The Reckoning: Deregulator Looks Back, Unswayed
By ERIC LIPTON and STEPHEN LABATON | November 17, 2008
WASHINGTON — Back in 1950 in Columbus, Ga., a young nurse working double shifts to support her three children and disabled husband managed to buy a modest bungalow on a street called Dogwood Avenue.
Phil Gramm, the former United States senator, often told that story of how his mother acquired his childhood home. Considered something of a risk, she took out a mortgage with relatively high interest rates that he likened to today’s subprime loans.
A fierce opponent of government intervention in the marketplace, Mr. Gramm, a Republican from Texas, recalled the episode during a 2001 Senate debate over a measure to curb predatory lending. What some view as exploitive, he argued, others see as a gift.
“Some people look at subprime lending and see evil. I look at subprime lending and I see the American dream in action,” he said. “My mother lived it as a result of a finance company making a mortgage loan that a bank would not make.”
On Capitol Hill, Mr. Gramm became the most effective proponent of deregulation in a generation, by dint of his expertise (a Ph.D in economics), free-market ideology, perch on the Senate banking committee and force of personality (a writer in Texas once called him “a snapping turtle”). And in one remarkable stretch from 1999 to 2001, he pushed laws and promoted policies that he says unshackled businesses from needless restraints but his critics charge significantly contributed to the financial crisis that has rattled the nation.
He led the effort to block measures curtailing deceptive or predatory lending, which was just beginning to result in a jump in home foreclosures that would undermine the financial markets. He advanced legislation that fractured oversight of Wall Street while knocking down Depression-era barriers that restricted the rise and reach of financial conglomerates.
And he pushed through a provision that ensured virtually no regulation of the complex financial instruments known as derivatives, including credit swaps, contracts that would encourage risky investment practices at Wall Street’s most venerable institutions and spread the risks, like a virus, around the world.
Many of his deregulation efforts were backed by the Clinton administration. Other members of Congress — who collectively received hundreds of millions of dollars in campaign contributions from financial industry donors over the last decade — also played roles.
Many lawmakers, for example, insisted that Fannie Mae and Freddie Mac, the nation’s largest mortgage finance companies, take on riskier mortgages in an effort to aid poor families. Several Republicans resisted efforts to address lending abuses. And Congressional committees failed to address early symptoms of the coming illness.
But, until he left Capitol Hill in 2002 to work as an investment banker and lobbyist for UBS, a Swiss bank that has been hard hit by the market downturn, it was Mr. Gramm who most effectively took up the fight against more government intervention in the markets.
“Phil Gramm was the great spokesman and leader of the view that market forces should drive the economy without regulation,” said James D. Cox, a corporate law scholar at Duke University. “The movement he helped to lead contributed mightily to our problems.”
In two recent interviews, Mr. Gramm described the current turmoil as “an incredible trauma,” but said he was proud of his record.
He blamed others for the crisis: Democrats who dropped barriers to borrowing in order to promote homeownership; what he once termed “predatory borrowers” who took out mortgages they could not afford; banks that took on too much risk; and large financial institutions that did not set aside enough capital to cover their bad bets.
But looser regulation played virtually no role, he argued, saying that is simply an emerging myth.
“There is this idea afloat that if you had more regulation you would have fewer mistakes,” he said. “I don’t see any evidence in our history or anybody else’s to substantiate it.” He added, “The markets have worked better than you might have thought.”
Rejecting Common Wisdom
Mr. Gramm sees himself as a myth buster, and has long argued that economic events are misunderstood.
Before entering politics in the 1970s, he taught at Texas A & M University. He studied the Great Depression, producing research rejecting the conventional wisdom that suicides surged after the market crashed. He examined financial panics of the 19th century, concluding that policy makers and economists had repeatedly misread events to justify burdensome regulation.
“There is always a revisionist history that tries to claim that the system has failed and what we need to do is have government run things,” he said.
From the start of his career in Washington, Mr. Gramm aggressively promoted his conservative ideology and free-market beliefs. (He was so insistent about having his way that one House speaker joked that if Mr. Gramm had been around when Moses brought the Ten Commandments down from Mount Sinai, the Texan would have substituted his own.)
He could be impolitic. Over the years, he has urged that food stamps be cut because “all our poor people are fat,” said it was hard for him “to feel sorry” for Social Security recipients and, as the economy soured last summer, called America “a nation of whiners.”
His economic views — and seat on the Senate banking committee — quickly won him support from the nation’s major financial institutions. From 1989 to 2002, federal records show, he was the top recipient of campaign contributions from commercial banks and in the top five for donations from Wall Street. He and his staff often appeared at industry-sponsored speaking events around the country.
From 1999 to 2001, Congress first considered steps to curb predatory loans — those that typically had high fees, significant prepayment penalties and ballooning monthly payments and were often issued to low-income borrowers. Foreclosures on such loans were on the rise, setting off a wave of personal bankruptcies.
But Mr. Gramm did everything he could to block the measures. In 2000, he refused to have his banking committee consider the proposals, an intervention hailed by the National Association of Mortgage Brokers as a “huge, huge step for us.”
A year later, he objected again when Democrats tried to stop lenders from being able to pursue claims in bankruptcy court against borrowers who had defaulted on predatory loans.
While acknowledging some abuses, Mr. Gramm argued that the measure would drive thousands of reputable lenders out of the housing market. And he told fellow senators the story of his mother and her mortgage.
“What incredible exploitation,” he said sarcastically. “As a result of that loan, at a 50 percent premium, so far as I am aware, she was the first person in her family, from Adam and Eve, ever to own her own home.”
Once again, he succeeded in putting off consideration of lending restrictions. His opposition infuriated consumer advocates. “He wouldn’t listen to reason,” said Margot Saunders of the National Consumer Law Center. “He would not allow himself to be persuaded that the free market would not be working.”
Speaking at a bankers’ conference that month, Mr. Gramm said the problem of predatory loans was not of the banks’ making. Instead, he faulted “predatory borrowers.” The American Banker, a trade publication, later reported that he was greeted “like a conquering hero.”
At the Altar of Wall Street
Mr. Gramm would sometimes speak with reverence about the nation’s financial markets, the trading and deal making that churn out wealth.
“When I am on Wall Street and I realize that that’s the very nerve center of American capitalism and I realize what capitalism has done for the working people of America, to me that’s a holy place,” he said at an April 2000 Senate hearing after a visit to New York.
That viewpoint — and concerns that Wall Street’s dominance was threatened by global competition and outdated regulations — shaped his agenda.
In late 1999, Mr. Gramm played a central role in what would be the most significant financial services legislation since the Depression. The Gramm-Leach-Bliley Act, as the measure was called, removed barriers between commercial and investment banks that had been instituted to reduce the risk of economic catastrophes. Long sought by the industry, the law would let commercial banks, securities firms and insurers become financial supermarkets offering an array of services.
The measure, which Mr. Gramm helped write and move through the Senate, also split up oversight of conglomerates among government agencies. The Securities and Exchange Commission, for example, would oversee the brokerage arm of a company. Bank regulators would supervise its banking operation. State insurance commissioners would examine the insurance business. But no single agency would have authority over the entire company.
“There was no attention given to how these regulators would interact with one another,” said Professor Cox of Duke. “Nobody was looking at the holes of the regulatory structure.”
The arrangement was a compromise required to get the law adopted. When the law was signed in November 1999, he proudly declared it “a deregulatory bill,” and added, “We have learned government is not the answer.”
In the final days of the Clinton administration a year later, Mr. Gramm celebrated another triumph. Determined to close the door on any future regulation of the emerging market of derivatives and swaps, he helped pushed through legislation that accomplished that goal.
Created to help companies and investors limit risk, swaps are contracts that typically work like a form of insurance. A bank concerned about rises in interest rates, for instance, can buy a derivatives instrument that would protect it from rate swings. Credit-default swaps, one type of derivative, could protect the holder of a mortgage security against a possible default.
Earlier laws had left the regulation issue sufficiently ambiguous, worrying Wall Street, the Clinton administration and lawmakers of both parties, who argued that too many restrictions would hurt financial activity and spur traders to take their business overseas. And while the Commodity Futures Trading Commission — under the leadership of Mr. Gramm’s wife, Wendy — had approved rules in 1989 and 1993 exempting some swaps and derivatives from regulation, there was still concern that step was not enough.
After Mrs. Gramm left the commission in 1993, several lawmakers proposed regulating derivatives. By spreading risks, they and other critics believed, such contracts made the system prone to cascading failures. Their proposals, though, went nowhere.
But late in the Clinton administration, Brooksley E. Born, who took over the agency Mrs. Gramm once led, raised the issue anew. Her suggestion for government regulations alarmed the markets and drew fierce opposition.
In November 1999, senior Clinton administration officials, including Treasury Secretary Lawrence H. Summers, joined by the Federal Reserve chairman, Alan Greenspan, and Arthur Levitt Jr., the head of the Securities and Exchange Commission, issued a report that instead recommended legislation exempting many kinds of derivatives from federal oversight.
Mr. Gramm helped lead the charge in Congress. Demanding even more freedom from regulators than the financial industry had sought, he persuaded colleagues and negotiated with senior administration officials, pushing so hard that he nearly scuttled the deal. “When I get in the red zone, I like to score,” Mr. Gramm told reporters at the time.
Finally, he had extracted enough. In December 2000, the Commodity Futures Modernization Act was passed as part of a larger bill by unanimous consent after Mr. Gramm dominated the Senate debate.
“This legislation is important to every American investor,” he said at the time. “It will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets.”
But some critics worried that the lack of oversight would allow abuses that could threaten the economy.
Frank Partnoy, a law professor at the University of San Diego and an expert on derivatives, said, “No one, including regulators, could get an accurate picture of this market. The consequences of that is that it left us in the dark for the last eight years.” And, he added, “Bad things happen when it’s dark.”
In 2002, Mr. Gramm left Congress, joining UBS as a senior investment banker and head of the company’s lobbying operation.
But he would not be abandoning Washington.
Lobbying From the Outside
Soon, he was helping persuade lawmakers to block Congressional Democrats’ efforts to combat predatory lending. He arranged meetings with executives and top Washington officials. He turned over his $1 million political action committee to a former aide to make donations to like-minded lawmakers.
Mr. Gramm, now 66, who declined to discuss his compensation at UBS, picked an opportune moment to move to Wall Street. Major financial institutions, including UBS, were growing, partly as a result of the Gramm-Leach-Bliley Act.
Increasingly, institutions were trading the derivatives instruments that Mr. Gramm had helped escape the scrutiny of regulators. UBS was collecting hundreds of millions of dollars from credit-default swaps. (Mr. Gramm said he was not involved in that activity at the bank.) In 2001, a year after passage of the commodities law, the derivatives market insured about $900 billion worth of credit; by last year, the number hadswelled to $62 trillion.
But as housing prices began to fall last year, foreclosure rates began to rise, particularly in regions where there had been heavy use of subprime loans. That set off a calamitous chain of events. The weak housing markets would create strains that eventually would have financial institutions around the world on the edge of collapse.
UBS was among them. The bank has declared nearly $50 billion in credit losses and write-downs since the start of last year, prompting a bailout of up to $60 billion by the Swiss government.
As Mr. Gramm’s record in Congress has come under attack amid all the turmoil, some former colleagues have come to his defense.
“He is a true dyed-in-the-wool free-market guy. He is very much a purist, an idealist, as he has a set of principles and he has never abandoned them,” said Peter G. Fitzgerald, a Republican and former senator from Illinois. “This notion of blaming the economic collapse on Phil Gramm is absurd to me.”
But Michael D. Donovan, a former S.E.C. lawyer, faulted Mr. Gramm for his insistence on deregulating the derivatives market.
“He was the architect, advocate and the most knowledgeable person in Congress on these topics,” Mr. Donovan said. “To me, Phil Gramm is the single most important reason for the current financial crisis.”
Mr. Gramm, ever the economics professor, disputes his critics’ analysis of the causes of the upheaval. He asserts that swaps, by enabling companies to insure themselves against defaults, have diminished, not increased, the effects of the declining housing markets.
“This is part of this myth of deregulation,” he said in the interview. “By and large, credit-default swaps have distributed the risks. They didn’t create it. The only reason people have focused on them is that some politicians don’t know a credit-default swap from a turnip.”
But many experts disagree, including some of Mr. Gramm’s former allies in Congress. They say the lack of oversight left the system vulnerable.
“The virtually unregulated over-the-counter market in credit-default swaps has played a significant role in the credit crisis, including the now $167 billion taxpayer rescue of A.I.G.,” Christopher Cox, the chairman of the S.E.C. and a former congressman, said Friday.
Mr. Gramm says that, given what has happened, there are modest regulatory changes he would favor, including requiring issuers of credit-default swaps to demonstrate that they have enough capital to back up their pledges. But his belief that government should intervene only minimally in markets is unshaken.
“They are saying there was 15 years of massive deregulation and that’s what caused the problem,” Mr. Gramm said of his critics. “I just don’t see any evidence of it.”
Griff Palmer contributed reporting from New York.
Showing posts with label economy. Show all posts
Showing posts with label economy. Show all posts
NYT : House Rejects Bailout Package, 228-205; Stocks Plunge
Monday, September 29, 2008
House Rejects Bailout Package, 228-205; Stocks Plunge
By CARL HULSE and DAVID M. HERSZENHORN | September 30, 2008
WASHINGTON — In a moment of historic import in the Capitol and on Wall Street, the House of Representatives voted on Monday to reject a $700 billion rescue of the financial industry. The vote came in stunning defiance of President Bush and Congressional leaders of both parties, who said the bailout was needed to prevent a widespread financial collapse.
The vote against the measure was 228 to 205, with 133 Republicans turning against President Bush to join 95 Democrats in opposition. The bill was backed by 140 Democrats and 65 Republicans.
Supporters vowed to try to bring the rescue package up again as soon as possible, perhaps late Wednesday or Thursday, but there were no definite plans to do so. A former Treasury Department official predicted that the administration would try to get another House vote before the end of the week, and with only “tiny tweaks” to the package, given the relative closeness of the vote.
Stock markets plunged as it appeared that the measure would go down to defeat, and kept slumping into the afternoon when that appearance became a reality. By late afternoon the Dow industrials had fallen more than 5 percent, and other indexes even more sharply. Oil prices fell steeply on fears of a global recession; investors bid up prices of Treasury securities and gold in a flight to safety.
The vote was a catastrophic political defeat for President Bush, who tried to muster national support for a recovery plan in a televised address last Wednesday, then lobbied wavering Republican legislators in intensely personal telephone calls on Monday morning.
“We put forth a plan that was big because we got a big problem,” the president said afterward. “And we’ll be working with members of Congress, leaders of Congress on the way forward. Our strategy is to continue to address this economic situation head on.”
The president was described as “very disappointed” by a spokesman, Tony Fratto. Mr. Bush’s disappointment may have been deepened by the fact that members of his own party voted against the package by more than 2 to 1.
Treasury Secretary Henry M. Paulson Jr., appearing at the White House late Monday afternoon, warned that the failure of the rescue plan could dry up credit for businesses big and small, making them unable to make payrolls or buy inventory. Vowing to continue working with Congress to revive the rescue plan, Mr. Paulson said it was “much too important to simply let fail.”
Supporters of the bill had argued that it was necessary to avoid a collapse of the economic system, a calamity that would drag down not just Wall Street investment houses but possibly the savings and portfolios of millions of Americans. Moreover, supporters argued, a lingering crisis in America could choke off business and consumer loans to a degree that could prompt bank failures in Europe and slow down the global economy.
Opponents said the bill was cobbled together in too much haste and might amount to throwing good money from taxpayers after bad investments from Wall Street gamblers.
House leaders pushing for the package kept the voting period open for some 40 minutes past the allotted time at mid-day, trying to convert “no” votes by pointing to damage being done to the markets, but to no avail.
The former Treasury Department official who predicted another House vote this week said that before there could be another vote, he would expect Speaker Nancy Pelosi, the California Democrat, and Representative John A. Boehner of Ohio, the Republican minority leader, to approach members with seats in safe districts and tell them, in effect: “You’ve got to do this. The fate of the country hangs on your vote.”
On the other hand, the former official, who spoke on condition of anonymity, said he was not sure what adjustments would satisfy the Republican lawmakers who voted against the package, given that the Republicans had already succeeded in tacking government insurance on to the bill, and that other items on their list of proposals, like a suspension of the capital gains tax, are non-starters.
The United States Chamber of Commerce vowed to exert pressure, warning in a letter to members of Congress that it would keep track of who votes how. “Make no mistake,” the letter said. “When the aftermath of Congressional inaction becomes clear, Americans will not tolerate those who stood by and let the calamity happen.”
Secretary Paulson, in promising to continue working with Congressional leaders to win passage of a rescue plan, alluded to remedial steps that the Treasury and Federal Reserve could take on their own, like lowering short-term interest rates. “Our tool kit is substantial,” he said, “but insufficient.”
Immediately after the vote, many House members appeared stunned. Some Republicans blamed Ms. Pelosi for a speech before the vote that disdained President Bush’s economic policies, and did so, in the opinion of the speaker’s critics, in too partisan a way.
“Clearly, there was something lacking in the leadership here,” said Representative Eric Cantor, Republican of Virginia.
Democrats, meanwhile, blamed the Republicans for not coming up with enough support for the measure on their side of the aisle.
Members of both parties, doing a quick political post-mortem, said those who voted no had encountered too much hostility for the bill among their constituents, and were worried that a vote in favor would be political suicide.
The Senate had been expected to vote later in the week if the bill had cleared the House on Monday. Senate vote-counters had predicted that there was enough support in the chamber for the measure to pass. But the stunning vote in the House, coupled with the Jewish holidays, made it difficult to predict when other votes might be held. Many House members who voted for the bill held their noses, figuratively speaking, as they did so.
Mr. Boehner, the Republican minority leader, called the measure “a mud sandwich” at one point, but he said that there was too much at stake not to support it. He urged members to reflect on the damage that a defeat of the measure could mean “to your friends, your neighbors, your constituents” as they might watch their retirement savings “shrivel up to zero.”
And Representative Steny Hoyer of Maryland, who as Democratic majority leader often clashes with Mr. Boehner, said that on this “day of consequence for America” he and Mr. Boehner “speak with one voice” in pleading for passage.
When it comes to America’s economy, Mr. Hoyer said, “none of us is an island.”
The House vote came after a weekend of tense negotiations produced a rescue plan that Congressional leaders said was greatly strengthened by new taxpayer safeguards. “If we defeat this bill today, it will be a very bad day for the financial sector of the economy,” said Representative Barney Frank, Democrat of Massachusetts and the chairman of the Financial Services Committee. Earlier Monday, President Bush urged Congress to act quickly. Calling the rescue bill “bold,” Mr. Bush praised lawmakers “from both sides of the aisle” for reaching agreement, and said it would “help keep the crisis in our financial system from spreading throughout our economy.”
After long favoring a hands-off approach and deregulation of the financial industry, the Bush administration has found itself in recent weeks interceding repeatedly in the private market to try to avert one calamity after another.
Even before the House vote, European and Asian stock markets declined sharply on Monday, especially in countries where major banks have had significant problems with mortgage investments, like Britain and Ireland. In the credit markets, investors once again bid up prices of Treasury securities and shunned more risky debt.
Early in the House debate, Jeb Hensarling, Republican of Texas, said he intended to vote against the package, which he said would put the nation on “the slippery slope to socialism.” He said that he was afraid that it ultimately would not work, leaving the taxpayers responsible for “the mother of all debt.”
Another Texas Republican, John Culberson, spoke scathingly about the unbridled power he said the bill would hand over to the Treasury secretary, Henry M. Paulson Jr., whom he called “King Henry.”
A third Texan, Lloyd Doggett, a Democrat, said the negotiators had “never seriously considered any alternative” to the administration’s plan, and had only barely modified what they were given. He criticized the plan for handing over sweeping new powers to an administration that he said was to blame for allowing the crisis to develop in the first place.
The administration accepted limits on executive pay and tougher oversight; Democrats sacrificed a push to allow bankruptcy judges to rewrite mortgages. But Republicans fell short in their effort to require that the federal government insure, rather than buy, the bad debt.
The final version of the bill included a deal-sealing plan for eventually recouping losses; if the Treasury program to purchase and resell troubled mortgage-backed securities has lost money after five years, the president must submit a plan to Congress to recover those losses from the financial industry.
Presumably that plan would involve new fees or taxes, perhaps on securities transactions.
The deal would also restrict gold-plated farewells for executives of companies that sell devalued assets to the Treasury Department. But by mid-afternoon on Monday, no one could safely predict whether the provisions in the 110-page bill were strictly academic.
“The legislation has failed,” Speaker Pelosi said at a news conference after the vote. “The crisis has not gone away. We must continue to work in a bipartisan manner.”
Reporting was contributed by David Stout and Robert Pear from Washington,
Keith Bradsher from Hong Kong and Graham Bowley from New York.
By CARL HULSE and DAVID M. HERSZENHORN | September 30, 2008
WASHINGTON — In a moment of historic import in the Capitol and on Wall Street, the House of Representatives voted on Monday to reject a $700 billion rescue of the financial industry. The vote came in stunning defiance of President Bush and Congressional leaders of both parties, who said the bailout was needed to prevent a widespread financial collapse.
The vote against the measure was 228 to 205, with 133 Republicans turning against President Bush to join 95 Democrats in opposition. The bill was backed by 140 Democrats and 65 Republicans.
Supporters vowed to try to bring the rescue package up again as soon as possible, perhaps late Wednesday or Thursday, but there were no definite plans to do so. A former Treasury Department official predicted that the administration would try to get another House vote before the end of the week, and with only “tiny tweaks” to the package, given the relative closeness of the vote.
Stock markets plunged as it appeared that the measure would go down to defeat, and kept slumping into the afternoon when that appearance became a reality. By late afternoon the Dow industrials had fallen more than 5 percent, and other indexes even more sharply. Oil prices fell steeply on fears of a global recession; investors bid up prices of Treasury securities and gold in a flight to safety.
The vote was a catastrophic political defeat for President Bush, who tried to muster national support for a recovery plan in a televised address last Wednesday, then lobbied wavering Republican legislators in intensely personal telephone calls on Monday morning.
“We put forth a plan that was big because we got a big problem,” the president said afterward. “And we’ll be working with members of Congress, leaders of Congress on the way forward. Our strategy is to continue to address this economic situation head on.”
The president was described as “very disappointed” by a spokesman, Tony Fratto. Mr. Bush’s disappointment may have been deepened by the fact that members of his own party voted against the package by more than 2 to 1.
Treasury Secretary Henry M. Paulson Jr., appearing at the White House late Monday afternoon, warned that the failure of the rescue plan could dry up credit for businesses big and small, making them unable to make payrolls or buy inventory. Vowing to continue working with Congress to revive the rescue plan, Mr. Paulson said it was “much too important to simply let fail.”
Supporters of the bill had argued that it was necessary to avoid a collapse of the economic system, a calamity that would drag down not just Wall Street investment houses but possibly the savings and portfolios of millions of Americans. Moreover, supporters argued, a lingering crisis in America could choke off business and consumer loans to a degree that could prompt bank failures in Europe and slow down the global economy.
Opponents said the bill was cobbled together in too much haste and might amount to throwing good money from taxpayers after bad investments from Wall Street gamblers.
House leaders pushing for the package kept the voting period open for some 40 minutes past the allotted time at mid-day, trying to convert “no” votes by pointing to damage being done to the markets, but to no avail.
The former Treasury Department official who predicted another House vote this week said that before there could be another vote, he would expect Speaker Nancy Pelosi, the California Democrat, and Representative John A. Boehner of Ohio, the Republican minority leader, to approach members with seats in safe districts and tell them, in effect: “You’ve got to do this. The fate of the country hangs on your vote.”
On the other hand, the former official, who spoke on condition of anonymity, said he was not sure what adjustments would satisfy the Republican lawmakers who voted against the package, given that the Republicans had already succeeded in tacking government insurance on to the bill, and that other items on their list of proposals, like a suspension of the capital gains tax, are non-starters.
The United States Chamber of Commerce vowed to exert pressure, warning in a letter to members of Congress that it would keep track of who votes how. “Make no mistake,” the letter said. “When the aftermath of Congressional inaction becomes clear, Americans will not tolerate those who stood by and let the calamity happen.”
Secretary Paulson, in promising to continue working with Congressional leaders to win passage of a rescue plan, alluded to remedial steps that the Treasury and Federal Reserve could take on their own, like lowering short-term interest rates. “Our tool kit is substantial,” he said, “but insufficient.”
Immediately after the vote, many House members appeared stunned. Some Republicans blamed Ms. Pelosi for a speech before the vote that disdained President Bush’s economic policies, and did so, in the opinion of the speaker’s critics, in too partisan a way.
“Clearly, there was something lacking in the leadership here,” said Representative Eric Cantor, Republican of Virginia.
Democrats, meanwhile, blamed the Republicans for not coming up with enough support for the measure on their side of the aisle.
Members of both parties, doing a quick political post-mortem, said those who voted no had encountered too much hostility for the bill among their constituents, and were worried that a vote in favor would be political suicide.
The Senate had been expected to vote later in the week if the bill had cleared the House on Monday. Senate vote-counters had predicted that there was enough support in the chamber for the measure to pass. But the stunning vote in the House, coupled with the Jewish holidays, made it difficult to predict when other votes might be held. Many House members who voted for the bill held their noses, figuratively speaking, as they did so.
Mr. Boehner, the Republican minority leader, called the measure “a mud sandwich” at one point, but he said that there was too much at stake not to support it. He urged members to reflect on the damage that a defeat of the measure could mean “to your friends, your neighbors, your constituents” as they might watch their retirement savings “shrivel up to zero.”
And Representative Steny Hoyer of Maryland, who as Democratic majority leader often clashes with Mr. Boehner, said that on this “day of consequence for America” he and Mr. Boehner “speak with one voice” in pleading for passage.
When it comes to America’s economy, Mr. Hoyer said, “none of us is an island.”
The House vote came after a weekend of tense negotiations produced a rescue plan that Congressional leaders said was greatly strengthened by new taxpayer safeguards. “If we defeat this bill today, it will be a very bad day for the financial sector of the economy,” said Representative Barney Frank, Democrat of Massachusetts and the chairman of the Financial Services Committee. Earlier Monday, President Bush urged Congress to act quickly. Calling the rescue bill “bold,” Mr. Bush praised lawmakers “from both sides of the aisle” for reaching agreement, and said it would “help keep the crisis in our financial system from spreading throughout our economy.”
After long favoring a hands-off approach and deregulation of the financial industry, the Bush administration has found itself in recent weeks interceding repeatedly in the private market to try to avert one calamity after another.
Even before the House vote, European and Asian stock markets declined sharply on Monday, especially in countries where major banks have had significant problems with mortgage investments, like Britain and Ireland. In the credit markets, investors once again bid up prices of Treasury securities and shunned more risky debt.
Early in the House debate, Jeb Hensarling, Republican of Texas, said he intended to vote against the package, which he said would put the nation on “the slippery slope to socialism.” He said that he was afraid that it ultimately would not work, leaving the taxpayers responsible for “the mother of all debt.”
Another Texas Republican, John Culberson, spoke scathingly about the unbridled power he said the bill would hand over to the Treasury secretary, Henry M. Paulson Jr., whom he called “King Henry.”
A third Texan, Lloyd Doggett, a Democrat, said the negotiators had “never seriously considered any alternative” to the administration’s plan, and had only barely modified what they were given. He criticized the plan for handing over sweeping new powers to an administration that he said was to blame for allowing the crisis to develop in the first place.
The administration accepted limits on executive pay and tougher oversight; Democrats sacrificed a push to allow bankruptcy judges to rewrite mortgages. But Republicans fell short in their effort to require that the federal government insure, rather than buy, the bad debt.
The final version of the bill included a deal-sealing plan for eventually recouping losses; if the Treasury program to purchase and resell troubled mortgage-backed securities has lost money after five years, the president must submit a plan to Congress to recover those losses from the financial industry.
Presumably that plan would involve new fees or taxes, perhaps on securities transactions.
The deal would also restrict gold-plated farewells for executives of companies that sell devalued assets to the Treasury Department. But by mid-afternoon on Monday, no one could safely predict whether the provisions in the 110-page bill were strictly academic.
“The legislation has failed,” Speaker Pelosi said at a news conference after the vote. “The crisis has not gone away. We must continue to work in a bipartisan manner.”
Reporting was contributed by David Stout and Robert Pear from Washington,
Keith Bradsher from Hong Kong and Graham Bowley from New York.
Reuters : Large U.S. bank collapse ahead, says ex-IMF economist
Wednesday, August 20, 2008
Large U.S. bank collapse ahead, says ex-IMF economist
By Jan Dahinten | August 19, 2008
SINGAPORE (Reuters) - The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.
"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.
"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.
"We have to see more consolidation in the financial sector before this is over," he said, when asked for early signs of an end to the crisis.
"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."
Rogoff's comments come as investors dumped shares of the largest U.S. home funding companies Fannie Mae and Freddie Mac on Monday after a newspaper report said government officials may have no choice but to effectively nationalize the U.S. housing finance titans.
A government move to recapitalize the two companies by injecting funds could wipe out existing common stock holders, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.
Rogoff said multi-billion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits because they had not taken into account the broader market conditions that the industry faces.
"There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.
"That view neglects the point that the financial system has become very bloated in size and needed to shrink," Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup
In response to the sharp U.S. housing retrenchment and turmoil in credit markets, the U.S. Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 percent since mid-September.
Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as "dramatically" as it did.
"Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States."
(Editing by Neil Chatterjee)
© Thomson Reuters 2008 All rights reserved
By Jan Dahinten | August 19, 2008
SINGAPORE (Reuters) - The worst of the global financial crisis is yet to come and a large U.S. bank will fail in the next few months as the world's biggest economy hits further troubles, former IMF chief economist Kenneth Rogoff said on Tuesday.
"The U.S. is not out of the woods. I think the financial crisis is at the halfway point, perhaps. I would even go further to say 'the worst is to come'," he told a financial conference.
"We're not just going to see mid-sized banks go under in the next few months, we're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks," said Rogoff, who is an economics professor at Harvard University and was the International Monetary Fund's chief economist from 2001 to 2004.
"We have to see more consolidation in the financial sector before this is over," he said, when asked for early signs of an end to the crisis.
"Probably Fannie Mae and Freddie Mac -- despite what U.S. Treasury Secretary Hank Paulson said -- these giant mortgage guarantee agencies are not going to exist in their present form in a few years."
Rogoff's comments come as investors dumped shares of the largest U.S. home funding companies Fannie Mae and Freddie Mac on Monday after a newspaper report said government officials may have no choice but to effectively nationalize the U.S. housing finance titans.
A government move to recapitalize the two companies by injecting funds could wipe out existing common stock holders, the weekend Barron's story said. Preferred shareholders and even holders of the two government-sponsored entities' $19 billion of subordinated debt would also suffer losses.
Rogoff said multi-billion dollar investments by sovereign wealth funds from Asia and the Middle East in western financial firms may not necessarily result in large profits because they had not taken into account the broader market conditions that the industry faces.
"There was this view early on in the crisis that sovereign wealth funds could save everybody. Investment banks did something stupid, they lost money in the sub-prime, they're great buys, sovereign wealth funds come in and make a lot of money by buying them.
"That view neglects the point that the financial system has become very bloated in size and needed to shrink," Rogoff told the conference in Singapore, whose wealth funds GIC and Temasek have invested billions in Merrill Lynch and Citigroup
In response to the sharp U.S. housing retrenchment and turmoil in credit markets, the U.S. Federal Reserve has reduced interest rates by a cumulative 3.25 percentage points to 2 percent since mid-September.
Rogoff said the U.S. Federal Reserve was wrong to cut interest rates as "dramatically" as it did.
"Cutting interest rates is going to lead to a lot of inflation in the next few years in the United States."
(Editing by Neil Chatterjee)
© Thomson Reuters 2008 All rights reserved
NYT : Dr. Doom
Monday, August 18, 2008
Dr. Doom
By STEPHEN MIHM | August 17, 2008
On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.
The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.
But Roubini was soon vindicated. In the year that followed, subprime lenders began entering bankruptcy, hedge funds began going under and the stock market plunged. There was declining employment, a deteriorating dollar, ever-increasing evidence of a huge housing bust and a growing air of panic in financial markets as the credit crisis deepened. By late summer, the Federal Reserve was rushing to the rescue, making the first of many unorthodox interventions in the economy, including cutting the lending rate by 50 basis points and buying up tens of billions of dollars in mortgage-backed securities. When Roubini returned to the I.M.F. last September, he delivered a second talk, predicting a growing crisis of solvency that would infect every sector of the financial system. This time, no one laughed. “He sounded like a madman in 2006,” recalls the I.M.F. economist Prakash Loungani, who invited Roubini on both occasions. “He was a prophet when he returned in 2007.”
Over the past year, whenever optimists have declared the worst of the economic crisis behind us, Roubini has countered with steadfast pessimism. In February, when the conventional wisdom held that the venerable investment firms of Wall Street would weather the crisis, Roubini warned that one or more of them would go “belly up” — and six weeks later, Bear Stearns collapsed. Following the Fed’s further extraordinary actions in the spring — including making lines of credit available to selected investment banks and brokerage houses — many economists made note of the ensuing economic rally and proclaimed the credit crisis over and a recession averted. Roubini, who dismissed the rally as nothing more than a “delusional complacency” encouraged by a “bunch of self-serving spinmasters,” stuck to his script of “nightmare” events: waves of corporate bankrupticies, collapses in markets like commercial real estate and municipal bonds and, most alarming, the possible bankruptcy of a large regional or national bank that would trigger a panic by depositors. Not all of these developments have come to pass (and perhaps never will), but the demise last month of the California bank IndyMac — one of the largest such failures in U.S. history — drew only more attention to Roubini’s seeming prescience.
As a result, Roubini, a respected but formerly obscure academic, has become a major figure in the public debate about the economy: the seer who saw it coming. He has been summoned to speak before Congress, the Council on Foreign Relations and the World Economic Forum at Davos. He is now a sought-after adviser, spending much of his time shuttling between meetings with central bank governors and finance ministers in Europe and Asia. Though he continues to issue colorful doomsday prophecies of a decidedly nonmainstream sort — especially on his popular and polemical blog, where he offers visions of “equity market slaughter” and the “Coming Systemic Bust of the U.S. Banking System” — the mainstream economic establishment appears to be moving closer, however fitfully, to his way of seeing things. “I have in the last few months become more pessimistic than the consensus,” the former Treasury secretary Lawrence Summers told me earlier this year. “Certainly, Nouriel’s writings have been a contributor to that.”
On a cold and dreary day last winter, I met Roubini over lunch in the TriBeCa neighborhood of New York City. “I’m not a pessimist by nature,” he insisted. “I’m not someone who sees things in a bleak way.” Just looking at him, I found the assertion hard to credit. With a dour manner and an aura of gloom about him, Roubini gives the impression of being permanently pained, as if the burden of what he knows is almost too much for him to bear. He rarely smiles, and when he does, his face, topped by an unruly mop of brown hair, contorts into something more closely resembling a grimace.
When I pressed him on his claim that he wasn’t pessimistic, he paused for a moment and then relented a little. “I have more concerns about potential risks and vulnerabilities than most people,” he said, with glum understatement. But these concerns, he argued, make him more of a realist than a pessimist and put him in the role of the cleareyed outsider — unsettling complacency and puncturing pieties.
Roubini, who is 50, has been an outsider his entire life. He was born in Istanbul, the child of Iranian Jews, and his family moved to Tehran when he was 2, then to Tel Aviv and finally to Italy, where he grew up and attended college. He moved to the United States to pursue his doctorate in international economics at Harvard. Along the way he became fluent in Farsi, Hebrew, Italian and English. His accent, an inimitable polyglot growl, radiates a weariness that comes with being what he calls a “global nomad.”
As a graduate student at Harvard, Roubini was an unusual talent, according to his adviser, the Columbia economist Jeffrey Sachs. He was as comfortable in the world of arcane mathematics as he was studying political and economic institutions. “It’s a mix of skills that rarely comes packaged in one person,” Sachs told me. After completing his Ph.D. in 1988, Roubini joined the economics department at Yale, where he first met and began sharing ideas with Robert Shiller, the economist now known for his prescient warnings about the 1990s tech bubble.
The ’90s were an eventful time for an international economist like Roubini. Throughout the decade, one emerging economy after another was beset by crisis, beginning with Mexico’s in 1994. Panics swept Asia, including Thailand, Indonesia and Korea, in 1997 and 1998. The economies of Brazil and Russia imploded in 1998. Argentina’s followed in 2000. Roubini began studying these countries and soon identified what he saw as their common weaknesses. On the eve of the crises that befell them, he noticed, most had huge current-account deficits (meaning, basically, that they spent far more than they made), and they typically financed these deficits by borrowing from abroad in ways that exposed them to the national equivalent of bank runs. Most of these countries also had poorly regulated banking systems plagued by excessive borrowing and reckless lending. Corporate governance was often weak, with cronyism in abundance.
Roubini’s work was distinguished not only by his conclusions but also by his approach. By making extensive use of transnational comparisons and historical analogies, he was employing a subjective, nontechnical framework, the sort embraced by popular economists like the Times Op-Ed columnist Paul Krugman and Joseph Stiglitz in order to reach a nonacademic audience. Roubini takes pains to note that he remains a rigorous scholarly economist — “When I weigh evidence,” he told me, “I’m drawing on 20 years of accumulated experience using models” — but his approach is not the contemporary scholarly ideal in which an economist builds a model in order to constrain his subjective impressions and abide by a discrete set of data. As Shiller told me, “Nouriel has a different way of seeing things than most economists: he gets into everything.”
Roubini likens his style to that of a policy maker like Alan Greenspan, the former Fed chairman who was said (perhaps apocryphally) to pore over vast quantities of technical economic data while sitting in the bathtub, looking to sniff out where the economy was headed. Roubini also cites, as a more ideologically congenial example, the sweeping, cosmopolitan approach of the legendary economist John Maynard Keynes, whom Roubini, with only slight exaggeration, calls “the most brilliant economist who never wrote down an equation.” The book that Roubini ultimately wrote (with the economist Brad Setser) on the emerging market crises, “Bailouts or Bail-Ins?” contains not a single equation in its 400-plus pages.
After analyzing the markets that collapsed in the ’90s, Roubini set out to determine which country’s economy would be the next to succumb to the same pressures. His surprising answer: the United States’. “The United States,” Roubini remembers thinking, “looked like the biggest emerging market of all.” Of course, the United States wasn’t an emerging market; it was (and still is) the largest economy in the world. But Roubini was unnerved by what he saw in the U.S. economy, in particular its 2004 current-account deficit of $600 billion. He began writing extensively about the dangers of that deficit and then branched out, researching the various effects of the credit boom — including the biggest housing bubble in the nation’s history — that began after the Federal Reserve cut rates to close to zero in 2003. Roubini became convinced that the housing bubble was going to pop.
By late 2004 he had started to write about a “nightmare hard landing scenario for the United States.” He predicted that foreign investors would stop financing the fiscal and current-account deficit and abandon the dollar, wreaking havoc on the economy. He said that these problems, which he called the “twin financial train wrecks,” might manifest themselves in 2005 or, at the latest, 2006. “You have been warned here first,” he wrote ominously on his blog. But by the end of 2006, the train wrecks hadn’t occurred.
Recessions are signal events in any modern economy. And yet remarkably, the profession of economics is quite bad at predicting them. A recent study looked at “consensus forecasts” (the predictions of large groups of economists) that were made in advance of 60 different national recessions that hit around the world in the ’90s: in 97 percent of the cases, the study found, the economists failed to predict the coming contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated the severity of the downturns. Worse, many of the economists failed to anticipate recessions that occurred as soon as two months later.
The dismal science, it seems, is an optimistic profession. Many economists, Roubini among them, argue that some of the optimism is built into the very machinery, the mathematics, of modern economic theory. Econometric models typically rely on the assumption that the near future is likely to be similar to the recent past, and thus it is rare that the models anticipate breaks in the economy. And if the models can’t foresee a relatively minor break like a recession, they have even more trouble modeling and predicting a major rupture like a full-blown financial crisis. Only a handful of 20th-century economists have even bothered to study financial panics. (The most notable example is probably the late economist Hyman Minksy, of whom Roubini is an avid reader.) “These are things most economists barely understand,” Roubini told me. “We’re in uncharted territory where standard economic theory isn’t helpful.”
True though this may be, Roubini’s critics do not agree that his approach is any more accurate. Anirvan Banerji, the economist who challenged Roubini’s first I.M.F. talk, points out that Roubini has been peddling pessimism for years; Banerji contends that Roubini’s apparent foresight is nothing more than an unhappy coincidence of events. “Even a stopped clock is right twice a day,” he told me. “The justification for his bearish call has evolved over the years,” Banerji went on, ticking off the different reasons that Roubini has used to justify his predictions of recessions and crises: rising trade deficits, exploding current-account deficits, Hurricane Katrina, soaring oil prices. All of Roubini’s predictions, Banerji observed, have been based on analogies with past experience. “This forecasting by analogy is a tempting thing to do,” he said. “But you have to pick the right analogy. The danger of this more subjective approach is that instead of letting the objective facts shape your views, you will choose the facts that confirm your existing views.”
Kenneth Rogoff, an economist at Harvard who has known Roubini for decades, told me that he sees great value in Roubini’s willingness to entertain possible situations that are far outside the consensus view of most economists. “If you’re sitting around at the European Central Bank,” he said, “and you’re asking what’s the worst thing that could happen, the first thing people will say is, ‘Let’s see what Nouriel says.’ ” But Rogoff cautioned against equating that skill with forecasting. Roubini, in other words, might be the kind of economist you want to consult about the possibility of the collapse of the municipal-bond market, but he is not necessarily the kind you ask to predict, say, the rise in global demand for paper clips.
His defenders contend that Roubini is not unduly pessimistic. Jeffrey Sachs, his former adviser, told me that “if the underlying conditions call for optimism, Nouriel would be optimistic.” And to be sure, Roubini is capable of being optimistic — or at least of steering clear of absolute worst-case prognostications. He agrees, for example, with the conventional economic wisdom that oil will drop below $100 a barrel in the coming months as global demand weakens. “I’m not comfortable saying that we’re going to end up in the Great Depression,” he told me. “I’m a reasonable person.”
What economic developments does Roubini see on the horizon? And what does he think we should do about them? The first step, he told me in a recent conversation, is to acknowledge the extent of the problem. “We are in a recession, and denying it is nonsense,” he said. When Jim Nussle, the White House budget director, announced last month that the nation had “avoided a recession,” Roubini was incredulous. For months, he has been predicting that the United States will suffer through an 18-month recession that will eventually rank as the “worst since the Great Depression.” Though he is confident that the economy will enter a technical recovery toward the end of next year, he says that job losses, corporate bankruptcies and other drags on growth will continue to take a toll for years.
Roubini has counseled various policy makers, including Federal Reserve governors and senior Treasury Department officials, to mount an aggressive response to the crisis. He applauded when the Federal Reserve cut interest rates to 2 percent from 5.25 percent beginning last summer. He also supported the Fed’s willingness to engineer a takeover of Bear Stearns. Roubini argues that the Fed’s actions averted catastrophe, though he says he believes that future bailouts should focus on mortgage owners, not investors. Accordingly, he sees the choice facing the United States as stark but simple: either the government backs up a trillion-plus dollars’ worth of high-risk mortgages (in exchange for the lenders’ agreement to reduce monthly mortgage payments), or the banks and other institutions holding those mortgages — or the complex securities derived from them — go under. “You either nationalize the banks or you nationalize the mortgages,” he said. “Otherwise, they’re all toast.”
For months Roubini has been arguing that the true cost of the housing crisis will not be a mere $300 billion — the amount allowed for by the housing legislation sponsored by Representative Barney Frank and Senator Christopher Dodd — but something between a trillion and a trillion and a half dollars. But most important, in Roubini’s opinion, is to realize that the problem is deeper than the housing crisis. “Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”
Roubini argues that most of the losses from this bad debt have yet to be written off, and the toll from bad commercial real estate loans alone may help send hundreds of local banks into the arms of the Federal Deposit Insurance Corporation. “A good third of the regional banks won’t make it,” he predicted. In turn, these bailouts will add hundreds of billions of dollars to an already gargantuan federal debt, and someone, somewhere, is going to have to finance that debt, along with all the other debt accumulated by consumers and corporations. “Our biggest financiers are China, Russia and the gulf states,” Roubini noted. “These are rivals, not allies.”
The United States, Roubini went on, will likely muddle through the crisis but will emerge from it a different nation, with a different place in the world. “Once you run current-account deficits, you depend on the kindness of strangers,” he said, pausing to let out a resigned sigh. “This might be the beginning of the end of the American empire.”
Stephen Mihm, an assistant professor of economic history at the University of Georgia, is the author of “A Nation of Counterfeiters: Capitalists, Con Men and the Making of the United States.” His last feature article for the magazine was about North Korean counterfeiting.
By STEPHEN MIHM | August 17, 2008
On Sept. 7, 2006, Nouriel Roubini, an economics professor at New York University, stood before an audience of economists at the International Monetary Fund and announced that a crisis was brewing. In the coming months and years, he warned, the United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence and, ultimately, a deep recession. He laid out a bleak sequence of events: homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt. These developments, he went on, could cripple or destroy hedge funds, investment banks and other major financial institutions like Fannie Mae and Freddie Mac.
The audience seemed skeptical, even dismissive. As Roubini stepped down from the lectern after his talk, the moderator of the event quipped, “I think perhaps we will need a stiff drink after that.” People laughed — and not without reason. At the time, unemployment and inflation remained low, and the economy, while weak, was still growing, despite rising oil prices and a softening housing market. And then there was the espouser of doom himself: Roubini was known to be a perpetual pessimist, what economists call a “permabear.” When the economist Anirvan Banerji delivered his response to Roubini’s talk, he noted that Roubini’s predictions did not make use of mathematical models and dismissed his hunches as those of a career naysayer.
But Roubini was soon vindicated. In the year that followed, subprime lenders began entering bankruptcy, hedge funds began going under and the stock market plunged. There was declining employment, a deteriorating dollar, ever-increasing evidence of a huge housing bust and a growing air of panic in financial markets as the credit crisis deepened. By late summer, the Federal Reserve was rushing to the rescue, making the first of many unorthodox interventions in the economy, including cutting the lending rate by 50 basis points and buying up tens of billions of dollars in mortgage-backed securities. When Roubini returned to the I.M.F. last September, he delivered a second talk, predicting a growing crisis of solvency that would infect every sector of the financial system. This time, no one laughed. “He sounded like a madman in 2006,” recalls the I.M.F. economist Prakash Loungani, who invited Roubini on both occasions. “He was a prophet when he returned in 2007.”
Over the past year, whenever optimists have declared the worst of the economic crisis behind us, Roubini has countered with steadfast pessimism. In February, when the conventional wisdom held that the venerable investment firms of Wall Street would weather the crisis, Roubini warned that one or more of them would go “belly up” — and six weeks later, Bear Stearns collapsed. Following the Fed’s further extraordinary actions in the spring — including making lines of credit available to selected investment banks and brokerage houses — many economists made note of the ensuing economic rally and proclaimed the credit crisis over and a recession averted. Roubini, who dismissed the rally as nothing more than a “delusional complacency” encouraged by a “bunch of self-serving spinmasters,” stuck to his script of “nightmare” events: waves of corporate bankrupticies, collapses in markets like commercial real estate and municipal bonds and, most alarming, the possible bankruptcy of a large regional or national bank that would trigger a panic by depositors. Not all of these developments have come to pass (and perhaps never will), but the demise last month of the California bank IndyMac — one of the largest such failures in U.S. history — drew only more attention to Roubini’s seeming prescience.
As a result, Roubini, a respected but formerly obscure academic, has become a major figure in the public debate about the economy: the seer who saw it coming. He has been summoned to speak before Congress, the Council on Foreign Relations and the World Economic Forum at Davos. He is now a sought-after adviser, spending much of his time shuttling between meetings with central bank governors and finance ministers in Europe and Asia. Though he continues to issue colorful doomsday prophecies of a decidedly nonmainstream sort — especially on his popular and polemical blog, where he offers visions of “equity market slaughter” and the “Coming Systemic Bust of the U.S. Banking System” — the mainstream economic establishment appears to be moving closer, however fitfully, to his way of seeing things. “I have in the last few months become more pessimistic than the consensus,” the former Treasury secretary Lawrence Summers told me earlier this year. “Certainly, Nouriel’s writings have been a contributor to that.”
On a cold and dreary day last winter, I met Roubini over lunch in the TriBeCa neighborhood of New York City. “I’m not a pessimist by nature,” he insisted. “I’m not someone who sees things in a bleak way.” Just looking at him, I found the assertion hard to credit. With a dour manner and an aura of gloom about him, Roubini gives the impression of being permanently pained, as if the burden of what he knows is almost too much for him to bear. He rarely smiles, and when he does, his face, topped by an unruly mop of brown hair, contorts into something more closely resembling a grimace.
When I pressed him on his claim that he wasn’t pessimistic, he paused for a moment and then relented a little. “I have more concerns about potential risks and vulnerabilities than most people,” he said, with glum understatement. But these concerns, he argued, make him more of a realist than a pessimist and put him in the role of the cleareyed outsider — unsettling complacency and puncturing pieties.
Roubini, who is 50, has been an outsider his entire life. He was born in Istanbul, the child of Iranian Jews, and his family moved to Tehran when he was 2, then to Tel Aviv and finally to Italy, where he grew up and attended college. He moved to the United States to pursue his doctorate in international economics at Harvard. Along the way he became fluent in Farsi, Hebrew, Italian and English. His accent, an inimitable polyglot growl, radiates a weariness that comes with being what he calls a “global nomad.”
As a graduate student at Harvard, Roubini was an unusual talent, according to his adviser, the Columbia economist Jeffrey Sachs. He was as comfortable in the world of arcane mathematics as he was studying political and economic institutions. “It’s a mix of skills that rarely comes packaged in one person,” Sachs told me. After completing his Ph.D. in 1988, Roubini joined the economics department at Yale, where he first met and began sharing ideas with Robert Shiller, the economist now known for his prescient warnings about the 1990s tech bubble.
The ’90s were an eventful time for an international economist like Roubini. Throughout the decade, one emerging economy after another was beset by crisis, beginning with Mexico’s in 1994. Panics swept Asia, including Thailand, Indonesia and Korea, in 1997 and 1998. The economies of Brazil and Russia imploded in 1998. Argentina’s followed in 2000. Roubini began studying these countries and soon identified what he saw as their common weaknesses. On the eve of the crises that befell them, he noticed, most had huge current-account deficits (meaning, basically, that they spent far more than they made), and they typically financed these deficits by borrowing from abroad in ways that exposed them to the national equivalent of bank runs. Most of these countries also had poorly regulated banking systems plagued by excessive borrowing and reckless lending. Corporate governance was often weak, with cronyism in abundance.
Roubini’s work was distinguished not only by his conclusions but also by his approach. By making extensive use of transnational comparisons and historical analogies, he was employing a subjective, nontechnical framework, the sort embraced by popular economists like the Times Op-Ed columnist Paul Krugman and Joseph Stiglitz in order to reach a nonacademic audience. Roubini takes pains to note that he remains a rigorous scholarly economist — “When I weigh evidence,” he told me, “I’m drawing on 20 years of accumulated experience using models” — but his approach is not the contemporary scholarly ideal in which an economist builds a model in order to constrain his subjective impressions and abide by a discrete set of data. As Shiller told me, “Nouriel has a different way of seeing things than most economists: he gets into everything.”
Roubini likens his style to that of a policy maker like Alan Greenspan, the former Fed chairman who was said (perhaps apocryphally) to pore over vast quantities of technical economic data while sitting in the bathtub, looking to sniff out where the economy was headed. Roubini also cites, as a more ideologically congenial example, the sweeping, cosmopolitan approach of the legendary economist John Maynard Keynes, whom Roubini, with only slight exaggeration, calls “the most brilliant economist who never wrote down an equation.” The book that Roubini ultimately wrote (with the economist Brad Setser) on the emerging market crises, “Bailouts or Bail-Ins?” contains not a single equation in its 400-plus pages.
After analyzing the markets that collapsed in the ’90s, Roubini set out to determine which country’s economy would be the next to succumb to the same pressures. His surprising answer: the United States’. “The United States,” Roubini remembers thinking, “looked like the biggest emerging market of all.” Of course, the United States wasn’t an emerging market; it was (and still is) the largest economy in the world. But Roubini was unnerved by what he saw in the U.S. economy, in particular its 2004 current-account deficit of $600 billion. He began writing extensively about the dangers of that deficit and then branched out, researching the various effects of the credit boom — including the biggest housing bubble in the nation’s history — that began after the Federal Reserve cut rates to close to zero in 2003. Roubini became convinced that the housing bubble was going to pop.
By late 2004 he had started to write about a “nightmare hard landing scenario for the United States.” He predicted that foreign investors would stop financing the fiscal and current-account deficit and abandon the dollar, wreaking havoc on the economy. He said that these problems, which he called the “twin financial train wrecks,” might manifest themselves in 2005 or, at the latest, 2006. “You have been warned here first,” he wrote ominously on his blog. But by the end of 2006, the train wrecks hadn’t occurred.
Recessions are signal events in any modern economy. And yet remarkably, the profession of economics is quite bad at predicting them. A recent study looked at “consensus forecasts” (the predictions of large groups of economists) that were made in advance of 60 different national recessions that hit around the world in the ’90s: in 97 percent of the cases, the study found, the economists failed to predict the coming contraction a year in advance. On those rare occasions when economists did successfully predict recessions, they significantly underestimated the severity of the downturns. Worse, many of the economists failed to anticipate recessions that occurred as soon as two months later.
The dismal science, it seems, is an optimistic profession. Many economists, Roubini among them, argue that some of the optimism is built into the very machinery, the mathematics, of modern economic theory. Econometric models typically rely on the assumption that the near future is likely to be similar to the recent past, and thus it is rare that the models anticipate breaks in the economy. And if the models can’t foresee a relatively minor break like a recession, they have even more trouble modeling and predicting a major rupture like a full-blown financial crisis. Only a handful of 20th-century economists have even bothered to study financial panics. (The most notable example is probably the late economist Hyman Minksy, of whom Roubini is an avid reader.) “These are things most economists barely understand,” Roubini told me. “We’re in uncharted territory where standard economic theory isn’t helpful.”
True though this may be, Roubini’s critics do not agree that his approach is any more accurate. Anirvan Banerji, the economist who challenged Roubini’s first I.M.F. talk, points out that Roubini has been peddling pessimism for years; Banerji contends that Roubini’s apparent foresight is nothing more than an unhappy coincidence of events. “Even a stopped clock is right twice a day,” he told me. “The justification for his bearish call has evolved over the years,” Banerji went on, ticking off the different reasons that Roubini has used to justify his predictions of recessions and crises: rising trade deficits, exploding current-account deficits, Hurricane Katrina, soaring oil prices. All of Roubini’s predictions, Banerji observed, have been based on analogies with past experience. “This forecasting by analogy is a tempting thing to do,” he said. “But you have to pick the right analogy. The danger of this more subjective approach is that instead of letting the objective facts shape your views, you will choose the facts that confirm your existing views.”
Kenneth Rogoff, an economist at Harvard who has known Roubini for decades, told me that he sees great value in Roubini’s willingness to entertain possible situations that are far outside the consensus view of most economists. “If you’re sitting around at the European Central Bank,” he said, “and you’re asking what’s the worst thing that could happen, the first thing people will say is, ‘Let’s see what Nouriel says.’ ” But Rogoff cautioned against equating that skill with forecasting. Roubini, in other words, might be the kind of economist you want to consult about the possibility of the collapse of the municipal-bond market, but he is not necessarily the kind you ask to predict, say, the rise in global demand for paper clips.
His defenders contend that Roubini is not unduly pessimistic. Jeffrey Sachs, his former adviser, told me that “if the underlying conditions call for optimism, Nouriel would be optimistic.” And to be sure, Roubini is capable of being optimistic — or at least of steering clear of absolute worst-case prognostications. He agrees, for example, with the conventional economic wisdom that oil will drop below $100 a barrel in the coming months as global demand weakens. “I’m not comfortable saying that we’re going to end up in the Great Depression,” he told me. “I’m a reasonable person.”
What economic developments does Roubini see on the horizon? And what does he think we should do about them? The first step, he told me in a recent conversation, is to acknowledge the extent of the problem. “We are in a recession, and denying it is nonsense,” he said. When Jim Nussle, the White House budget director, announced last month that the nation had “avoided a recession,” Roubini was incredulous. For months, he has been predicting that the United States will suffer through an 18-month recession that will eventually rank as the “worst since the Great Depression.” Though he is confident that the economy will enter a technical recovery toward the end of next year, he says that job losses, corporate bankruptcies and other drags on growth will continue to take a toll for years.
Roubini has counseled various policy makers, including Federal Reserve governors and senior Treasury Department officials, to mount an aggressive response to the crisis. He applauded when the Federal Reserve cut interest rates to 2 percent from 5.25 percent beginning last summer. He also supported the Fed’s willingness to engineer a takeover of Bear Stearns. Roubini argues that the Fed’s actions averted catastrophe, though he says he believes that future bailouts should focus on mortgage owners, not investors. Accordingly, he sees the choice facing the United States as stark but simple: either the government backs up a trillion-plus dollars’ worth of high-risk mortgages (in exchange for the lenders’ agreement to reduce monthly mortgage payments), or the banks and other institutions holding those mortgages — or the complex securities derived from them — go under. “You either nationalize the banks or you nationalize the mortgages,” he said. “Otherwise, they’re all toast.”
For months Roubini has been arguing that the true cost of the housing crisis will not be a mere $300 billion — the amount allowed for by the housing legislation sponsored by Representative Barney Frank and Senator Christopher Dodd — but something between a trillion and a trillion and a half dollars. But most important, in Roubini’s opinion, is to realize that the problem is deeper than the housing crisis. “Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”
Roubini argues that most of the losses from this bad debt have yet to be written off, and the toll from bad commercial real estate loans alone may help send hundreds of local banks into the arms of the Federal Deposit Insurance Corporation. “A good third of the regional banks won’t make it,” he predicted. In turn, these bailouts will add hundreds of billions of dollars to an already gargantuan federal debt, and someone, somewhere, is going to have to finance that debt, along with all the other debt accumulated by consumers and corporations. “Our biggest financiers are China, Russia and the gulf states,” Roubini noted. “These are rivals, not allies.”
The United States, Roubini went on, will likely muddle through the crisis but will emerge from it a different nation, with a different place in the world. “Once you run current-account deficits, you depend on the kindness of strangers,” he said, pausing to let out a resigned sigh. “This might be the beginning of the end of the American empire.”
Stephen Mihm, an assistant professor of economic history at the University of Georgia, is the author of “A Nation of Counterfeiters: Capitalists, Con Men and the Making of the United States.” His last feature article for the magazine was about North Korean counterfeiting.
NYT : Low Spending Is Taking Toll on Economy
Wednesday, April 30, 2008
Low Spending Is Taking Toll on Economy
By PETER S. GOODMAN | May 1, 2008
For months, beleaguered American consumers have defied expert forecasts that they would soon succumb to the pressures of falling home prices, fewer jobs and shrinking paychecks. Now, they appear to have given in.
On Wednesday, the Commerce Department reported that the economy continued to stagnate during the first three months of the year, with a sharp pullback in consumer spending the primary factor at play.
Pressures on households in which cash is tight appeared to weigh significantly in the calculations of the Federal Reserve as it rolled back interest rates Wednesday for the seventh time since September — this time by one-fourth of a percentage point — in a bid to prevent a further falloff in the economy.
The Fed made clear, though, that investors and borrowers should not expect another drop in interest rates anytime soon. In the statement accompanying their action, policy makers said they believed that with the short-term rate at 2 percent, they had already unleashed enough economic stimulus to “help promote moderate growth.”
With the overall economy growing at a mere 0.6 percent annual rate for the second quarter in a row, consumer spending advanced by only 1 percent, the government estimated. That was down sharply from the 2.9 percent gain for all of 2007 and the 3.1 percent gain for 2006. It was the weakest showing since 2001, the last time the economy was ensnared in a recession.
Even more ominously, Americans cut back on a wide variety of discretionary purchases, conserving their cash for necessary spending.
In the dip, economists saw evidence that the basic laws of arithmetic are now impinging on millions of households.
As real estate prices plunge, so does the ability of homeowners to borrow against the value of their homes, crimping a major artery of spending. As banks grow tighter with their dollars in a period of uncertainty, families are running up against credit limits, forcing many to live within their incomes. And as companies lay off employees and cut working hours, paychecks are effectively shrinking.
“This is not a fluke or a technical quirk,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “It’s fundamental. Real disposable income has been squeezed.”
Consumer spending fell for a broad range of goods and services, including cars, auto parts, furniture, food and recreation, reflecting a growing inclination toward thrift. Areas in which spending rose were predominantly those not considered optional purchases, including health care, housing and utilities.
The fact that the economy expanded at all, even by a tiny margin, sowed hopes that a recession might yet be averted. But most economists found in the details of the preliminary report signs of broadening economic distress at home even as businesses expanded production to meet growing demand from abroad.
A panel of economists at the National Bureau of Economic Research, a private research organization, ultimately decides whether a particular period of weakness qualifies as a recession, which it defines as a “significant decline in economic activity spread across the economy, lasting more than a few months.”
Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington, said, “The argument that we’re not in a recession certainly gets a little bit more of a boost from this report.”
But he and many other specialists still assume the economy will slide into negative territory. Moreover, the recession-or-not question is now almost entirely academic, Mr. Bernstein contended, given the steady erosion of American spending power and soaring costs for food and gasoline.
On Wednesday, the Labor Department reported that wages and benefits, adjusted for inflation, were down 0.6 percent in the January-March period, compared with a year earlier.
“A very significant slowdown in the economy has caused a lot of pain,” Mr. Bernstein said. “That’s a done deal.”
The Commerce Department reported that growth was hampered in the first three months of the year by a continued decline in home construction, which fell for the ninth straight quarter, and by a pullback in investments for business equipment and buildings.
The only factors preventing the economy from sliding backward were the growth of American exports — aided by a weakening dollar — and a swing in business inventories from shrinking to swelling. Putting exports and inventories aside, the final sales of goods and services produced domestically dipped at a 0.4 percent annual rate in inflation-adjusted terms, the first such decline since the end of 1991.
“You’re seeing a sharp slowdown in domestic demand,” said Michael T. Darda, chief economist at MKM Partners in Greenwich, Conn. “This is stall-speed growth.”
Economists suggested that larger stocks of unsold goods might portend trouble in the months ahead. If business does not swiftly improve, allowing factories to sell the products they have piled up, firms are likely to lay off workers at a more aggressive clip.
Even if business picks up and orders materialize, averting broader layoffs, factories will probably not need to produce as many new things in coming months, prompting some to trim working hours and purchases of materials.
“A big inventory contribution in one quarter means a payback in another quarter,” said Zach Pandl, United States economist at Lehman Brothers. “Firms are likely to pull back.”
The biggest questions ahead center on the duration and severity of the downturn. Attention now turns to the job market and the tax rebate checks being sent out to roughly 130 million American taxpayers to encourage spending.
On Friday, the Labor Department is to release its monthly snapshot of the jobs picture, which has become a primary factor gnawing at the economy. For four months in a row, the private sector has shed jobs, with 80,000 nonfarm jobs lost in March alone, according to the Labor Department.
If, as widely expected, the jobs report shows another monthly decline, markets are likely to absorb it as a sign of an economy that has effectively slipped into a recession despite the modestly reassuring positive figures from the Commerce Department.
Most economists agree that the tax rebate checks will finance a flurry of spending that should stimulate economic growth. But whether it will be a quick binge lasting only a few months, or whether spending will crystallize a sense of confidence, prompting companies to expand and hire, is a matter of much contention.
Even with the rebate checks, consumer spending should grow by only 1.7 percent this year and roughly the same next year, predicted Alan D. Levenson, chief economist at T. Rowe Price Associates in Baltimore. With spending that weak, the economy would probably continue to shed 75,000 to 80,000 jobs a month, even after stronger growth resumes, he said.
The government has offered the rebate checks to buy time while it waits for the Fed’s lowered interest rates to wash through the economy, nurturing fresh investment and hiring. But many economists are skeptical that such timing can be pulled off. Many forecasts show a dip in economic activity from April through June, then a bump up from the rebate checks before the economy slows again at the end of this year.
“It doesn’t get us across the chasm,” said Robert Barbera, chief economist at the research and trading firm ITG, speaking of the rebate checks. “It will make things look better than they are for a few months, but it doesn’t change the fundamentals. The underlying circumstances are unambiguously recessionary.”
By PETER S. GOODMAN | May 1, 2008
For months, beleaguered American consumers have defied expert forecasts that they would soon succumb to the pressures of falling home prices, fewer jobs and shrinking paychecks. Now, they appear to have given in.
On Wednesday, the Commerce Department reported that the economy continued to stagnate during the first three months of the year, with a sharp pullback in consumer spending the primary factor at play.
Pressures on households in which cash is tight appeared to weigh significantly in the calculations of the Federal Reserve as it rolled back interest rates Wednesday for the seventh time since September — this time by one-fourth of a percentage point — in a bid to prevent a further falloff in the economy.
The Fed made clear, though, that investors and borrowers should not expect another drop in interest rates anytime soon. In the statement accompanying their action, policy makers said they believed that with the short-term rate at 2 percent, they had already unleashed enough economic stimulus to “help promote moderate growth.”
With the overall economy growing at a mere 0.6 percent annual rate for the second quarter in a row, consumer spending advanced by only 1 percent, the government estimated. That was down sharply from the 2.9 percent gain for all of 2007 and the 3.1 percent gain for 2006. It was the weakest showing since 2001, the last time the economy was ensnared in a recession.
Even more ominously, Americans cut back on a wide variety of discretionary purchases, conserving their cash for necessary spending.
In the dip, economists saw evidence that the basic laws of arithmetic are now impinging on millions of households.
As real estate prices plunge, so does the ability of homeowners to borrow against the value of their homes, crimping a major artery of spending. As banks grow tighter with their dollars in a period of uncertainty, families are running up against credit limits, forcing many to live within their incomes. And as companies lay off employees and cut working hours, paychecks are effectively shrinking.
“This is not a fluke or a technical quirk,” said John E. Silvia, chief economist at Wachovia in Charlotte, N.C. “It’s fundamental. Real disposable income has been squeezed.”
Consumer spending fell for a broad range of goods and services, including cars, auto parts, furniture, food and recreation, reflecting a growing inclination toward thrift. Areas in which spending rose were predominantly those not considered optional purchases, including health care, housing and utilities.
The fact that the economy expanded at all, even by a tiny margin, sowed hopes that a recession might yet be averted. But most economists found in the details of the preliminary report signs of broadening economic distress at home even as businesses expanded production to meet growing demand from abroad.
A panel of economists at the National Bureau of Economic Research, a private research organization, ultimately decides whether a particular period of weakness qualifies as a recession, which it defines as a “significant decline in economic activity spread across the economy, lasting more than a few months.”
Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington, said, “The argument that we’re not in a recession certainly gets a little bit more of a boost from this report.”
But he and many other specialists still assume the economy will slide into negative territory. Moreover, the recession-or-not question is now almost entirely academic, Mr. Bernstein contended, given the steady erosion of American spending power and soaring costs for food and gasoline.
On Wednesday, the Labor Department reported that wages and benefits, adjusted for inflation, were down 0.6 percent in the January-March period, compared with a year earlier.
“A very significant slowdown in the economy has caused a lot of pain,” Mr. Bernstein said. “That’s a done deal.”
The Commerce Department reported that growth was hampered in the first three months of the year by a continued decline in home construction, which fell for the ninth straight quarter, and by a pullback in investments for business equipment and buildings.
The only factors preventing the economy from sliding backward were the growth of American exports — aided by a weakening dollar — and a swing in business inventories from shrinking to swelling. Putting exports and inventories aside, the final sales of goods and services produced domestically dipped at a 0.4 percent annual rate in inflation-adjusted terms, the first such decline since the end of 1991.
“You’re seeing a sharp slowdown in domestic demand,” said Michael T. Darda, chief economist at MKM Partners in Greenwich, Conn. “This is stall-speed growth.”
Economists suggested that larger stocks of unsold goods might portend trouble in the months ahead. If business does not swiftly improve, allowing factories to sell the products they have piled up, firms are likely to lay off workers at a more aggressive clip.
Even if business picks up and orders materialize, averting broader layoffs, factories will probably not need to produce as many new things in coming months, prompting some to trim working hours and purchases of materials.
“A big inventory contribution in one quarter means a payback in another quarter,” said Zach Pandl, United States economist at Lehman Brothers. “Firms are likely to pull back.”
The biggest questions ahead center on the duration and severity of the downturn. Attention now turns to the job market and the tax rebate checks being sent out to roughly 130 million American taxpayers to encourage spending.
On Friday, the Labor Department is to release its monthly snapshot of the jobs picture, which has become a primary factor gnawing at the economy. For four months in a row, the private sector has shed jobs, with 80,000 nonfarm jobs lost in March alone, according to the Labor Department.
If, as widely expected, the jobs report shows another monthly decline, markets are likely to absorb it as a sign of an economy that has effectively slipped into a recession despite the modestly reassuring positive figures from the Commerce Department.
Most economists agree that the tax rebate checks will finance a flurry of spending that should stimulate economic growth. But whether it will be a quick binge lasting only a few months, or whether spending will crystallize a sense of confidence, prompting companies to expand and hire, is a matter of much contention.
Even with the rebate checks, consumer spending should grow by only 1.7 percent this year and roughly the same next year, predicted Alan D. Levenson, chief economist at T. Rowe Price Associates in Baltimore. With spending that weak, the economy would probably continue to shed 75,000 to 80,000 jobs a month, even after stronger growth resumes, he said.
The government has offered the rebate checks to buy time while it waits for the Fed’s lowered interest rates to wash through the economy, nurturing fresh investment and hiring. But many economists are skeptical that such timing can be pulled off. Many forecasts show a dip in economic activity from April through June, then a bump up from the rebate checks before the economy slows again at the end of this year.
“It doesn’t get us across the chasm,” said Robert Barbera, chief economist at the research and trading firm ITG, speaking of the rebate checks. “It will make things look better than they are for a few months, but it doesn’t change the fundamentals. The underlying circumstances are unambiguously recessionary.”
NYT : Mortgage Crisis Spreads Past Subprime Loans
Tuesday, February 12, 2008
Mortgage Crisis Spreads Past Subprime Loans
By VIKAS BAJAJ and LOUISE STORY | February 12, 2008
The credit crisis is no longer just a subprime mortgage problem.
As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.
The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.
Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.
“This collapse in housing value is sucking in all borrowers,” said Mark Zandi, chief economist at Moody’s Economy.com.
Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later. As long as home prices were rising, these borrowers could refinance their loans or sell their properties to pay off their mortgages. But now, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit.
“Subprime was a symptom of the problem,” said James F. Keegan, a bond portfolio manager at American Century Investments, a mutual fund company. “The problem was we had a debt or credit bubble.”
The bursting of that bubble has led to steep losses across the financial industry. American International Group said on Monday that auditors found it may have understated losses on complex financial instruments linked to mortgages and corporate loans.
The running turmoil is also stirring fears that some hedge funds may run into trouble. At the end of September, nearly 4 percent of prime mortgages were past due or in foreclosure, according to the Mortgage Bankers Association.
That was the highest rate since the group started tracking prime and subprime mortgages separately in 1998. The delinquency and foreclosure rate for all mortgages, 7.3 percent, is higher than at any time since the group started tracking that data in 1979, largely as a result of the surge in subprime lending during the last few years.
An example of the spreading credit crisis is seen in Don Doyle, a computer engineer at Lockheed Martin who makes a six-figure income and had a stellar credit score in 2004, when he refinanced his home in Northern California to take cash out to pay for his daughter’s college tuition.
Mr. Doyle, 52, is now worried that he will have to file for bankruptcy, because he cannot afford to make the higher variable payments on his mortgage, and he cannot sell his home for more than his $740,000 mortgage.
“The whole plan was to get out” before his rate reset, he said. “Now I am caught. I can’t sell my house. I’m having a hard time refinancing. I’ve avoided bankruptcy for months trying to pull this out of my savings.”
The default rate for prime mortgages is still far lower than for subprime loans, about 24 percent of which are delinquent or in foreclosure. Some economists note that slightly more than a third of American homeowners have paid off their mortgages completely. This group is generally more affluent and contributes more to consumer spending and the economy relative to its size.
Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have greater means to restructure their debt if they lose jobs or encounter other financial challenges. The recent reductions in short term interest rates by the Federal Reserve should also help by reducing the reset rate for adjustable loans.
Still, economists say the rate cuts and the $168 billion fiscal stimulus package are unlikely to make a significant dent in the large debts weighing on many Americans, because banks have tightened lending standards and expected rebates from the government will not cover most house payments.
The problems are most acute in areas that experienced a big boom in housing — California, the Southwest, Florida and other coastal markets — and in the Midwest, which is suffering from job losses in the manufacturing sector.
And it is not just first-mortgage default rates that are rising. About 5.7 percent of home equity lines of credit were delinquent or in default at the end of last year, up from 4.5 percent a year earlier, according to Moody’s Economy.com and Equifax, the credit bureau.
About 7.1 percent of auto loans were in trouble, up from 6.1 percent. Personal bankruptcy filings, which fell significantly after a 2005 federal law made it harder to wipe out debts in bankruptcy, are starting to inch up.
On Monday, Fitch Ratings, the debt rating firm, reported that credit card companies wrote off 5.4 percent of their prime card balances in January, up from 4.3 percent a year ago. The so-called charge-off rate is still lower than before the 2005 law went into effect.
Banks are responding to the rise in delinquencies by capping home equity lines of credit in areas with falling real estate prices. A few credit card companies have also moved to reduce the credit limits of customers they deem more risky.
Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo are expected to announce on Tuesday at the Treasury Department that they will offer both prime and subprime borrowers who are more than three months behind a chance to halt foreclosure proceedings for 30 days and work out new loan terms.
In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appear to be giving up on their homes as prices fall, noting a “change in social attitudes toward default.”
“You don’t mind making a $2,000 payment when the house is going up” in value, said Steve Walsh, a mortgage broker in Scottsdale, Arizona, who has seen several clients walk away from their homes because they couldn’t refinance or sell. “When it’s going down, it becomes a weight around your neck, it becomes an anchor.”
Home prices in the North Las Vegas neighborhood of Brenda Harris, a technology analyst at a casino company, have fallen 20 percent to 30 percent. The builder who sold her a new three-bedroom home on Pink Flamingos Place for about $392,000 in 2006 is now listing similar properties for $314,000. A larger house a block down from Ms. Harris was recently listed online for $310,000.
But Ms. Harris does not want to leave her home. She estimates that she has spent close to $40,000 on her property, about half for a down payment and much of the rest on a deck and landscaping.
“I’m not behind in my payments, but I’m trying to prevent getting behind,” Ms. Harris said. “I don’t want to ruin my credit.”
In addition to the declining value of her home, Ms. Harris, 53, will soon be hit with a sharply higher house payment. She has an option adjustable-rate mortgage, a loan that allows borrowers to pay less than the interest and principal due every month. The unpaid interest gets added to the principal balance. She is making the minimum monthly payments due on her loan, about $2,400.
But she knows she will not be able to pay the $3,400 needed to cover her interest and principal, which she will be required to pay once her loan balance reaches 115 percent of her starting balance. And under the terms of her loan, which was made by Countrywide Financial, she would have to pay a prepayment penalty of about $40,000 if she chose to refinance or sell her home before May 2009.
She said that she now wishes she had taken a traditional fixed-rate loan when she bought the home. At the time, she asked for a loan that could be refinanced after one year without penalty. She said her broker had told her a week before the closing that the penalty would extend until May 2009 and that she reluctantly agreed because she had already started moving.
A nonprofit community group, Acorn Housing, is trying to broker a modification of Ms. Harris’s loan. In a statement Friday, Countrywide said the company had been in touch with Ms. Harris and would work with her.
Credit counselors say many borrowers like Ms. Harris were cajoled or pushed into risky mortgages that they never had the ability to repay.
Others disregarded warnings about complex loans because they wanted to be a part of the housing boom, which like the technology stock bubble lured people in with seemingly instant and risk-free profits, said Mory Brenner, vice president of Financial Firebird Corporation, a company based in Pittsfield, Mass., that publishes consumer debt information and refers borrowers to credit counselors.
“I’d say, Let me tell you something, this is crazy,” Mr. Brenner said. “You cannot afford this house, even if nothing happens and rates stay as low as they are today. And the response would be: I don’t care.”
Lenders extended credit to people without verifying their incomes and allowing them to make little or no down payments.
But borrowers like Mr. Doyle, the engineer in Northern California, say they are victims of their circumstances — housing prices collapsed and lending standards tightened just as they needed to sell or refinance.
In refinancing their home in 2004, Mr. Doyle and his wife were doing what millions of other homeowners did in the last decade — tapping into the rising value of their homes for home improvements, paying off credit card debt, college tuition and for other spending.
The Doyles took advantage of the housing boom by refinancing their home nearly every year since they bought it in 1995 for $275,000. Until their most recent loan they never had a problem making their payments. They invested much of the money in shares of companies that subsequently went bankrupt.
Still, Mr. Doyle does not regret refinancing in 2004. “My goal was clear: I wanted to help my daughter go through college,” he said. “It wasn’t like it was for us.”
By VIKAS BAJAJ and LOUISE STORY | February 12, 2008
The credit crisis is no longer just a subprime mortgage problem.
As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.
The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.
Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.
“This collapse in housing value is sucking in all borrowers,” said Mark Zandi, chief economist at Moody’s Economy.com.
Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later. As long as home prices were rising, these borrowers could refinance their loans or sell their properties to pay off their mortgages. But now, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit.
“Subprime was a symptom of the problem,” said James F. Keegan, a bond portfolio manager at American Century Investments, a mutual fund company. “The problem was we had a debt or credit bubble.”
The bursting of that bubble has led to steep losses across the financial industry. American International Group said on Monday that auditors found it may have understated losses on complex financial instruments linked to mortgages and corporate loans.
The running turmoil is also stirring fears that some hedge funds may run into trouble. At the end of September, nearly 4 percent of prime mortgages were past due or in foreclosure, according to the Mortgage Bankers Association.
That was the highest rate since the group started tracking prime and subprime mortgages separately in 1998. The delinquency and foreclosure rate for all mortgages, 7.3 percent, is higher than at any time since the group started tracking that data in 1979, largely as a result of the surge in subprime lending during the last few years.
An example of the spreading credit crisis is seen in Don Doyle, a computer engineer at Lockheed Martin who makes a six-figure income and had a stellar credit score in 2004, when he refinanced his home in Northern California to take cash out to pay for his daughter’s college tuition.
Mr. Doyle, 52, is now worried that he will have to file for bankruptcy, because he cannot afford to make the higher variable payments on his mortgage, and he cannot sell his home for more than his $740,000 mortgage.
“The whole plan was to get out” before his rate reset, he said. “Now I am caught. I can’t sell my house. I’m having a hard time refinancing. I’ve avoided bankruptcy for months trying to pull this out of my savings.”
The default rate for prime mortgages is still far lower than for subprime loans, about 24 percent of which are delinquent or in foreclosure. Some economists note that slightly more than a third of American homeowners have paid off their mortgages completely. This group is generally more affluent and contributes more to consumer spending and the economy relative to its size.
Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have greater means to restructure their debt if they lose jobs or encounter other financial challenges. The recent reductions in short term interest rates by the Federal Reserve should also help by reducing the reset rate for adjustable loans.
Still, economists say the rate cuts and the $168 billion fiscal stimulus package are unlikely to make a significant dent in the large debts weighing on many Americans, because banks have tightened lending standards and expected rebates from the government will not cover most house payments.
The problems are most acute in areas that experienced a big boom in housing — California, the Southwest, Florida and other coastal markets — and in the Midwest, which is suffering from job losses in the manufacturing sector.
And it is not just first-mortgage default rates that are rising. About 5.7 percent of home equity lines of credit were delinquent or in default at the end of last year, up from 4.5 percent a year earlier, according to Moody’s Economy.com and Equifax, the credit bureau.
About 7.1 percent of auto loans were in trouble, up from 6.1 percent. Personal bankruptcy filings, which fell significantly after a 2005 federal law made it harder to wipe out debts in bankruptcy, are starting to inch up.
On Monday, Fitch Ratings, the debt rating firm, reported that credit card companies wrote off 5.4 percent of their prime card balances in January, up from 4.3 percent a year ago. The so-called charge-off rate is still lower than before the 2005 law went into effect.
Banks are responding to the rise in delinquencies by capping home equity lines of credit in areas with falling real estate prices. A few credit card companies have also moved to reduce the credit limits of customers they deem more risky.
Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo are expected to announce on Tuesday at the Treasury Department that they will offer both prime and subprime borrowers who are more than three months behind a chance to halt foreclosure proceedings for 30 days and work out new loan terms.
In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appear to be giving up on their homes as prices fall, noting a “change in social attitudes toward default.”
“You don’t mind making a $2,000 payment when the house is going up” in value, said Steve Walsh, a mortgage broker in Scottsdale, Arizona, who has seen several clients walk away from their homes because they couldn’t refinance or sell. “When it’s going down, it becomes a weight around your neck, it becomes an anchor.”
Home prices in the North Las Vegas neighborhood of Brenda Harris, a technology analyst at a casino company, have fallen 20 percent to 30 percent. The builder who sold her a new three-bedroom home on Pink Flamingos Place for about $392,000 in 2006 is now listing similar properties for $314,000. A larger house a block down from Ms. Harris was recently listed online for $310,000.
But Ms. Harris does not want to leave her home. She estimates that she has spent close to $40,000 on her property, about half for a down payment and much of the rest on a deck and landscaping.
“I’m not behind in my payments, but I’m trying to prevent getting behind,” Ms. Harris said. “I don’t want to ruin my credit.”
In addition to the declining value of her home, Ms. Harris, 53, will soon be hit with a sharply higher house payment. She has an option adjustable-rate mortgage, a loan that allows borrowers to pay less than the interest and principal due every month. The unpaid interest gets added to the principal balance. She is making the minimum monthly payments due on her loan, about $2,400.
But she knows she will not be able to pay the $3,400 needed to cover her interest and principal, which she will be required to pay once her loan balance reaches 115 percent of her starting balance. And under the terms of her loan, which was made by Countrywide Financial, she would have to pay a prepayment penalty of about $40,000 if she chose to refinance or sell her home before May 2009.
She said that she now wishes she had taken a traditional fixed-rate loan when she bought the home. At the time, she asked for a loan that could be refinanced after one year without penalty. She said her broker had told her a week before the closing that the penalty would extend until May 2009 and that she reluctantly agreed because she had already started moving.
A nonprofit community group, Acorn Housing, is trying to broker a modification of Ms. Harris’s loan. In a statement Friday, Countrywide said the company had been in touch with Ms. Harris and would work with her.
Credit counselors say many borrowers like Ms. Harris were cajoled or pushed into risky mortgages that they never had the ability to repay.
Others disregarded warnings about complex loans because they wanted to be a part of the housing boom, which like the technology stock bubble lured people in with seemingly instant and risk-free profits, said Mory Brenner, vice president of Financial Firebird Corporation, a company based in Pittsfield, Mass., that publishes consumer debt information and refers borrowers to credit counselors.
“I’d say, Let me tell you something, this is crazy,” Mr. Brenner said. “You cannot afford this house, even if nothing happens and rates stay as low as they are today. And the response would be: I don’t care.”
Lenders extended credit to people without verifying their incomes and allowing them to make little or no down payments.
But borrowers like Mr. Doyle, the engineer in Northern California, say they are victims of their circumstances — housing prices collapsed and lending standards tightened just as they needed to sell or refinance.
In refinancing their home in 2004, Mr. Doyle and his wife were doing what millions of other homeowners did in the last decade — tapping into the rising value of their homes for home improvements, paying off credit card debt, college tuition and for other spending.
The Doyles took advantage of the housing boom by refinancing their home nearly every year since they bought it in 1995 for $275,000. Until their most recent loan they never had a problem making their payments. They invested much of the money in shares of companies that subsequently went bankrupt.
Still, Mr. Doyle does not regret refinancing in 2004. “My goal was clear: I wanted to help my daughter go through college,” he said. “It wasn’t like it was for us.”
NYT : Fed Cuts Key Interest Rate by a Half Point
Tuesday, September 18, 2007
Fed Cuts Key Interest Rate by a Half Point
By EDMUND L. ANDREWS and JEREMY W. PETERS | September 18, 2007
WASHINGTON, Sept. 18 — The Federal Reserve today lowered its benchmark interest rate by a half point, a forceful policy shift intended to limit the damage to the economy from the recent disorder in the housing and credit markets.
While an interest rate cut was widely expected, it had been uncertain whether the Fed would opt for a half-point or a quarter-point reduction. The decision, which reset the overnight lending rate to 4.75 percent, was unanimous.
In a statement announcing its decision, the Fed left open the possibility of another cut in the weeks ahead if the economic outlook deteriorates further. It said it will “will act as needed to foster price stability and sustainable economic growth.”
The statement’s emphasis on the uncertain outlook indicates that the Fed now believes a slowdown in growth — not high inflation — is the biggest risk to the economy.
Many on Wall Street had been clamoring for weeks for a half-point cut, and the Fed’s announcement today buoyed investors.
Stocks immediately soared. The Dow Jones industrial average had been up about 75 points shortly before the announcement at 2:15 p.m., and within seconds it jumped another 100 points. At 2:45 p.m., it was showing a gain of 250 points on the day, or almost 2 percent.
For consumers, the Fed’s move could mean lower borrowing costs on major loans like mortgages, home equity credit lines and auto loans.
In a separate move to bolster the banking system, the Fed also said today that it cut its discount lending rate, which applies to short-term emergency loans to banks, to 5.25 percent — also a half-point cut.
This was the Federal Reserve’s first rate cut in four years, and its most abrupt reversal of course since January 2001, when it suddenly slashed rates at an unscheduled emergency meeting because of signs that the economy was slipping into a recession.
As recently as six weeks ago, the central bank was still predicting “modest” growth for the economy and warning that inflation remained its “predominant concern.” As in 2001, the Fed’s move today came after a panic in financial markets and the collapse of a speculative bubble. This time, the panic is in credit markets spooked by dubious mortgages on inflated housing prices. Back then, it was the stock market that crashed, initially because the air went out of inflated dot-com stocks.
In the jargon of economists, the turmoil in both cases represented a sudden “repricing” of risk. Other signs have surfaced recently that the financial market upheaval may not be isolated. Earlier this month, the Labor Department reported the first monthly loss of jobs in four years. Employers eliminated 4,000 positions in August, a factor that may have played a role in the Fed’s decision today.
By today, it seemed clear that Fed policy makers were no longer debating whether to reduce rates but how much to lower them. Despite the seemingly narrow debate — whether to lower the overnight federal funds rate by one-quarter of a percent or by one-half of a percent — the uncertainty about this policy meeting was higher than any other in the past four years.
The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.
Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.
But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.
Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.
The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.
Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.
But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.
Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.
The Labor Department also reported today that producer prices fell by 1.4 percent in August — much more than expected — because of slumping energy prices. That was positive news on inflation, but analysts said it was unlikely to have much influence on the Fed because the "core” measure excluding energy and food prices increased 0.2 percent, slightly more than expected.
Except for the housing downturn, which Fed officials admit is much more severe than they had expected, the evidence of a recession in the real economy is ambiguous. Global economic growth is much stronger than in 2001, and American exports have climbed about 14 percent over the last year.
Instead of the United States’ being the world’s engine of growth, the global economy could now become the engine of American growth.
For the last four years, the Federal Reserve has telegraphed its intentions months in advance as it pursued a gradualist approach of slow but steady adjustments in monetary policy. It advertised its intention to raise rates gradually many months before it actually did so in June 2004, and then raised rates in well-signaled increments at each policy meeting over the next two years.
By contrast, Wall Street analysts were sharply divided as of early today about how much the Fed would cut rates and what it would say in its statement about the economic outlook.
A smaller rate reduction posed a risk of moving too slowly if the economy was indeed in danger of stalling. But a bigger rate reduction could have been taken as a sign of Fed panic, and it added to the risk of stoking inflationary pressures that the central bank had just begun to tamp down.
But the evidence so far is inconclusive. In August, for the first time in four years, the Labor Department estimated that the number of jobs declined slightly. It also reduced its estimates of job growth in June and July, suggesting that the labor market weakened even before credit markets froze up in early August.
But other indicators — on consumer spending, consumer confidence and export growth — point to a continuation of modest growth.
Right or wrong, today’s decision will be a defining moment for Mr. Bernanke, the former economics scholar at Princeton who became Fed chairman in February 2006.
Many Wall Street economists place the odds of a recession at about one in three or somewhat higher. Alan Greenspan, who preceded Mr. Bernanke as Fed chairman, puts the odds at somewhat more than the one-in-three that he estimated earlier this year.
The Fed’s course change has been under way since early August, when fears about huge losses on subprime mortgage loans and continued downturn in housing caused a much broader panic in credit markets.
The resulting credit crunch has now affected all but the safest home mortgages, and also greatly reduced the ability of private equity funds and hedge funds to borrow money at low rates. Many banks, which had been planning to resell their loans into the giant market for tradable commercial debt securities, are now being forced to absorb loans that the securities markets will no longer take.
On Aug. 17, the Federal Reserve moved to ease the liquidity crisis by encouraging banks to borrow money through its “discount window,” a program originally created as an emergency source of overnight funds for banks in a cash squeeze.
But by most accounts, the turmoil in credit markets has abated very little. The market for subprime mortgages has all but disappeared, and demand for all forms of “asset-backed commercial paper,” which are securities backed by mortgages, credit card debt, company receivables, remains very weak.
Vikas Bajaj contributed reporting from New York.
By EDMUND L. ANDREWS and JEREMY W. PETERS | September 18, 2007
WASHINGTON, Sept. 18 — The Federal Reserve today lowered its benchmark interest rate by a half point, a forceful policy shift intended to limit the damage to the economy from the recent disorder in the housing and credit markets.
While an interest rate cut was widely expected, it had been uncertain whether the Fed would opt for a half-point or a quarter-point reduction. The decision, which reset the overnight lending rate to 4.75 percent, was unanimous.
In a statement announcing its decision, the Fed left open the possibility of another cut in the weeks ahead if the economic outlook deteriorates further. It said it will “will act as needed to foster price stability and sustainable economic growth.”
The statement’s emphasis on the uncertain outlook indicates that the Fed now believes a slowdown in growth — not high inflation — is the biggest risk to the economy.
Many on Wall Street had been clamoring for weeks for a half-point cut, and the Fed’s announcement today buoyed investors.
Stocks immediately soared. The Dow Jones industrial average had been up about 75 points shortly before the announcement at 2:15 p.m., and within seconds it jumped another 100 points. At 2:45 p.m., it was showing a gain of 250 points on the day, or almost 2 percent.
For consumers, the Fed’s move could mean lower borrowing costs on major loans like mortgages, home equity credit lines and auto loans.
In a separate move to bolster the banking system, the Fed also said today that it cut its discount lending rate, which applies to short-term emergency loans to banks, to 5.25 percent — also a half-point cut.
This was the Federal Reserve’s first rate cut in four years, and its most abrupt reversal of course since January 2001, when it suddenly slashed rates at an unscheduled emergency meeting because of signs that the economy was slipping into a recession.
As recently as six weeks ago, the central bank was still predicting “modest” growth for the economy and warning that inflation remained its “predominant concern.” As in 2001, the Fed’s move today came after a panic in financial markets and the collapse of a speculative bubble. This time, the panic is in credit markets spooked by dubious mortgages on inflated housing prices. Back then, it was the stock market that crashed, initially because the air went out of inflated dot-com stocks.
In the jargon of economists, the turmoil in both cases represented a sudden “repricing” of risk. Other signs have surfaced recently that the financial market upheaval may not be isolated. Earlier this month, the Labor Department reported the first monthly loss of jobs in four years. Employers eliminated 4,000 positions in August, a factor that may have played a role in the Fed’s decision today.
By today, it seemed clear that Fed policy makers were no longer debating whether to reduce rates but how much to lower them. Despite the seemingly narrow debate — whether to lower the overnight federal funds rate by one-quarter of a percent or by one-half of a percent — the uncertainty about this policy meeting was higher than any other in the past four years.
The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.
Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.
But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.
Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.
The debate within the Fed was all about risk probabilities: what were the odds the twin meltdowns in housing and mortgage markets would tip the overall economy into a recession later this year? If policy makers cut rates too cautiously, they risked a recession; if they cut them too much or too early, they risked stoking inflation.
Ben S. Bernanke, chairman of the Federal Reserve, had made it clear over the past month that the Fed did not simply want to rescue Wall Street investors who made bad bets or real estate speculators who bought properties on the assumption that prices would keep skyrocketing.
But Mr. Bernanke also pledged that the Fed would act if the dislocation in financial markets or the downturn in housing threatened to derail overall growth.
Just a few hours before the central bank announced its decision, new statistics indicated that the pace of home foreclosures is accelerating. RealtyTrac of Irvine, Calif., reported that foreclosure filings — from default notices and auction sales to bank repossessions — were 36 percent higher in August than in July and 115 percent higher than one year ago.
The Labor Department also reported today that producer prices fell by 1.4 percent in August — much more than expected — because of slumping energy prices. That was positive news on inflation, but analysts said it was unlikely to have much influence on the Fed because the "core” measure excluding energy and food prices increased 0.2 percent, slightly more than expected.
Except for the housing downturn, which Fed officials admit is much more severe than they had expected, the evidence of a recession in the real economy is ambiguous. Global economic growth is much stronger than in 2001, and American exports have climbed about 14 percent over the last year.
Instead of the United States’ being the world’s engine of growth, the global economy could now become the engine of American growth.
For the last four years, the Federal Reserve has telegraphed its intentions months in advance as it pursued a gradualist approach of slow but steady adjustments in monetary policy. It advertised its intention to raise rates gradually many months before it actually did so in June 2004, and then raised rates in well-signaled increments at each policy meeting over the next two years.
By contrast, Wall Street analysts were sharply divided as of early today about how much the Fed would cut rates and what it would say in its statement about the economic outlook.
A smaller rate reduction posed a risk of moving too slowly if the economy was indeed in danger of stalling. But a bigger rate reduction could have been taken as a sign of Fed panic, and it added to the risk of stoking inflationary pressures that the central bank had just begun to tamp down.
But the evidence so far is inconclusive. In August, for the first time in four years, the Labor Department estimated that the number of jobs declined slightly. It also reduced its estimates of job growth in June and July, suggesting that the labor market weakened even before credit markets froze up in early August.
But other indicators — on consumer spending, consumer confidence and export growth — point to a continuation of modest growth.
Right or wrong, today’s decision will be a defining moment for Mr. Bernanke, the former economics scholar at Princeton who became Fed chairman in February 2006.
Many Wall Street economists place the odds of a recession at about one in three or somewhat higher. Alan Greenspan, who preceded Mr. Bernanke as Fed chairman, puts the odds at somewhat more than the one-in-three that he estimated earlier this year.
The Fed’s course change has been under way since early August, when fears about huge losses on subprime mortgage loans and continued downturn in housing caused a much broader panic in credit markets.
The resulting credit crunch has now affected all but the safest home mortgages, and also greatly reduced the ability of private equity funds and hedge funds to borrow money at low rates. Many banks, which had been planning to resell their loans into the giant market for tradable commercial debt securities, are now being forced to absorb loans that the securities markets will no longer take.
On Aug. 17, the Federal Reserve moved to ease the liquidity crisis by encouraging banks to borrow money through its “discount window,” a program originally created as an emergency source of overnight funds for banks in a cash squeeze.
But by most accounts, the turmoil in credit markets has abated very little. The market for subprime mortgages has all but disappeared, and demand for all forms of “asset-backed commercial paper,” which are securities backed by mortgages, credit card debt, company receivables, remains very weak.
Vikas Bajaj contributed reporting from New York.
IHT : Warning signs and defining economic moments
Friday, September 14, 2007
Warning signs and defining economic moments
By Vikas Bajaj and Jeremy W. Peters | September 14, 2007
When Annie Cox is unsure if the economy is headed south — a question on the minds of many on Wall Street and Main Street these days — she keeps an eye on the orders for beverages at the diner she runs in Oklahoma City.
In recent weeks, Cox said she had seen a slight drop-off, leading her to believe that business could slow in coming months. "When they start ordering water instead of tea or Pepsi, that means they're cutting back," said Cox, who runs the 1950s-style restaurant, Sherri's Diner, that is named after her mother.
Leon Tuberman, the chief executive of the Barn Furniture Mart in Southern California, is similarly wary. Despite widespread troubles in the housing market, business is down only about 5 percent. But Tuberman said he was not replacing the five employees who left the store voluntarily in the last six months, because he suspected that spending would remain sluggish.
Across the nation, the impact of the turmoil in the housing and credit markets on the broader economy has been relatively modest so far. But just as some of Cox's customers are becoming more cautious and Tuberman is holding back on hiring, many people are preparing to hit some economic headwinds.
Whether that caution on the part of consumers and business translates into little more than a modest economic slowdown or turns into a full-blown recession will depend on a variety of factors. But perhaps the most important are whether jobs remain plentiful and consumers keep spending.
That is what was so ominous about the government's report last week that businesses reduced total employment by 4,000 jobs in August and that payroll gains for previous months were being lowered. Another important labor market indicator — the share of the working-age population that reports holding a job — has fallen to its lowest level in nearly two years. And consumer spending, while it continues to grow, has slowed in recent months.
"Large numbers of people are leaving the job market," said Jan Hatzius, chief United States economist at Goldman Sachs. "That is not just a sudden bout of laziness, but it's a response to reduced labor market activity."
Hatzius and his peers on Wall Street now put the risk of a recession at about one in three, which is significantly higher than earlier this year but far from a sure thing.
They note that in recent years consumer spending was led higher by the torrid boom in housing, especially in big states like California, Florida, Arizona and New York. Now, as home prices fall, loans are harder to get and home equity borrowing is tapering off. As a result, consumer spending is likely to suffer.
Those downward pressures, though, are being offset by a robust global economy that is providing a significant lift to exports, corporate profits and real wages, which finally picked up in the last year after stagnating for much of the decade. Optimists note that consumer spending is unlikely to slow as long as hourly wages are perking along at a nominal annual pace of about 4 percent, about 1.5 percentage points above the inflation rate.
"There clearly is a problem in mortgages," said David Kelley, an economist at Putnam Investments, the mutual fund company in Boston. But "outside the mortgage market, we don't really see the consumer stopping spending."
Consumer spending has often defied dour predictions. There was no decline in spending during the recession of 2001, even as job losses mounted and business sentiment sank after the technology bubble burst. That is one reason the downturn was so mild compared with the harsher recessions of the early 1980s and early 1990s.
Economists also note that spending by higher-income consumers has a far more significant impact on the economy than purchases by those who are less well- off, a group that appears to be most vulnerable to declining home prices, resetting mortgages and job loss.
"There are essentially two consumer economies right now, and they parallel the split between the very rich and everybody else," said J. Walker Smith, president of Yankelovich, the consumer research firm based in Norwalk, Connecticut "There is one part of the consumer economy that is unlikely to be affected at all by the recent events in the financial markets. Those are the people making the loans. The people taking the loans, however, are the people who are affected."
Tuberman sees that bifurcation in his furniture business.
Even as a number of competitors and distributors have gone out of business, Barn Furniture's sales have held up, he says, because it receives most of its orders from repeat and longtime customers, who are drawn to his traditional wood products.
But new customers are hard to find.
"When someone refinances a home and they have extra money, they buy new furniture; when somebody buys a new home, they buy new furniture," said Tuberman, whose family has run the store since the 1940's. "When their adjustable-rate mortgage just increased by 40 percent, they don't buy furniture."
The downturn in housing is visible far and wide. Tex Pitfield, who owns a petroleum distributing business outside Atlanta, says he is not renewing the leases on 4 of his 20 trucks because business has slackened, especially in areas directly connected to residential real estate.
"We are not running any fuel to the construction companies for new home sites, the guys that put in the sewer lines and the utilities," he said. "Big block stores are down in consumption and retail consumption is down."
Some of that may be related to rising energy prices — oil prices this week topped $80 a barrel and the average price of gasoline nationally is $2.81 a gallon, up about 20 cents from a year ago, according to the Energy Information Administration.
In much of the country, Americans cannot change their driving habits easily or in the short term. But consumer behavior experts say gas prices could force people who may already be stretched thin by debts to cut back. Families facing a higher house payment or the loss of a job will probably go out less, buy fewer clothes or spend less on entertainment.
"From one week to the next, to fill up your car could cost $30 or $50 — and for a lot of families, that's either the cable bill or a night out to eat," said Phil Rist, executive vice president of BIGresearch, a consumer research firm in Worthington, Ohio. "The fact that they don't know where gas prices are one week to the next, that creates trepidations."
Smith of Yankelovich echoed the sentiments of Cox in Oklahoma City in highlighting how consumers may change their spending: "Some of our restaurant clients joke that they know when the economy is starting to head down by dessert sales," he said.
Consumers always start by eliminating the purchases they see as unnecessary. "They begin to eat out differently. They eat out less. Often they trade down to lower-priced restaurants. And they quit buying all the extras like dessert."
For her part, Cox is confident that her business will survive even if customers stop buying dessert. After all, she's seen worse.
"We made it through the last two recessions just fine," she said. "You just have to be resourceful."
By Vikas Bajaj and Jeremy W. Peters | September 14, 2007
When Annie Cox is unsure if the economy is headed south — a question on the minds of many on Wall Street and Main Street these days — she keeps an eye on the orders for beverages at the diner she runs in Oklahoma City.
In recent weeks, Cox said she had seen a slight drop-off, leading her to believe that business could slow in coming months. "When they start ordering water instead of tea or Pepsi, that means they're cutting back," said Cox, who runs the 1950s-style restaurant, Sherri's Diner, that is named after her mother.
Leon Tuberman, the chief executive of the Barn Furniture Mart in Southern California, is similarly wary. Despite widespread troubles in the housing market, business is down only about 5 percent. But Tuberman said he was not replacing the five employees who left the store voluntarily in the last six months, because he suspected that spending would remain sluggish.
Across the nation, the impact of the turmoil in the housing and credit markets on the broader economy has been relatively modest so far. But just as some of Cox's customers are becoming more cautious and Tuberman is holding back on hiring, many people are preparing to hit some economic headwinds.
Whether that caution on the part of consumers and business translates into little more than a modest economic slowdown or turns into a full-blown recession will depend on a variety of factors. But perhaps the most important are whether jobs remain plentiful and consumers keep spending.
That is what was so ominous about the government's report last week that businesses reduced total employment by 4,000 jobs in August and that payroll gains for previous months were being lowered. Another important labor market indicator — the share of the working-age population that reports holding a job — has fallen to its lowest level in nearly two years. And consumer spending, while it continues to grow, has slowed in recent months.
"Large numbers of people are leaving the job market," said Jan Hatzius, chief United States economist at Goldman Sachs. "That is not just a sudden bout of laziness, but it's a response to reduced labor market activity."
Hatzius and his peers on Wall Street now put the risk of a recession at about one in three, which is significantly higher than earlier this year but far from a sure thing.
They note that in recent years consumer spending was led higher by the torrid boom in housing, especially in big states like California, Florida, Arizona and New York. Now, as home prices fall, loans are harder to get and home equity borrowing is tapering off. As a result, consumer spending is likely to suffer.
Those downward pressures, though, are being offset by a robust global economy that is providing a significant lift to exports, corporate profits and real wages, which finally picked up in the last year after stagnating for much of the decade. Optimists note that consumer spending is unlikely to slow as long as hourly wages are perking along at a nominal annual pace of about 4 percent, about 1.5 percentage points above the inflation rate.
"There clearly is a problem in mortgages," said David Kelley, an economist at Putnam Investments, the mutual fund company in Boston. But "outside the mortgage market, we don't really see the consumer stopping spending."
Consumer spending has often defied dour predictions. There was no decline in spending during the recession of 2001, even as job losses mounted and business sentiment sank after the technology bubble burst. That is one reason the downturn was so mild compared with the harsher recessions of the early 1980s and early 1990s.
Economists also note that spending by higher-income consumers has a far more significant impact on the economy than purchases by those who are less well- off, a group that appears to be most vulnerable to declining home prices, resetting mortgages and job loss.
"There are essentially two consumer economies right now, and they parallel the split between the very rich and everybody else," said J. Walker Smith, president of Yankelovich, the consumer research firm based in Norwalk, Connecticut "There is one part of the consumer economy that is unlikely to be affected at all by the recent events in the financial markets. Those are the people making the loans. The people taking the loans, however, are the people who are affected."
Tuberman sees that bifurcation in his furniture business.
Even as a number of competitors and distributors have gone out of business, Barn Furniture's sales have held up, he says, because it receives most of its orders from repeat and longtime customers, who are drawn to his traditional wood products.
But new customers are hard to find.
"When someone refinances a home and they have extra money, they buy new furniture; when somebody buys a new home, they buy new furniture," said Tuberman, whose family has run the store since the 1940's. "When their adjustable-rate mortgage just increased by 40 percent, they don't buy furniture."
The downturn in housing is visible far and wide. Tex Pitfield, who owns a petroleum distributing business outside Atlanta, says he is not renewing the leases on 4 of his 20 trucks because business has slackened, especially in areas directly connected to residential real estate.
"We are not running any fuel to the construction companies for new home sites, the guys that put in the sewer lines and the utilities," he said. "Big block stores are down in consumption and retail consumption is down."
Some of that may be related to rising energy prices — oil prices this week topped $80 a barrel and the average price of gasoline nationally is $2.81 a gallon, up about 20 cents from a year ago, according to the Energy Information Administration.
In much of the country, Americans cannot change their driving habits easily or in the short term. But consumer behavior experts say gas prices could force people who may already be stretched thin by debts to cut back. Families facing a higher house payment or the loss of a job will probably go out less, buy fewer clothes or spend less on entertainment.
"From one week to the next, to fill up your car could cost $30 or $50 — and for a lot of families, that's either the cable bill or a night out to eat," said Phil Rist, executive vice president of BIGresearch, a consumer research firm in Worthington, Ohio. "The fact that they don't know where gas prices are one week to the next, that creates trepidations."
Smith of Yankelovich echoed the sentiments of Cox in Oklahoma City in highlighting how consumers may change their spending: "Some of our restaurant clients joke that they know when the economy is starting to head down by dessert sales," he said.
Consumers always start by eliminating the purchases they see as unnecessary. "They begin to eat out differently. They eat out less. Often they trade down to lower-priced restaurants. And they quit buying all the extras like dessert."
For her part, Cox is confident that her business will survive even if customers stop buying dessert. After all, she's seen worse.
"We made it through the last two recessions just fine," she said. "You just have to be resourceful."
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