Friedman’s euro crisis is proving to be improbable

The discussion over the future of the Euro continues, here is one view from Barry Eichengreen, professor of economics at the University of California, Berkeley

Many euro skeptics have argued that the worst is yet to come, but given recent events, it is now they who bear the burden of proof

The global financial crisis has breathed new life into hoary arguments about the euro’s imminent demise. Such arguments often invoke Milton Friedman, who warned in 1998 that Europe’s commitment to the euro would be tested by the first serious economic downturn. That downturn is now upon us, but the results have been precisely the opposite of what Friedman predicted.
Unemployment is rising — and with it populist posturing. In countries like Italy, already suffering from Chinese competition, and Spain, which is experiencing a massive housing bust, the pain will be excruciating. Yet neither country shows any inclination to abandon the euro.

They understand that even whispering about that possibility would panic investors. They see how countries like Denmark that maintained their own currencies have been forced to raise interest rates to defend their exchange rates when the US Federal Reserve and the European Central Bank are cutting interest rates. They see how, if there was still a lira or a peseta, they would be experiencing capital flight. They understand that they would have to fend off an old-fashioned currency crisis at the worst possible time. They appreciate that there is stability and security in numbers.

Similarly, the euro-collapse scenario in which such countries successfully pressure the European Central Bank (ECB) to inflate, compelling Germany to abandon the euro, has shown no signs of developing. The ECB, protected by statutory independence and a price-stability mandate, has shown no inclination to accede to pressure from French President Nicolas Sarkozy or anyone else.

One can argue that the worst is yet to come — that there will be more inflation and unemployment down the road — and that, when they come, the euro area will collapse. Euro skeptics always make this argument. But, given recent events, it is now they who bear the burden of proof.

What neither Friedman nor anyone else anticipated in 1998 was that the first serious downturn following the advent of the euro would coincide with the mother of all financial crises. Runs by panicked investors have required central banks to undertake unprecedented lender-of-last-resort operations. Extensive loan losses have required expensive bank recapitalization operations.

There have been predictions that governments stretched to the limit by the financial crisis might respond by abandoning the euro. They might resort to the inflation tax and inject the national currency to restore liquidity to their banking systems and financial markets.

In fact, the response has been the opposite. The ECB has provided essentially unlimited amounts of liquidity to euro-area financial systems. The Stability and Growth Pact has been relaxed in order to increase governments’ capacity to borrow to recapitalize their banks.

It is European countries outside the euro area, still with their own currencies, that have suffered the gravest difficulties. Because their currencies are not widely used internationally, many of their bank liabilities are in euros. This renders them dependent on interest rate hikes to attract — via the market and on swap lines from the ECB — the euro liquidity that their banks desperately need. So far, those swaps have been forthcoming, but with delay and political baggage attached.

The implication is clear. National banking systems need a lender of last resort. In small countries, where a significant share of bank liabilities is in someone else’s currency, the national central bank lacks this capacity. The only options are then to slap draconian controls on the banking system or join the euro area.

Given the difficulty of rolling back the financial clock and the constraints of the Single Market, it is clear which way European countries will move. One already sees a shift in public opinion toward euro adoption in Denmark and Sweden. Poland has reiterated its commitment to adopting the euro. Hungary is certain to do likewise.

Obviously, the crisis will be economically and financial challenging for Eastern Europe. It will heighten the difficulty of meeting the convergence criteria for euro adoption. But it will also heighten the will to succeed.

The implication, then, is a larger euro area, not a smaller one, as more countries see the writing on the wall. Indeed, there are already signs of countries not even in the EU, notably Iceland and Switzerland, contemplating accession as a step toward adopting the euro and resolving their financial dilemma.

The one exception is probably Britain, whose currency is used internationally as a legacy of its history. In any case, Britain has always had one foot in Europe and one foot out. It is conceivable, therefore, that Europe will have two currencies, the euro and sterling, in the long run. But having three currencies, much less three dozen, is out of the question.

COPYRIGHT: PROJECT SYNDICATE

All raged up with no nose to punch

With a mixed bag of bad news and less job security, no wonder the mood can be sort of mute, to say the least, in and around the workplace. So it was no big surprise reading Reuters account of how employees are feeling the pinch. We have to be cool under pressure……

- Amr

Get out of the way, road rage. Here comes desk rage.

(Reuters) Anger in the workplace — employees and employers who are grumpy, insulting, short-tempered or worse — is shockingly common and likely growing as Americans cope with woes of rising costs, job uncertainty or overwhelming debt, experts say.

“It runs the gamut from just rudeness up to pretty extreme abusive behaviors,” said Paul Spector, professor of industrial and organizational psychology at the University of South Florida. “The severe cases of fatal violence get a lot of press but in some ways this is more insidious because it affects millions of people.”

Nearly half of U.S. workers in America report yelling and verbal abuse on the job, with roughly a quarter saying it has driven them to tears, research has shown.

Other research showed one-sixth of workers reported anger at work has led to property damage, while a tenth reported physical violence and fear their workplace might not be safe.

“It’s a total disaster,” said Anna Maravelas, author of “How to Reduce Workplace Conflict and Stress.” “Rudeness, impatience, people being angry — we used to do that kind of stuff at home but at work, we were professional. Now it’s almost becoming trendy to do it at work.

“It was something we did behind closed doors,” she said. “Now people are losing their sense of embarrassment over it.”

Contemporary pressures such as rising fuel costs fan the flames, said John Challenger, head of Chicago’s Challenger, Gray & Christmas workplace consultants.

“People are coming to work after a long commute, sitting in traffic watching their discretionary income burn up. They’re ready for a fight or just really upset,” he said.

Added to that, he said, are financially strapped workers having to cut back on paying for personal pastimes that might serve as an antidote to work pressures.

LET OFF STEAM

“That means people come into work after a weekend and they haven’t been able to let off any steam,” he said.

Spector said his research has found 2 percent to 3 percent of people admit to pushing, slapping or hitting someone at work. With roughly 100 million people in the U.S. work force, he said, that’s as many as 3 million people.

Maravelas said she conducted a seminar this week in rural Iowa, where she asked participants if they thought anger was increasing at their workplace.

Everyone raised their hands, she said, which is typically the response she gets. She cited research showing 88 percent of U.S. employees think incivility is rising at work.

“Many of us sense we’re losing ground economically and socially. The safety net is unraveling. Hence, anxiety and unease are skyrocketing,” she said.

People reassure themselves by blaming others and “find comfort in believing their suffering is caused by a callous, incompetent or selfish organization, leader, supplier, union or regulatory body,” she said.

The worst offenders are overachievers, said Rachelle Canter, a workplace expert and social psychologist. “The usual profile is Type A, really, really smart, with impossibly high standards they set for themselves as well as for other people.

“They are so invested, I would say maybe over-invested, in success and in everyone being every bit as driven as they are that they just lose their sense of perspective, and they can lash out at other people,” said Canter, author of “Make the Right Career Move.”

But desk rage extends across industry and class lines, from top white-collar jobs to gritty blue-collar work, and companies pay dearly in terms of lost productivity, sagging morale and higher absenteeism, Spector said.

The worst cases end in violence, he said.

“Somebody didn’t just come to work one day and shoot somebody,” Spector said. “There’s probably been a pattern of less extreme behaviors leading up to it.”Desk rage spoils workplace for many Americans

Global Finance has new bosses

This week The Financial Times published two pieces reviewing the newly emerging global finance lansdscape. No analysis of how new players are contributing to the stability of the world economy, but a mere view of what is taking place in markets, and some caution ahead of what is shaping to be a new model in global finance:

The fall of a financial model

Recent changes in the world economy and financial markets mark the end of the present standard model of financial capitalism, built up over the last decade or so. In this model, financial stability is mainly based on the self-regulation of the financial sector, which alone assesses the risks produced by its financial innovations.

Moreover, the link between finance and the real economy hinges on an adequate return on investment for shareholders, who punish poor management by making share prices fall, leaving the company open to takeover. The only role assigned to governments is to guarantee free circulation of capital between companies and between countries. As alternative economic models collapsed over the past two decades, public opinion came to accept this model of financial capitalism. Today, governments and labour unions accept profit as the most relevant criterion for assessing a company’s efficiency. This model is experiencing three crises, all of which refer to changes in the relationship between governments and markets.

The first concerns the significant, yet silent, return of governments to the economic playing field. Three of the five richest nations by total gross domestic product have become de facto neo-mercantilist, setting their sights on trade surpluses. China is keeping its currency artificially low in order to increase its trade surplus and lower its costs of production vis-a-vis competitor countries. Japan is pursuing government-oriented policies to bolster its position in high-technology markets. Finally, and to a lesser degree, Germany has been carrying out reforms to restore industrial competitiveness. In addition, countries that have access to natural resources, notably oil and gas, have revenues that serve as both an instrument and aim of their international policy. Trade surpluses have resulted, demonstrating the capacity of governments to acquire massive amounts of foreign assets through sovereign wealth funds. The problems that arise are not economic, but political. Governments may use technology transfer or control of strategic national assets as a means to increase bargaining power in international affairs.

The second change involves company ownership. Three transformations should be noted. The first relates to the emergence of active shareholders, who build up significant stakes with the aim of exerting strong influence on management. The second relates to activist shareholders and their demand for short-term returns, resulting in decisions that are not in the company’s long-term interests. The third involves leveraged buy-outs, closely linking the interests of managers and shareholders and taking advantage of easy credit.

These shifts in the distribution of power raise questions: what is the relationship between shareholder meetings and boards? To what extent should companies be allowed to protect themselves from hostile bids or creeping takeovers? In what form and how frequently should accounting information be provided to shareholders?

Company ownership has not yet found a new balance, as shown in Europe by the absence of agreement on the takeover directive and on one share/one vote rather than multiple voting rights. Regulators’ desire to increase supervision of creeping takeovers is telling. The trends are risky: a shareholder can pursue speculative or self-interested aims to the detriment of other shareholders and against the company’s best interest by breaking up the business or by avoiding taking risk.

The third crisis is the one rocking financial markets. Unlike the internet bubble, this is not a crisis based on irrational behaviour but one of sophistication and disintermediation. The new risks produced by financial innovation were left to a sector that alone was considered able to understand its instruments. The crisis demonstrates the costs to the real economy and lack of an efficient self-regulating system.

All these risks call for a new relationship between the workings of financial markets and regulatory actions of governments. Democratic governments will have to deal for a long time with less democratic economies that use financial market mechanisms for political ends. Each sovereign investor must clarify its intentions and define its code of conduct. Governments must also define with greater precision the sectors they consider strategic.

The changes in company ownership also call for greater transparency in order to prevent actions that offend business ethics, such as creeping takeovers and speculative strategies that undermine companies’ long-term interests. The board’s role of defining solutions that satisfy shareholders’ divergent interests will have to be strengthened. It should allow for corporate governance that encourages long-term strategies while satisfying shareholder interests. Finally, regulators should supervise the whole of financial markets to assess systemic risk, eliminate off-balance-sheet ambiguities and bring within the scope of supervision actors that have eluded market authorities.

How governments deal with these crises will depend on their national interests. These issues will be difficult to deal with in Europe where country responses will diverge. One can expect to see the co-existence of various models, varying by level of government intervention in financial markets. There is a great distance, however, between co-existence and compatibility.

—————————— 

Jean-Louis Beffa is chairman of Saint-Gobain and co-president of the Cournot Centre for Economic Studies. Xavier Ragot is associate professor at the Paris School of Economics

A new force in global finance

How can it be that Merrill Lynch, Citigroup, Morgan Stanley, Bear Stearns, UBS and other big banks have been turning to foreign governments for financial lifelines with so little public controversy? Perhaps it is because the dangerous broader context of what is happening – the rise of “state capitalism” – is not sufficiently recognised. Indeed, the reality may be that the era of free markets unleashed by Margaret Thatcher and reinforced by Ronald Reagan in the 1980s is fading away. In place of deregulation and privatisation are government efforts to reassert control over their economies and to use this to enhance their global influence. It is an ill wind that blows.

Exhibit A is a quantum increase of regulation nationally and globally. The issues of product and food safety will spawn new and highly complex trade regulations in the US, the European Union, China and the World Trade Organisation. The blizzard of energy and environmental legislation in a number of countries is mind-boggling. The subprime debacle will probably lead to new rules for every type of institution that securitises debt.

Evidence of the rise of state capitalism can also be found in increasing public sector ownership of natural resources. Government-run energy companies from Saudi Arabia, China, India and Brazil now own more than 80 per cent of the world’s reserves. Their reach is growing. Russian and Chinese government entities also look poised to make a run for global domination of aluminium and iron ore.

Finance is being taken over too. Beijing’s state-controlled banks are now moving into the US and taking large stakes in important banks such as South Africa’s Standard Bank . Last year sovereign wealth funds in the Gulf and east Asia invested more than $60bn in foreign financial institutions and the amounts are rising rapidly. Assets in these funds will, in the years ahead, exceed the combined capital in private equity and hedge funds.

We should not be surprised by these trends. Since the mid-1980s the world economy has been on steroids, resulting in exceptional growth and wealth creation. Now governments are reacting against the excesses of free markets. A lot of people were left behind as soaring income inequality accompanied the boom. In trade, product quality went unsupervised. In finance, risk management was neglected by bankers, regulators and credit agencies. The 27-nation EU, being more prone to intervention in markets than the US, has taken the lead in reasserting a robust role for regulation. China and India, neither of which has any deregulatory DNA, have also become influential in changing the global gestalt .

Government officials also turned a blind eye towards dangerous financial imbalances. The very countries that had little history of free markets accumulated massive reserves, while the US accepted large deficits and became hungry for money from anywhere it could find it. In a world economy where power has become highly de­centralised and in which international institutions are weak, governments backed by huge reserves have dis­covered they have significant leverage in global markets. That is especially true in downturns, such as now.

The implications are worrying. While prudent regulation in selected areas can be justified, the new zeitgeist is likely to produce too much government intervention, too fast. We can expect less productivity, less innovation and less growth, since governments have many goals that the private sector does not. These include employment generation, income redistribution and the aggrandisement of political power. The expansion of regulation will also open up new possibilities for trade disruption. For example, countries may block the importation of goods that do not meet their precise national environmental standards.

Beyond that, trade and finance will become more politicised as governments leverage the companies they control as instruments of their foreign policies. Russia’s president, Vladimir Putin, has used Gazprom’s natural gas to influence his neighbours’ economic and political directions. China has provided aid to repressive regimes to open up opportunities for companies such as Sinopec. President Nicolas Sarkozy seems poised to use the combination of France’s Atomic Energy Commission, the state-controlled nuclear power company Areva and the national engineering champion Alstom to sell civilian nuclear power in the Gulf and China.

Unfortunately, the trend is unstoppable. But officials from market-friendly finance ministries could acknowledge the momentum behind the rise of state capitalism to demand their own governments produce impact statements that spell out all the costs of new laws and regulations. They could commission reviews in the International Monetary Fund and the WTO of all the implications of growing government intervention. Think-tanks and universities should gear more research to the costs and benefits of state capitalism.

When it comes to foreign investment by state-owned companies or from sovereign wealth funds, the US and the EU need to set common standards for transparency, ownership and reciprocity. The rules should be enforceable – not milk-toast, voluntary guidelines.

In the late 18th century, capitalism was replacing feudalism. In the 20th century, freer markets won the day. Now the world is flirting with another big transformation in the philosophy and rules of global commerce. Unlike the changes of the past, this new trajectory does not represent progress.

 ————————————

Juan Trippe professor of international trade and finance at the Yale School of Management

Source: The Financial Times Limited 2008

__ Amr  

Wall Street Blues!

Three articles published in the past few days observe the investing and money lending landscape with a keen eye on the economic realities of people. From Microsoft Money, Bloomberg Financial Services, and The Guardian respectively: 
 

The next banking crisis on the way

Write-downs for high-risk, high-yield corporate debt, known as ‘junk,’ could dwarf losses in the mortgage mess. And

that’s when this financial crisis will finally hit bottom.

Is this the quarter when banks finally admit all of their problems?

On Jan. 15, Citigroup announced it would take an $18.1 billion write-down on its portfolio of subprime mortgages

and other risky debt, and the bank cut its dividend 41%.

With other banks following suit — Merrill Lynch  reported $16 billion in write-downs and other

charges two days later, and Wells Fargo  delivered similarly huge losses — will they throw everything, including

the kitchen sink, into their losses? That kind of quarter always marks the bottom in a crisis like this.

Nah. The banks and other financials have more losses from the subprime-mortgage mess on their books that they

haven’t yet confessed. Worse, the mortgage debacle has spread to other types of debt, with banks and other

financial companies reporting mounting losses in their credit card and auto loan portfolios. And worst of all, the

next big leg of the crisis — the one I think will mark the true bottom — has just started.

As the economy slows, the default rate is rising for corporate debt, especially for the high-risk, high-yield

corporate debt called “junk” by many of us. That’s opening a Pandora’s box of potential write-downs that could

dwarf the losses in the mortgage market.

If that’s true, it would push off the kitchen-sink bottom until the second or third quarter of 2008, depending on

how bad the economy gets and how long it stays in the dumps. 
 
It’s not surprising that it will take so long to work through this mess, if you remember how it all began. The

current crisis is yet another in a string of financial bubbles — the tech bubble that burst in 2000, the housing

bubble that burst in 2007 and the debt-market bubble that’s bursting now. Behind each bubble stands a global flood

of cheap money created by:

Central banks running their printing presses to fend off economic slowdowns or financial-market crashes.

A weak yen that let traders and speculators borrow for almost nothing in Japan in order to buy stocks and bonds in

other markets.

A huge surge of exports from countries such as China determined to hold down domestic consumption.

Soaring oil prices that gave oil producers billions of dollars to invest somewhere.
All of those dollars chased a limited supply of real assets and traditional stocks and bonds, bringing down returns

just as a falling dollar and signs of inflation lowered real returns more. Everyone wanted something as safe as

U.S. Treasurys that paid more than Treasurys.

Wall Street obliged by packaging and then slicing debt backed by mortgages, so that even the riskiest mortgages

could earn a safe AA or AAA rating from Standard & Poor’s, Moody’s  or Fitch. It performed the same magic with

credit card debt, with auto loans and finally with corporate debt — even the riskiest kind, called high-yield

because it pays out a higher dividend to compensate for its higher risk. It’s known as junk because in hard

economic times it can become worthless.

Everyone wanted to believe that Wall Street’s magic worked. Investors from Citigroup to the Hillsborough County

Public Schools in Florida (exposure: $573 million) bought in. The more investors who bought in, the more of these

new products Wall Street could sell and the more money it was willing to lend to home builders, home mortgage

lenders and credit card companies; to the savings and loans and banks that created the raw materials (mortgages,

credit card debt, auto loans) that Wall Street needed to manufacture its products; and to the hedge funds and

structured investment vehicles that bought what Wall Street produced.

It worked out just fine until reality stuck a pin in the bubble. It turns out that you can’t lend more and more

money to less- and less-qualified home buyers without driving up the number of borrowers who pay late or can’t pay

at all.

JPMorgan Chase reserved $2.3 billion against rising loan losses in the fourth quarter. That looks good compared

with an $18 billion write-down at Citigroup. Now, MSN Money’s Jim Jubak says, the buzz is that JPMorgan could buy

Washington Mutual. But is that a good idea?

On Jan. 9, Countrywide Financial reported that the foreclosure rate on its 9 million mortgages had climbed to 1.44%

in December, double the 0.7% rate of December 2006. The delinquency rate had climbed to 7.2% of unpaid balances, up

from 4.6% in December 2006. The rates were the highest ever for Countrywide, which entered the mortgage business in

2002.

Within a week, as bankruptcy rumors swirled around Countrywide, Bank of America agreed to acquire the company for

$4 billion.

Damage goes beyond mortgages

But the cause of this mess stretched far beyond any problems specific to the mortgage sector, so the damage wasn’t

limited to that part of the debt markets. On Jan. 10, for example, American Express (AXP, news, msgs) announced

that credit card debt at least 30 days past due had climbed to 3.2% of its portfolio from 2.9% in the third

quarter, and write-offs of bad debt had climbed to 4.3% from 3.7% in the same period. In 2008, American Express

expects write-offs to average 5.1% to 5.3%.

How about auto loans? On Jan. 15, Sovereign Banc said it would take $1.6 billion in charges for the fourth quarter

of 2007, including a $600 million write-down on consumer and auto loans. The company had aggressively expanded its

auto loan business in Arizona, California, Florida, Georgia and Nevada in 2006 and 2007 — just in time to get hit

by the cooling of the hot real-estate market in those states. The company has pulled out of the auto loan market in

Arizona, Florida, Georgia, Nevada, North Carolina, South Carolina and Utah because of rising default levels.

But it’s the emerging problems in the corporate-junk-bond market that really worry me. The sector and the problems

are big enough to produce another big setback for financial companies and the economy as a whole.

The real concern: Credit-default swaps

Actually, I’m worried not so much about the junk-bond market itself as the huge market for a derivative called a

credit-default swap, or CDS, built on top of that junk-bond market. Credit-default swaps are a kind of insurance

against default, arranged between two parties. One party, the seller, agrees to pay the face value of the policy in

case of a default by a specific company. The buyer pays a premium, a fee, to the seller for that protection.

This has grown to be a huge market: The total value of all CDS contracts is something like $450 trillion. Because

buyers and sellers of insurance usually create multiple “policies” as they attempt to control risk, that number

includes a lot of duplication. Real exposure, says the Bank for International Settlements, may be only 20% of that,

or $90 trillion. Some studies have put the real credit risk at just 6% of the total, or about $27 trillion. That

puts the CDS market at somewhere between two and six times the size of the U.S. economy.

The CDS market has been a good place to make money in the past few years because default rates in the junk-bond

market have been historically low. The default rate for all junk bonds declined to 1.7% in 2006. That’s the lowest

rate since 1996. With defaults that low, sellers were paid insurance premiums but didn’t have to cough up much in

return.

But that default rate started to rise in 2007, climbing to 2.6%. And Standard & Poor’s projects the rate will climb

to 3.4% by October. At that rate, 56 bonds would go into default in 2008, compared with 14 in 2007.

That level of default isn’t likely to inflict too much damage on the CDS market. The historical rate for defaults

by corporate junk bonds has averaged 5% a year since 1980. But the default rate has run as high as 12.7% in

previous recessions.

Will investors walk or run for the exits?

The junk-bond market isn’t in a panic yet, but the fear is climbing. The spread between the yield on the safe U.S.

Treasury bonds and comparably risky high-yield bonds climbed by 0.81 percentage point in the few trading days up to

Jan. 9. That’s the biggest increase in the spread in the first days of January ever measured.

I’d say that junk-bond investors, taking a clue from the 30%-to-50% losses suffered in the subprime-mortgage market

by investors who held on too long, are moving toward the exits with all due speed. They also know that in the CDS

market it’s very hard to tell who is ultimately holding the long or short end of any deal. And it’s even harder to

judge the financial strength of the ultimate holder of any individual insurance contract. If the mortgage crisis is

a guide, some of that insurance may turn out to be worthless because it’s held by an investor without the ability

to pay.

Whether that exit continues at a purposeful walk or turns into panicked flight largely depends on the speed with

which the economy slows and on the duration of any slowdown. Wall Street continues to talk as if all we’re facing

is a two-quarter downturn, although perhaps of some severity, but the early money is starting to behave as though

things are likely to be worse than that.

JPMorgan Chase reserved $2.3 billion against rising loan losses in the fourth quarter. That looks good compared

with an $18 billion write-down at Citigroup. Now, MSN Money’s Jim Jubak says, the buzz is that JPMorgan could buy

Washington Mutual. But is that a good idea?

On Wall Street, fears have a nasty tendency of becoming self-fulfilling prophecies.

All it takes is enough investors behaving as if the short-term, asset-backed commercial-paper market is risky for

that market to freeze into immobility, which leaves companies with less-than-sterling credit ratings without a

source of short-term working capital.

All it will take in the CDS market is enough buyers and sellers deciding they can’t rely on this insurance anymore

for junk-bond prices to tumble and for companies to find it very expensive or impossible to raise money in this

market.

And that would be enough to make any economic downturn both longer and deeper than stock prices yet reflect.

Source: MSN Money (By Jim Jubak)

MBIA, Ambac Bond Default Risk Exceeds 70%, Swaps Show

MBIA Inc. and Ambac Financial Group Inc., the two biggest bond insurers, have a more than 70 percent chance of

going bankrupt, credit-default swaps show.

Prices for contracts that pay investors if Armonk, New York- based MBIA can’t meet its debt obligations imply a 71

percent chance the company will default in the next five years, according to a JPMorgan Chase & Co. valuation

model. Contracts on New York- based Ambac imply 72 percent odds.

Ambac shares have plunged 71 percent the past three days as the company scrapped plans to raise equity capital and

Moody’s Investors Service and Standard & Poor’s put the insurer on review for a downgrade. Fitch Ratings cut

Ambac’s AAA guaranty rating today. MBIA has dropped 47 percent since Jan. 15. Credit-default swaps on the

companies, which rise as confidence erodes, are trading at record highs.

“In this market, a downgrade could mean the beginning of that company’s eventual collapse,” said Matt Fabian, an

analyst with Municipal Market Advisors in Westport, Connecticut. While Fabian said he still expects the companies

to keep their rankings, he said he has grown “much more anxious.”

MBIA and Ambac are the largest of seven bond insurers that place their AAA stamp on $2.4 trillion of debt,

including municipal bonds and securities linked to mortgages. Losing those rankings may cost borrowers and

investors as much as $200 billion, according to data compiled by Bloomberg.

Dividend Cuts

Both companies slashed their dividends this month and announced plans to raise as much as $2 billion each. MBIA has

lost 88 percent of its market value since the start of 2007 while Ambac’s has fallen 93 percent after the insurers

expanded into subprime-mortgage securities and collateralized debt obligations that are now slumping in value.

Ambac today said it’s opting not to raise equity capital because of “market conditions and other factors” and

“is continuing to evaluate alternatives,” according to a statement.

Ratings companies, which affirmed their assessments a month ago, are scrutinizing bond insurers to ensure they have

enough capital to protect against losses. Standard & Poor’s yesterday said industry losses on subprime securities

will be 20 percent more than it initially forecast. S&P said that isn’t enough to start downgrading the companies.

MBIA spokeswoman Elizabeth James and Ambac spokesman Peter Poillon didn’t immediately return telephone calls for

comment.

Investor Protection

MBIA and Ambac credit-default swap prices are soaring as investors rush to protect against the risk the companies

won’t make good on guarantees the bond insurers sold them on securities linked to mortgage bonds, corporate loans

and other assets.

“Investors are concerned about counterparty exposure,” Gregory Peters, head credit strategist at Morgan Stanley

in New York, said in an interview on Bloomberg Television today. “That’s the overhang that the market has to

contend with.”

Lehman Brothers Holdings Inc., the biggest U.S. underwriter of mortgage bonds, told investors last month that it

was buying credit-default swaps to hedge against the risk that bond insurer guarantees on securities become

worthless.

Merrill Lynch & Co., the biggest underwriter of collateralized debt obligations, said it will write off $2.6

billion in default protection from bond insurers, mostly from ACA Capital Holdings Inc., whose ratings were cut 12

levels to CCC in December.

`Material Jeopardy’

Credit-default swaps tied to MBIA bonds have risen 10 percentage points the past two days to 26 percent upfront and

5 percent a year, according to CMA Datavision in New York. That means it would cost $2.6 million initially and

$500,000 a year to protect $10 million in MBIA bonds from default for five years.

Credit-default swaps on Ambac, the second-biggest insurer, have risen 11.5 percentage points to 26.5 percent

upfront and 5 percent a year, prices from CMA Datavision show.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s

ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash

equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the

perception of credit quality; a decline, the opposite.

Fitch today lowered its rating on Ambac’s insurance unit two levels to AA and said it may cut further. Without its

AAA rating, Ambac may be unable to write the top-ranked bond insurance that makes up 74 percent of its revenue.

`Two Options’

“They have two options,” said John Giordano, a credit analyst at New York-based BlueMountain Capital Management,

which manages $4.8 billion. “One is you get the white knight who comes in and buys you and is a natural AAA and

solves a lot of problems. And the other is maybe private equity. I don’t think they can even touch the public

markets, whether that be debt or equity. I can’t imagine anybody’s going to touch them.”

Ambac shares fell 4 cents to $6.20 today in New York Stock Exchange trading. MBIA fell 67 cents to $8.55.

“The ability of Ambac to survive as a going concern is now in material jeopardy,” Rob Haines, an analyst at bond

research firm CreditSights Inc. in New York, wrote in a report yesterday.

The default probability derived from the pricing model, which traders use to value the contracts, assumes a 40

percent recovery rate on the companies’ bonds in the event of a default.

MBIA and Ambac are trading near levels reached by Countrywide Financial Corp., the mortgage lender battered by

speculation it would file for bankruptcy before agreeing last week to be bought by Bank of America Corp.

Bonds Plunge

Ambac’s $400 million of 6.15 percent bonds due in 2037 have plunged by 25 cents on the dollar this week to 35.4

cents on the dollar, according to Trace, the bond-price reporting system of the Financial Industry Regulatory

Authority. The yield has soared to 17.6 percent from 10.5 percent and the extra yield investors demand over

government securities with similar maturities has widened 7.2 percentage points to 13.4 percentage points.

Ambac would survive without its AAA rating if it stopped trying to insure debt and let the existing policies wind

down, shareholder Evercore Asset Management LLC wrote in a letter to directors that it released yesterday. Evercore

had opposed Ambac’s plan to raise capital.

Ambac’s chief executive officer departed Jan. 16 after the company reported greater-than-expected writedowns on the

bonds it insures. Moody’s said the losses were “significantly” more than Ambac indicated.

Ambac said yesterday that the Moody’s review was “surprising.”

Assumptions

S&P assumes losses on mortgages made in 2006 to people with poor credit will reach 19 percent, up from its prior

forecast of 14 percent, as housing prices decline more than it anticipated.

Under the new assumptions, losses for bond insurers may be $13.6 billion, 20 percent higher on average than those

projected a month ago, S&P said yesterday. Ambac’s projected losses are now $2.25 billion, 22 percent more than in

December. MBIA’s are $3.5 billion, an increase of 11 percent, S&P said.

The revised S&P assumptions probably won’t require MBIA to raise more capital than it already plans, according to a

statement on MBIA’s Web site.

Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to

specific events like changes in the weather or interest rates.

Source:Bloomberg

Panic selling shuts £2bn fund

Scottish Equitable acts after slump
Fears that other funds are at risk

The fund, invested in London office blocks and shopping centres across Britain, apparently no longer has sufficient

cash reserves to meet demands from investors. Photograph: Martin Argles

One of Britain’s biggest property funds was forced to shut its doors to withdrawals yesterday after the slump in

commercial prices triggered panic selling by small investors.

The move prompted fears of a Northern Rock-style run on billions of pounds invested in once high-flying funds which

many savers have seen as a safe haven for their pensions.

Scottish Equitable said yesterday that 129,000 small investors in its £2bn property fund will not be able to access

their money for up to a year, although payments relating to regular income already being paid, retirements and

death claims will not be affected.

It said the fund, invested in London office blocks and shopping centres across Britain, no longer had sufficient

cash reserves to meet demands from investors wanting to withdraw their money. Its “buffer fund” was down to 1% of

its total assets, instead of the usual 10-15%.

Commercial property values, especially in the City of London office market, have dived amid fears of a recession

brought on by the global credit crunch.

In late December another insurer, Friends Provident, halted access to its £1.2bn property fund and last night

speculation was growing that Scottish Widows may be on the verge of restricting customer withdrawals on some of its

funds. The insurer said last night: “We are looking at all the options, but no decisions have been taken.”

Scottish Equitable’s parent group, Aegon UK, is due to announce the closure of its fund today. It said last night:

“Aegon UK has decided to take this step to protect investors following a significant level of customer withdrawals

from the UK property fund market.” It blamed “worldwide phenomena relating to concerns over the US sub-prime

mortgage market fallout, rising interest rates and talk of recession”.

The Financial Services Authority said it was closely monitoring the situation and had been informed by Aegon of the

decision to halt withdrawals.

The crisis in Britain’s commercial property market is now worse than at any time since the early 1990s, when

Olympia & York, the company that began the Canary Wharf office development in London, went into administration.

The credit crunch has raised borrowing costs, making many property deals no longer attractive. Financial

institutions hit by the fallout are already beginning to cut staff, reducing demand in the City office market in

which most of the UK’s property funds are invested. A downturn in consumer spending growth is also making retail

shopping developments less attractive to investors.

Small investors have put about £15bn into property unit trusts – £5bn pouring in during 2006 and early 2007 alone.

Billions more are invested through pension funds held by millions of company employees. Investors bought into

promises of rich returns after a decade in which returns far outstripped gains on shares or bonds.

But the downturn in values since the middle of 2007 has been savage. Shares in British Land, the UK’s leading

property company, have fallen by nearly half, and most funds are showing falls of between 20% and 40%. But

investors stampeding for the exit are now finding that they cannot access their cash.

The crux of the problem is that the funds are invested in buildings which can take months to sell, and therefore

cannot produce the cash to pay out money to small investors if they all want it back at the same time.

Usually the funds hold a cash “buffer” of 10-15% of total assets to meet withdrawals. But Scottish Equitable said

yesterday that the cash buffer in the £2bn fund had fallen to just £80m following a wave of redemptions, giving it

little choice but to suspend the fund. The only alternative was a “fire sale” of its holdings which could leave

investors even worse off.

It emerged yesterday that staff at some of the property managers have been informing key clients in advance that a

fund is heading for suspension. The FSA said that such trading may fall foul of its rules regarding treating

customers fairly.

Financial advisers continue to recommend that investors take their cash out of the funds that remain open. Jason

Hemmings of Albannach Financial Management in Edinburgh said: “There are lots of rumours going about that other

providers may be considering following Friends Provident and Aegon.”

The Aegon/Scottish Equitable property funds are managed by Morley Fund Management, which also runs the £4bn Norwich

Union Property unit trust, the UK’s biggest property fund. This week Norwich Union said the fund had fallen in

value by a fifth over the year, but its cash buffer was at 6.4% after selling office blocks in London and

Manchester worth £165m.

Aegon UK added that it believes the “underlying fundamentals of the asset class remain healthy”.

Source:The Guardian

– Amr

Will Fannie and Freddie lose their home?

NAR the US National Association of Realtors expects the housing market to be badly damaged and the value of homes to fall; in markets there is a credit deep freeze, there is hedge funds bloodbath, and there is the highest level of uncertainty; given the fact that there is no clear signal of a turnaround in US markets, world central banks stepped in to protect global markets from from falling back. It’s assuring to know that large economies will chip in to steer away from a major global collapse when the US economy is hit hard. This by all means constitues nothing less than government intervention in free markets, which goes against principles of free markets and principles of those firms and banks who are being bailed out! but what’s the alternative?…more to come!…

Read on the outlook for the global economy by the Bank of International Settlements:  bis-global-economy-report.pdf

Read on the US housing market: housing-meltdown.pdf

And to understand a bit what was going on at the top of the home mortgage pyramid just few years ago (and less than 2 years after the corporate scandal haven of summer 2002), read about the two dominant players below by Bob Alford from 2004: 

“In recent months, the nation’s two largest mortgage finance lenders have come under increasing scrutiny at the hands of Congress, the Justice Department and the Securities and Exchange Commission (SEC). The Federal National Mortgage Association, nicknamed Fannie Mae, and the Federal Home Mortgage Corporation, nicknamed Freddie Mac, have operated since 1968 as government sponsored enterprises (GSEs). This means that, although the two companies are privately owned and operated by shareholders, they are protected financially by the support of the Federal Government. These government protections include access to a line of credit through the U.S. Treasury, exemption from state and local income taxes and exemption from SEC oversight. A recent accounting scandal at Freddie Mac that resulted in the replacement of three of the company’s top executives has lead to mounting concerns over the privileged status these GSEs enjoy in the marketplace.

Fannie Mae was created in 1938 as part of Franklin Delano Roosevelt’s New Deal. The collapse of the national housing market in the wake of the Great Depression discouraged private lenders from investing in home loans. Fannie Mae was established in order to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.

Initially, Fannie Mae operated like a national savings and loan, allowing local banks to charge low interest rates on mortgages for the benefit of the home buyer. This lead to the development of what is now known as the secondary mortgage market. Within the secondary mortgage market, companies such as Fannie Mae are able to borrow money from foreign investors at low interest rates because of the financial support that they receive from the U.S. Government. It is this ability to borrow at low rates that allows Fannie Mae to provide fixed interest rate mortgages with low down payments to home buyers. Fannie Mae makes a profit from the difference between the interest rates homeowners pay and foreign lenders charge.

For the first thirty years following its inception, Fannie Mae held a veritable monopoly over the secondary mortgage market. In 1968, due to fiscal pressures created by the Vietnam War, Lyndon B. Johnson privatized Fannie Mae in order to remove it from the national budget. At this point, Fannie Mae began operating as a GSE, generating profits for stock holders while enjoying the benefits of exemption from taxation and oversight as well as implied government backing. In order to prevent any further monopolization of the market, a second GSE known as Freddie Mac was created in 1970. Currently, Fannie Mae and Freddie Mac control about 90 percent of the nation’s secondary mortgage market.

GSEs such as Fannie Mae and Freddie Mae, with their combination of private enterprise and public backing have experienced a period of unprecedented financial growth over the past few decades. The current assets of these two companies combine for a total that is 45 percent greater than that of the nation’s largest bank.

On the other hand, their combined debt is equal to 46 percent of the current national debt. It is this combination of rapid growth and over leveraging that has lead to the current concerns of Congress, the Justice Department and the SEC with regards to the financial practices of these GSEs.

Fannie Mae and Freddie Mac are the only two Fortune 500 companies that are not required to inform the public about any financial difficulties that they may be having. In the event that there was some sort of financial collapse within either of these companies, U.S. taxpayers could be held responsible for hundreds of billions of dollars in outstanding debts. A recent investigation by the Justice Department and the SEC into the accounting practices at Freddie Mac revealed accounting errors in the amount of 4.5 to 4.7 billion dollars and resulted in the termination of three of the company’s top executives. Ongoing investigations by Congress, particular the House Finance Services subcommittee that oversees the activity of GSEs, will determine the future role of Fannie Mae and Freddie Mac and the secondary mortgage market that they dominate.”

– Amr

Business Owners Rank Internet as Most Important Marketing Tool

Interesting !

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Entrepreneurs now say the Internet is the most important marketing tool for their companies, but they primarily still use the Web for e-mail and research, according to a new survey. The Capital Access Network Small Business Barometer, a quarterly poll of 250 business owners nationwide who accept credit cards from customers as a method of payment, found that small companies ranked an Internet presence or website as the number one method for business marketing, over such traditional tools as networking, public relations and print and radio advertising. However, respondents also said their top two online business-related activities are checking e-mail and researching business solutions.

“Our survey indicates that there is a definite disconnect between a smaller business’s needs and their goals for meeting them,” said Glenn Goldman, president and CEO of Capital Access Network. “There is this gap of understanding between the type of business and what the Web can do for you.” Capital Access Network, based in Scarsdale, N.Y., provides merchant cash advances to small businesses through its main subsidiary, AdvanceMe. While e-mail may top the list of Internet-related activities, many small businesses have begun implementing online advertising strategies. Of survey respondents, 59 percent use online ads and 68 percent utilize search engine optimization “sometimes” or “often.” Online social tools like blogs and message boards, however, are not as popular an option for business marketing. Almost half of small business owners never use a blog, 37 percent never visit message boards or chat rooms, and 59 percent have never tried the virtual world of Second Life. “It’s human nature, particularly when funds are scarce, to focus on what is known,” Goldman said. “For some folks, maximum use of the Web is buying a book on Amazon.”

Business owners are making efforts to increase their Internet presence. Forty-four percent say they plan on spending more on Internet tools this year compared to 2006, while 27 percent plan to spend the same amount as last year. The amount small businesses will shell out for their Web activities varies, with the largest group (45 percent) spending less than $2,500. On the other hand, a quarter of respondents will not spend anything on the Internet this year. Of those, 30 percent named a lack of funds as the main obstacle preventing them from using the Internet for their business. “Clearly, folks are learning the benefits of the Web but in many cases are constrained resource-wise,” Goldman said. Overall, 46 percent of respondents say they derive at least some of their revenue from Internet sales. Based on that, Goldman said, “I think it’s safe to conclude that not using the Web results in missed opportunities.”
 
Source: Mansueto Ventures LLC.

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Broken Steps…

Following my May 9th post, it seems things have turned worse for some heavy weights. What’s broiling with hedge funds!?

read more.. Bear Stearns bails out hedge fund 

                  A confluence of investor fears from hedge fund land

                 Wall Street stumbles as subprime worries reemerge

– Amr