value on many of the banks assets. But whatever the reasons for this, the banks simply stopped lending to each other. Then they stopped lending to us.

Peter Spencer is Professor of Economics and Finance, University of York and Economic Adviser, Ernst & Young ITEM Club

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/4782758/The-Queens-tough-question-about-the-credit-crunch-has-not-been-answered.html

Valuations are the core determinant of equity market returns.

Reason to hope for stock market investors
The "brutal" lesson will can learn from the past 10 years is that valuations are the core determinant of equity market returns.

By Paul Farrow
Last Updated: 12:14PM GMT 23 Feb 2009

John Maynard-Keynes: 'Success is always to the minority and never to the majority'
It is official. Equities were the worst performing asset class over the past decade, delivering negative real returns since 1998.

I don't suppose that those of you who have owned shares, unit trusts or Isas over the period will be too surprised at the revelation.

Unless you had been canny and bagged profits when they came and timed your run into commodities or emerging markets (and got out again) – or followed the gold bugs – you would have been a loser.

Fund statements that will have landed on doormats over the past year will have made for grim reading, while workers who are in defined contribution pension schemes have just learned that their pension fund has fallen in value by 25pc last year.

Consensus on where equities go from here is difficult to gauge, although the bears seem to outnumber the bulls. Investors seem to be shunning equities in favour if bonds.

Many advisers are once again advocating the merits of diversification – in other words, if you had invested in other assets such as cash and bonds, you would have fared better than someone who was overexposed to equities.

Yet not everyone believes diversification is the name of the game. Gary Potter, a multi-manager at Thames River, is one who argues that the crisis has narrowed the correlation between assets, making diversification less of a benefit.

He is happy to remain overweight in cash for the time being.

Some might be proclaiming the death of equities, although such thoughts could be premature.

It is easy to be sceptical about shares right now given their woeful performance, but the analysts who have just finished writing the 2009 Barclays Equity Gilt Study give reason for hope.

Firstly, the underperformance of shares has nothing to do with the asset class per se. Secondly, it says the macroeconomic environment has little influence on shares, which is a cheery thought given the deepening global recession.

Even corporate profitability, you might be surprised to learn, isn't the deciding factor on whether a share outperforms or not.

The study concludes that the "brutal" lesson will can learn from the past 10 years is that valuations are the core determinant of equity market returns.

Its research suggests that the reason shares have had such an abysmal ride over the past decade is that they were overvalued. Through the good times we were paying too much to get access to bumper profits.

"When the surge in growth ended abruptly in 2008, equity prices fell in line with the actual and expected decline in profits.

Expensive valuations therefore caused equity returns to underperform profits following the 2001 slowdown and then did the same during the ensuing boom, while finally failing to provide a cushion when the business cycle turned down," the study concludes.

You can probably guess where the Barclays mob are going with this, so if you are considering stuffing your spare cash under your mattress, keeping it in a savings account despite the dismal rates of interest, or even following the herd and piling into bonds, then bear this in mind.

The authors of the study believe that equity valuations will fall a little further and remain low for a while, before recovering late in the decade. Meanwhile, bonds' rising yields will "self-evidently" damage returns. The end result is that equities will outperform bonds over the next 10 years.

The contrarian argument put forward by Barclays might whet the appetite of those yearning for some optimism. Those optimists might also want to be reminded of this post-Depression scribbling from John Maynard Keynes, the most famous contrarian investor of them all.

In 1937 he wrote: "It is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find anyone agreeing with you, change your mind."

http://www.telegraph.co.uk/finance/personalfinance/comment/paulfarrow/4786377/Reason-to-hope-for-stock-market-investors.html

Darling’s latest rescue plan for the economy is to print fresh money.

By GEORGE PASCOE-WATSON
Political Editor


CHANCELLOR Alistair Darling’s latest rescue plan for the economy is to print fresh money.
The Treasury and the Bank of England will agree this week on a £100billion injection of cash which currently doesn’t exist. Economists call the highly risky strategy “quantitative easing”.

Here is The Sun’s guide to modern-day printing money:


Why is it happening?
The Bank of England’s main weapon against a slump is interest rates. It has cut them down to one per cent already to put more cash in people’s pockets.

But that still hasn’t done the trick and once interest rates fall to zero per cent, it must find a new way of kick- starting the economy.


Does this literally mean fresh bank notes, i.e fivers and tenners, being printed?
No.


So why is it called printing money?
Quantitative easing means flooding the economy with more money than currently exists. But the cash injected is not new bank notes. It is done electronically by the Bank of England, our central bank.


How does it happen?
High Street banks will “sell” their assets to the Bank of England. These can be mortgage deals they have with customers, Government bonds and other debt. The Bank of England will then pay the banks for these assets with money that currently doesn’t exist. It won’t be hard cash — it will be electronic transfers of money.

In fact, the Bank of England will merely increase the size of commercial banks’ accounts held there. All banks must keep reserves of cash at the Bank of England.

So the commercial banks’ assets will be swapped for more cash reserves by the Bank of England.


What happens next?
Commercial banks will have more money to use — and lend. Printing money will also keep long-term interest rates down — meaning banks will be more likely to lend to each other.

This will encourage them to give credit to firms and individuals who will start spending money.


How much cash is there in the money supply?
We currently have £1.95trillion in the UK money supply. Only £50billion is cash — or £850 per person. The rest is in banks as savings and investments.


Are there risks?
There is a risk of hyper-inflation if printing money is done too rapidly.


Has it ever been done before?
Yes. Most recently the Japanese government did it for six years, only ending the practice in 2006. But experts believe the move did not make a significant difference to their long-term slump.


What about disasters?
Money was printed and pumped into the economy in Zimbabwe under Robert Mugabe and in pre-Second World War Germany. Both actions led to the economies’ collapse as banknotes became worthless.

In Germany people carried cash in wheelbarrows because each note was worth so little. The barrows were soon stolen because they were worth more than the cash due to hyperinflation.

http://www.thesun.co.uk/sol/homepage/news/money/article2262459.ece

Stocks and Earnings: Racing to the Bottom

November 20, 2008,
Stocks and Earnings: Racing to the Bottom
By David Leonhardt
One problem for the stock market right now is that estimates of corporate earnings are falling almost as fast as share prices.

That means that even as stocks lose value, they are not really getting cheaper — at least in the way that their valuation is most commonly measured (which is relative to the earnings of the underlying companies). Just to keep from getting more expensive, stocks have had to fall.

After today’s drop, the Standard & Poor 500-stock index has dropped 14.2 percent since Oct. 24, for instance. But S.&P.’s estimates for the net earnings of the 500 companies in its index has dropped 13.9 percent over that same four-week span. (Thanks to Howard Silverblatt of S.&P. for these numbers. They are for the year ending June 30, 2009.) S.&P. has had to lower its earnings estimates because the deteriorating economy is causing companies to lower their own estimates.

The standard measure of stocks’ valuation is the price-earnings ratio: the stock price of the average company in the S.&P. 500 company divided by its annual earnings. Right now, the forward-looking version of that ratio — today’s stock price, divided by estimated earnings over the next year — is about 16, which also happens to be roughly its average over the last century. By this measure, in other words, stocks are not yet inexpensive despite the enormous losses of the last year.

Some stock watchers — like John Bogle of Vanguard and Robert Shiller, the author of “Irrational Exurberance” — prefer a longer-term P/E ratio, one that is based on 10 years of earnings. That helps control for the sharp declines in corporate earnings during a recession. By this measure, the P/E ratio appears to be about 13.

That is below its historical average — and offers some reason to think stocks are starting to become cheap. On the other hand, that ratio bottomed out at close to 5 during the other two great bear markets of the past century, in the 1930s and the 1970s and early 80s.
Stocks are definitely becoming cheaper. If you are a long-term investor, they may even be worth buying at this point. But they may still have a ways to fall.

http://economix.blogs.nytimes.com/2008/11/20/stocks-and-earnings-racing-to-the-bottom/

Why Stocks Still Aren’t Cheap

February 20, 2009,
Why Stocks Still Aren’t Cheap
By David Leonhardt

At long last, are stocks cheap? Amazingly enough, they still are not, at least by one commonly used measure.

Stocks fell again today. The Standard & Poor’s 500-stock index closed at 770, which isn’t too far from the low of 752 that it reached in November. In inflation-adjusted terms, the index is about 55 percent below its 2000 peak.

Those comparisons certainly make it sound as if stocks are incredibly cheap. But they aren’t, at least not according to the price-earnings ratio. That ratio, a standard measure of market valuation, divides the average price of stock in the index by the earnings of the companies in the index.

Based on the average earnings of companies over the past year, the current p-e ratio is about 30, far above the long-term historical average of 16. By this metric, stocks actually look expensive and may seem as if they still much further to fall.

The problem with this metric, however, is that it’s overly sensitive to economic swings. Corporate earnings are plunging now, because of the recession. P-E ratios always spike during recessions — and corporate earnings always recover, so many investors simply ignore short-term ratios during recessions.

It makes more sense to look at earnings over a longer period of time, which smooths out the economic cycle. I have written before about a P-E ratio based on the previous 10 years of earnings, a measure favored by Robert Shiller, the author of “Irrational Exuberance,” and others. (I first wrote about it in the summer of 2007, when being bearish was a lot lonelier.)

By this measure, the P-E ratio of the S.&P. 500 is now about 14.5. It’s below average, but not enormously so. By comparison, this ratio fell to 6 during the 1930s and 7 during the early 1980s. In short, stocks are a little less expensive than their historical average. But they are far more expensive than they were at the worst points of the other two worst recessions of the past century.

How could this be? The main answer is that stocks were incredibly expensive before the current crisis began — more expensive than at almost any other point in the last 100 years, save the bubbles of the 1920s and 1990s. They had a long way to fall. The fact that earnings are falling — and may well remain low for the next several years — doesn’t help either.

For the average investor, I would repeat the advice I offered in November:
Stocks are definitely becoming cheaper. If you are a long-term investor, they may even be worth buying at this point. But they may still have a ways to fall.
As per usual, thanks to Howard Silverblatt at S.&P., for providing valuable data.

http://economix.blogs.nytimes.com/2009/02/20/why-stocks-still-arent-cheap/