Cuaderno De Documentacion

SECRETARIA DE ESTADO DE ECONOMÍA,

MINISTERIO SECRETARÍA GENERAL DE POLÍTICA ECONÓMICA DE ECONOMÍA Y ECONOMÍA INTERNACIONAL Y HACIENDA SUBDIRECCIÓN GENERAL DE ECONOMÍA INTERNACIONAL

CUADERNO DE DOCUMENTACION

Número 89º ANEXO I

Alvaro Espina Vocal Asesor 31 de Julio de 2009

BACKGROUND PAPERS:

1. Interbank and Credit Markets Improving: The Commercial Paper Test, RGE Monitor … 11 2. Federal Reserve Board, Press release…13 3. Big Banks paid billions in bonuses amid Wall St. Crisis The New Yor Times by Louise Story and Eric Dash …14 4. Health care realities, The New York Times by Paul Krugman…17 5. The lessons of 1979-82, The Conscience of a Liberal …18 6. Industry is generous to influential bloc, The Washington Post by Dan Eggen …20 7. New poll finds growing unease on health plan, The New York Times by Adam Nagourney and Megan Thee-Brenan…22 8. Lucrative fees may deter efforts to alter troubled loans, The New York Times by Peter S. Goodman …25 9. House seems to be set on pork-padded defense bill, The Washington Post by ByR Jeffrey Smith …28 10. RGE Monitor’s Newsletter, RGE Monitor…30 11. The financial truth commission, The New York Times …32 12. Call to curb speculators in energy, The New York Times, by Edmund L Andrews…33 13. Is the decline in US home prices easing? RGE Monitor …35 14. Obama opens policy talks with China, The New York Times by Mark Landler…38 15. Politicians accused of meddling in bank rules, The New York Times by Floyd Norris…40 16. Small Banks at Center of Overhaul Debate, The Washington Post by Brady Dennis…42 17. Foreclosures are often in lender’s best interest, The Washington Post by Renae Merle…43 18. In Tennesse Corner, Stimulus meets new deal by The New York Times by Michel Cooper …48 19. An Incoherent truth, The New York Times, by Paul Krugman…51 20. Dethrone king Bernanke and cour to keep recovery: Amity shlaes, Bloomberg com …53

1 21. Man without a Plan, The New York Times by Anna Jacobson Schwartz…55 22. The great preventer, The New York Times by Nouriel Roubini…57 23. The west can’t spend. China won’t spend, Times Online by Carl Mortished…59 24. Animal spirits rarely stay down for long, FT.com by Paul Ormerod …61 25. The problem with relying on the dollar to produce a real appreciation in China, Brad Setser Follow the Money by bstser…63 26. And now, the rest of the story: long-term portfolio flows have fallen by more than the trade deficit, by bsetser…67 27. Europe braced for rising credit card defaults, TF.com by Jane Croft…71 28. Una pronta recuperación: ¿ficción o realidad?, El País by Paul A. Samuelson…73 29. Grandes metas y problemas no resueltos, El País by Jeffrey D. Sachs…76 30. Reportaje: Empresas y sectores, El País, Fernando Barcela…78 31. Reportaje: Empresas y sectores, Ariadna Trillas, Wait and see para invertir, El País…80 32. When debtors decide to default, The New York Times by David Streifeld…82 33. A Jump-start for new battery plants, The Washington Post by Steven Mufson…84 34. After peak finance: Larry Summers’ bubble, by Simon Johnson…87 35. How we got into today’s mess and where we go from here, Standard the Weekly by David M Smick…89 36. Goldman stakes pays off for buffett. No duh, The Street.com by Lauren Tara La Capra…98 37. What’s at stake for the US China strategic and economic dialogue? RGE Monitor …100 38. Germany: will the economic recovery remain technical or prove sustainable?, RGE Monitor…102 39. UK GDP shrinks at fastest rate for 60 years, FT.com by Norma Cohen…105 40. A 4 billion push for better schools, The Washington Post by Michael D Shear and Nick Anderson…107 41. Geithner defends financial oversight reform, The Washington Post, by Neil Irwin …110

2 42. A regulator heeds lessons from the past, The Washington Post by Zachary A Gooldfarb…112 43. Costs and Compassion, The New York Times by Paul Krugman …115 44. Professor in chief, The Conscience of a Liberal …116 45. The most misunderstood man in America, Newsweek by Michal Hirsh…119 46. The road ahead for the global economy, RGE Monitor …123 47. Can Japan avoid another lost decade?, RGE Monitor…126 48. Can the military find the answer to alternative energy? Bussinessweek, by Steve LeVine…128 49. Europe’s jobless youth, Businessweek, by Mar Scott …131 50. Asia’s recovery prospects hinge on the G-3 recovery, RGE Monitor …133 51. Federal reserve proposes significant changes to regulation Z (Truth in lending) intended to improve the disclosures consumers receive in connection with closed end morgages and home equity lines of credit, FRB Press Release …135 52. Obama seeks to calm fears on health reform, The Washington Post, by Ceci Connolly and Michael d¡D Shear…138 53. Goldman agrees to higher price in buying back taxpayer’s stake, The Washington Post, by David Cho…141 54. Government takes over Delphi’s pensions, The New York Times, by Mary Williams Walsh…143 55. Subprime mortgage loss forecast is raised by Standard and Poor’s by Jody Shem…145 56. Chinese reserves to help companies go global? Outward investment still government-led, RGE Monitor …146 57. Harvard’s Feldstein sees risk of “Double-Dip” Recession in US, Bloomberg.com by Bob Willis and Betty Liu …145 58. Bernanke: The Fed’s exit strategy, Calculated Risk …149 59. EU and IMF diverge over Latvia: Loan Disbursements in Doubt?, RGE Monitor …150 60. The Fed’s exit strategy in full-and why not many people believe it, Eurointelligence …153 61. Economics is in crisis: it is time for a profound revamp, FT.com by Paul De Grauwe…156

3 62. Chairman Ben S. Bernanke. Semiannual moneatary policy report to the Congress, Board Governors of the Federal Reserve System…159 63. Bernanke outlines Fed’s exit strategy, FT.com by Sarah O’Connor…163 64. CRE Losses Piling Up, Calculatd Risk…165 65. Moody’s is unimpressed by German bad bank scheme, Eurointelligence …166 66. The Failure of Macroeconomics?, Econbrowser, by Menzie Chinn…168 67. The semi-daily journal of economist Brad Delong: a fair, balanced, reality-based, and more than two-handed look at the world…170 68. Economics not without success, Economist.com…174 69. The state of economics, The other-worldly philosophers The Economist …175 70. The efficient-markets hypothesis has underpinned many of the financial indstry’s models for year. Afters the crash, what remains of it?, The Economist. Financial Economics…180 71. What went wrong with economics, The Economist…183 72. Pourquoi Blair ferait un bon president de l’Europe, Le Figaro, by Piere Rousselin…186 73. Placebo effects: part 1, Eurointelligence by Satyajit Das…188 74. Cashing in, again, on risky mortgages, The New York Times, by Peter S. Goodman…191 75. German government is considering bnak nationalization, Eurointelligence …196 76. Stress test: les banques françaises jugent scenarios plus sévères qu’aux Etats-Unis, Les Echos…198 77. Industry cash flowed to drafters of reform, The Washington Post, by Dan Eggen…199 78. UK and France told to agree on regulation of OTC derivatives, FT.com by Peggy Hollinger…202 79. Warning to UK and France on derivatives, FT.com by Peggy Hollinger…203 80. Los últimos sucesos en Guatemala, Perú y Honduras restan credibilidad a la democracia liberal y refuerzan popularidad a Chávez, El País, Santiago Roncagliolo…204

4 81. Financiación de “pymes” y contexto recesivo, El País, José A. Herce y Arturo Rojas…207 82. Son las empresas, estúpido, El País, Angel Laborada…209 83. Estadísticas que cuentan historias, El País by Antoni Zabalza…211 84. Las apuestas bajists repuntan pese al escenario de euforia que reina en la Bolsa, El País, David Fernández…214 85. La ONU coge las riendas, El País by Joseph Stiglitz…216 86. Corresponsabilidad y transparencia, El País, Carmen Alcaíde…218 87. Los controles fallaron, pero el furor por las reformas se apaga a medida que se inicia la recuperación. Los banqueros han cobrado millones y no han sido juzgados, El País, Iñigo Barrón…220 88. Statement On US economic Outlook, RGE Monitor by Dr. Nouriel Roubini…221 89. The joy of Sachs, The New York Times by Paul Krugman…226 90. Two Giants emerge from Wall Street ruins, The New York Times, by Graham Bowley…228 91. Data show credit crunch already started in Germany, Eurointelligence …231 92. L’Allemagne apaisée enterre le rêve européen, Le Monde…232 93. Les hedge funds: un conflit de règlementation, Le Monde by Georges Ugeux…237 94. TIC Data and the US current account deficit: Foreigns back to t-bills in may, RGE Monitor…239 95. Renminbi politics: Changing tone about the RMB from de US and IMF? RGE Monitor…241 96. China revs up its dealmaking machine, Businessweek by Dexter Roberts…243 97. Turnaround, what turnaround?, Spiegelonline by Alexander Jung…246 98. Recovery: Where will the jobs come from?, Businessweek by Chris Farrell…250 99. The time bomb in corporate debt, Businessweek by David Henry…253 100. Goldman defector draws attention to electronic trading firms, CNN.Money by William D Cohan…255 101. From the runways of Austria, Mises Daily by Pia Varma…258 102. Housing: sticky prices by Calculated Risk…261

5 103. Blair and Barroso, Eurointelligence…263 104. The negative impact of the financial crisis on potential output necessitates an EU-led policy response, Vox by Declan Costello…266 105. China’s 2,000bn foreign reserves, FT.com…272 106. The Federal Reserve board on Wednesday approved an interim final rule amending regulation Z to require creditor to increase the amount of notice consumers reseive before the rate on a credi card account is increased or a significant change is made to the account’s terms, Federal Reserve press release…274 107. Chinese reserve growth surges: hot money inflows resume?, RGE Monitor…275 108. Systemic risk levy doubling capital charges on trading books: Regulators tackle size and complexity, RGE Monitor…276 109. Why the crisis hasn’t ended, Mises Daily…278 110. Insurers aghast at new accounting rules, Eurointelligence …280 111. How to fix the OTC derivatives market?, RGE Monitor…282 112. Derivatives are focus of antitrust investigators, The New York Times, by Eric Dash…285 113. Mortgages are now a Bank’s best friend, The New York Times by Eric Dash…287 114. RGE Monitor’s newsletter, RGE Monitor…289 115. RGE Monitor US economic outlook: Q2 2009 update, RGE Monitor by Christian Menegatti…292 116. El Banco de España alivia al sector al reducer las provisiones obligatorias, El País, Iñigo de Barrón…295 117. La termosolar puede cubrir la cuarta parte de la electricidad mundial en 2050, energía diario.com…297 118. The political consequences of Germany’s constitutional court, Eurointelligence by Wolfgang Munchau…299 119. La solidez bancaria amortigua la crisis en Latinoamerica, un seminario analiza los desafios alos que se enfrenta la región, El País, por Deisse Cepeda…301 120. Análisis: el acento, El País, …303 121. Oil’s puzzling spring surge reignites debate about speculators, The Washington Post by Steven Mufson…304

6 122. Congress muls trading curbs for its own, The Washington Post by Zachary A Goldfarb…307 123. U.S. Considers rescue of major small-business lender, The Washington Post by Binyamin Appelbaum …308 124. Socialist for Barroso, Eurointelligence …310 125. The semi daily journal of economist Brad Delong…312 126. Another bubble in housing? It could happen, says Yale’s Robert Shiller, Yahoo Finance…314 127. US trade deficit narrows as exports rebound:sustainable?, RGE Monitor…315 128. Germany’s bad scheme: How good is it?, RGE Monitor…317 129. Chinese exports contracted by 21% in june: could exports be close to a bottom?, RGE Monitor …319 130. Bavaria’s CSU wants co-decision rights with government on EU Policy, Eurointelligence …321 131. Kenneth Rogoff, Les Echos…324 132. Boiling the Frog, The New York Times by Paul Krugman…326 133. The Human Equation, The New York Times, by Bob Herbert…328 134. The stimulus trap, The New York Times, by Paul Krugman…330 135. Global investors dump euro assets, Eurointelligence …332 136. The G9’s too easy German-American Consensus, Eurointelligence by Adams Posen…334 137. China attacks doll’s dominance, FT.com by George Parker…336 138. HK seeks to boost renminbi business by Justine Lau …337 139. Value of Bank repayments draws scrutiny, The Washington Post by Amit R.Paley…338 140. Oil wakens as recovery hopes dim, The New York Times by Jad Mouawad…339 141. G8 fails to agree economic strategy, Eurointelligence …341 142. Treasury dials back plan to aid banks, The Washinton Post by David Cho…343 143. US unveils more frugal bank plan, The New York Times, by Graham Bowley and Michael J de la Merced…348 144. Boe unorthodox Monetary Policy: no change again, RGE Monitor…350

7 145. 75 years of housing fascism, Mises Daily by Dale Steinreich…352 146. The end of the world has been cancelled, Spiegelonline…357 147. Global economic outlook: is a recovery in sight? RBE Monitor…359 148. Global banking economist warned of coming crisis, Spiegelonline by Beat Balzli and Michaela Schiessl…361 149. Treasury works on plan C to fend off lingering threats, The Washington Post by David Cho and Biyamin Appenlbaum…372 150. Power of stimulus slow to take hold, The Washington Post by Lori Montgomery…374 151. France, unlike US, is deep into stimulus projects, The New York Times, by Nelson D Schwartz…376 152. US considerers curbs on speculative trading of oil, The New York Times by Edmund L Andrews…379 153. RGE Monitor –US Economic outlook: Q2 2009 update, RGE Monitor…381 154. Regulators closing speculative loopholes in commodity markets, RGE Monitor…384 155. Bos says stability pact is in danger, Eurointelligence …386 156. Insight: Effective rules require sound knowledge, FT. com by Satyajit Das…388 157. Commodity derivatives regulation, FT.com…390 158. Under restraint, FT.com by Gillian Tett and Aline Van Duyn …391 159. Banks to boost trade credit, Ft.com by Frances Williams …395 160. Ok dell’Ecofin a maggiori reserve anti-crisi per le banche, Il sole 24 ore…396 161. Why US financial markets need a public credit rating agency, The Economists’ voice, by M Ahmed Diomande…397 162. A more balanced economy might allow the world to live with a less perfect financial system, Brad Setser follow the money by bsetser…401 163. Lost through destructive creation, FT.com by Gillian Tett…404 164. Getting desperate about banks, Eurointelligence …409 165. There is no alternative. FT.com by Wolfgang Munchau…411 166. Not quite fail-safe yet, Eurointelligence by Axel Leijonhufvud…413 167. Automaker’s swift cases in bankruptcy shock experts, The New York Times, by Micheline Maynard…415

8 168. The credit crunch in the Eurozone: Bank lending to the private sector starts contracting, RGE Monitor…418 169. Economists out to lunch, The Washington Post, by Roberts J Samuelson…420 170. Hurrah for hedge funds, The Observer, by Tristram Hunt…421 171. Help is on the way, The New York Times, by Paul Krugman…424 172. Administrative costs, The Conscience of a Liberal…426 173. Dollar is buoyed by weak jobs data, TWSJ…427 174. Oil price drivers: role of speculation in the oil spike, RGE Monitor…428 175. Familiar players in health bill lobbying , The Washington Post, by Dan Eggen…429 176. Obama’s testing time, The Washington Post by EJ Dionne Jr…433 177. Steinbruck threatens german banks, Eurointelligence…435 178. Exporters squeezed by euro strength, FT.com by Richard Milne…438 179. Securisation reinvented to cut cost, FT.com by Patrick Jenkins…439 180. Liquidity injections alone are not enough, FT.com by Wolfgang Munchau…440 181. Guaino: Je me bats conte la nouvelle pensé unique, Les echos.fr…442 182. Trichet warns world leaders to co-oprate or risk new crisis, Independent by Mark Deen …446 183. Europe’s got it right on Keynes, Guardian.co, by Kenneth Rogoff…447 184. Merkel favors G20 to tackle world’s problems, Spiegel…449 185. German nuclear plant shutdown sparks debate, Spiedgel…451 186. Obama is like a Ches Player, Spiegelonline…453 187. Angst vor Kreditklemme, Faz.net…458 188. Berlin making hollow threats to bnaks over credit crunch, Spiegelonline…461 189. European Commission sees permanent decline in euro area’s potential outut, Spiegelonline…464 190. European banking needs s state-led triage body, FT.com by Adam Posen and Nicolas Véron…467 191. The consequences of external reform:lessons from the French revolution,Vox by Daron Acemoglu…469

9 192. Wall Street’s toxic message, Vanityfair, by Joseph Stiglitz…472 193. That ‘30s show, The New York Times, by Paul Krugman…478 194. The lessons of 1937, Economist.com by Christina Romer…480 195. U.S. Job report suggests that green shoots are mostly yellow weeds, RGE Monitor by Nouriel Roubini…483 196. US lost 467,000 jobs in june: too soon to call for a recovery?, RGE Monitor…487 197. ECB Benchmark rate at 1%; any more rate cuts left?, RGE Monitor…490 198. Federal reserve press release…492 199. The gloves are coming off in the European debate on financial reg, Eurointelligence…493 200. German finance minister accuses brits of kowtowing to bankers, Spiegel online…495 201. Voting quirk could favor Merkel in German Elections Unexpected Boost, Spiegel online …496 202. Sweden defends private quity, FT.com by Tony Barber…498 203. Commerzbank soars on asset plan hope, FT.com by Jack Farchy…499 204. Innovación? A veces se neceista la ayuda del vecino, Boletín de Universia-Knowledge-Wharton…501

10 Jul 30, 2009 Interbank and Credit Markets Improving: The Commercial Paper Test Overview: Government guarantees and commitment of not letting any counterparty fail is showing desired impact in interbank and money markets but it distorts somewhat the character of the purely unsecured lending quote among banks. One important activity indicator is the issuance of unsecured short-term commercial paper with which financial and non-financial companies finance their day-to-day operations. As of July 29 total outstanding (seasonally adjusted) is down from $2.2 trillion in August 20007 to $1.06 trillion. Outstandings are still declining, although asset-backed commercial paper (one of the 'shadow banking' funding sources) stabilized at US$437 billion - a third of its peak volume in 2007. The Fed's commercial paper lending facility declined to US$124 billion as of June 24 o July 30 WSJ: "Investors have developed a voracious demand for short-term commercial paper issued by U.S. and European banks, while Libor has declined significantly." Caveat: "Banks are using the fresh cash to repay existing debt, or are simply hoarding it."see: U.S. Bank Lending Continues to Fall and Credit Crunch in the Eurozone o June 21: Dan Greenhaus, analyst in the strategy group with Miller Tabak + Co in New York (via Reuters): "We need to look for a turn in indicators such as commercial paper to indicate an upturn in business needs, but we haven't seen a need in companies to increase their working capital just yet." (Reuters) o July 29: Fed Board: ABCP outstanding declined from $1.2 trillion before the crash to US$436.8billion, lowest since data began in 2001, before recovering to US$437.8 billion in week of July 29. see also Structured Investment Vehicles (SIV). o July 29: Fed Board: Total commercial paper outstanding continues its decline to US$1.065 trillion. Of this, financial commercial paper continues to decline to US$517.4 billion. Non-financial CP continues to decline to US$110.4 billion. (seasonally adjusted) o July 27 Bloomberg: 3month USD Libor dropped below 50 basis points. This is the benchmark rate for about US$360 trillion in financial products around the world. o July Fed report: data show that banks are still hoarding liquidity and parking record amounts of excess reserves with the Fed instead of lending the free liquidity. o Keister/McAndrews (NY Fed): "The quantity of reserves is determined by the size of the Fed's policy initiatives and in no way reflects the initiatives' effects on bank lending." Moreover, the payment of interest on reserves ensures that these excess holdings are not inflationary. o June 18 Bloomberg: British Bankers' Association (BBA) that compiles the LIBOR rates is considering to expand number of banks that submit daily interbank lending quotes. "Investors said they were convinced institutions were reporting incorrect Libor figures to keep from appearing that they were in difficulties. The BBA threatened to ban members

11 that deliberately understated rates before beginning a consultation process to discuss improvements." o May 18 Bloomberg: Analyst Jim Vogel: The drop in Libor is being fueled by surging customer deposits as much as increased confidence among banks. Deposits at U.S. banks jumped by almost $400 billion in H1 2009, contributing to reduced demand for loans in the interbank market. Jan Misch: "We’ve now reached a level where I wouldn’t expect further declines.” o Kedrosky: Question for debate: How much of the improvement is due to massive government guarantees and interventions? The U.S. government, FDIC, and the Federal Reserve have committed $12.8 trillion and spent $4.1 trillion. The ECB decided to extend 1 year term loans to banks in order to unfreeze the interbank lending market and to engage in credit easing (covered bonds). o July 30: O/N LIBOR: 23bp; - TED spread: 30 basis points: lowest since August 2007; - 3m USD LIBOR-OIS spread: 28basis points; - 3m EUR LIBOR-OIS spread: 45basis points - CDX IG: 115basis points - CDX HY: 813 basis points - ITRX IG: 94 basis points - ITRX HY: 653 basis points o CMBX spread collapsed in early April and prices spiked up with a view to TALF and PPIP program start in June. CMBS ratings round trip fuels optimism on the one hand but analysts point towards asset sales in the pipeline in H2. o May 18 Economist: Re-intermediation of off-balance sheet exposure is not over yet. Toxic assets are still clugging the balance sheets and the securitization market is unlikely to reemerge as before which is why some writedowns are permanent. McKinsey/ASF Study speaks of $2 trillion hole left by lack of demand for securitized products. o Edward Hadas (BreakingViews): Effectively unlimited liquidity provision by central banks and the vast amount of money pumped into the system is sustaining the current market euphoria that is not fully reflected in fundamentals - even when thinking ahead. o March 31, Pittman/Ivry (Bloomberg): The U.S. government, FDIC, and the Federal Reserve have committed $12.8 trillion and spent $4.1 trillion. The ECB decided to extend 1 year term loans to banks in order to unfreeze the interbank lending market and to engage in credit easing (covered bonds). o Claessens, Kose, Terrones (Vox): "A “creditless recovery” is possible, but it would likely be slow and shallow. In particular, output typically recovers well ahead of a trough observed in credit and house prices. On average the recession ends two quarters before the credit crunch ends and nine quarters before housing prices bottom out; equity prices tend to bottom out just as the associated recession ends." http://www.rgemonitor.com/10006/Finance_and_Banking?cluster_id=13791

Release Date: July 30, 2009

For immediate release

The Federal Reserve Board on Thursday approved final amendments to Regulation Z (Truth in Lending) that revise the disclosure requirements for private education loans. The amendments implement provisions of the Higher Education Opportunity Act (HEOA) enacted in August 2008. Under the amendments, creditors that extend private education loans must provide disclosures about loan terms and features on or with the loan application and must also disclose information about federal student loan programs that may offer less costly alternatives. Additional disclosures must be provided when the loan is approved and when the loan is consummated. The Board is also providing model disclosure forms that creditors could use to comply with the new disclosure requirements. The new disclosure requirements apply to loans made expressly for postsecondary educational expenses but do not apply where educational expenses are funded by credit card advances, or real-estate-secured loans. In addition, the amendments do not apply to education loans made, insured, or guaranteed by the federal government, which are subject to disclosure rules issued by the Department of Education. The Board's amendments also implement the HEOA's restrictions on using the name, emblem, or mascot of an educational institution in a way that implies that the institution endorses the creditor's loans. The mandatory effective date for the amendments is 180 days after publication in the Federal Register, which is expected shortly. Federal Register notice (2 MB PDF) Consumer Research and Testing for Private Education Loans: Final Report of Findings (4.1 MB PDF)

Model forms and samples: 1. H-18 (63.3 KB PDF) Private Education Loan Application and Solicitation Model Form 2. H-19 (65.2 KB PDF) Private Education Loan Approval Model Form 3. H-20 (62 KB PDF) Private Education Loan Final Model Form 4. H-21 (184 KB PDF) Private Education Loan Application and Solicitation Sample 5. H-22 (80.3 KB PDF) Private Education Loan Approval Sample 6. H-23 (74.2 KB PDF) Provate Education Loan Final Sample

http://www.federalreserve.gov/newsevents/press/bcreg/20090730a.htm

13 Business

July 31, 2009 Big Banks Paid Billions in Bonuses Amid Wall St. Crisis By LOUISE STORY and ERIC DASH Thousands of top traders and bankers on Wall Street were awarded huge bonuses and pay packages last year, even as their employers were battered by the financial crisis. Nine of the financial firms that were among the largest recipients of federal bailout money paid about 5,000 of their traders and bankers bonuses of more than $1 million apiece for 2008, according to a report released Thursday by Andrew M. Cuomo, the New York attorney general. At Goldman Sachs, for example, bonuses of more than $1 million went to 953 traders and bankers, and Morgan Stanley awarded seven-figure bonuses to 428 employees. Even at weaker banks like Citigroup and Bank of America, million-dollar awards were distributed to hundreds of workers. The report is certain to intensify the growing debate over how, and how much, Wall Street bankers should be paid. In January, President Obama called financial institutions “shameful” for giving themselves nearly $20 billion in bonuses as the economy was faltering and the government was spending billions to bail out financial institutions. On Friday, the House of Representatives may vote on a bill that would order bank regulators to restrict “inappropriate or imprudently risky” pay packages at larger banks. Mr. Cuomo, who for months has criticized the companies over pay, said the bonuses were particularly galling because the banks survived the crisis with the government’s support. “If the bank lost money, where do you get the money to pay the bonus?” he said. All the banks named in the report declined to comment. Mr. Cuomo’s stance — that compensation for every employee in a financial firm should rise and fall in line with the company’s overall results — is not shared on Wall Street, which tends to reward employees based more on their individual performance. Otherwise, the thinking goes, top workers could easily leave for another firm that would reward them more directly for their personal contribution. Many banks partly base their bonuses on overall results, but Mr. Cuomo has said they should do so to a greater degree. At Morgan Stanley, for example, compensation last year was more than seven times as large as the bank’s profit. In 2004 and 2005, when the stock markets were doing well, Morgan Stanley spent only two times its profits on compensation. Robert A. Profusek, a lawyer with the law firm Jones Day, which works with many of the large banks, said bank executives and boards spent considerable time deciding bonuses based on the value of workers to their companies.

14 “There’s this assumption that everyone was like drunken sailors passing out money without regard to the consequences or without giving it any thought,” Mr. Profusek said. “That wasn’t the case.” Mr. Cuomo’s office did not study the correlation between all of the individual bonuses and the performance of the people who received them. Congressional leaders have introduced several other bills aimed at reining in the bank bonus culture. Federal regulators and a new government pay czar, Kenneth Feinberg, are also scrutinizing bank bonuses, which have fueled populist outrage. Incentives that led to large bonuses on Wall Street are often cited as a cause of the financial crisis. Though it has been known for months that billions of dollars were spent on bonuses last year, it was unclear whether that money was spread widely or concentrated among a few workers. The report suggests that those roughly 5,000 people — a small subset of the industry — accounted for more than $5 billion in bonuses. At Goldman, just 200 people collectively were paid nearly $1 billion in total, and at Morgan Stanley, $577 million was shared by 101 people. All told, the bonus pools at the nine banks that received bailout money was $32.6 billion, while those banks lost $81 billion. Some compensation experts questioned whether the bonuses should have been paid at all while the banks were receiving government aid. “There are some real ethical questions given the bailouts and the precariousness of so many of these financial institutions,” said Jesse M. Brill, an outspoken pay critic who is the chairman of CompensationStandards.com, a research firm in California. “It’s troublesome that the old ways are so ingrained that it is very hard for them to shed them.” The report does not include certain other highly paid employees, like brokers who are paid on commission. The report also does not include some bank subsidiaries, like the Phibro commodities trading unit at Citigroup, where one trader stands to collect $100 million for his work last year. Now that most banks are making money again, hefty bonuses will probably be even more common this year. And many banks have increased salaries among highly paid workers so that they will not depend as heavily on bonuses. Banks typically do not disclose compensation figures beyond their total compensation expenses and the amounts paid to top five highly paid executives, but they turned over information on their bonus pools to a House committee and to Mr. Cuomo after the bailout last year. The last few years provide a “virtual laboratory” to test whether bankers’ pay moved in line with bank performance, Mr. Cuomo said. If it did, he said, the pay levels would have dropped off in 2007 and 2008 as bank profits fell. So far this year, Morgan Stanley has set aside about $7 billion for compensation — which includes salaries, bonuses and expenses like health care — even though it has reported quarterly losses. At some banks last year, revenue fell to levels not seen in more than five years, but pay did not. At Citigroup, revenue was the lowest since 2002. But the amount the bank spent on compensation was higher than in any other year between 2003 and 2006.

15 At Bank of America, revenue last year was at the same level as in 2006, and the bank kept the amount it paid to employees in line with 2006. Profit at the bank last year, however, was one- fifth of the level in 2006. Still, regulators may have limited resources for keeping pay in check. Only banks that still have bailout money are subject to oversight by Mr. Feinberg, the pay czar. He will approve pay for the top 100 compensated employees at banks like Citigroup and Bank of America as well as automakers like General Motors. http://www.nytimes.com/2009/07/31/business/31pay.html?th&emc=th

16 Opinion

July 31, 2009 OP-ED COLUMNIST Health Care Realities By PAUL KRUGMAN At a recent town hall meeting, a man stood up and told Representative Bob Inglis to “keep your government hands off my Medicare.” The congressman, a Republican from South Carolina, tried to explain that Medicare is already a government program — but the voter, Mr. Inglis said, “wasn’t having any of it.” It’s a funny story — but it illustrates the extent to which health reform must climb a wall of misinformation. It’s not just that many Americans don’t understand what President Obama is proposing; many people don’t understand the way American health care works right now. They don’t understand, in particular, that getting the government involved in health care wouldn’t be a radical step: the government is already deeply involved, even in private insurance. And that government involvement is the only reason our system works at all. The key thing you need to know about health care is that it depends crucially on insurance. You don’t know when or whether you’ll need treatment — but if you do, treatment can be extremely expensive, well beyond what most people can pay out of pocket. Triple coronary bypasses, not routine doctor’s visits, are where the real money is, so insurance is essential. Yet private markets for health insurance, left to their own devices, work very badly: insurers deny as many claims as possible, and they also try to avoid covering people who are likely to need care. Horror stories are legion: the insurance company that refused to pay for urgently needed cancer surgery because of questions about the patient’s acne treatment; the healthy young woman denied coverage because she briefly saw a psychologist after breaking up with her boyfriend. And in their efforts to avoid “medical losses,” the industry term for paying medical bills, insurers spend much of the money taken in through premiums not on medical treatment, but on “underwriting” — screening out people likely to make insurance claims. In the individual insurance market, where people buy insurance directly rather than getting it through their employers, so much money goes into underwriting and other expenses that only around 70 cents of each premium dollar actually goes to care. Still, most Americans do have health insurance, and are reasonably satisfied with it. How is that possible, when insurance markets work so badly? The answer is government intervention. Most obviously, the government directly provides insurance via Medicare and other programs. Before Medicare was established, more than 40 percent of elderly Americans lacked any kind of health insurance. Today, Medicare — which is, by the way, one of those “single payer” systems conservatives love to demonize — covers everyone 65 and older. And surveys show that Medicare recipients are much more satisfied with their coverage than Americans with private insurance. Still, most Americans under 65 do have some form of private insurance. The vast majority, however, don’t buy it directly: they get it through their employers. There’s a big tax advantage

17 to doing it that way, since employer contributions to health care aren’t considered taxable income. But to get that tax advantage employers have to follow a number of rules; roughly speaking, they can’t discriminate based on pre-existing medical conditions or restrict benefits to highly paid employees. And it’s thanks to these rules that employment-based insurance more or less works, at least in the sense that horror stories are a lot less common than they are in the individual insurance market. So here’s the bottom line: if you currently have decent health insurance, thank the government. It’s true that if you’re young and healthy, with nothing in your medical history that could possibly have raised red flags with corporate accountants, you might have been able to get insurance without government intervention. But time and chance happen to us all, and the only reason you have a reasonable prospect of still having insurance coverage when you need it is the large role the government already plays. Which brings us to the current debate over reform. Right-wing opponents of reform would have you believe that President Obama is a wild-eyed socialist, attacking the free market. But unregulated markets don’t work for health care — never have, never will. To the extent we have a working health care system at all right now it’s only because the government covers the elderly, while a combination of regulation and tax subsidies makes it possible for many, but not all, nonelderly Americans to get decent private coverage. Now Mr. Obama basically proposes using additional regulation and subsidies to make decent insurance available to all of us. That’s not radical; it’s as American as, well, Medicare.

July 30, 2009, 5:59 pm The lessons of 1979-82 One argument you often hear from anti-Keynesians — it pops up in comments here — is that the experience of stagflation in the 1970s proved Keynesian wrong. It didn’t; what it did disprove was the naive Phillips curve, which said that there’s a stable tradeoff between unemployment and inflation. By the end of the 70s most macroeconomists had accepted some version of the Friedman/Phelps natural rate hypothesis, which says that sustained inflation gets built into price-setting, so that inflation can persist for a while even in the face of high unemployment. But that’s very far from rejecting the basic Keynesian insight that demand matters. Still, many people continue to use the 70s to denounce all things liberal or activist. What’s odd, though, is how little talk there is about the way the 70s ended — which I viewed at the time, and still do, as a huge vindication of Keynesianism. Here’s what happened: the Fed decided to squeeze inflation out of the system through a monetary contraction. If you believed in Lucas-type rational expectations, this should have caused a rise in unemployment only to the extent that people didn’t realize what the Fed was doing; once the policy shift was clear, inflation should have subsided and the economy should have returned to the natural rate. If you believed in real business cycle theory, the Fed’s policies should have had no real effect at all.

18 What actually happened was a terrible, three-year slump, which eased only when the Fed relented.

It was 79-82 that made me a convinced saltwater economist. And nothing that has happened since — certainly not the current crisis — has dented that conviction. http://krugman.blogs.nytimes.com/2009/07/30/the-lessons-of-1979-82/

Industry Is Generous To Influential Bloc By Dan Eggen Washington Post Staff Writer Friday, July 31, 2009 On June 19, Rep. Mike Ross of Arkansas made clear that he and a group of other conservative Democrats known as the Blue Dogs were increasingly unhappy with the direction that health- care legislation was taking in the House. "The committees' draft falls short," the former pharmacy owner said in a statement that day, citing, among other things, provisions that major health-care companies also strongly oppose. Five days later, Ross was the guest of honor at a special "health-care industry reception," one of at least seven fundraisers for the Arkansas lawmaker held by health-care companies or their lobbyists this year, according to publicly available invitations. The roiling debate about health-care reform has been a boon to the political fortunes of Ross and 51 other members of the Blue Dog Coalition, who have become key brokers in shaping legislation in the House. Objections from the group resulted in a compromise bill announced this week that includes higher payments for rural providers and softens a public insurance option that industry groups object to. The deal also would allow states to set up nonprofit cooperatives to offer coverage, a Republican-generated idea that insurers favor as an alternative to a public insurance option. At the same time, the group has set a record pace for fundraising this year through its political action committee, surpassing other congressional leadership PACs in collecting more than $1.1 million through June. More than half the money came from the health-care, insurance and financial services industries, marking a notable surge in donations from those sectors compared with earlier years, according to an analysis by the Center for Public Integrity. A look at career contribution patterns also shows that typical Blue Dogs receive significantly more money -- about 25 percent -- from the health-care and insurance sectors than other Democrats, putting them closer to Republicans in attracting industry support. Most of the major corporations and trade groups in those sectors are regular contributors to the Blue Dog PAC. They include drugmakers such as Pfizer and Novartis; insurers such as WellPoint and Northwestern Mutual Life; and industry organizations such as America's Health Insurance Plans. The American Medical Association also has been one of the top contributors to individual Blue Dog members over the past 20 years. Many liberal Democrats and advocates of health-care reform were angry about the compromise bill and view the Blue Dogs as being too cozy with drugmakers, hospitals and insurers, and they argue that the conservative Democrats should be more supportive of the agenda set by President Obama and Democratic leaders. "The Blue Dogs are carrying water for the industry instead of their constituents," said Richard Kirsch, national campaign manager for Health Care for America Now, a liberal pro-reform group. "In effect, the Blue Dogs and the Republicans are taking positions that are closer all the time and further away from what most Americans want." Aides to Ross and several other key Blue Dogs did not respond this week to requests for comment about their campaign contributions. But the lawmakers have said in recent

20 interviews that they are striving to represent the moderate views of their constituents, and that leaving reform to more liberal lawmakers such as Rep. Henry A. Waxman (D-Calif.) will imperil the party's future. Most of the Blue Dogs are from rural Southern and Midwestern districts that overwhelmingly voted for Republican Sen. John McCain (Ariz.) over Obama in the 2008 presidential election. "I know there were some that thought we were trying to stop health-care reform," Ross said in an interview this week for The Washington Post's "Voices of Power" series. "Nothing could be further from the truth. We simply wanted to slow the process down and ensure that we were working toward the kind of health-care reform that the American people need and want." Ross has received nearly $1 million in contributions from the health-care sector and insurance industry during his five terms in Congress, according to an analysis by the Center for Responsive Politics, which tracks campaign contributions. The lawmaker founded Ross Pharmacy of Prescott, Ark., which he and his wife sold in 2007. The couple received $100,000 to $1 million in dividends last year from the sale, according to House financial disclosure forms. Records of political fundraisers since 2008 compiled by the Sunlight Foundation, a Washington-based watchdog group, show a steady schedule of events for Ross sponsored by the health industry or lobbying firms that represent health-care companies. They include two "health-care lunches" at Capitol Hill restaurants in May 2008 and March 2009, as well as receptions sponsored by Patton Boggs and other major lobbying firms. Overall, the typical Blue Dog has received $63,000 more in campaign contributions from the health-care sector than other House Democrats over the past two decades, according to the CRP analysis. The top three recipients were Rep. Earl Pomeroy (N.D.), with $1.5 million, and Tennessee Reps. Bart Gordon and John Tanner, both of whom collected over $1.2 million from the industry and its employees, according to the data. David Donnelly, national campaigns director for the Public Campaign Action Fund, which favors public financing of political races, said the heavy industry contributions cast doubt on the Blue Dogs' motives. "The public believes that campaign contributions shape or stop public policy," Donnelly said. "When we see significant fundraising to one segment of Congress, it raises serious questions about the campaign finance system and whether it works to the benefit of all Americans." But Charles W. Stenholm, a former congressman from Texas who was part of the original Blue Dog group in the mid-1990s, disagrees. "The idea behind giving to a group like the Blue Dogs is that you believe that they will agree with your positions most of the time," said Stenholm, who now lobbies on behalf of agricultural companies and some health-care firms. "The same is true for liberals or anyone else. It's normal in politics." Stenholm also argued that conservative Democrats are helping to save health-care reform from the extremes. "They have played a tremendously important role in keeping the process from getting out of control," he said. "This compromise is a perfect example of what being a Blue Dog is all about." Staff writer Lois Romano contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/30/AR2009073004267.html?wpisrc=newsletter

21 Politics

July 30, 2009 New Poll Finds Growing Unease on Health Plan By ADAM NAGOURNEY and MEGAN THEE-BRENAN President Obama’s ability to shape the debate on health care appears to be eroding as opponents aggressively portray his overhaul plan as a government takeover that could limit Americans’ ability to choose their doctors and course of treatment, according to the latest New York Times/CBS News poll. Americans are concerned that revamping the health care system would reduce the quality of their care, increase their out-of-pocket health costs and tax bills, and limit their options in choosing doctors, treatments and tests, the poll found. The percentage who describe health care costs as a serious threat to the American economy — a central argument made by Mr. Obama — has dropped over the past month. Mr. Obama continues to benefit from strong support for the basic goal of revamping the health care system, and he is seen as far more likely than Congressional Republicans to have the best ideas to accomplish that. But reflecting a problem that has hindered efforts to bring major changes to health care for decades, Americans expressed considerable unease about what the end result would mean for them individually. “We need to fix health care,” Mary Bevering, a Democrat from Fort Madison, Iowa, said in a follow-up interview, “but if the government creates the system, I’m afraid the quality of care will go down and costs will go up: We will pay more taxes.” “It’s going to come down to regulation,” Ms. Bevering said. “What also worries me is whether we will be told what physician we can have.” The poll was taken at a moment of extreme fluidity, both in terms of the complicated negotiations in the House and the Senate as lawmakers and the administration sort out the substance and politics of competing proposals, and in the efforts by both sides to define the stakes of the health care debate for the public. With Congress now almost certain to recess until after Labor Day without floor votes on any specific plan, a vigorous advertising and grass-roots effort to shift public opinion is likely in the next month or two. The poll offers hope to both sides. The changes in the public’s attitude over the past month, even if not huge, suggest one reason Mr. Obama sought so hard to get Congress to vote on some version of an overhaul before heading home. Opponents of the proposed health care overhaul have already spent $9 million on television advertisements raising concerns about it, said Evan Tracey, the chief operating officer of Campaign Media Analysis Group, which tracks political advertising. The advertisements are financed by the Republican National Committee and aimed at constituents of wavering lawmakers. The committee is also running radio spots. Officials said the advertising would accelerate as the legislators returned home for the summer. The advertisements present the overhaul as a risky experiment, or a government takeover of health care that would prevent people from choosing their own doctors.

22 Mr. Obama is making an intense effort to rebut those claims. On Wednesday, he flew to Raleigh, N.C., for a town-hall-style meeting to address the kinds of public concerns reflected in the poll results. “First of all,” Mr. Obama said, “nobody is talking about some government takeover of health care. I’m tired of hearing that. I have been as clear as I can be. Under the reform I’ve proposed, if you like your doctor, you keep your doctor; if you like your health care plan, you keep your health care plan. These folks need to stop scaring everybody, you know?” Mr. Obama sought in particular to reassure people who already have health insurance and whom the overhaul plans under consideration in Congress would benefit by preventing insurers from dropping them or diluting their coverage if they become ill, while also bringing rapidly rising costs under control. And he sought to stoke a sense of urgency for getting a bill signed this year. “If we do nothing, I can almost guarantee you your premiums will double over the next 10 years, because that’s what they did over the last 10 years,” Mr. Obama said. “It will eat into the possibility of you getting a raise on your job because your employer is going to be looking and saying, ‘I can’t afford to give you a raise because my health care costs just went up 10, 20, 30 percent.’ ” The national poll was conducted by telephone starting on Friday and ending on Tuesday. It involved 1,050 adults, and has a margin of sampling error of plus or minus three percentage points.

23 Mr. Obama’s job approval rating has dropped 10 points, to 58 percent, from a high point in April. And despite his efforts — in speeches, news conferences, town-hall-style meetings and other forums — to address public misgivings, 69 percent of respondents in the poll said they were concerned that the quality of their own care would decline if the government created a program that covers everyone. Still, Mr. Obama remains the dominant figure in the debate, both because he continues to enjoy relatively high levels of public support even after seeing his approval ratings dip, and because there appears to be a strong desire to get something done: 49 percent said they supported fundamental changes, and 33 percent said the health care system needed to be completely rebuilt. The poll found 66 percent of respondents were concerned that they might eventually lose their insurance if the government did not create a new health care system, and 80 percent said they were concerned that the percentage of Americans without health care would continue to rise if Congress did not act. By 55 percent to 26 percent, respondents said Mr. Obama had better ideas about how to change health care than Republicans in Congress did. There is overwhelming support for a bipartisan agreement on health care, and here again, Mr. Obama appears in the stronger position: 59 percent said that he was making an effort to work with Congressional Republicans, while just 33 percent said Republicans were trying to work with him on the issue. Over all, the poll portrays a nation torn by conflicting impulses and confusion. In one finding, 75 percent of respondents said they were concerned that the cost of their own health care would eventually go up if the government did not create a system of providing health care for all Americans. But in another finding, 77 percent said they were concerned that the cost of health care would go up if the government did create such a system. Helene Cooper, Marina Stefan and Dalia Sussman contributed reporting. http://www.nytimes.com/2009/07/30/us/politics/30poll.html?th&emc=th

24 Business

July 30, 2009 Lucrative Fees May Deter Efforts to Alter Troubled Loans By PETER S. GOODMAN This week, the Obama administration summoned mortgage company executives to Washington to demand they move faster to lower payments for homeowners sliding toward foreclosure. Treasury officials called on the companies to hire and train more people quickly to field applications for relief. But industry insiders and legal experts say the limited capacity of mortgage companies is not the primary factor impeding the government’s $75 billion program to prevent foreclosures. Instead, it is that many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans. Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services. “It frustrates me when I see the government looking to the servicer for the solution, because it will never ever happen,” said Margery Golant, a Florida lawyer who defends homeowners against foreclosure and who worked in the law department of a major mortgage company, Ocwen Financial. “I don’t think they’re motivated to do modifications at all. They keep hitting the loan all the way through for junk fees. It’s a license to do whatever they want.” Rich Miller, a governance project manager at Countrywide Financial and Bank of America before he left in January, said Bank of America had been reluctant to modify loans, which hurt the bottom line. The company has been waiting and hoping the economy will improve and delinquent customers will resume making payments, he said. “That’s the short-term strategy,” said Mr. Miller, who oversaw training programs at Countrywide, which was bought by Bank of America. He now works as an industry consultant. Bank of America disputed that characterization. “To think that somehow or other we would jeopardize investor relationships and customer relationships for the very small incremental income we would receive by delaying seems ludicrous,” said Robert V. James, the bank’s senior vice president for mortgage operations and insurance. “It’s not the right thing to do.” Mortgage companies, some of which are affiliated with the nation’s largest banks, are paid to manage pools of loans owned by investors. The companies typically collect a percentage of the value of the loans they service. They extract their share regardless of whether borrowers are current on their payments. Indeed, their percentage often increases on delinquent loans. Legal experts say the opportunities for additional revenue in delinquency are considerable, confronting mortgage companies with a conflict between their own financial interest in collecting fees and their responsibility to recoup money for investors who own most mortgages.

25 “The rules by which servicers are reimbursed for expenses may provide a perverse incentive to foreclose rather than modify,” concluded a recent paper published by the Federal Reserve Bank of Boston. Under the Obama administration’s foreclosure program, a servicer that modifies a loan for a homeowner collects $1,000 from the government, followed by $1,000 a year for each of the next three years. A senior Treasury adviser, Seth Wheeler, said these payments amounted to “meaningful incentives to servicers to help overcome the challenges and competing demands they face in considering and completing loan modifications.” He added that mortgage companies “are contractually obligated to the terms of this program, which require them to offer modifications to qualified borrowers.” But experts say the administration’s incentives are often outweighed by the benefits of collecting fees from delinquency, and then more fees through the sale of homes in foreclosure. “If they do a loan modification, they get a few shekels from the government,” said David Dickey, who led a mortgage sales team at Countrywide and Bank of America, leaving in March to start his own mortgage advisory firm, National Home Loan Advocates. By contrast, he said, the road to foreclosure is lined with fees, especially if it is prolonged. “There’s all sorts of things behind the scenes,” he said. When borrowers fall behind, mortgage companies typically collect late fees reaching 6 percent of the monthly payments. “For many subprime servicers, late fees alone constitute a significant fraction of their total income and profit,” said Diane E. Thompson, a lawyer for the National Consumer Law Center, in testimony to the Senate Banking Committee this month. “Servicers thus have an incentive to push homeowners into late payments and keep them there: if the loan pays late, the servicer is more likely to profit.” She cited Ocwen Financial, which reported that nearly 12 percent of its income in 2007 came from fees to borrowers. Paul A. Koches, Ocwen’s general counsel, said: “We’d prefer that to be zero. The costs associated with our delinquent loans are in every instance in excess of the late fees.” Data on delinquencies reinforces the notion that servicers are inclined to let problem loans float in purgatory — neither taking control of houses and selling them, nor modifying loans to give homeowners a break. From June 2008 to June 2009, the number of American mortgages that were 90 days or more delinquent soared from 1.8 million to nearly 3 million, according to the realty research company First American Core Logic. During that period, the number of loans that resulted in the bank taking ownership of the home declined to 245,000, from 333,000. As a home slides toward foreclosure, mortgage companies pay for many services required to take control of the property and resell it. They typically funnel orders for title searches, insurance policies, appraisals and legal filings to companies they own or share revenue with. Ocwen established its own title company, Premium Title Services, in part to keep more of the revenue from foreclosures, said Ms. Golant, who helped start it. “It was hugely profitable,” she said. “Premium Title would charge for the title when it got transferred to Ocwen, then charge again when it got transferred to the new buyer, and then sell title insurance. It was easy money.” Mortgage companies not only gain this extra business through their subsidiaries, but also collect reimbursement for the payments when the houses are sold.

26 The investors who own bad mortgages accept whatever is left. Investors typically do not notice how much they give up to the servicers, because fees are embedded in complex sales. “It’s under the radar,” Ms. Golant said. Ultimately, the benefits of delinquency erode incentives for mortgage companies to dispose of troubled loans quickly, say experts, allowing distressed houses to decay and fall in value — a fact of little interest to the servicer. “At the end of the day, it doesn’t matter what the house sells for, because they don’t take that loss,” said Ms. Golant. “Meanwhile, they are collecting all these fees.”

Peter S. Goodman, “Lucrative Fees May Deter Efforts to lter Troubled Loans”, NYT, 30 Julio, 2009, en: http://www.nytimes.com/2009/07/30/business/30services.html?th&emc=th

27 Thursday, July 30, 2009 House Seems To Be Set on Pork-Padded Defense Bill By R. Jeffrey Smith, Washington Post Staff Writer The Democratic-controlled House is poised to give the Pentagon dozens of new ships, planes, helicopters and armored vehicles that Defense Secretary Robert M. Gates says the military does not need to fund next year, acting in many cases in response to defense industry pressures and campaign contributions under an approach he has decried as "business as usual" and vowed to help end. The unwanted equipment in a military spending bill expected to come to a vote on the House floor Thursday or Friday has a price tag of at least $6.9 billion. The White House has said that some but not all of the extra expenditures could draw a presidential veto of the Defense Department's entire $636 billion budget for 2010, and it sent a message to House lawmakers Tuesday urging them to cut expenditures for items that "duplicate existing programs, or that have outlived their usefulness." While the administration won a big victory when the Senate voted July 21 to end the F-22 fighter-jet program, the House's imminent action demonstrates its continued rebellion on many other Obama administration military spending priorities. Gates continues to struggle with lawmakers on both sides of the aisle who are loyal to existing military programs benefiting contractors that provide jobs and large campaign donations. House appropriators want to buy, for example, extra C-17 transport planes and F-18 jets, as well as four extra military jets used by lawmakers and Pentagon VIPs. And they want to keep alive a troubled missile-defense interceptor program and continue the troubled VH-71 presidential helicopter program. Gates vowed in April to fundamentally overhaul the military's "approach to procurement, acquisition and contracting" and urged Congress to support the termination of many traditional weapons programs in favor of more spending on counterinsurgency efforts and operations in Iraq and Afghanistan. In this round, those Democratic and Republican lawmakers who support maintaining or expanding programs that Gates proposed to eliminate or trim appear likely to prevail, because an unusually restrictive rule for floor debate agreed upon Wednesday will allow only amendments that could strip less than half of the spending the administration did not request. Roughly $2.75 billion of the extra funds -- all of which were unanimously approved in an 18- minute markup Monday by the House Appropriations Committee -- would finance "earmarks," or projects demanded by individual lawmakers that the Pentagon did not request. About half of that amount reflects spending requested by private firms, including 95 companies or related political action committees that donated a total of $789,190 in the past 2 1/2 years to members of the appropriations subcommittee on defense, according to an analysis by Taxpayers for Common Sense, a nonprofit watchdog group. Rep. Jeff Flake (R-Ariz.), a government-spending critic who has long campaigned against such earmarks, has said he will try again Thursday to strike all such spending. But his prior earmark-stripping efforts have succeeded only once in dozens of attempts, and never on defense spending.

28 "Simply put, Members of Congress should not have the ability to award no-bid contracts" to private firms, Flake said in a statement explaining the 540 proposed amendments he plans to bring up. "The practice has created an ethical cloud over Congress, and it needs to end." He noted that at least 70 of the earmarks are for former clients of the PMA Group, a lobbying firm close to appropriations subcommittee head John P. Murtha (D-Pa.) that is now being probed by the Justice Department and the House ethics committee. Although President Obama has repeatedly criticized earmarks, the White House statement of policy on the House bill obliquely criticized only "programs that fund narrowly focused activities." No mention was made of items such as a proposed $8 million Defense Department grant Murtha inserted for Argon ST, a Pennsylvania military contractor that has contributed $35,200 to him in the past four years, or of a $5 million grant Rep. C.W. Bill Young (R-Fla.) inserted for DRS Technologies, a Florida contractor that has contributed $46,350 to Young during that period, according to Taxpayers for Common Sense. The White House criticized the addition of $80 million for the Kinetic Energy Interceptor program, which Gates and other Pentagon officials have said is technically troubled, behind schedule, and billions of dollars over budget. But Northrop Grumman, the principal contractor, is building a technology center in Murtha's district that would bring 150 related jobs, and Murtha's subcommittee sought its continuation as a way "to recoup the technology," according to an appropriations staff member, who was not authorized to speak on the record. A spokesman for Murtha did not reply to a request for comment. In its letter to the House, the White House also specifically targeted the committee's addition of $400 million to finish five VH-71 presidential helicopters. Obama has said he does not want them, and Gates ridiculed them in a July 16 speech in Chicago as helicopters that "cost nearly half a billion dollars each" and would enable the president to "cook dinner while in flight under nuclear attack." Murtha countered a week later that he was upset at the idea that the Pentagon would spend $3.2 billion on such a program and "get nothing out of it," adding: "That's unacceptable." He also suggested in a session with defense reporters that the Pentagon really did not want to kill the VH-1: "It's not the Defense Department. The Defense Department is speaking for the White House," he said. Many lawmakers have similarly argued that despite what Gates and his top appointees have been saying, the military services have repeatedly let them know they want to continue programs formally stricken from the Pentagon's budget request. Gates tried to restrict such behind-the-scenes lobbying for weeks after his April announcement, but he eventually relented under sharp criticism from lawmakers and contractors. Regarding the disputed C-17 transport aircraft, for example, senior defense officials have formally testified that those purchased in previous years, in combination with upgraded C-5 aircraft, will be sufficient to meet any conceivable military needs. But the committee added $674 million for three unwanted planes because "the Air Force will say on the record that they don't support it, but if you ask them off the record if they will actually use the planes, they will say, 'Absolutely,' " said a House staff member who also was not allowed to speak on the record. Political action committees affiliated with Boeing, the C-17's principal manufacturer, donated $161,500 to House defense appropriations subcommittee members since the beginning of 2007, according to Taxpayers for Common Sense.

Staff researcher Madonna Lebling contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/29/AR2009072902676.html?wpisrc=newsletter

miércoles 29/07/2009 8:00

RGE Monitor's Newsletter Greetings from RGE Monitor!

Coinciding with this week’s release of RGE Monitor’s updated 2009/10 Global Economic Outlook, here we present an overview of our European Economic Outlook, including the Nordics, the Baltics and Central and Eastern Europe. Previous newsletters addressed RGE’s U.S. outlook, the outlook for China, and Japan. The full version of the European outlook, available to subscribers, includes the following sections: • Is the Worst Over? Clues from Industrial Production and World Trade • Potential Output, Potential Growth and Output Gap • Inflation or Deflation? • Fiscal Policy • Credit Market Conditions • The European Banking Sector • Sovereign Risk Watch: Ireland • Sovereign Risk Watch: Greece • Private Consumption and Labor Markets • Power Shift Back to Nation States?

European Monetary Union RGE Monitor expects the cyclical recovery in the eurozone--led by Germany and France--to lag recovery in the U.S., the BRICs and non-Central and Eastern Europe (CEE) emerging markets. Among the main factors muting Europe’s recovery in 2010 are a permanent decline in potential output; unwinding pressures of large internal imbalances leading to deflationary pressures; a more restricted monetary and fiscal policy response compared to the U.S. and especially to China; a leveraged financial sector with too-big-to-fail institutions and too-big-to-save features; and a strong reliance on bank funding by the corporate sector subject to a larger financing gap than that seen in the U.S. In order not to impair the banking sector’s lending ability permanently, a quick disposal of bad assets is warranted. Lending to the private sector is slowing quickly, and for small and medium sized enterprises with no access to capital markets, bank credit lines represent the only recourse for liquidity. Based on IMF and ECB estimates, total bank losses in the eurozone will amount to between $650 billion and $900 billion, implying substantial additional recapitalization costs. Germany’s specialization in cyclical industrial goods, and its export-led growth model, have been particularly damaging to growth. Going forward, RGE cautions that given the likely reticence of the U.S. consumer in the medium term future, an exclusive reliance on export-led growth is not advisable. France’s more balanced domestic demand-led growth model has served it relatively better. Italy is grappling with a structural and long-term decline in its relative living standard--a situation that requires a radical overhaul of structural impediments in product and labor markets. Spain’s challenge lies in an expected 20% unemployment rate and deflationary pressures to restore relative price competitiveness. Ireland is among the developed countries hit hardest by the crisis and its large banking sector (relative to GDP) represents a contingent liability despite the

30 country’s commendable ‘bad bank’ scheme. United Kingdom The UK’s mainstay is its financial sector, which has accordingly received substantial government support. The country’s strained fiscal position puts more radical solutions for unviable banking institutions on the table for regulators, who are openly discussing options like splitting banks that are too-big-to-fail. The lending environment is equally important for the housing market, which is fundamental to the British economy. Central and Eastern Europe Among emerging market regions, CEE economies are experiencing the steepest roller-coaster ride in terms of growth. After exceeding global growth averages for the last decade, regional growth is plummeting in 2009 and is expected to underperform both emerging Asia and Latin America. All EU newcomers in the region are either in or headed for recession. A dangerous combination of falling exports and slowing capital inflows is behind the bleak growth picture. The hardest-hit economies have tended to be very open, with wide current account deficits in recent years and high levels of foreign currency borrowing. Not all CEE economies are in the same boat. The Czech Republic and Poland, for example, are considered relatively healthy and are expected to experience relatively mild contractions in 2009. Those in more dire straits--Estonia, Latvia, Lithuania--are facing double-digit contractions. Hungary, Latvia, Romania and Serbia have already turned to the IMF for financial assistance, and more are likely to face severe downturns. RGE Monitor points to the following as possible downside risks to regional growth: Risk of regional financial contagion (e.g. the possibility of spillover effects in the event of a Latvian devaluation) ; Potential for a cross-border banking crisis; Rising political instability Repeat of January gas crisis Given the strong financial and trade linkages with Western Europe, a recovery in Eastern Europe will not come until its western neighbors’ economies improve. That means the region’s recovery will lag behind that of Western Europe. Meanwhile, the downside risks described above could further delay recovery. And even when recovery comes, RGE expects sluggish positive growth in the medium-term, rather than a return to the soaring growth rates seen earlier this decade.

Nordics

After strong growth earlier this decade, all five Nordic economies are now in the midst of recessions. These are small, open economies that have been hit hard by slumping external demand for their exports. Given their strong public finances, Nordic economies, with the exception of Iceland, have resources available to cushion their contractions. Ultimately, however, economic recovery in the region hinges on a global recovery. Norway’s economy will experience the mildest GDP contraction in the region in 2009, whi le Iceland will see the sharpest contraction. Norway is the best placed for a quick rebound to positive growth given its sizeable buildup of oil revenues and its large maneuver room on fiscal and monetary policy. Recovery in Finland and Sweden is tied to a revival in demand for their export products. The global production slump has been particularly bad news for Finland and Sweden given the large share of capital goods in the makeup of their exports. Not surprisingly, these economies are facing the region’s sharpest contractions in 2009 behind Iceland. Stress in the Swedish banking sector could r esult in a more protracted recovery there.

31 Opinion EDITORIAL http://www.nytimes.com/2009/07/29/opinion/29wed1.html?th&emc=th July 29, 2009 The Financial Truth Commission Congress has pledged to reform the banking system, but too often over the past year lawmakers have chosen instead to shield the financial industry, a big campaign contributor, from accountability. So the public has every right to ask whether the newly formed Financial Crisis Inquiry Commission — created by Congress to investigate the meltdown — can be counted on to put the public interest ahead of political loyalties, professional ties and ideological biases. The men and women on the panel are accomplished in their fields — business, law, economics and academia — and many have past government experience. They have been chosen to perform a service that is crucial to restoring trust in the markets and in the government; their findings will also inform regulatory reform efforts. The 10 members — six chosen by the Democratic leadership, four by the Republican leadership — also have long partisan histories and at least one has strong ties to the financial industry. The Democratic chairman, Phil Angelides, a former California state treasurer, has given, together with his wife, nearly $327,000 to Democratic candidates over the past two decades, according to the Center for Responsive Politics. The vice chairman, former Representative Bill Thomas, a Republican, received $1.6 million in campaign contributions from financial, insurance and real estate interests during his nearly two decades on Capitol Hill. He is now an adviser to a law firm that represents banking and financial-services clients. All of this suggests that the commission’s efforts bear close monitoring. Here are some early indicators to watch to see whether they are rising to the occasion. CHOOSING A LEAD INVESTIGATOR It is imperative that Mr. Angelides and Mr. Thomas agree on a strong investigator — with a proven record of exposing deceptive or fraudulent activities — to serve as the commission’s director. The director must also be given the resources to assemble a strong team of experts and have the commission’s full support to press the investigation. The law allows the commission to issue subpoenas if the chairman and vice chairman agree or if a majority of the panel agrees, as long as the majority includes at least one Republican. If subpoenas are inhibited by partisan votes, the commission will be hamstrung. STANDING UP TO THE BANKS The law requires the commission to investigate each failure of a major financial institution during the crisis, such as Lehman Brothers, and each major failure that was averted by assistance from the Treasury. Some banks may try to argue that although they received assistance, they were never in danger of failure, and thus are off limits to commission investigators. But all of the major banks are implicated in the crisis, and none should be outside the commission’s purview. STANDING UP TO THE GOVERNMENT The law requires government agencies and departments to furnish information to the commission upon request. Even though much of what the panel will investigate happened under President Bush, the executive branch tends to guard its secrets. President Obama has already reserved the right to assert executive privilege. The commission must be willing, if necessary, to fight for access to documents. The commission is expected to hold its first meeting around Labor Day. As its work unfolds, there will be more benchmarks of success, or lack thereof. For now, it is important that it gets started with the right staff and a commitment to use its powers to the fullest.

32 Energy & Environment

July 29, 2009 Call to Curb Speculators in Energy By EDMUND L. ANDREWS WASHINGTON — The country’s top regulator of commodity markets said Tuesday that the government should “seriously consider” strict limits on the trades of purely financial investors in the futures markets for oil, natural gas and other energy products. Opening the first of three hearings on proposals to curb speculative trading and reduce volatile price swings in oil and gas, the chairman of the Commodity Futures Trading Commission made it clear that he favored tighter volume limits on noncommercial traders — banks, hedge funds and other financial institutions — that account for a big share of trading in energy contracts. “The C.F.T.C. is in the best position to apply limits across different exchanges, and we are most able to strike a balance between competing interests and the responsibility to protect the American public,” the commission chairman, Gary Gensler, said. “I believe we must seriously consider setting strict position limits in the energy markets.” Mr. Gensler, President Obama’s choice to head the agency, was sympathetic to complaints from Democratic lawmakers that purely financial traders, who typically never take physical delivery of the oil or gas, have aggravated the violent swings in energy prices in the last several years. Big buyers of oil-based fuels, like airlines, gasoline retailers and municipal power companies, have loudly complained about the volatility in energy prices and blamed much of it on the surge in financial trading. Much of the criticism has focused on exchange-traded index funds, which are like index mutual funds but that trade like stocks and allow investors to bet on rising energy prices. The index funds are usually passive players, but they have enjoyed explosive growth as investors have tried to ride the boom in oil prices. “This increase in volatility has been associated with a massive increase in speculative investment in oil futures,” Ben Hirst, senior vice president at Delta Airlines, told the commission on Tuesday. Mr. Hirst estimated that the surge and subsequent plunge in oil prices over the last 18 months had added $8.4 billion to his company’s bill for jet fuel. About $1.7 billion of that extra cost, he added, came from the cost of hedging against big price changes. Crude oil prices jumped 52 percent in the first half of 2008, peaking at more than $145 a barrel last July. The price then collapsed to less than $33 a barrel last December, and is now trading around $68 a barrel. Earlier this month, Mr. Gensler announced that the commission would consider federal volume limits on speculative traders and that it would consider tightening or overriding existing limits that were imposed by commodity exchanges like the Chicago Mercantile Exchange and the Nymex in New York. Craig S. Donohue, the chief executive of the CME Group, which owns both the Chicago Merc and the Nymex, denied that the volatility stemmed from financial traders. He also defended the so-called index funds that have enjoyed explosive growth in the last several years.

33 “Blaming speculators for high prices diverts attention from the real causes of rising prices and does not contribute to a solution,” Mr. Donohue told the commission. He warned that federal volume limits on financial traders could make things worse for consumers. “Position limits, when improperly calibrated and administered, can easily distort markets, increase the costs to hedgers and effectively increase the costs to consumers,” he said. New position limits would simply drive traders to less regulated electronic exchanges, including those based outside the United States. “The market for energy products is global,” Mr. Donohue said, “and there is nothing to prevent market activity from migrating to those platforms that are beyond the commission’s and beyond the Congress’s reach.” But Mr. Donohue also indicated a willingness to compromise with regulators, saying that the CME was prepared to impose its own “hard limits” on the volume of contracts that financial traders could hold at one time. The big fight is likely to be about the exceptions to volume limits that exchanges give to major banks and Wall Street firms. JPMorgan Chase and Goldman Sachs are both major traders in energy futures, both as fund managers and for their own accounts. Both firms received exemptions based on their need to hedge against price swings, but neither bank is a commercial buyer or seller of energy products. At the moment, the commodity exchanges impose soft limits, or accountability levels, on speculative traders. But traders routinely exceed the exchange-imposed limits, either because the exchanges do not enforce them or because they grant hedging exceptions to companies like Goldman and JPMorgan. Mr. Gensler released data showing that dozens of traders routinely exceeded the Nymex’s accountability levels by wide margins for crude oil, natural gas, heating oil and gasoline. In natural gas, many traders had positions almost four times bigger than the exchange accountability levels. “The exchanges do have the authority to ask market participants to take their positions down,” Mr. Gensler said. “The majority of the time, however, the exchanges do not execute their authority.” If the commission does decide to impose new restrictions, Mr. Gensler said on Tuesday, he hopes to have them ready some time this fall. The commission is preparing a new report on whether speculators played a significant role in the rising price volatility. But on Tuesday afternoon, Mr. Gensler said press reports were “premature” and inaccurate in speculating on what the report’s conclusion would be. http://www.nytimes.com/2009/07/29/business/energy- environment/29oil.html?_r=1&th&emc=th

34 Jul 28, 2009 Is the Decline in U.S. Home Prices Easing? After more than a decade of rising prices in the U.S. housing sector, home prices began declining in Q2 2006 and continue to decline into 2009, now the third year of deflation in the housing market. The pace of decline has eased in 2009, though measures of home prices indicate that home values continue to fall y/y. While the supply of new housing has undergone a significant downward correction, rising foreclosures are still adding to excess housing inventories. On the demand side, the weak labor market will continue to weigh down the indebted U.S. consumer in the near future. Without an improvement in the demand- supply mismatch, there remains a risk of a prolonged decline in home prices. o May 2009: The S&P/Case-Shiller 20-City Composite Index fell 17.1% y/y in May 2009 after declining 18.1% y/y in April. Of the 20 cities covered in the survey, 17 showed an improvement in the y/y return in May over April, though the y/y decline continued to be in double digits for 16 cities. The m/m return in May was positive for 13 of the 20 cities (in 8 of the 20 cities after accounting for seasonality). (S&P) o As of April 2009, average home prices are at similar levels to what they were in mid- 2003. From the peak in mid-2006, the 10-City Composite is down 33.3% and the 20-City Composite is down 32.3%.(S&P) o Blitzer: There is a clear inflection point in the y/y data due to four consecutive months of improved returns, indicating a stabilization in price declines. On a y/y basis, prices are down 17% on an average across all metros, and there is some way to go before home prices show sustained appreciation.(S&P) o May 2009: The FHFA Monthly Home Price Index rose 0.9% in May after falling 0.3% in April. The index is down 5.6% y/y and 10.7% below it's peak in April 2007. The FHFA purchase-only Home Price Index fell 0.5% in Q12009, after falling a record 3.3% in Q4 2008 and is down 7.1% y/y.(Federal Housing Finance Agency) o Q1 2009: The S&P/Case-Shiller U.S. National Home Price Index recorded an 19.1% decline in Q1 2009, largest in the series' history. This has increased from the annual declines of 18.2% and 16.6%, reported for the Q4 and Q3 2008, respectively. National home values are down 46.3% from peak as of Q1 2009. (S&P) o The FHFA Home Price Index covers both purchase and refinance transactions though only involving those conventional mortgages purchased/securitized by Fannie Mae and Freddie Mac. While the S&P Case Shiller Indexes only include purchase transactions, they also include purchases backed by non-agency mortgages, including subprime mortgages.

The Outlook for Housing and Peak to Trough Decline Estimates: o Menegatti: Based on a range of indicators (Real home price index by Shiller 2006, price rent ratio and price/income ratio) the fall in home prices from their peak will reach 44%.(RGE Monitor)

35 o Inventories persist at an all time high, and while starts might be close to a bottom and will likely move sideways for some time, it is the demand side that has to pick up to reabsorb inventories. As long as demand remains weak and inventories high, downward pressures on prices will continue. o Stress test scenarios: The baseline scenario assumes a q/q decline of 14% in Q4 2009 and 4% in Q4 2010, while the adverse scenario assumes a decline of 22% in Q4 2009 and 7% in Q4 2010, implying a peak to trough fall of 39.5% in the baseline and 47% in the adverse scenario. (Federal Reserve) o Calculated Risk: As of May 2009 house prices are tracking the baseline scenario, but I believe the seasonal adjustment is insufficient and I expect that the index will show steeper declines, especially starting in October and November. o Shiller: Prices may continue to fall or stagnate into 2010 or 2011. There is much less demand for housing than is supply. Even if there is a quick end to the recession, the housing market's poor performance may linger. (via New York Times) Cities with relatively smaller declines like Boston could show signs of rebound, after the pace of foreclosures has fallen. Given the inventory on the markets and shadow inventory of houses, a scenario where home prices decline for years is more probable. (via Yahoo Finance) o Wheaton: The supply side fundamentals of the housing market point to a bottoming out and prices should stabilize soon and resume rising. The excess inventory of housing should be back below normal in 2011. Most US houses are valued at or under replacement cost, making Japan-style decades of price decline unlikely.(via VoxEU) o PMI U.S. Market Risk Index: The risk of home price declines in most Metropolitan Statistical Areas (MSAs) increased in Q1 2009, driven by unemployment and foreclosure rates. 60% of the nations top 50 MSAs have a greater than 50% chance of declining home prices in two years time, with the risk highest for MSAs in Arizona, Nevada California and Florida. (PMI Mortgage Insurance Co.) o Abiel Reinhart (not online): The pace of decline in home prices is expected to moderate, given that the sharp diversion of home prices from rents during the housing boom has been reversed to a fair extent. (J.P. Morgan) o Davis, Lehnert and Martin: The average rent to price ratio for the U.S. between 1960- 2000 was 5.24%. By Q1 2006 the rent to price ratio (based on the Case Shiller index) had fallen down to 3.10%. As of Q1 2009, the rent to price ratio has risen up to 5.09%. (via University of Wisconsin- Madison) http://www.rgemonitor.com/80/Housing_Bubble_and_Bust?cluster_id=6077 'Flash' Orders and Dark Liquidity Pools: Regulators Start Asking Questions Overview: FT, July 28: "Flash orders have come under increasing scrutiny recently as U.S. securities regulators look for ways to regulate 'dark pools.' These anonymous electronic trading venues, which do not display public quotes for stocks, have flourished in recent years." In June, both the SEC and the European Commission announced reviews of the impact of off-exchange equity trading platforms with respect to market access, price transparency and liquidity deepening or fragmentation. One important difference: "dark pools are currently exempted from certain obligations under special 'pre-trade transparency waivers.' ”

36 o In a July 27 letter to the SEC, Senator Charles E. Schumer requested that the SEC "act to prohibit the use of so-called 'flash orders' in connection with optional display periods currently permitted by DirectEdge’s Expedited Liquidity Program, NASDAQ’s Flash order program and BATS’s Bolt Optional Liquidity Program. Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public, allowing those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity....This kind of unfair access seriously compromises the integrity of our markets and creates a two-tiered system where a privileged group of insiders receives preferential treatment, depriving others of a fair price for their transactions....If the SEC fails to curb this practice, I plan to introduce legislation in the U.S. Senate to prohibit the use of flash orders." o FT, Lex, July 28: "It is worth distinguishing between the illegal and the irritating. Frontrunning–or trading ahead of customer orders–is the former. Successfully employing the biggest nerds and the best millisecond-saving technology is not." Regulators should focus on the former, not the latter. o Bloomberg, July 28: Traders say that speed was always an integral part of trading success. "The competition for profits that gave rise to today’s rapid-fire execution has roots that span decades and has helped reduce costs for investors." Ben Townson of New York- based BlackBox Group: “We’ve built a racecar that is optimized for driving fast. Is that an advantage? Yes. Is it an unfair advantage? No.” o Bloomberg:"About 46 percent of daily volume is handled through high-frequency strategies, according to estimates by NYSE Euronext...The transactions are made by about 400 of the 20,000 firms trading stocks in the U.S., according to Tabb Group LLC, a New York-based financial services consultant. Each makes bets in hundredths of a second to exploit tiny price swings in equities and discrepancies in futures, options and exchange-traded funds." Tabb Group LLC via ZeroHedge: Potential profits are about US$15-25 billion a year. o Bernard Donefer of Baruch College via ZeroHedge, July 12: Algorithmic trading prompts several regulatory concerns. First,"slicing and dicing" decreases market bid-offer size, which reduces market liquidity and promotes fragmentation. Second, high-speed trading "adds noise to the pricing." Algorithmic trading also disadvantages retail orders and could lead to trading control issues. o In the EU, the Financial Instruments Directive (MiFID) introduced in November 2007 aims at increasing competition between exchanges and over-the-counter (OTC) equity trading by mandating the "best execution of equity trades" (an initiative not expanded to bonds). The industry's response is Project Turquoise, a plan by Europe’s largest investment banks to provide buy-side with direct low-cost share trading and access to hidden pools of liquidity that are off-exchange to avoid "market impact" (meaning price movement during large order execution). o In June 2009, EU authorities plan a review of MiFID upon concerns that the introduction of enhanced competition between banks' OTC equity trading platforms such as Project Turquoise or MTF Chi-X and the public exchanges could lead to amplified liquidity fragmentation and increased fee and pricing opacity instead of higher transparency as envisaged by the commission (see IMF Euro Area Policies Country Report, July 2007). Moreover, "dark pools are currently exempted from certain obligations under special 'pre- trade transparency waivers.' " (FT, EDHEC) http://www.rgemonitor.com/66/Capital_Market_Intermediaries?cluster_id=14254

37 World http://www.nytimes.com/2009/07/28/world/28strategy.html?th&emc=th

July 28, 2009 Obama Opens Policy Talks With China By MARK LANDLER WASHINGTON — The United States and China inaugurated two days of high-level talks on Monday, exchanging promises of great-power cooperation on weighty issues like climate change while steering clear of potential conflicts over exchange rates and human rights. President Obama, saying that ties between the countries are as “important as any bilateral relationship in the world,” welcomed senior Chinese leaders to the meetings here, which were jointly led by Secretary of State Hillary Rodham Clinton and Treasury Secretary Timothy F. Geithner. “I have no illusions that the United States and China will agree on every issue, nor choose to see the world in the same way,” Mr. Obama said. “But that only makes dialogue more important.” Ticking off a long list of priorities, the president said the two countries would seek ways to work together on economic recovery, climate change, clean-energy technology, nuclear nonproliferation, counterterrorism and humanitarian disasters like the one in Darfur, Sudan. Analysts said the United States seemed eager to play down areas of friction like China’s currency policy, in part because the Obama administration does not want to antagonize Beijing, its largest foreign creditor, when Washington is running a yawning deficit. “This is not an issue that the administration is banging the table on,” said Myron Brilliant, senior vice president for international affairs at the United States Chamber of Commerce. The meetings, called the Strategic and Economic Dialogue, are a successor to a wide- ranging consultation begun during the Bush administration by Treasury Secretary Henry M. Paulson Jr. Mrs. Clinton pushed for the State Department to take an equal role in the talks, previously weighted toward economic issues. By broadening the scope, China and the United States were able to forge common cause on issues like North Korea. Mrs. Clinton praised the Chinese government last week for doing more to support American efforts to pressure Pyongyang. “At this point, the relationship is basically in good shape,” said Kenneth G. Lieberthal, who worked on China policy in the Clinton White House. “But I don’t think anyone can assume things will remain in good shape, given the difficulty of the issues.” Mr. Obama referred frankly to tensions over human rights, saying that the United States believes the “that all peoples should be free to speak their minds — and that includes ethnic and religious minorities in China.” But he expressed respect for what he called an “ancient and dynamic” society, and noted that he had named two Chinese-Americans to his cabinet: Steven Chu, the energy

38 secretary, and Gary Locke, the commerce secretary. Mr. Chu later made a presentation on climate change.

Secretary of State Hillary Rodham Clinton and Treasury Secretary Timothy F. Geithner listening to Dai Bingguo, a Chinese state councilor, at the start of talks on Monday in Washington. The Chinese delegation was led by Wang Qishan, a vice premier who oversees economic policy, and Dai Bingguo, a state councilor responsible for foreign policy. Mr. Dai said the upheaval of the recent economic crisis had united the two countries. “We’re actually in the same big boat that has been hit by fierce wind and huge waves,” he said. While there are nascent signs of recovery in both countries, Mr. Obama stressed the need for Americans to save more and for Chinese consumers to spend more. The Americans told the Chinese they would have to adjust to higher household savings in the United States, said David Loevinger, the Treasury’s senior coordinator for the meetings. Mr. Loevinger said American officials did broach the issue of China’s exchange rate, which Beijing deliberately keeps depressed to bolster its exports. But he declined to characterize the exchange. Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics, said, “The currency issue is going to remain important because of the need to get to ‘balanced growth.’ ” Some of the more contentious issues may be taken up on Tuesday. For example, the United States had yet to register its dissatisfaction with government procurement rules in China that favor Chinese manufacturers. “Let’s be honest,” Mr. Obama said, “some in China think that America will try to contain China’s ambitions; some in America that think there is something to fear in a rising China. I take a different view.”

39 Business

July 28, 2009 Politicians Accused of Meddling in Bank Rules By FLOYD NORRIS Accounting rules did not cause the financial crisis, and they still allow banks to overstate the value of their assets, an international group composed of current and former regulators and corporate officials said in a report to be released Tuesday. The report, from the Financial Crisis Advisory Group, also deplored successful efforts by politicians to force changes in accounting rules and said that accounting standards should be kept separate from regulatory standards, contrary to the desire of large banks. “The message to political bodies of ‘Don’t threaten, Don’t coerce’ flies in the face of some of what has been coming from the European Commission and from members of Congress,” said Harvey Goldschmid, a co-chairman of the group and a former member of the Securities and Exchange Commission. The report itself, written by a group that included Tommaso Padoa-Schioppa, a former Italian finance minister; Lucas Papademos, a vice president for the European Central Bank, and Michel Prada, a former head of the French stock market regulator, used considerably more diplomatic language. “We have become increasingly concerned about the excessive pressure placed on the two boards to make rapid, piecemeal, uncoordinated and prescribed changes to standards, outside of their normal due process procedures,” the group wrote in its report, which was commissioned by the Financial Accounting Standards Board of the United States and the International Accounting Standards Board. “While it is appropriate for public authorities to voice their concerns and give input to standard setters, in doing so they should not seek to prescribe specific standard-setting outcomes,” the report added. Earlier this year both boards, under pressure from banks and politicians, made rapid changes to allow banks more leeway in valuing assets and thus reduce the losses they would otherwise have to report. The group, whose other co-chairman is Hans Hoogervorst, the chairman of the Netherlands Authority for the Financial Markets, said that despite arguments that the financial crisis was worsened by forcing banks to write down their assets to market value, the overall effect had been the opposite. Pointing to rules that delayed the write-down of bad loans and allowed banks to hide risks off their balance sheets, the group said the net impact of accounting rules “has probably been to understate the losses that were embedded in the system.” Banking regulators have been looking for ways to make the regulatory system less “procyclical,” perhaps by allowing banks to postpone recognition of profits in good times so that losses would not be as large in bad times.

40 The group cautioned that there could be conflicts between the aim of accounting rule makers to accurately reflect a company’s financial position and the goals of banking regulators. “For example,” the group wrote, “transparency may not always be the best way to prevent a run on the bank.” When those differences arise, it said, it may make sense for regulators to measure bank capital differently than accounting rules would call for, but “the effects of those differences should be disclosed in a manner that does not compromise the transparency and integrity of financial reporting.” Despite the apparent conflict with both bankers and bank regulators, the Financial Crisis Advisory Group included a number of people with experience in those fields. Among them were Gerry Corrigan, a former president of the Federal Reserve Bank of New York and now an official with Goldman Sachs; Nobuo Inaba, a former executive director of the Bank of Japan; Gene Ludwig, a former comptroller of the currency; and Klaus-Peter Müller, the chairman of the supervisory board of Commerzbank in Germany. The group also warned against changing rules in ways that would make it easier for banks to manage earnings. At the center of the arguments are fundamental differences in the purpose of financial statements. In one comment letter submitted to the Financial Crisis Advisory Group, the French Banking Federation argued that only assets that banks intend to trade should have to be shown at fair value, with most others valued at the original cost unless the bank had determined that losses were likely. Using market value for such assets, the bankers said, has unreasonably damaged bank capital levels. “In the current financial crisis, financial statements could be hardly used as a tool to evaluate the economic performance of entities from a financial stability perspective as they have more reflected the collapse of financial markets,” the bankers wrote. A competing view was voiced by Edward Trott, a former member of FASB and former partner in KPMG, a large accounting firm, who said that the banks imposed different standards on their customers than they wished to have imposed on them. “The area for bank regulators to be involved with accounting standards setting is to help identify the financial information the banks need from others to make appropriate lending and investing decisions,” Mr. Trott wrote. “In my experience, banks want current fair value information about assets that serve as collateral for loans. They do not want information about what assets cost two or three years ago.” http://www.nytimes.com/2009/07/28/business/28account.html?th&emc=th

Small Banks at Center of Overhaul Debate By Brady Dennis Washington Post Staff Writer Tuesday, July 28, 2009 While the country's biggest banks have taken much of the blame for the economic crisis, the fate of the Obama administration's efforts to overhaul regulation of the financial industry could rest in the hands of thousands of small local banks, which have remained out of the national spotlight. The country's 8,000 community banks are a powerful lobbying force, and no one knows that better than the nation's largest financial firms, most of which oppose the creation of an agency to oversee consumer products ranging from mortgages to credit cards. Wall Street firms might have millions of dollars to spend on Washington lobbyists and public relations campaigns, but these companies possess neither the strong reputation nor the grass-roots reach of community banks. "The larger financial institutions have the opposite of political clout today. They're radioactive," Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, said in an interview. "The only way the big banks can win is if they get the community banks to be their troops." The alliance between big and small banks isn't a natural one. Community bankers are in an altogether different business than the nation's largest firms. They are far less involved with the mortgages and credit cards that the new agency aims to rein in. But they worry that they will face extra regulatory burdens nevertheless. That's why community bankers have spoken out mostly against the plan, even as it puts them in the awkward position of siding with the sullied banks of Wall Street. Community bankers have recently begun to flex their muscles. They have written thousands of letters to lawmakers, questioning the creation of another federal regulator. They have written newspaper op-eds in Iowa and letters to the editor in Oklahoma. In North Carolina, a recent newsletter from the state bankers association urged members to "use the August congressional recess period to make the case that the Consumer Financial Protection Agency is wrong." It encouraged them to invite lawmakers to their banks, ask employees to send letters to Congress and reach out to local media and business groups. "When the charge is sounded, these guys mount up, and they are credible," said Thad Woodard, president of the North Carolina Bankers Association. "Today, people don't like banking, but they like their banker. There's believability in what they have to say." Frank has recently met with local bankers, including delegations from Texas and Massachusetts, to tell them that the new agency is not aimed at them and that he doesn't intend to burden them with unnecessary new regulations, instead seeking to rein in the larger firms whose practices helped provoke the financial meltdown. Frank wants the small bankers on his side. "It's a mistake to think that money is everything in politics," Frank said. "Money helps. But votes will beat money any day. The most effective kind of lobbying is grass-roots. And [community banks] are in everybody's district."

42 It's no wonder that Cam Fine, president of the Independent Community Bankers of America, has become such a popular man this summer. He said he's increasingly been fielding calls from those on both sides of the debate unfolding in Congress. "I've talked with members of the consumer lobby; I've talked to representatives of the largest Wall Street firms," said Fine, whose group represents nearly 5,000 small banks across the country. "I'm hearing from people I never heard from before. It's unlike anything I've ever seen, both the volume and the pace." Community bankers point out that they didn't cause the current crisis. They say they shouldn't be forced to shoulder new rules because larger firms that embraced complex financial derivatives and abusive lending practices wrecked the system. "We just don't think we need another regulator. One size does not fit all in the regulatory scheme," said Chris Williston, president of the Independent Bankers Association of Texas. "We're really getting punished for the sins of a lot of our big bank brethren." The American Bankers Association, whose members include large and small firms, has firmly opposed the new agency, saying it would add an unnecessary layer of government regulation, increase costs, stifle innovation and curtail choices for consumers. The ICBA has urged its members to voice its "serious concerns" about the proposed agency to lawmakers. The group's members across the country have the power to do just that. "Community bankers know their local congressman," said Peter Fitzgerald, a former Illinois senator and now chairman of Chain Bridge Bank in McLean. "They would be able to get in to see their local congressman. That is one advantage community bankers have. They have personal relationships in their community." It's that attribute that also makes small bankers attractive to consumer advocacy groups, scores of which have banded together in support of the new agency, arguing that it would benefit community banks. "It's really quite simple. The big banks are based in Charlotte, New York and a couple other places," said Ed Mierzwinski, consumer program director at the U.S. Public Interest Research Group and a member of Americans for Financial Reform. "The little banks are based in Everytown, USA. They aren't out-of-town suits. That's why everyone wants them on their side. "We would, in a perfect world, love to have them on our side." Brady Dennis, “Small Banks at Center of Overhaul Debate”, WT, 28, Julio, 2009 http://www.washingtonpost.com/wp-dyn/content/article/2009/07/27/AR2009072702191.html

Foreclosures Are Often In Lenders' Best Interest Numbers Work Against Government Efforts To Help Homeowners By Renae Merle Washington Post Staff Writer Tuesday, July 28, 2009 Government initiatives to stem the country's mounting foreclosures are hampered because banks and other lenders in many cases have more financial incentive to let borrowers lose their homes than to work out settlements, some economists have concluded. The Lender's Calculus Lenders have been flooded with pleas for help from homeowners during the foreclosure crisis. Policymakers often say it makes economic sense for a lender to modify the mortgages of distressed borrowers, lowering their monthly payments, because foreclosed homes yield even less money. In reality, lenders are modifying far fewer mortgages than expected.

44 Policymakers often say it's a good deal for lenders to cut borrowers a break on mortgage payments to keep them in their homes. But, according to researchers and industry experts, foreclosing can be more profitable. The problem is that modifying mortgages is profitable to banks for only one set of distressed borrowers, while lenders are actually dealing with three very different types. Modification makes economic sense for a bank or other lender only if the borrower can't sustain payments without it yet will be able to keep up with new, more modest terms. A second set are those who are likely to fall behind on their payments again even after receiving a modified loan and are likely to lose their homes one way or another. Lenders don't want to help these borrowers because waiting to foreclose can be costly. Finally, there are those delinquent borrowers who can somehow, even at great sacrifice, catch up without a modification. Lenders have little financial incentive to help them. These financial calculations on the part of lenders pose a difficult challenge for President Obama's ambitious efforts to address the mortgage crisis, which remains at the heart of the country's economic troubles and continues to upend millions of lives. Senior officials at the Treasury Department and the Department of Housing and Urban Development have summoned industry executives to a meeting Tuesday to discuss how to step up the pace of loan relief. The administration is seeking to influence lenders' calculus in part by offering them billions of dollars in incentives to modify home loans. Still, foreclosed homes continue to flood the market, forcing down home prices. That contributed to the unexpectedly large jump in new-home sales in June, reported yesterday by the Commerce Department. "There has been this policy push to use modifications as the tool of choice," said Michael Fratantoni, vice president of single-family-home research at the Mortgage Bankers Association. But "there is going to be this narrow slice of borrowers for which modifications is the right answer." The size of that slice is tough to discern, he said. "The industry and policymakers have been grappling with that." The effort to understand the dynamics of the mortgage business comes as the administration is prodding lenders to do more to help borrowers under its Making Home Affordable plan, which gives lenders subsidies to lower the payments for distressed borrowers. About 200,000 homeowners have received modified loans since the program launched in March, while more than 1.5 million borrowers were subject during the first half of the year to some form of foreclosure filings, from default notices to completed foreclosure sales, according to RealtyTrac. No doubt part of the explanation is that lenders are overwhelmed by the volume of borrowers seeking to modify their mortgages. Rising unemployment and falling home prices have added to the problem. But a study released last month by the Federal Reserve Bank of Boston was downbeat on the prospects for widespread modifications. The analysis, which looked at the performance of loans in 2007 and 2008, found that lenders lowered the monthly payments of only 3 percent of delinquent borrowers, those who had missed at least two payments. Lenders tried to avoid modifying the loans of borrowers who could "self-cure," or catch up on their payments without help, and those who would fall behind again even after receiving help, the study found.

45 "If the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily 'preventable' foreclosures may be far smaller than many commentators believe," the report said. Nearly a third of the borrowers who miss two payments are able to self-cure without help from their lender, according to the Boston Fed study. Separately, Moody's Economy.com, a research firm, estimated that about a fifth of those who miss three payments will self-cure. When Adrian Jones fell behind on the mortgage payments for her Dallas home earlier this year, her lender asked her to cut other expenses. Jones said she eliminated movies and coffee breaks. She turned to family members for loans. When that failed to raise enough, she sold her second car. "It hurt, but it also made sense. The debt was my responsibility," Jones said. But six months later, after catching up on the mortgage, Jones is again feeling pinched after her hours as an office assistant at an architecture firm were cut. This time, she's not sure she can fix the problem herself. "I am going to try, obviously," she said. "But it is getting harder and harder." Like Jones, those who are most determined to meet their obligations are often unlikely candidates for loan modifications. "These are the people who will get a second job, borrow from their family to keep up," explained Paul S. Willen, a senior economist at the Federal Reserve Bank of Boston and an author of its report. ". . . From a cold-blooded profit-maximizing standpoint, these are the people the banks will help the least." Lenders also worry that borrowers may re-default even after receiving a loan modification. This only delays foreclosure, which can be costly to the lender because housing prices are falling throughout the country and the home's condition may deteriorate if the owner isn't maintaining it. In some cases, lenders lose twice as much foreclosing on a home as they did two years ago, said Laurie Goodman, senior managing director at Amherst Securities. American Home Mortgage Services, based in Texas, was willing to modify Edward Partain's mortgage on his Tennessee home last April after business at his beauty salon slowed and a divorce stretched his budget. But after months of negotiating with his lender, Partain said he was surprised to learn that it would only lower his payments by $90 a month, instead of the $250 decrease he expected. "At $250, I would have had a chance, but after they added in late fees and payments, I couldn't do it," he said. Partain soon fell behind on his payments again and went back to American Home Mortgage Services seeking a more affordable payment. Partain said he was told that he was ineligible for another modification because it had been less than a year since his last. A foreclosure sale was scheduled for late July. After American Home Mortgage Services was contacted by The Washington Post about the case, the company said Partain would be considered for the federal foreclosure-prevention program and it delayed the sale by three months. Partain is relieved but anxious about the details. "You want to wait and see what figures they come up with," he said. Administration officials have not said publicly how many borrowers they expect to re-default under Obama's program.

46 But the experience of a separate program run by the Federal Deposit Insurance Corp. could be instructive. After taking over the failed bank IndyMac last year, the FDIC began modifying troubled mortgages held or serviced by the company. Richard Brown, the FDIC's chief economist, said the agency expects up to 40 percent of those borrowers to re-default. Even at that rate, he said, the modification program is more profitable than doing nothing. "The idea that 30 to 40 percent re-default is a failure to a program is false," Brown said. The administration has estimated that its foreclosure-prevention program would help 3 million to 4 million borrowers by 2012. But lenders' reluctance could limit the impact to less than half that, said Mark Zandi, chief economist for Moody's Economy.com. Coupled with re- defaults, this would mean that the number of people losing their homes to foreclosure could reach nearly 5 million by 2011, he said. Mark A. Calabria, director of financial-regulation studies at the Cato Institute, warned that political rhetoric is driving the policy discussion. "What we really need to do is have an honest debate about what are the magnitudes of people we really can help," he said. But administration officials defended their program's progress, reporting that it has surpassed an initial goal of offering 20,000 modifications a week. These officials said they have taken into account the re-default risk and possibility for self-cure in designing the effort. Michael S. Barr, assistant Treasury secretary for financial institutions, noted that the report by the Boston Fed does not cover the period since the administration launched its initiative. "We will continue to refine the program as new data becomes available," he said. "We are committed to studying the effectiveness and efficiency of the program, and we welcome outside analysis." Willen, of the Boston Fed, said the government program could boost several-fold the number of seriously delinquent borrowers receiving modifications. But so few people had been getting their loans modified that even a dramatic increase in the percentage would still touch only a small fraction of troubled borrowers, he said. "We're still not talking about a program that will stop a large number of foreclosures," he said. "We're talking about a program that, at the margins, will assist more people. It is unlikely we will see a sea change." Renae Merle, “Foreclosures Are Often In Lenders' Best Interest Numbers Work Against Government Efforts To Help Homeowners”, July 28, 2009 http://www.washingtonpost.com/wp- dyn/content/article/2009/07/27/AR2009072703065.html

47 U.S. http://www.nytimes.com/2009/07/28/us/28county.html?_r=1&th&emc=th

July 28, 2009 In Tennessee Corner, Stimulus Meets New Deal By MICHAEL COOPER

Josh Anderson for The New York Times

Steven Sullivan, right, was given a job with the Tennessee Department of Transportation after Perry County received federal stimulus money. LINDEN, Tenn. — Critics elsewhere may be questioning how many jobs the stimulus program has created, but here in central Tennessee, hundreds of workers are again drawing paychecks after many months out of work, thanks to a novel use of federal stimulus money by state officials. Here in one of Tennessee’s hardest-hit areas, some workers were cutting down pine trees with chainsaws and clearing undergrowth on a recent morning, just past the auto parts factory that laid them off last year when it moved to Mexico. Others were taking applications for unemployment benefits at the very center where they themselves had applied not long ago. A few were making turnovers at the Armstrong Pie Company (“The South’s Finest Since 1946”). The state decided to spend some of its money to try to reduce unemployment by up to 40 percent here in Perry County, a rural county of 7,600 people, 90 miles southwest of Nashville where the unemployment rate had risen to above 25 percent after its biggest plant, the auto parts factory, closed. Rather than waiting for big projects to be planned and awarded to construction companies, or for tax cuts to trickle through the economy, state officials hit upon a New Deal model of trying to put people directly to work as quickly as possible.

48 They are using welfare money from the stimulus package to subsidize 300 new jobs across Perry County, with employers ranging from the state Transportation Department to the milkshake place near the high school. As a result, the June unemployment rate, which does not yet include all the new jobs, dropped to 22.1 percent.

Audio Slide Show

Echoes of 1930s in County's Unemployment Fix

“If I could have done a W.P.A. out there, I would have done a W.P.A. out there,” said Gov. Phil Bredesen of Tennessee, a Democrat, referring to the Works Progress Administration, which employed millions during the Great Depression. “I really think the president is trying to do the right thing with the stimulus,” Mr. Bredesen said, “but so much of that stuff is kind of stratospheric. When you’ve got 27 percent unemployment, that is a full-fledged depression down in Perry County, and let’s just see if we can’t figure out how to do something that’s just much more on the ground and direct, that actually gets people jobs.” Tennessee is planning to pay for most of the new jobs, which it expects will cost $3 million to $5 million, with part of its share of $5 billion that was included in the stimulus for the Temporary Assistance for Needy Families program, the main cash welfare program for families with children. The state did not wait for the federal paperwork to clear before putting residents of Perry County back to work. Other states are still drawing up plans for spending the welfare money, which is typically used for items like cash grants for families and job training. Some are likely to use part of it to subsidize employment, as Tennessee is doing, but it is hard to imagine many other places where the creation of so few jobs could have such an immediate and outsize impact as it did in this bucolic county. A stimulus job came just in time for Frank Smith, 41, whose family was facing eviction after he lost his job as a long-haul truck driver. Then he landed a job with the Transportation Department. “The day I came from my interview here, I was sitting in the court up here where I was being evicted,” Mr. Smith said after a sweaty morning clearing trees under a hot sun to make room for new electric poles. “Luckily I’m still in the same place. There’s a lot of people that were totally displaced.” Scott and Allison Kimble married after meeting on the assembly line at the Fisher & Company auto parts plant. When the factory closed last year and relocated to Mexico, the Kimbles, along with many of their friends and neighbors, found themselves out of work. Now Mr. Kimble has a stimulus job working for the Transportation Department, and Ms. Kimble has one in what has become a growth industry, taking telephone applications for unemployment benefits.

49 “I know what they feel like,” she said between calls. “I’ve been in their position.” Michael B. Smith, 53, who drove a forklift at the plant for 31 years, now drives a Caterpillar to clear land for a developer. Robert Mackin, 55, who lost his job, his health insurance and his home, now has a job with the Transportation Department, a rental home, health insurance and an added benefit: the state employee discount when his daughter goes to a state college. “With a degree, she can always go somewhere,” Mr. Mackin said. The impact has been enormous, all across the county. Even the look of the place is changing, following the old W.P.A. model. In addition to the jobs for adults, there are 150 summer jobs for young people, some of whom have been working with resident artists to paint murals depicting local history on the buildings along Main Street in Linden, the county seat. Over all, two-thirds of the new jobs are in private sector businesses, which are reimbursed by the state for the salaries of eligible stimulus workers. Some, in retail, might be hard to sustain when the stimulus money runs out in September 2010. Other businesses say the free labor will help them expand, hopefully enough to keep a bigger work force. The Commodore Hotel Linden, a newly restored 1939 hotel that has brought new life to downtown, has seen an increase in its bookings since it has expanded its staff thanks to the stimulus. And the Armstrong Pie Company expects to be able to keep on the new bakery assistants and drivers it hired with stimulus money, saying the new workers have helped the company triple its pie production and expand its reach through central Tennessee. The county mayor, John Carroll, has been working to lure new industry to the area. Walking through the cavernous, empty Fisher plant, Mr. Carroll pointed to a forgotten display case filled with dozens of awards for safety and manufacturing excellence. “What we can offer,” he said, “is a great work force.” Mr. Kimble said the new jobs had given him and his wife paychecks, health insurance and a reason to get up each morning. But he said he hoped that a big, long-term employer would move in soon. “This job here is not a permanent fix,” he said. “We still need some kind of industry to look and come into Perry County. But for right now we’ve got hope, and when you’ve got hope, you’ve got a way.”

50 Opinion

July 27, 2009 OP-ED COLUMNIST An Incoherent Truth By PAUL KRUGMAN Right now the fate of health care reform seems to rest in the hands of relatively conservative Democrats — mainly members of the Blue Dog Coalition, created in 1995. And you might be tempted to say that President Obama needs to give those Democrats what they want. But he can’t — because the Blue Dogs aren’t making sense. To grasp the problem, you need to understand the outline of the proposed reform (all of the Democratic plans on the table agree on the essentials.) Reform, if it happens, will rest on four main pillars: regulation, mandates, subsidies and competition. By regulation I mean the nationwide imposition of rules that would prevent insurance companies from denying coverage based on your medical history, or dropping your coverage when you get sick. This would stop insurers from gaming the system by covering only healthy people. On the other side, individuals would also be prevented from gaming the system: Americans would be required to buy insurance even if they’re currently healthy, rather than signing up only when they need care. And all but the smallest businesses would be required either to provide their employees with insurance, or to pay fees that help cover the cost of subsidies — subsidies that would make insurance affordable for lower-income American families. Finally, there would be a public option: a government-run insurance plan competing with private insurers, which would help hold down costs. The subsidy portion of health reform would cost around a trillion dollars over the next decade. In all the plans currently on the table, this expense would be offset with a combination of cost savings elsewhere and additional taxes, so that there would be no overall effect on the federal deficit. So what are the objections of the Blue Dogs? Well, they talk a lot about fiscal responsibility, which basically boils down to worrying about the cost of those subsidies. And it’s tempting to stop right there, and cry foul. After all, where were those concerns about fiscal responsibility back in 2001, when most conservative Democrats voted enthusiastically for that year’s big Bush tax cut — a tax cut that added $1.35 trillion to the deficit? But it’s actually much worse than that — because even as they complain about the plan’s cost, the Blue Dogs are making demands that would greatly increase that cost. There has been a lot of publicity about Blue Dog opposition to the public option, and rightly so: a plan without a public option to hold down insurance premiums would cost taxpayers more than a plan with such an option.

51 But Blue Dogs have also been complaining about the employer mandate, which is even more at odds with their supposed concern about spending. The Congressional Budget Office has already weighed in on this issue: without an employer mandate, health care reform would be undermined as many companies dropped their existing insurance plans, forcing workers to seek federal aid — and causing the cost of subsidies to balloon. It makes no sense at all to complain about the cost of subsidies and at the same time oppose an employer mandate. So what do the Blue Dogs want? Maybe they’re just being complete hypocrites. It’s worth remembering the history of one of the Blue Dog Coalition’s founders: former Representative Billy Tauzin of Louisiana. Mr. Tauzin switched to the Republicans soon after the group’s creation; eight years later he pushed through the 2003 Medicare Modernization Act, a deeply irresponsible bill that included huge giveaways to drug and insurance companies. And then he left Congress to become, yes, the lavishly paid president of PhRMA, the pharmaceutical industry lobby. One interpretation, then, is that the Blue Dogs are basically following in Mr. Tauzin’s footsteps: if their position is incoherent, it’s because they’re nothing but corporate tools, defending special interests. And as the Center for Responsive Politics pointed out in a recent report, drug and insurance companies have lately been pouring money into Blue Dog coffers. But I guess I’m not quite that cynical. After all, today’s Blue Dogs are politicians who didn’t go the Tauzin route — they didn’t switch parties even when the G.O.P. seemed to hold all the cards and pundits were declaring the Republican majority permanent. So these are Democrats who, despite their relative conservatism, have shown some commitment to their party and its values. Now, however, they face their moment of truth. For they can’t extract major concessions on the shape of health care reform without dooming the whole project: knock away any of the four main pillars of reform, and the whole thing will collapse — and probably take the Obama presidency down with it. Is that what the Blue Dogs really want to see happen? We’ll soon find out. http://www.nytimes.com/2009/07/27/opinion/27krugman.html?th=&emc=th&pagewante d=print

Dethrone King Bernanke and Court to Keep Recovery: Amity Shlaes Commentary by Amity Shlaes July 28 (Bloomberg) -- The Queen of England recently heard from her nation’s economic experts, who wrote to apologize for their profession’s inability to predict the financial crisis. It’s different in the U.S. Here, economists don’t apologize to the throne. They sit on it. The throne in the U.S. is the post of chairman at the Federal Reserve. As currently configured, this office is more powerful than Elizabeth II’s, with almost unlimited discretionary authority to intervene in the world economy. The Fed was created in 1913. Lawmakers strengthened its powers in the 1930s and then again after World War II by effectively charging it with watching over not only money but economic growth generally. Until 1971, there existed a mechanism that served as a check on the Fed’s discretion, at least theoretically. It was the gold standard (later, the gold exchange standard). If the Fed created too much money, capital went abroad to less inflationary venues. That in turn forced the economy to contract. Central bankers controlled money creation because they didn’t want to be blamed for a recession. President Richard Nixon broke that mechanism when he took the country off the gold exchange standard in August 1971. Since then, the economy has been in the hands of the king -- the Fed chairman -- and his counts and barons, the members of the Federal Open Market Committee. The record of central bankers suggests that they aren’t deserving of their royal status. Awful Choices Central bankers always argued that there was a tradeoff between unemployment and inflation: the country had to pick one of the two poisons. Then the 1970s brought both poisons -- joblessness with inflation. Former Fed Chairman Alan Greenspan, current Chairman Ben Bernanke and many of their economic colleagues all failed to predict the current crisis. Worse, they may have helped cause it by keeping interest rates too low this decade. Why did the Fed keep rates low? We can guess that the events of Sept. 11, 2001, and the start of the Iraq War in 2003 are part of the answer. The U.S. didn’t want economic trouble at home while it was fighting abroad. What’s clear is that rates were kept low in part for an arbitrary reason: because Greenspan, then Bernanke, felt like keeping them there. Bernanke’s Promise In 2002, when Bernanke was still a mere count in the Fed court, he spoke at an event honoring his fellow economist, Milton Friedman. Bernanke recited the errors of the Depression- era monetary authorities, errors Friedman himself had first pointed out: they forced an epic deflation and banking credit crisis on Americans.

53 Bernanke then promised that he and his Fed colleagues “won’t do it again.” Fast forward to Sunday in Kansas City, where Bernanke, now chairman, said the current crisis might already be worse than the Great Depression. In other words, the Fed policy of the current decade has worked insufficiently, or hasn’t worked, or has made matters worse. Hardly the festive results both Bernanke and the late Friedman hoped for. Yet the more trouble their arbitrary policy causes, the more ennobled our central bankers seem. Washington has the power to end this monarchy. It can replace economists with economics -- rules-based mechanisms that automatically curtail Fed discretion. This offers the possibility of experimenting with economic models and letting Congress keep or toss them, according to performance. Follow the Formula One such experiment could involve the Taylor Rule, named for Stanford University economist John Taylor. It says the Fed should aim to set short-term interest rates following a formula that measures inflation, employment and the pattern of interest rates. In a damning book released in February, Taylor showed that interest rates diverged from his rule for much of this decade. Had the Fed followed the Taylor Rule, it wouldn’t have loosened rates as much as it did, and that might have slowed the housing boom. Friedman himself was skeptical about too much discretion and sought a legislated rule on monetary policy. He “wanted the rate of growth for money to be fixed to the rate of growth of the economy,” recalls Don Boudreaux, chairman of the economics department at George Mason University. Let Markets Rule Others advocate a new gold standard, which would make the movement of money more automatic, even to the point of “free banking.” Such a system would have no central government bank. The market, not Washington, would determine the survival or death of financial institutions. It’s not a new idea: George Selgin of West Virginia University wrote a book about how British manufacturers in the early 19th century successfully challenged the Crown for control of their country’s money. Right now, thousands of pages are being typed in hundreds of summer houses in an effort to blame Greenspan or Bernanke, or perhaps their colleagues at the Treasury Department, another imperial institution. The trouble is not Bernanke or Greenspan or even their respective courts. The trouble is that the throne exists in the first place. (Amity Shlaes, author of “The Forgotten Man: A New History of the Great Depression” is a Bloomberg News columnist. The opinions expressed are her own.) To contact the writer of this column: Amity Shlaes at [email protected] Last Updated: July 27, 2009 21:00 EDT http://www.bloomberg.com/apps/news?pid=20601039&sid=ajShAlQzKQkM#

54 Opinion

July 26, 2009 OP-ED CONTRIBUTOR Man Without a Plan

By ANNA JACOBSON SCHWARTZ AS Federal Reserve chairman, Ben Bernanke has committed serious sins of commission and omission — and for those many sins, he does not deserve reappointment. Let me begin with the former. It is standard practice for a central bank like the Federal Reserve to ease monetary policy to combat a recession, and then to tighten it as recovery gets under way. Mr. Bernanke so far has only had to do the first half, and has conducted a policy of extreme ease. The Fed’s Open Market Committee cut the federal funds rate in October to 1 percent from 1.5 percent, and then in December to a range of zero percent to 0.25 percent. What drove down the funds rate was the Federal Reserve’s decision to increase its depository bank reserves. Bank reserves have been rising since Sept. 17, as the Fed purchased securities and financed loans. When the Fed committee cut the rate to zero, it was merely ratifying the de facto rate. Mr. Bernanke seems to know only two amounts: zero and trillions. Before 2008 there were only moderate increases in the Federal Reserve’s aggregate balance sheet numbers, but since then the balance sheet has exploded by trillions of dollars. The increase was spurred by the Fed’s loans to troubled institutions and purchases of securities. Why is easy monetary policy such a sin? Because in such an environment, loans are cheap and borrowers can finance every project that they dream up. This results in excesses, and also increases the severity of the recession that inevitably follows when the bubble bursts. Let’s move on to the sins of omission. After 2007, the Federal Reserve clearly observed that the mortgage loan industry was being transformed into an issuer of securities backed by a pool of mortgages of varying quality. Yet the Fed at no point clearly warned investors that these new instruments were difficult to price. (These securities were backed by everything from top-quality mortgages to subprime ones, and it was difficult to determine what value to assign to different mortgages.) Partly as a result of the Fed’s silence, investors who loaded up their balance sheets with these securities were ignorant of the great risks of trying to sell assets that are difficult to price. Other new instruments, like derivatives, were not risk-free, although the market became enamored of them. The Fed is the manager of markets. There is thus every reason to expect that it would see the problems that these new instruments were likely to create for normal transactions, and speak up about them. The Fed delivered plenty of rhetoric about the importance of transparency, yet failed to articulate its own goals. The market was thus bewildered when the Fed rescued certain

55 firms and not others. Mr. Bernanke should have explained the principles behind these decisions. The market could not understand why the Fed rescued Bear Stearns and then permitted Lehman Brothers to die. As a consequence, there was volatility in the credit and equity markets and a general sense of turmoil that demonstrated that participants were at a loss to understand the functioning of the Fed. Last year, when the credit market became dysfunctional and normal channels for borrowing broke down, the Fed misread the situation. It persisted in believing that the market needed more liquidity, even though this was not a solution to the market disturbances. The real problem was that because of the mysterious new instruments that investors had acquired, no one knew which firms were solvent or what assets were worth. At the same time, these new instruments were being repriced in the market. The firms that owned them then needed to restore their depleted capital. When big firms experienced enormous losses, the Fed did not respond in a way that calmed markets. Most of all, Mr. Bernanke ultimately failed to convince the market that the Fed had a plan, and was not performing ad hoc. I am certain that there are economists whose reputations for outstanding academic work in monetary policy are every bit as distinguished as Mr. Bernanke’s, and who have good judgment and experience within the Federal Reserve System. President Obama should choose one of them. Anna Jacobson Schwartz is an economist at the National Bureau of Economic Research and the author, with Milton Friedman, of “A Monetary History of the United States, 1867 to 1960.” http://www.nytimes.com/2009/07/26/opinion/26schwartz.html?_r=1&ref=opinion

56 Opinion

July 26, 2009 OP-ED CONTRIBUTOR The Great Preventer By NOURIEL ROUBINI LAST week Ben Bernanke appeared before Congress, setting off a discussion over whether the president should reappoint him as chairman of the Federal Reserve when his term ends next January. Mr. Bernanke deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0. Mr. Bernanke understands that in the Great Depression, the collapse of the money supply and the lack of monetary stimulus during contractions worsened the country’s economic free fall. This lesson has paid off. Mr. Bernanke’s decision to keep interest rates low and encourage lending has, for now, averted the L-shaped near depression that seemed highly likely after the financial collapse last fall. To be sure, an endorsement of Mr. Bernanke’s reappointment comes with many caveats. Mr. Bernanke, a Fed governor in the early part of this decade, supported flawed policies when Alan Greenspan pushed the federal funds rate (the policy rate set by the Fed as its main tool of monetary policy) too low for too long and failed to monitor mortgage lending properly, thus creating the housing and credit and mortgage bubbles. He and the Fed made three major mistakes when the subprime mortgage crisis began. First, he kept arguing that the housing recession would bottom out soon (it has not bottomed out even three years later). Second, he argued that the subprime problem was a contained problem when in reality it was a symptom of the biggest leverage and credit bubble in American history. Third, he argued that the collapse in the housing market would not lead to a recession, even though about one-third of jobs created in the latest economic recovery were directly or indirectly related to housing. Mr. Bernanke’s analysis was mistaken in several other important ways. He argued that monetary policy should not be used to control asset bubbles. He attributed the large United States current account deficits to a savings glut in China and emerging markets, understating the role that excessive fiscal deficits and debt accumulation by American households and the financial system played. Still, when a liquidity and credit crunch emerged in the summer of 2007, Mr. Bernanke engineered a U-turn in Fed policy that prevented the crisis from turning into a near depression. He did this largely with actions and programs that were not in the traditional toolbox of monetary policy. The federal funds rate was effectively pushed down to zero to reduce borrowing costs and prevent the collapse of consumer demand and capital spending by business. New programs encouraged skittish institutions to resume lending. For the first time since the Great Depression, the Fed’s role as lender of last resort was extended to investment banks. Mr. Bernanke also introduced a wide range of other programs, like those to maintain the functioning of the commercial paper market (which makes short-term loans to companies so they can cover operating expenses like payrolls). The Fed was involved directly in the rescue of financial institutions like Bear Stearns and American International Group. It lent

57 money to foreign central banks to ease a global shortage of dollars. The Fed even committed to purchasing up to $1.7 trillion of Treasury bonds, mortgage-backed securities and agency debt to reduce market rates. These are all radical actions that had almost never been undertaken before. Some of these moves have raised important questions: Did the Fed help bail out institutions that should have been allowed to fail? Did it cause moral hazard as reckless lenders and investors were effectively bailed out? How and when will the Fed mop up the excess liquidity that its actions have created? Will these actions eventually cause inflation and a sharp fall of the value of the dollar? Has the Fed lost its independence as it has accommodated the fiscal needs of the government by bailing out banks and printing money to cover large fiscal deficits? Still, the basic point remains: The Fed’s creative and aggressive actions have significantly reduced the risks of a near depression. For this reason alone Mr. Bernanke deserves to be reappointed so that he can manage the Fed’s exit from its most radical economic intervention since its creation in 1913. Nouriel Roubini is a professor of economics at the New York University Stern School of Business and the chairman of an economic consulting firm. http://www.nytimes.com/2009/07/26/opinion/26roubini.html?_r=1

From The Times July 28, 2009 The West can’t spend. China won’t spend We need Chinese consumers to start splashing the cash. Will they break the habit of a lifetime? Carl Mortished

Arrogant and rich, Victorian Britons were once the ugly face of world tourism. In the 20th century, the crown of shame passed to America. Yanks in slacks became objects of scorn and ridicule from the Louvre to the Uffizi. Debt and the shrinking dollar have upset America’s claim to the title of world’s most despised foreign visitor. A new aspirant has taken up the challenge of bringing sartorial shame to the world’s fleshpots. From Bondi Beach to Phuket, the Chinese tourist is making waves. Taiwan turned up its nose last year when mainland Chinese arrived after six decades of travel bans. Locals complained about spitting, loud voices and boorish behaviour. For their part, the Chinese tourists found Taiwan “tatty and rundown”. Complaints about uncouth visitors in Thailand prompted China’s Spiritual Civilisation Steering Committee to provide guides on behaviour abroad. Even so, America and Europe are hoping for an invasion because these new Victorians have something that speaks louder than manners: cash. After months of nail-biting worry in the workshop, Beijing’s mechanics have coaxed China’s engine out of low gear. Primed with billions of dollars of government funds, the economy is at cruising speed and expected to move into the fast lane this year. The Shanghai stock market is up 85 per cent since the beginning of the year. Last week the company that built the Water Cube aquatic centre at the Beijing Olympics raised $7.3 billion in its first public offering. Investors put up 35 times as much money as there were shares on offer. The Chinese economy expanded by 7.9 per cent in the second quarter compared with 6.1 per cent in the first, bank lending is up 35 per cent and real estate investment 18 per cent since the start of the year. Buyers are returning to the homes market and car showrooms in droves, while property developers are back in the game. US and European estate agents hope some of this money will trickle into their bombed- out markets. Where Russian oligarchs swaggered in Hampstead and Cap d’Antibes, we may soon find Chinese tycoons. So fast and so unexpected is the recovery that Morgan Stanley reckons China may be decoupling from the rest of the world. Like Shanghai’s superfast Maglev train, the China express is breaking free from America’s diesel loco, flying over the rusting rails of the economy. China lacks our over-borrowed banks, our ballooning government debt and insolvent households but it still needs us, the customers. We have stopped buying the stuff that comes out of Guangdong’s factories. Instead, the Beijing Government is keeping things moving by spending its rainy-day money. Meanwhile, the Chinese people, the world’s greatest savers, are still hiding half their disposable income under the mattress. HSBC’s

59 economists reckon that 80 per cent of the GDP increase was engineered by hundreds of billions of stimulus renminbi. Loosened credit restrictions have created a building boom and car purchase frenzy. Investment was up by a third in June over last year as the State bought steel and cement. But exports fell by more than a fifth. In the short-term, the Chinese Maglev can surge ahead, but in the long-term, much depends on a big recovery in US consumption (unlikely) or a sea change in Chinese consumer behaviour (improbable). The world will change utterly when China’s rural millions begin to buy the TVs, fridges and knock-off Prada shoes that we can no longer afford. Chinese retail spending is up by 15 per cent but it is half the rate of growth in investment spending. Consumer price deflation continues; there is investment in cars and new homes but not much cash is frittered away on laptops and lipstick. McDonald’s is so worried about weak Chinese spending that it recently cut back expansion plans. Its rival, Yum Brands which owns KFC, is expecting nil growth in China. Cash is hoarded, not spent on indulgence. There is still no universal pension or health scheme and the Chinese have long memories of hardship and famine. If China is decoupling from the world economy, many want to know where it is headed. Can we afford to go there and do we want to? For more than a decade, we funded our lifestyles with cheap loans made possible by cash surpluses hoarded in China and recycled into Western economies. Now we have no choice but to save and pay back what we borrowed. Our pensions depend on the dividends of mining and oil companies that supply China’s mills but it is not enough. We must begin once again to make things Chinese people might be tempted to buy. China’s recovery is hailed as our salvation. Our leaders plead with China — as Hillary Clinton and Tim Geithner did yesterday — to release a floodgate of aspiring Chinese consumers eager to buy stuff from us. It is not clear how this will happen. The Chinese save, because they don’t entirely trust the future mapped out by their unelected leaders. Our trust should not be taken for granted and we should not let China set the terms of trade. We are entering a world led by a dictatorship that does not believe in individual freedom, the rule of law or even open markets. It is through China’s support and acquiescence that some of the world’s nastiest regimes continue to bully and repress. We bluster about sanctions. Without the support of the world’s most important economy, what does it mean? Carl Mortished is world business editor http://www.timesonline.co.uk/tol/comment/columnists/guest_contributors/article672 9557.ece

Animal spirits rarely stay down for long By Paul Ormerod Published: July 27 2009 19:03 | Last updated: July 27 2009 19:03 The fall in output in the current recession has been sharp. In the US, for example, gross domestic product fell at an annual rate of just above 6 per cent in the two most recent quarters. In Japan, GDP is down by nearly 9 per cent on its 2008 first-quarter peak. The latest UK data suggest output is nearly 6 per cent lower than a year ago, the sharpest fall since 1931. The conventional wisdom is that the steepness of the fall means the recession will be long, and that the recovery when it happens will be anaemic. In the UK, for example, the National Institute of Economic and Social Research argued last week that GDP per head would take five years to get back to pre-recession levels. This was despite an earlier declaration by the think-tank that the UK has been moving out of recession since output reached a trough in March. The UK government projects a fall in GDP of 3.5 per cent for 2009, followed by a rise of 1.25 per cent in 2010 and a 3.5 per cent upswing in 2011. But these official forecasts have been widely criticised as too optimistic. In the US, the consensus among forecasters is that growth at or near trend will not resume until the second half of 2010 and that the 2008 second-quarter peak level will not be regained until the first half of 2011. As late as the autumn of 2008, economic forecasters in general were far too optimistic about 2009. Are these same forecasters now too pessimistic about recovery? The historical evidence reveals a typical pattern of recession and recovery that suggests this may be so. Very few recessions last longer than two years. And most recoveries, once they start, are strong. Since the late 19th century, there have been 255 recessions in western economies. Of these, 164 have lasted just one year and only 32 have lasted for more than two years. In other words, two-thirds of recessions last a single year, and only one in eight lasts more than two years. If we strip out the peculiar circumstances at the end of the two world wars, 70 per cent of all recessions last just one year. The pattern of duration is virtually identical regardless of the size of the initial shock. Even when the initial fall in output has been more than 6 per cent, 70 per cent of recessions have lasted just one year. Even in the 11 examples where the initial fall in GDP was more than 8 per cent in a year, eight recessions only lasted that single year. This does not of course guarantee that the current recessions in western economies will be short-lived, but, equally, the speed of the fall does not imply they will be long. An analysis of recessions since the second world war shows that those lasting one year or less typically end more abruptly. The average growth rate in the year after such a recession was 3.5 per cent, and in the subsequent year 3.8 per cent. This is compatible with the view that short recessions are essentially inventory cycles. Once inventories are reduced to satisfactory

61 levels, normal production levels resume, and fixed capital investment expenditures postponed during the recession are carried out. The 4.8 per cent GDP growth rate projected by the UK government from 2009 to 2011 has been criticised as too optimistic. It is in fact rather modest in this wider context. Recovery was rapid even after the Great Depression. The nature of the economic catastrophe that started in 1929 varied enormously across countries, both in size and duration. The UK escaped relatively lightly with a 6 per cent fall in output spread over two years. In Japan, Denmark and Norway the recession lasted only a single year. But in Germany, Austria, Canada and the US, the cumulative fall in output was between 25 and 30 per cent, with the recession lasting four years in the latter three countries and three in Germany. However, once the recovery began – in different calendar years in different countries – the average rate of growth was strong. GDP growth in the first year after the Great Depression averaged 4.7 per cent, followed by 4.6 per cent in the second and third years. The caveat to all this is that the current circumstances are unusual. But so was the Great Depression. There is some evidence to suggest that, after recession has reached a certain size or duration, recovery is then harder and more sluggish. Keynes’ animal spirits become depressed. But it takes an awful lot to depress them for more than a couple of years. Capitalism seems a pretty resilient beast. The writer is author of ‘Why Most Things Fail’ and a director of Volterra Consulting http://www.ft.com/cms/s/0/5768b08a-7ad7-11de-8c34-00144feabdc0.html

The problem with relying on the dollar to produce a real appreciation in China … Posted on Monday, July 27th, 2009 By bsetser Is now rather obvious. The dollar goes down as well as up. Last fall, demand for dollars rose — in part because Americans pulled funds out of the rest of the world faster than foreigners pulled funds out of the US. The dollar soared. As the crisis abated though, demand for US financial assets fell and Americans regained their appetite for the world’s financial assets. Not surprising, over the last few months, the dollar has depreciated. And since — at least for now — China’s currency is tightly pegged to the dollar, the RMB also has depreciated. Fairly significantly. The real exchange rate index produced by the BIS suggests that, in real terms, the RMB is back where it was last June. That is when China more or less gave up on its policy of letting the RMB appreciate against the dollar and went back to something that looks like a simple dollar peg.

Does the RMB’s recent depreciation matter? I think so. To start, China looks to be leading the world out of the current slump. That normally would result in an appreciating, not a depreciating, currency. As importantly, there is now plenty of evidence that a weak RMB does have an impact on the pattern of global trade. A big impact. The boom in China’s exports that characterized this decade came after the dollar’s 2002- 2004 depreciation produced a significant real depreciation of China’s RMB — a depreciation that came just as a host of internal reforms pushed China’s own productivity up. The net result: a huge export boom.*

The average rate of growth in China’s exports in the years that followed the RMB’s depreciation was certainly far higher than the average rate of growth in the years when a a strong (and rising) dollar produced a strong (and rising) RMB.

Yes, the 1997-2002 period includes a US recession and the 2003-2007 period doesn’t. But the recovery started in 2002, so looking at the 1997-02 period picks up a recovery as well as a recession. And the 2003-2007 period was also influenced by a US slowdown — as for that matter is the 2003-2008** period. The US economy, remember, started to cool at the end of 2006. I don’t think that much stronger average US growth in 03-07 (or 03-08) relative to 97- 02 is the best explanation for the difference in the average rate of growth in China’s exports over these two periods. To be sure, the weak RMB isn’t the only driver of China’s export success. But the host of factors that make China an exporting powerhouse — increasingly skilled labor, a growing network of firms that supply needed components, a lot of accumulated know-how in manufacturing, good infrastructure and the like — normally would push the real exchange rate up. It took the combination of all these ingredients and the RMB’s real depreciation from 2002-2005 to generate the mother of all export booms. And to me it is surprising that China’s real exchange rate at the end of June 2008 isn’t any higher than it was in late 2001 or early 2002. In every other respect China is a very different place. Lest we forget, in 2001 China’s exports only totaled $270 billion. That total was

64 brought down by the US recession, but in 2002, China’s exports were still only $325 billion. By 2008 they had reached $1425 billion. They are falling now, but it was still a phenomenal increase — and one that in my view was the product, at least in part, of a slew of Chinese government policies, including the decision to intervene heavily to limit the RMB’s appreciation against the often depreciating dollar, that favored export growth over domestic demand growth. As Simon Johnson observes, China itself made the decision to accumulate a huge pile of dollar and euro reserves, reserves that now clearly far exceed what China needs to guarantee its own financial stability. Remember, when exports were booming, China was running a tight fiscal policy and limiting domestic lending - -and thus restraining domestic demand growth. As the following graph — from David Boucher of the University of Montreal — shows, the loan to deposit ratio in China’s banks was generally falling during China’s export boom.

That was especially true from 2004 on, after Chinese policy makers opted to curb domestic inflation — which picked up in 2003 — by restraining lending rather than by letting the RMB appreciate. China could have opted for a different macroeconomic policy mix back then — one that might have limited the growth in China’s current account surplus. That in turn would have meant that China was less able to supply the US with financing, something that might have helped the US avoid a few of its own financial excesses. UPDATE: Don requested data on export and import growth. Here is the data, shown as a y/y change in billions of dollars in a 3m moving average of China’s exports and imports v the real exchange rate. Import growth failed to keep up with export from the end of 2003 to the end of 2007, something that I attribute to the combination of the depreciation in China’s RER from a level of 110 or above on the BIS index to a level consistently below 100 on the BIS index and China’s fateful decision to make a nominal renminbi depreciation consistent with low inflation by restraining lending growth and tightening fiscal policy. The moves in China’s imports since 2007 were strong influenced by gyrations in the price of oil, and then the global collapse of trade.

Not surprisingly, China’s trade surplus was rising during this period. The following charts shows the y/y change in China’s rolling 3m trade surplus, also in dollar billion.

More recently, China’s surplus moved up (in q4 2008) and then fell (in q2 2009), which is presumably one reason why the IMF’s forecasts of China’s trade surplus — as Menzie Chinn recently noted — haven’t been all that stable. * Exports are presented as a rolling 12m sum, in $ billion. ** Technically, I looked at the average y/y growth in a 3month moving average. Adding 2008 to the data doesn’t change much; average export growth from 2003 to 2008 was 28%. Adding 2009 in will bring the average down, but sorting out cause and effect is a bit hard, as the RMB appreciated as the global economy slowed. I would attribute most of the fall in China’s exports to the slowdown, but that no doubt will be debated. http://blogs.cfr.org/setser/2009/07/27/the-problem-with-relying-on-the-dollar-to- produce-a-real-appreciation-in-china/

66 And now, the rest of the story: long-term portfolio flows have fallen by more than the trade deficit

Posted on Monday, July 20th, 2009 By bsetser The goods news: the US trade deficit has shrunk. On a rolling 12m basis the trade deficit is down to around $500 billion, and the data from the last few months suggests that it should fall even further. The bad news: the US trade deficit hasn’t shrunk by as much as foreign demand for US long- term assets.

My graph only showed inward portfolio flows. That isn’t the entire balance balance of payments. But inward and outward FDI flows tend to offset each other. And in general Americans have been adding to their foreign portfolio, not reducing their foreign holdings. That means the (remaining) deficit is increasingly financed by short-term flows, which isn’t the most comfortable thing in the world. All this is pretty clear if you look at the details of the last TIC data release (already covered in depth by Rachel). Over the last three months, private investors reduced their US holdings by over $100 billion (line 31). That total was offset by the repayment of the Fed’s swap lines — but the long-term flow picture isn’t great. Net portfolio inflows over the last 12ms totaled $188 billion (line 19). After adjusting for repayment of ABS, that total falls to zero (lines 20 and 21). As the following graph shows, net private demand for long-term US assets — that is gross long-term private portfolio inflows net of US portfolio outflows — started to disappear in late 2006, and then took another down leg after the subprime crisis broke in August 2007. And over the last 9 months, official demand for US long-term bonds also disappeared — as reserve growth slowed (until recently) and central banks moved in mass toward short-term treasury bills.

The split between official and private flows in the chart reflects my adjustments to the TIC data – but my adjustments basically just make the TIC data match the US survey data and the revised BEA data on official flows.* My adjustments change the official/ private split, but not the total. The usual narrative would argue that the fall in demand for US long-term assets is a reflection of foreigners concerns about the scale of the US fiscal deficit. That though isn’t really the case. Demand for long-term Treasuries has held up better than demand for almost all other kinds of US assets. The reality is that the rest of the world has lost confidence in claims on the US private sector, not in claims on the US government. Consider the following chart …

The higher frequency data tells a similar story. Net (private) demand for US long-term financial assets (private demand for US long-term assets from the rest of the world, net of US purchases of long-term foreign assets) hasn’t been strong for some time. It picked up in the crisis, as flows contracted in a way that favored the US. Americans sold their foreign portfolio faster than the rest of the world sold their US portfolio. But as the crisis has abated, net private demand for US assets has fallen off. Foreign demand for long-term US assets remains weak – and over the last few months Americans resumed buying foreign assets.

Incidentally, this chart is one of many that suggests, at least to me, that the US could not have sustained large deficits over the past few years if the US had been forced to finance its deficits in the private markets. The demand wasn’t there. Not on the scale that was needed. ** For a while, official purchases of long-term assets offset weakness in private demand. But after the crisis, risk-adverse reserve managers have preferred short-term bills – so demand for long-term US assets from central bankers largely disappeared.

There are some tentative signs that central banks are once again buying Treasury notes, at least short-dated ones. My estimates suggest that official purchases of long-term US financial assets are trending up again — largely because of purchases of Treasuries through London.*** Even so, there was — at least in the three months to May — still a sizable gap between net demand for US long-term financial assets and the US trade deficit. The (much reduced) trade deficit is being financed by short-term inflows, and specifically short-term official inflows. That isn’t ideal. The “quality” of the financing of the US deficit has gone down. The fall in the trade deficit has, in my view, reduced the risk of a disruptive dollar adjustment — at least relative to the pre-crisis world where the slow growing US was running 6% of GDP or so current account deficits, deficits that private investors showed little sign of wanting to finance. Analysts who emphasize the rise in the fiscal deficit tend to ignore the (even bigger) fall in private sector borrowing and corresponding fall in the United States total

69 external financing need. But finding the financing to cover a period of adjustment is never easy; the US isn’t yet out of the woods. * Using the methodology described in my work with Arpana Pandey, I attributed some of long-term Treasury and Agency purchases through the UK (and for Agencies, Hong Kong) to official buyers on an ongoing basis. This avoids the jumps characteristic of the annual survey revisions. I also adjusted official equity purchases for Chinese purchases through Hong Kong from 2005 on, using a similar methodology. There was a big jump in Hong Kong’s equity purchases in early 2007, and the survey data subsequently attributed those purchases to China. The overall data should be fairly close to the BEA’s revised data series – though I didn’t adjust official purchases of corporate bonds down to reflect the survey revisions (apparently central banks do not use US custodians for this exposure), as I suspect that the data actually understates the official sector’s true exposure to corporate credit. Private fund managers did a lot of things to get a bit of extra yield, and some central banks made increasingly use of private fund managers when they themselves were reaching for a bit of yield. **A counter argument is that official demand displaced private demand, but didn’t change the overall equilibrium. This has two components. First, if say China’s government hadn’t been building up claims on the US and Europe, private Chinese investors would have bought the same amount of US and European assets (something I don’t believe). And second, if say China had bought more European assets and fewer US assets, private investors in Europe would have shifted funds from Europe to the US – keeping the US deficit up. That argument has a grain of truth, but it assumes a bit more substitutability between US and European assets (including a willingness to take unhedged currency risk) than I suspect is present in the market. *** The UK’s Treasury holdings rose by about $30 billion over the last three months. http://blogs.cfr.org/setser/2009/07/20/and-now-the-rest-of-the-story-long-term-portfolio- flows-have-fallen-by-more-than-the-trade-deficit/

70 Companies. Banks Europe braced for rising credit card defaults By Jane Croft and Megan Murphy in London and Francesco Guerrera in New York Published: July 26 2009 21:09 | Last updated: July 26 2009 21:09 Lenders in Europe bracing themselves for a rising wave of consumer debt defaults as the credit card crisis that has caused billions of dollars in losses among US banks spreads across the Atlantic. The International Monetary Fund estimates that of US consumer debt totalling $1,914bn, about 14 per cent will turn sour. It expects that 7 per cent of the $2,467bn of consumer debt in Europe will be lost, with much of that falling in the UK, the continent’s biggest nation of credit card borrowers. National Debtline of the UK said that the number of calls it had received from UK consumers worried about loans, credit cards and mortgage arrears had reached 41,000 in May – double the 20,000 calls it had received in May 2008. It added that the number of calls showed no sign of abating. In the US, credit card defaults have been rising for months as a spike in unemployment and the most severe economic downturn since the Great Depression took their toll on overstretched consumers. Banks such as Citigroup, Bank of America, JPMorgan Chase and Wells Fargo and credit card issuers such as American Express have suffered billions of dollars in losses in their credit card portfolios and have warned of more to come. The rate of US credit card losses has overtaken the rate of unemployment in recent months – a highly unusual occurrence that makes it more difficult for card issuers to forecast future losses. In the UK, the latest credit card indices from Moody’s, the ratings agency, show that annualised charge-off rates have risen from 6.4 per cent of loans in May 2008 to 9.37 per cent in May 2009. In the US, that rate is above 10 per cent. Analysts expect further defaults as UK unemployment rises and personal insolvencies, which reached 29,774 in the first quarter of the year, continue to increase. The falling UK housing market and more stringent lending requirements by banks has also meant that indebted consumers can now no longer rely on withdrawing equity from their homes to pay off other debts such as credit cards or unsecured loans. Jonathan Pierce, analyst at Credit Suisse, said in a recent note that UK credit card securitisation had suffered “a very sharp rise in arrears to a level well beyond the previous peak seen in 2006”. UK banks, which begin reporting their first-half results next week, have already warned that they faced a sharp increase in credit card debts, although this is relatively small in the context of writedowns in other areas such as commercial lending.

71 Barclays, the UK’s biggest credit card lender with 11.7m UK customers through Barclaycard, said in May that UK credit card delinquencies had increased in the first quarter of the year, reflecting adverse economic conditions and rising unemployment. As a result it had been reducing credit limits and tightening approval rates for new credit cards which were running at less than 50 per cent in March. Lloyds Banking Group also said in May it had seen impairments rise in both secured and unsecured lending. Lloyds will have to absorb any future losses on credit cards itself as it has not been able to include credit card loans among the £260bn of toxic assets it has insured with the UK government. With UK trends tending to trail the US by six months, analysts will be in particular watching the reporting season closely for any signs that default rates on UK securitised credit card debt is rising. The severity of the financial crisis coupled with rising unemployment on both sides of the Atlantic have stoked fears of a substantially higher default rate in the coming months. Copyright The Financial Times Limited 2009 http://www.ft.com/cms/s/0/02db48fa-7a11-11de-b86f-00144feabdc0.html

ANÁLISIS: Primer plano Una pronta recuperación: ¿ficción o realidad? PAUL A. SAMUELSON 26/07/2009

Hay un cuento de un muchacho que solía gritar "que viene el lobo" cuando en realidad no había un lobo. Al final, el chico gritó "que viene el lobo" cuando de hecho había un lobo feroz, pero nadie le hizo caso. Desde que empezó la crisis mundial en 2007, los expertos de Wall Street y el Gobierno han estado proclamando con alegre optimismo que se producirá una recuperación mundial significativa en la segunda mitad de 2009 o en el primer trimestre de 2010. Por consiguiente, como en épocas anteriores, nos dicen que sólo debemos temer al miedo. Pues bien, ya hemos entrado en la segunda mitad de 2009. Sí, y el desempleo sigue aumentando, al igual que las quiebras y las ejecuciones hipotecarias. A pesar de las admirables operaciones de rescate del equipo de Obama, el Banco de Inglaterra y el Banco Central Europeo, se mantiene el círculo vicioso de consumidores e inversores demasiado asustados para gastar. El desempleo seguirá empeorando y la baja tasa de crecimiento del PIB persistirá. Es racional que un banco rescatado tenga miedo de conceder préstamos arriesgados. (En tiempos de recesión grave, casi todas las operaciones les parecen arriesgadas a los banqueros racionales). ¿Por qué no pueden los bancos centrales ortodoxos impedir que se aceleren las recesiones? Pronto los activos oficiales a plazo más corto experimentan rendimientos cercanos a cero, y con esos tipos todo el mundo se paraliza y se convierte en un acaparador. Los macroeconomistas que estudiaron en las décadas de 1970 y 1980 en las elitistas Harvard, Chicago, Princeton, Stanford y MIT tardaron en comprender lo obvio. ¡Viejos excéntricos de 94 años podían enseñarles más acerca de la "economía del desequilibrio"! Cuando unos cuantos advertimos, ya en la primavera de 2007, que una recuperación significativa podría retrasarse años, éramos sólo una minoría de lunáticos.

73 Sí, Japón podía experimentar una década perdida, pero los ingenieros financieros académicos supuestamente habían creado para Occidente nuevas herramientas de medición del riesgo que permitían ampliarlo y controlarlo. Los listos no tendríamos décadas perdidas. Hermosa fábula. Sí, esas herramientas de ingeniería financiera, inventada por gente de instituciones como el MIT, Chicago y la Wharton School, podrían haber tenido una función útil. Pero si sustituimos la ficción por hechos, jamás conocerán a un consejero delegado que entendiera de verdad estas endemoniadas herramientas nuevas. En lugar de controlar el riesgo, las nuevas herramientas -permutas financieras, opciones de compra y de venta, paquetes titulizados de préstamos hipotecarios- en la forma de inversión financiera no reglamentada que se dio durante el mandato de Bush eliminaron de hecho toda transparencia y fomentaron un peligroso hiperendeudamiento. Resultado: un sistema financiero ultrafrágil, tendente a los desplomes y a las crisis mundiales que hemos visto en 2007-2009. El ingenioso secretario del Tesoro de Obama, Timothy Geithner, anuncia que las ayudas públicas ya están funcionando y que podemos prever una recuperación inminente, aunque necesitamos un poco de paciencia. Se equivoca. El rescate del necesario gasto sostenido en la economía real apenas ha comenzado. Sin eso, como descubrió el New Deal en la década de 1930, la recuperación es imposible. Sí, de no haber sido por las masivas ayudas de Geithner y Bernanke, a estas alturas podrían correr ríos de sangre por las calles estadounidenses. ¿Pero ha hablado algún miembro del maravilloso equipo económico de Obama día y noche sobre la necesidad de enviar dinero a la economía real para fomentar el gasto y el regasto sostenido? No. Paradójicamente, China, un país despótico con un solo partido, nos ganará a todos a la hora de lograr una recuperación macroeconómica significativa porque no para de acumular nuevo gasto deficitario. Cuando empecé de adolescente los estudios de posgrado en la Chicago Midway, en 1932, era la peor época de la depresión posterior a 1929. El presidente republicano Herbert Hoover y su multimillonario secretario del Tesoro, Andrew Mellon, con su agarrotado inactivismo, perdieron casi dos años tras el desplome de Wall Street en 1929, un retraso lo suficientemente grande como para provocar quiebras bancarias autogeneradas y un drástico aumento del desempleo. Los actuales especialistas en macroeconomía estaban poco preparados para evitar las catástrofes posteriores a 2006. Mientras parloteaban sobre transparencia y control de la inflación, no veían que Roma empezaba a arder. Sus libros de texto, ya fuesen de introducción o de macroeconomía avanzada, no hablaban de "trampas de liquidez" ni de "paradojas del ahorro", por las cuales el intento de los ciudadanos y de las empresas de ahorrar más sólo sirve para matar el gasto en la economía real, en lugar de aumentarlo. Lo que más cuenta es proporcionar fondos sostenidos a quienes estén dispuestos a gastarlos. Ahora, en el segundo semestre de 2009, es demasiado tarde para empezar a gastar en proyectos de infraestructuras de ejecución inmediata. Estados y municipios necesitan ayuda para cubrir sus necesidades presupuestarias y tardan tiempo en alcanzar un acuerdo legislativo sobre la manera de afrontar el déficit y de gastar los fondos de estímulo del Gobierno central. Los Estados con problemas gastarán todo lo que se les dé. Por tanto, olvidemos esas prometedoras afirmaciones de que de aquí a pocos meses se producirá una recuperación significativa.

74 El difunto Charles Kindleberger, experto en manías y crisis financieras, reiteraba la insistencia del victoriano Walter Bagehot en que todo sistema capitalista necesita un "prestamista de último recurso". Si viviera hoy, el profesor Kindleberger insistiría en que también necesita un "gastador de último recurso": el Gobierno. Los congresistas republicanos no entienden estos principios básicos, como tampoco los entienden unos cuantos demócratas del Congreso. Los retrasos son crucialmente mortales ahora que la recesión empieza a autorreproducirse al estilo gallina-huevo-gallina. Sólo Obama tiene carisma y popularidad para insistir en el significativo gasto deficitario nuevo y sostenido que se necesita. Sí, gasto deficitario. Hizo falta la astucia y la elocuencia de Franklin Roosevelt para mover las cosas y mantener la recuperación del New Deal. El aborrecible dictador Adolf Hitler, empeñado en llevar a cabo una futura guerra de venganza, usó de manera similar el gasto deficitario para recuperar el pleno empleo en Alemania en 1939. Esperemos que las democracias del siglo XXI alcancen pronto los acuerdos necesarios para restaurar la cordura económica. http://www.elpais.com/articulo/semana/pronta/recuperacion/ficcion/realidad/elpepueconeg/20 090726elpneglse_5/Tes

El poder de convocatoria de la ministra Corredor Beatriz Corredor, seguramente ajena a todos los cuchicheos sobre fusiones y compras entre las entidades financieras, estaba el miércoles exultante. La ministra de Vivienda reunió en la sede ministerial nada menos que a 123 entidades (15 de ellas calificadas como colaboradoras) para firmar el Plan de Vivienda y Rehabilitación 2009-2012, con una aportación de 10.000 millones y que movilizará 34.000. Por allí pasaron casi todos los presidentes de las cajas de ahorros y algunos primeros ejecutivos de los bancos. Un alto en el camino de tanto traqueteo para gloria de la ministra.

TRIBUNA: Laboratorio de ideas JEFFREY D. SACHS Grandes metas y problemas no resueltos

JEFFREY D. SACHS 26/07/2009 Un aspecto extraño y preocupante de la política mundial actual es la confusión entre negociaciones y resolución de problemas. Conforme a un calendario acordado en diciembre de 2007, disponemos de seis meses para alcanzar un acuerdo mundial sobre el cambio climático en Copenhague. Los Gobiernos están inmersos en una enorme negociación, pero no en un esfuerzo enorme para resolver los problemas. Cada uno de los países se pregunta: "¿cómo puedo hacer lo menos posible y que los demás países hagan lo más posible?", cuando, en realidad, deberían estar preguntándose: "¿cómo debemos cooperar para lograr nuestros fines compartidos con el mínimo costo y el máximo beneficio?". Puede parecer lo mismo, pero no lo es. Abordar el problema del cambio climático requiere reducir las emisiones de dióxido de carbono procedentes de combustibles fósiles, lo que, a su vez, entraña opciones en materia de tecnología, algunas de las cuales existen ya, mientras que gran parte de ellas se debe idear. Por ejemplo, las centrales eléctricas de carbón, para que puedan seguir siendo un elemento importante del conjunto de fuentes de energía, tendrán que capturar su CO2, proceso denominado "captura y almacenamiento de carbono" (CAC). Sin embargo, no está probada la eficiencia de esa tecnología. Asimismo, hará falta una nueva confianza pública en una nueva generación de centrales nucleares que sean seguras y estén supervisadas de forma fiable. Harán falta nuevas tecnologías para movilizar las energías solar, eólica y geotérmica en gran escala. Podríamos intentar aprovechar los biocombustibles, pero sólo de modo que no compitan con el suministro de alimentos ni con activos medioambientales valiosos. Sigue la lista. Será necesaria una mayor eficiencia energética, mediante "edificios ecológicos" y electrodomésticos más eficientes. Habrá que sustituir los automóviles con motores de combustión interna por vehículos híbridos o híbridos enchufables o accionados por baterías o accionados por baterías de combustible. Para lograr una nueva generación de vehículos eléctricos, hará falta un decenio de colaboración entre el sector público y el privado para conseguir un desarrollo tecnológico básico (como baterías mejoradas), una red eléctrica más sólida, una nueva infraestructura para recargar los automóviles y muchas cosas más. Asimismo, hará falta un decenio de inversiones públicas y privadas para demostrar la viabilidad de las centrales eléctricas de carbón que capturen su dióxido de carbono. El cambio a las nuevas tecnologías no es principalmente un asunto de negociación, sino también de ingeniería, planificación, financiación e incentivos. ¿Cómo puede el mundo desarrollar, demostrar y después difundir esas nuevas tecnologías de la forma más eficaz? En los casos en que no sea probable que los beneficios vayan a parar a inversores privados, ¿quién debe pagar los primeros modelos de demostración, que ascenderán a miles de millones de dólares? ¿Cómo debemos preservar los incentivos privados para la investigación y la innovación y al tiempo comprometernos a transferir las tecnologías logradas a los países en desarrollo? Se trata de cuestiones urgentes y no resueltas. Sin embargo, las negociaciones mundiales sobre el cambio climático se están centrando en un conjunto diferente de cuestiones. Las negociaciones versan principalmente sobre qué grupos de países deben reducir sus emisiones, en qué medida, con qué

76 rapidez y en relación con qué año de referencia. Se está apremiando a los países para que reduzcan las emisiones en 2020 a más tardar conforme a determinadas metas de porcentaje, sin examinar demasiado en serio cómo se pueden lograr las reducciones. Naturalmente, las respuestas dependen de las tecnologías de bajas emisiones de que se disponga y de la velocidad con que se pueda desplegarlas. Pensemos en Estados Unidos. Para reducir las emisiones marcadamente, deberán cambiar a una nueva flota de automóviles, accionados cada vez más por electricidad. También deberán decidir la renovación y ampliación de sus centrales nucleares y la utilización de terrenos públicos para construir nuevas centrales de energías renovables, en particular de energía solar, y necesitarán una nueva red eléctrica para transportar la energía renovable desde las zonas con poca densidad de población -como los desiertos surorientales en el caso de la energía solar y las llanuras septentrionales en el de la energía eólica- hasta las zonas de gran densidad de población de las costas. Sin embargo, todo eso requiere un plan nacional, no simplemente una meta de reducción de las emisiones. Asimismo, China, como Estados Unidos, puede reducir las emisiones de CO2 mediante una mayor eficiencia energética y una nueva flota de vehículos eléctricos, pero China debe examinar esa cuestión desde el punto de vista de una economía dependiente del carbón. Las opciones futuras de China dependen de si de verdad el "carbón limpio" puede funcionar eficazmente y en gran escala. Así pues, la vía para la reducción de las emisiones de China depende decisivamente de unos prontos ensayos de las tecnologías CAC. Conforme a un verdadero planteamiento cooperativo mundial, se examinarían primero las mejores opciones tecnológicas y económicas disponibles y la forma de mejorarlas mediante actividades concretas de investigación e innovación y mejores incentivos económicos. En las negociaciones se examinarían las diversas opciones posibles para cada uno de los países y las regiones -desde el CAC hasta las energías solar, eólica y nuclear- y se esbozaría un calendario para una nueva generación de automóviles de bajas emisiones, sin dejar de reconocer que la competencia en el mercado y la financiación pública impondrán el ritmo real. A partir de esas bases, el mundo podría asignar los costos de la aceleración del desarrollo y la difusión de las nuevas tecnologías de bajas emisiones. Ese marco mundial sostendría las metas nacionales y mundiales de control de las emisiones y de supervisión de los avances de la revisión tecnológica. A medida que se dispusiera de tecnologías de eficiencia comprobada, se fijarían metas más estrictas. Naturalmente, una parte de la estrategia consistiría en la creación de incentivos de mercado para las tecnologías de bajas emisiones a fin de que los inversores pudieran desarrollar sus ideas con la perspectiva de obtener grandes beneficios, en caso de que sean acertadas. Podría parecer que mi petición de que se examinen los planes y las estrategias junto con las metas concretas en materia de emisiones entraña el riesgo de impedir las negociaciones, pero si no tenemos una estrategia que acompañe a nuestras metas, los Gobiernos del mundo podrían no aceptar dichas metas, para empezar, o podrían aceptarlas cínicamente, sin una auténtica intención de cumplirlas. Hemos de reflexionar en serio y en colaboración sobre las opciones tecnológicas reales del mundo y después perseguir un marco común mundial que nos permita pasar a una nueva era, basada en tecnologías viables y sostenibles para la energía, el transporte, la industria y los edificios. - http://www.elpais.com/articulo/semana/Grandes/metas/problemas/resueltos/elpepueconeg/200 90726elpneglse_6/Tes?print=1

REPORTAJE: Empresas & sectores Los inversores temen a la biotecnología La falta de financiación puede abortar un sector en el que España podría situarse en vanguardia

FERNANDO BARCIELA 26/07/2009 El sector biotecnológico español, que cumple sus primeros 10 años de vida (la fundación de la patronal ASEBIO), celebra la efeméride en clave agridulce. Después de haber crecido con ímpetu, resulta que ahora las reticencias del capital riesgo y del inversor pueden dar al traste con un sector llamado a jugar un papel de primera línea en el nuevo modelo productivo auspiciado por el Gobierno. Y esto sería imperdonable una vez que España ha logrado situarse en los primeros puestos de la biotech mundial. "Somos el octavo país del mundo en número de biotecnológicas", afirma Isabel García Carnero, secretaria general de ASEBIO, "con 257 empresas"; es decir, casi cuatro veces las que había en 2003 (71). Además, porque estas empresas empiezan a mostrar resultados. En mayo, el sector tenía ya 114 indicaciones farmacológicas en diversas fases de desarrollo. Una, en el mercado (el Yondelis de Zeltia), y otra (el Triflusal de Palau Pharma), muy cerca de su lanzamiento. Esto, en parte, porque, como explica Juan Tomás Hernani, secretario general de innovación, "somos la novena potencia científica en biotecnología". Sólo las empresas del sector, y sin contar con las universidades y centros como el CIMA o el CSIC, registraron el año pasado 117 patentes. Esta calidad científica, las buenas perspectivas de algunas de las moléculas y el interés de los científicos en hacerlas llegar al mercado alentó la creación de empresas como Digna Biotech, fundada a partir del CIMA de la Universidad de Navarra, o Genetrix, puesta en marcha por la actual ministra de Ciencia e Innovación sobre la base de patentes originadas en el CSIC, que se vieron emuladas por decenas de iniciativas. Lo peor es que parece que el sector -y sus necesidades crediticias- ha crecido en exceso para las exiguas posibilidades de financiación disponibles. Ahora mismo hay unas 27 indicaciones en las fases 2 o 3 de desarrollo, justo cuando las necesidades de dinero (por los costes de los ensayos) se multiplican. Dado que estas empresas no han empezado a comercializar el producto y los contratos de licenciamiento son pocos y recientes, sus ingresos son insuficientes para asegurar los costes de desarrollo que les vienen encima. En 2007, la cifra de negocio de nueve de las primeras firmas del sector del I+D biotecnológico para la salud se quedó por debajo de los 17 millones de euros. Cellerix o Biotherapix, de Genetrix, ni siquiera obtuvieron ingresos. ¿De dónde sacan entonces el dinero para funcionar? Básicamente, de las ayudas públicas y el capital riesgo. Pero todo indica que el llamado private equity empieza a mostrarse receloso a la hora de soltar el dinero. La situación, apunta García Carnero, "empezó a deteriorarse en noviembre por la crisis financiera". De hecho, las últimas rondas de financiación no han ido bien. Cellerrix (de Genetrix), con un fármaco en la fase 3 (Ontaril), ha consumido ya 40 millones de euros. A finales de año fue al mercado para hacer una nueva ronda por valor de 25 millones, que no logró cerrar. Pablo Ortiz, director general de Digna Biotech, que ha recibido ya 31 millones de euros (15 de inversores, 10 del Estado y 6 de licencias), explica que su empresa tiene un gran pipeline, con 38 productos, resultado de la investigación del CIMA, "para cuyos proyectos he buscado dinero, pero sin resultado". Uno de ellos, ya en la fase 2, el Interferon (para la hepatitis C), podría quedarse en el camino. "Hemos metido ya ocho millones de euros", apunta Ortiz, "en este producto, pero ha sido imposible tener financiación adicional. Los mismos inversores que se asociaron para financiar el CIMA (con 150 millones) y Digna (con otros 15 millones) -El Corte Inglés, Alicia Koplowitz, Amancio Ortega, el BBVA- están reacios a poner más dinero. Se corre el riesgo de que los resultados del CIMA se queden en el laboratorio".

78 Las dificultades no afectan sólo a España. "Todas las sociedades que han venido invirtiendo en biotecnología lo han reducido al mínimo", reconoce Josep Sanfeliu, socio de Ysios Capital, una firma española especialista en el sector y que hasta ahora sólo ha entrado en Cellerix. Ortiz añade que "en el sector se comenta que en el Reino Unido las compañías locales sólo tienen caja hasta diciembre". Mal de muchos..., ya se sabe, pero la situación se agrava en el caso de España. "A fin de cuentas", explica García Carnero, "hay países que llevan 20 o 30 años, tienen productos consolidados, mientras que aquí apenas llevamos 10 años". El que la biotech española aún no haya tenido tiempo para revelar el potencial de las moléculas en desarrollo es un inconveniente. A lo que habría que añadir el presumible rechazo de EE UU al Yondelis de Zeltia para cáncer de ovario, una noticia que no viene a ayudar. La cautela del inversor tiene su lógica. La biotecnología es un sector de alto riesgo. De 10.000 moléculas que se investigan, sólo una llega al mercado. La tasa de fracaso es altísima en las fases iniciales, antes de la 2, cuando 7 u 8 de cada 10 productos se quedan por el camino. Kenneth Weissmahr, director general de Advancell, que tiene dos indicaciones en fase 1 y otras tres en preclínica, afirma que "la única solución es abordar muchos proyectos. A más productos en el pipeline, más posibilidades. Es una cuestión de media". Ortiz lo pone más crudo. "Sabemos que al final triunfarán apenas 7 de cada 100 empresas de biotech". Altísima incertidumbre, pues. Además, los ciclos de maduración son muy largos. Desde que se inician los ensayos preclínicos hasta que el producto llega al mercado pueden pasar desde 7 años, como mínimo, hasta 12 o 14. Según va avanzado, la seguridad es mayor, pero la inversión exigida también. Y triunfalismos aparte, el estado del pipeline español es incipiente. De las 257 firmas, sólo 25 tienen indicaciones en desarrollo (114). De éstas, sólo 6 han llegado a la fase 2 y nada más que 2 de ellas están en fase comercial o de preparación para el mercado. De los 114, sólo 26 están en fase 2 y posteriores, lo que les da a algunos -los que sobrevivan- ciertas posibilidades de llegar al mercado en 4 a 6 años. Las otras 87 son apenas una promesa. El capital riesgo, que nunca ha dedicado especial atención al sector (apenas 24 millones en 2007, según ASCRI), se aleja. Sociedades como Najeti parecen haber perdido interés. "Queda poco más que Ysios, Suan Pharma y CrossRoadBiotech", reconoce Feliu, quien apunta que "no es que los fondos e inversores se estén retirando, sino que son más selectivos". Tan selectivos que de las 100 empresas que Ysios analizó en el último año, no han seleccionado hasta el momento, al margen de Cellerix, ninguna. La situación se agrava por la actitud de las farmacéuticas, la llamada Big Pharma, como se la conoce en el sector. Pese a que casi todas reducen su actividad en I+D y despiden a miles de científicos, el sector se ha sentado a esperar... los resultados de las firmas de investigación independientes; entre ellas, las de biotech. Algunas farmacéuticas han creado sociedades de private equity o divisiones biotecnológicas que entran en el capital de las biotech emergentes (como Roche o la española Suan Farma), o se han mostrado dispuestas a firmar acuerdos de licenciamiento de fármacos (Isdin, por ejemplo). El problema es que, como explica Ortiz, "no se arriesgan hasta que pasamos la fase 2. Prefieren pagar cifras millonarias cuando el producto es ya muy seguro antes que apoyar a empresas cuando las moléculas están en fases iniciales. Una actitud que bloquea al sector, por lo que creo que deberían implicarse más". La situación ha provocado suficiente preocupación como para que toda la biotecnología europea se haya puesto de acuerdo. "Trabajamos con la patronal europea, EuropaBio", dice García Carnero, "para elaborar unas recomendaciones que se van a presentar a Bruselas, y aquí estamos en contacto con Ciencia e Innovación para la adopción de medidas. El sector necesita liquidez ya". Después de subrayar que la biotech está considerada por el Gobierno "como un sector clave y con gran capacidad de arrastre, en el que hemos inyectado más de 400 millones en los últimos cinco años", Tomás Hernani confirma que algunas de las medidas están ya en marcha. "El CDTI, que en estos cinco años ha financiado 196 proyectos con 112 millones, doblará este año su actividad de 2008. También estamos aplicando la no exigencia de aval para las pymes y se va a adelantar el 25% de las ayudas -que antes se daban a posteriori-, además de que queremos potenciar la alianza entre el capital riesgo público y privado". La prioridad es, sin duda, salvar un sector, del que Ortiz, de Digna, se muestra orgulloso. "Podemos morirnos, pero nadie puede decir que hayamos perdido la carrera. Antes ni estábamos en el mapa, antes no había biotech en España; ahora la hay". http://www.elpais.com/articulo/empresas/inversores/temen/biotecnologia/elpepueconeg/20090726elpnegemp_2/Tes?print=1

REPORTAJE: Empresas & sectores ARIADNA TRILLAS 26/07/2009 'Wait & see' para invertir Las empresas de EE UU paralizan o recortan sus proyectos en España

ARIADNA TRILLAS 26/07/2009 Estados Unidos, responsable de una quinta parte de toda la inversión extranjera que llega tradicionalmente a España y origen de numerosas implantaciones de carácter industrial en este país, afloja al ritmo cansino de la crisis. Sus 553 compañías con un pie instalado en el mercado español no escapan del sentimiento de parálisis, prudencia y temor por el futuro incierto que envuelve a la economía global y, en particular, a la economía española. Más de la mitad de las empresas encuestadas por la escuela de negocios ESADE para la Cámara de Comercio de EE UU en España confiesa que bien meterán en un cajón cualquier atisbo de nueva inversión, bien revisarán a la baja los proyectos que hubieren puesto sobre la mesa. Y otro tercio se conforma con quedarse como está. De modo que sólo 13 de cada 100 sacarán pecho con más dinero. El año pasado, inmerso ya de lleno en la crisis, el

80 mismo barómetro marcaba un panorama más halagüeño, en el que un 66% de las multinacionales se decía que mantendría o aumentaría sus planes inversores. El empresario americano parece, pues, deprimido. "Bueno, es un sentimiento general que abunda entre los empresarios españoles. Las empresas de Estados Unidos no van a ser ninguna excepción", comenta al respecto Jaime Malet, presidente de la Cámara de Comercio Americana en España, que no deja por ello de subrayar tanto el aguante de las inversiones en marcha, al menos hasta ahora, como el "largo camino por recorrer" que les queda en este país a las compañías estadounidenses. Si en España tienen presencia 553 de ellas, en Francia la cifra escala a 1.800. Por no hablar del Reino Unido, donde se cuentan cerca de 11.000. "España necesita redefinirse para atraer nuevas inversiones, algo que empieza a hacer", reflexiona Malet, para quien el cambio de inquilino en la Administración estadounidense, por sí mismo, no va a tener efecto alguno sobre las relaciones comerciales. Sobre el trasfondo del duro pulso triangular que libra el Gobierno español con sindicatos y patronal empresarial en relación con el diálogo social, la Cámara se apunta a la flexibilidad laboral, además de al coro de voces en favor de un sistema fiscal "menos complejo y más competitivo". Las respuestas sobre las pegas para implantarse en España que argumentan las empresas (son 97 los pesos pesados que responden, de la General Motors a General Electric, pasando por Pfizer, IBM, Nike o Citigroup, por citar a unas pocas) en el barómetro continúan incidiendo en estos aspectos, además de en otros clásicos como la persistencia, en su opinión, de excesivas trabas burocráticas. O en la conveniencia de mejorar en asignaturas pendientes como el dominio del inglés. En esta ocasión, al ser inquiridas por el entorno que rodea su actividad, por propia iniciativa parte de las encuestadas apunta la falta de medidas "adecuadas" para afrontar la crisis y la reactivación de la economía, el supuesto "escaso impulso de la inversión industrial", la morosidad de las administraciones, la ausencia de una financiación bancaria adecuada para las empresas o el deterioro de la confianza de los consumidores. El termómetro del pesimismo sube más de temperatura en la industria de la automoción, que vive instalada en los excesos de capacidad productiva en relación con la demanda y que en España está siendo fuente de numerosos expedientes de regulación, sobre todo de carácter temporal. Le sigue la industria química. El tono es menos sombrío en la industria farmacéutica y de material médico. Los abiertamente pesimistas representan el 54% del total. Lo que más inquieta a la Cámara de Comercio Americana es la triste perspectiva que persiste sobre la economía española. Y es que tan sólo un 4% de las respuestas le concede algún atisbo de mejora en materia de crecimiento. Hace dos años, cuando se iniciaba la desaceleración, la proporción de respuestas optimistas sobre las perspectivas económicas del país alcanzaba el 85%. La traducción de este horizonte sobre el mercado laboral es evidente. Casi un 40% del total de empresas avanzan que recortarán la plantilla. Es un porcentaje netamente superior al que se pronunciaba en este sentido hace un año (un 15%). La mayoría confiesa que "lo más que pueden hacer es mantener el nivel de la ocupación existente en sus plantillas". - http://www.elpais.com/articulo/empresas/Wait/26/see/invertir/elpepueconeg/20090726elpnegemp_7/T es?print=1

81 Week in Review July 26, 2009 When Debtors Decide to Default By DAVID STREITFELD Melissa Birks is being stalked. Her cellphone keeps ringing, always from a caller marked “unknown.” She says she knows it is her credit card company wondering why she stopped making payments. Ms. Birks, who owes $28,830, has nothing to say. Those on the front lines of the debt industry say there is a small but increasingly noticeable group of strapped consumers who, like Ms. Birks, are deciding they will simply stop paying. After loading up on debt eagerly provided by the card companies during the boom times, these people now find themselves trapped in an endless cycle where they are charged interest on interest and fees upon fees while the lenders get government bailouts. They are upset — at the unyielding banks and often at their free-spending selves — and are pre-emptively defaulting. They could continue to pay for a while longer but instead are walking away. “You reach a point where you embrace the darkness of default,” said Adam Levin, chairman of the financial products Web site Credit.com. The lending industry term for these people is “ruthless defaulters.” In a miserable economy where paychecks, savings and expectations are all diminished, their numbers will surely grow. “They’ve done the math on their account and they’re very angry,” said Corey Calabrese, a Fordham Law student who is an administrator of the school’s walk-in clinic for debtors at Manhattan Civil Court. Public sentiment is on their side, she added: “For the first time, Americans are no longer blaming the borrower but are looking at the credit card companies.” (That’s certainly true in the mortgage crisis. According to a Quinnipiac University poll in February, 62 percent of those polled blamed lenders “who loaned the money to people who may not be able to pay it back.” Only a quarter blamed homeowners.) The deteriorating relationship between Americans and their creditors has not yet reached the level of Shays’ Rebellion, the 1786 uprising by poor farmers in western Massachusetts during a recession. But the basic issues are strikingly similar, suggesting an eternal tension between creditor and consumer. Boston merchants, who were suffering themselves, aggressively sought payment from their customers. When the folks could not pay, which was often, they were jailed. The incensed farmers sought “reforms that would permit repayment on less destructive terms,” writes Bruce H. Mann in “Republic of Debtors,” a history of bankruptcy in early America. “Creditors replied with lectures on frugality, luxury, virtue and the sanctity of obligations.” Shays’ Rebellion provoked mixed reactions, then and now. Were the rebels trying to remedy grievous wrongs in the spirit of the Revolutionary War, or were they threatening public order and the fledgling state — acting as terrorists, in the modern parlance? Shays’ followers were quickly arrested and quickly pardoned, although two were hanged. Ruthless defaulters today face different perils. Delinquency destroys credit scores, can prompt a lawsuit and guarantees a very large number of hostile calls from collection agencies. Still, all that can seem the better alternative. Like many who default, Ms. Birks first asked her credit card company to lower her 19 percent interest rate. No dice, Bank of America responded. After she tried to get the bank’s attention by skipping a payment, it immediately

82 raised her rate to 25 percent. As Ms. Birks’ debt swelled, so did a sense of injustice mingled with helplessness. Bank of America has its hands full, with a June default rate of 13.8 percent, up from 12.5 percent in May. The other major credit card companies are in a similar fix. Estimates of the total industry losses are over $100 billion for the current recession. Collectors are noticing a shift not only in ability but in willingness to pay. “With all the bailouts the government is giving everyone, no one has any personal accountability about their own debts,” said Roger Knauf, who runs a trade group of debt-buying firms. Many of today’s debtors were maxed out long before the recession. Much of this debt was of course in the form of junky mortgages on wildly overpriced houses, and it was here that people first began to rebel. Countrywide Financial, the country’s biggest and most aggressive lender, surveyed its customers about why they were defaulting in the summer of 2007. One of the leading reasons was “low regard for property ownership.” In other words, people concluded that owning these houses was a bad deal. That people would intentionally default on loans they never should have gotten in the first place took lenders by surprise. “I’m astonished that people would walk away from their homes,” Bank of America chief executive Kenneth Lewis said in late 2007. Nineteen months later, walking away from mortgages is widespread if impossible to quantify, and no cause for embarrassment. Rather the opposite: it shows savviness. “I’ll walk away before I take a loss,” a Dallas financier recently boasted to Barron’s magazine about his efforts to sell his $6 million vacation estate. With credit cards, this type of chest-pounding seems less evident, at least so far. Ms. Birks, 43, readily admits that no one forced her to use her cards. “Some people are good with money,” she said. “I was stupid.” Still, just about everyone made mistakes during the boom — regulators, Congress, Wall Street. If Bank of America got a bailout for making bad loans, Ms. Birks figured, she deserved a bailout for accepting them. “You have to start looking at the future,” says Ms. Birks, who has been a writer and editor for various publications. “I already feel horrible because I can’t find a good job.” She earns $15 an hour as a copy editor for a magazine and does other part-time work. In previous downturns, Ms. Birks’ only recourse would have been a debt management plan, where she would restructure her payments with the help of a counselor, or bankruptcy. Now there is a third option: debt settlement. This means going on strike until the lender accepts a partial payment. Ms. Birks asked Bank of America about a settlement this spring. Since her account was up to date, she was told she didn’t qualify. She stopped paying, the bank started calling. When Bank of America finally got her on the phone, it agreed for the first time to drastically reduce her interest rate. She did not take the deal, but considered it progress. http://www.nytimes.com/2009/07/26/weekinreview/26streitfeld.html?_r=1&pagewanted=print

A Jump-Start for New Battery Plants Encouraged by Federal Aid, U.S. Firms Spring to Power Next Generation of Cars By Steven Mufson Washington Post Staff Writer Saturday, July 25, 2009 The Energy Department is getting ready to hand out about $2 billion in grants to create a domestic industry for electric-car batteries, and 122 companies are scrambling to get pieces. The companies range from small niche firms to giants such as Dow Chemical and Johnson Controls. All are promising a combination of innovation and ability to deliver new products on a commercial scale to prevent the United States from trading dependence on foreign oil or reliance on foreign-made batteries. "We've had 20 years of bad behavior in the United States in terms of developing ideas into products," said Mary Ann Wright, chief executive of Johnson Controls's joint venture developing hybrid battery systems. Now policymakers hope that helping domestic battery manufacturers will produce economic savings that often come with large-scale production and which are needed to make electric cars affordable. With funds provided by the stimulus bill in February, the Energy Department can cover up to half the cost of a battery-related project. "This investment will not only reduce our dependence on foreign oil, it will put Americans back to work," President Obama said in March. "It positions American manufacturers on the cutting edge of innovation and solving our energy challenges." The federally funded battery effort has its skeptics. Grants are expected to focus on lightweight lithium-ion batteries similar to those found in laptops. They are the newest thing in a business that had not changed much since lead-acid batteries were invented a century and a half ago. But U.S. hopefuls face stiff competition from foreign firms such as Japan's Panasonic and Sony, and South Korea's LG Chem, which already dominate the lithium-ion battery market in power tools, laptops and cellphones. Some domestic firms have recruited foreign companies as partners in new U.S.-based manufacturing facilities. Moreover, some economists warn of the perils of government subsidies. "To the extent that this is part of a broader industrial policy scheme, I'm against it for all the reasons I've always been against it," said Charles Schultze, a Brookings Institution senior fellow and former chairman of the Council of Economic Advisers. "If you're not heavy-handed about screening [applications], you're going to get a lot of the equivalent of political pork." Some industry experts also note that lithium-ion batteries may not be ready for tough road conditions, that they generate a lot of heat and that there is no infrastructure for recycling them. For the moment, it is easier to recycle lead-acid batteries, like those in combustion- engine cars, or nickel-metal hydride batteries, like those in the current generation of hybrid vehicles. Nonetheless, Obama has set a goal of having 1 million electric cars on the road by 2015 and the Energy Department is trying to make sure a large share of them are powered by U.S.-

84 made batteries. In addition to the $2 billion in grants it is expected to announce soon, the Energy Department can also lend from a separate $25 billion program. It has already announced a $1.6 billion loan to help Nissan develop an electric car, including the construction of a new battery plant, and a $465 million loan for Tesla Motors, part of which would go to a battery-pack facility that would stock Tesla and Daimler. Here's a quick look at some of the companies, big and small, that hope to benefit. -- Johnson Controls, the world's largest maker of lead-acid batteries, is applying with Ford Motor to make lithium-ion batteries at a Michigan plant that once made automobile interiors. The Wisconsin-based company says that the project would be up and running within 15 months, creating 4,700 jobs for Michigan, where unemployment has climbed to 15.2 percent. "Some people won't lose their jobs and some people who've lost theirs will get new ones," said Alex Molinaroli, president of power solutions at Johnson Controls. (The state of Michigan is also offering about $150 million in tax breaks and grants.) The company touts its experience. "It's a natural extension of what we do," Molinaroli said of the battery business. Last year, Johnson Controls made 112 million conventional car batteries; a joint venture in France already makes lithium-ion car batteries. -- Dow Chemical is also vying for Energy Department dollars. It has asked for $140 million in grants to scale up production of raw materials for batteries, as well as $550 million to cover about half the cost of setting up plants to manufacture battery packs in Michigan and Missouri. A South Korean company, Kokam, would be a partner in the venture. Dow says it can make the batteries affordable. "Dow is very experienced in scaling up and figuring out how to drive costs out" of production, said George Hamilton, a company vice president. -- A company called A123 Systems also thinks it deserves federal support. It has developed a lithium-ion battery using its own technology, which it says will deliver more power, endure more abuse and last longer than other batteries. The technology may be used in cars made by SAIC in China and by Chrysler. General Electric has invested in the company. A123 Systems had sought to win the contract to make batteries for General Motors's Chevy Volt, but GM ultimately opted for lithium-ion batteries from LG Chem. -- Quallion is another contestant for government battery grants. Founded in 1998 by biotechnology and aerospace entrepreneur Alfred E. Mann and lithium-ion battery specialist Hisashi Tsukamoto, Quallion has focused on high-priced niche markets such as custom aerospace uses, medical device implants and battery packs that soldiers can carry more easily on the battlefield. "We make 70,000 a year," said Paul Beach, Quallion's senior vice president; "really nothing" compared to Japanese companies that make around 70 million batteries a month, he added. Now Quallion has applied for up to $200 million to build a plant in Santa Clarita, Calif., that would make batteries for trucks and heavy vehicles, which could use them to avoid idling at truck stops. The Environmental Protection Agency says truck idling accounts for 11 million tons of carbon-dioxide emissions and for 960 million gallons of diesel fuel use. If Quallion gets the federal grant, state and local governments have promised to provide financial incentives and land. -- One of the smaller firms seeking Energy Department grants is run by Charles Haba, who was part of the team that pioneered semiconductors at Fairchild Semiconductor and later at Intel. Haba seeks $100 million in grant money to cover half of the cost for a lithium-ion

85 battery plant in Los Angeles. The city wants to install 400 megawatts of energy storage, and lithium-ion batteries can store energy from solar and wind facilities as they help provide a more continuous supply of energy from those sources. Haba says that "a lot of the techniques of the semiconductor industry were directly applicable" to help make the systems more effective and to come up with arrays that made it easier to manage the large amount of heat that the batteries give off. Haba's nine-year-old company, iCel, has already produced small quantities of batteries for specialty uses, such as movie-camera battery packs or television lighting. Haba also hopes to set up a nationwide chain of battery training centers with the help of the International Brotherhood of Electrical Workers. He said that at the Los Angeles local union, iCel has trained 3,700 people to install the company's batteries. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/24/AR2009072403163_pf.html

86 http://wallstreetpit.com/8787-after-peak-finance-larry- summers-bubble After Peak Finance: Larry Summers’ Bubble By Simon Johnson|Jul 24, 2009, 1:06 PM|

There are three kinds of “bubbles” - a term often used loosely when asset prices rise a great deal and then fall sharply, without an obvious corresponding shift in “fundamentals“. 1. A short-run bubble. Think about 17th century Dutch Tulip Mania: spectacular, probably disruptive, but not a major reason for the decline of the Netherlands as a global power. 2. A distorting bubble. In this case, the increase in asset prices contributes to a reallocation of resources across sectors. Think of the Dot-com Bubble: fortunes were made and lost, the collapse was scary to many, and – at the end of the day – you’ve built the Internet and some good companies. 3. A political bubble. Here rising asset prices generate resources that can be fed into the political process, through bribes, building politicians’ careers, and lobbying of all kinds. Bubbles in Emerging Markets often generate resources that impact the political process, sometimes in good ways – but most often in bad ways, which eventually contribute to a collapse. Larry Summers seems to think we are dealing with the consequences of bubble type #1. In his speech last week, “the bubble” is a modern deus ex machina – it explains why we have a crisis, but there is no explanation of where this bubble came from, what exactly was bubbling, and what changes this bubble brought to the real economy or to our politics. To the extent that Summers talks about the bubble at all, it seems to be in residential real estate. It’s hard to argue that there was an unsustainable run-up in housing prices and that the fall has real consequences. But what model – or even story – can explain the size of the global disruption we are facing without reference to what happened specifically in the financial sector? The overall official consensus - which Summers continues to shape – seems to be that our problems are: housing bubble plus bad management in a few big financial firms and slightly too weak regulation. So we’ll tweak regulation, ever so gently, and let the “good” big firms gobble up the people, market share, and perhaps even assets of those that fall by the wayside. But what if we are looking at the effects of a distorting bubble? In previous formulations – but not last week – Summers acknowledged that when financial sector profits hit 40 percent of total corporate profits, a few years ago, we should have seen that as a “warning sign”. But was this a warning sign of something just about houses, or more broadly about the financial

87 process in and around securitization that was both feeding the housing price increase and also reflecting a longer-run shift of resources into the financial sector? Even James Surowiecki, a most articulate defender of our current financial sector, implicitly concedes that as a percent of GDP, finance is likely to fall from around 8 percent to GDP back towards 6 percent of GDP (its level of the mid-1990s; see slide 19 in my recent presentation. Of course, there is no way to know exactly where finance is heading – except that it is likely down as a share of the economy. If the bubble (or metaboom with a series of bubbles) was in finance and pulled resources into that sector, we face an adjustment away from Peak Finance – and perhaps this will even more overshadow the next decade than Peak Oil. The economic adjustment will not be easy for the U.S. but it will be much more painful for smaller countries that have specialized in finance. The U.S., however, will likely struggle with the political adjustment – the financiers will not easily give up their licence to extract resources from citizens, either directly or through newly found rents channeled through the state (and coming ultimately out of your pocket, of course). The political consequences of Peak Finance greatly complicate our economic recovery.

Now What? How we got into today's mess and where we go from here. by David M. Smick 07/24/2009 9:00:00 AM When people asked what fundamentally caused the financial crisis, my answer is not what they expect. I respond with one phrase--the fall of the Berlin Wall. By the early 1990s, after the collapse of the socialist model, emerging market economies such as China, India, Eastern Europe, and the commodity producers wanted to be like the West--capitalists. And they became pretty good at making their economies more productive. This had the effect of lowering real wage costs globally while setting up these economies as powerful exporters. Soon a global ocean of capital--of excess savings--was beginning to swirl around a liberalized worldwide financial system. Partly as a consequence of the Asian crisis of the late 1990s, most of these emerging market economies by the late 1990s adopted a new export-oriented model for success. They tied their currencies to the U.S. dollar and refashioned their economies as large export platforms. The target: The U.S. consumer who fairly quickly became the world's consumer of last resort. As large parts of the world set up shop as a giant, low-cost, export engine, the low saving U.S. consumer became almost addicted to consumption. As we kept consuming, many of the world economies began stockpiling record amounts of excess savings. This reliance on exports, in lieu of developing consumer-based economies, created enormous global savings imbalances. In China alone, excess savings in the form of central bank reserves quickly approached $2 trillion. The problem was that there were too few investment opportunities for so much capital. A lot of this excess saving was recycled back into the U.S. financial system, usually in the form of fixed income purchases, with U.S. Treasury securities a favorite target. This dangerous ocean of capital, which again reduced global wage demands, allowed American policymakers to think they had defied the financial laws of gravity. That was the period when Alan Greenspan was called "the Maestro" and attempted to tame the business cycle. At one point, the Federal Reserve launched a series of hikes in short-term interest rates. Long-term rates not only failed to rise but dropped. That's not supposed to happen. In the process, financial risk became severely underpriced as long-term interest rates dropped to unrealistic lows. Wall Street thought it had discovered riskless risk. Because the global economy was out of balance, Americans went on a credit binge. U.S. household debt soared from 75 percent of annual disposable income in 1990 to 130 percent just before the crisis. At the height of this period, gluttonous Americans were spending far more than a dollar for every dollar they earned as they propped up the global economy. During the administration of George W. Bush, the U.S. economy would have grown at an annual rate of less than 1 percent without a steady stream of private equity loans, according to economist Niall Ferguson. And why were private equity loans so attractive? Because this dangerous global ocean of capital in our interlinked world financial system had unrealistically reduced long-term interest rates to unheard of low levels. This was an unsustainable situation. Asset prices, including the price of housing, shot through the roof with little response from the regulators, including the Federal Reserve.

89 At the same time, U.S. monetary policy remained extraordinarily accommodative. With the regulators asleep at the switch, here was a giant bubble certain to burst. Why? Because sooner or later financial bubbles always burst. THE "SALAD" EXPLANATION OF THE CREDIT CRISIS Perhaps the greatest mystery of this Great Credit Crisis is how some mortgage defaults in a relatively small subprime market (initially of only $200-$300 billion) could topple a world financial system worth several hundred trillion dollars. How could some collapsing mortgages bring about the worst financial crisis since the 1930s? It doesn't make sense. The answer is the credit crisis reflected something larger and more fundamental than a mere problem of mortgage defaults. The crisis erupted to such magnitude in large part because global markets declared a buyers' strike against our less than transparent financial architecture--the sophisticated paper assets including securitization financial institutions use to measure risk and deploy capital. The housing crisis was a mere trigger for a collapse in trust of paper, followed by a deleveraging of the entire bloated-with-credit global financial system. In the Wall Street Journal, J.P. Morgan Chase CEO Jamie Dimon recently wrote an op-ed in which he chastised the thrifts and other non-money center bank financial institutions for overly aggressive mortgage lending practices. The chairman has gall because his article conveniently overlooked the main culprit for the crisis--the big Wall Street banks and investment banks themselves. Here's how events unfolded. In 1998, Wall Street was deluged with this dangerous ocean of excess savings. So the bankers, to increase their fee and bonus income, received permission to deploy a new business model involving securitization. In the past, I as a banker would lend you the money for a mortgage based on my assessment of your character and financial base. If you were a business, I would bring together other banker friends and we would offer you a syndicated loan, but again based on our comfort with your reputation and the strength of your firm's balance sheet. In both cases, as a banker I had skin in the game. We knew each other. But that wouldn't be the case for long. The new model for handling risk and distributing capital--the securitization model--no longer required the big banks to have much skin in the game. For many people, the concept of a securitized asset or a mortgage-backed security is a mystery. So let me offer this analogy: As a banker, what if I took the thousands of mortgage loans I had issued and piled them onto a table, slicing and dicing them up into small pieces like a gigantic beautiful tossed salad. Then, for a nice big fee, what if I sold individual salad bowls of these bits of diversified assets all over the world. I'll call the salad bowls mortgage-backed securities. Each salad bowl would carry a report card issued by a credit-rating agency such as Moody's or Standard and Poor's. But of course there is no way logistically to investigate the content of each individual salad, so the final rating will be determined based merely on an educated guess--on mathematical modeling. For a while, the system worked spectacularly; securitization became particularly useful in the financing of expansion in the developing world. And even today we have to figure out reforms that both preserve this process but also make it transparent. But back then, it worked out particularly good for the banks--in fact, too good. In the five months prior to the outbreak of the credit crisis, for example, some Wall Street banks, because of the huge fees earned through this process of securitization, were achieving a return on equity in excess of 30 percent. During that particular period, some of the world's savviest investors, including George Soros and Warren Buffett, were achieving rates of return of only half that amount. Nobody, including the regulators, ever asked how the bankers could overnight have become such brilliant investors. Then something happened to fundamentally change the financial world. In the fall of 2007, some global investors noticed that every once in a while, one of the salad bowls contained a lettuce leaf under which was a speck of toxic waste in the form of a defaulting subprime loan. There weren't many of these contaminated pieces, but if you ate that salad's speck, you'd be dead. The only problem: No one knew which bowls of salad contained the toxic waste. That's called a problem of transparency. In

90 financial markets, when transparency is compromised bad things happen. Markets become highly volatile. Suddenly, the global investment community was no longer ordering salad. Investors had suddenly declared a global buyers strike against the sophisticated paper instruments of securitization that formed one of the main windpipes of the financial system. The unpurchased salad began piling up. Our financial system began wheezing for lack of financial oxygen. Then the patient turned red, then blue, and then all hell broke loose. And although the central banks' actions since then have unclogged the patient's windpipe some, things have yet to return to normal. And one reason is despite government's quick efforts at reform, including the bank stress tests, the suspicion is that the industrialized world banks still have balance sheets with murky balances, including off-balance-sheet liabilities that reflect overly optimistic valuations. So at the heart of the of the Great Credit Crisis was not the fact that some financial institutions made mortgage loans to poor people who defaulted on those loans at a rate three times higher than normal. Such political banking shouldn't have happened. But if it was all just about mortgages, the global financial market would have experienced merely a bumpy six or eight weeks of turbulence. Instead, the credit crisis involved something far more fundamental--the collapse of global investor confidence in our financial architecture itself. The fact is we have surrendered control of our financial system to 5,000 specialists who are the only people who can understand the nature of these sophisticated financial paper instruments, particularly during a crisis. Global investors concluded our complex financial system, including our system of shadow banking, no longer accurately measured risk. This lack of transparency was exacerbated by the realization that the financial system had implemented unheard of amounts of leverage to maximize the fee accumulation from the issuance of its dubious financial paper. To make matters worse, this dubious paper was insured by mountains of even more dubious financial paper, those notorious credit default swaps, where again the only measure of risk and value was sophisticated guesses that proved in the end not to be that educated. Our large financial institutions borrowed massively from the global ocean of capital to magnify their positions in the markets--to magnify their fee income from selling mortgage-backed salads. The failed U.S. investment firm Bear Stearns engaged in dangerous leverage--34 to 1. Freddie Mac and Fannie Mae, the U.S. financial institutions which enjoyed an implicit government guarantee, used lethal leverage of 75 to 1. But the grand prize goes to the German bank Hypo Real Estate, which employed the leverage of lunacy--112 to 1. HOW THE BANKS SKIRTED THE REGULATIONS There is a common belief that the financial crisis was the result of a complete lack of regulation--but that's only partly true and oversimplifies the situation. It is true things like the derivatives market were unregulated entities. And I think the Obama Administration's proposal for regulatory clearing house facilities, while not perfect, represents a realistic step in the right direction. The futures markets have deployed the clearing house concept for more than a decade--and to great success. But the sad thing is that the global financial system had rules which, if followed, would have protected against a lot of the reckless risk. The BIS capital adequacy standards stipulate that banks, if they take on additional risk (such as the issuance of mountains of mortgage-backed securities), must also set aside additional emergency rainy day capital. But for the banks, setting aside more capital would have hurt earnings. So for more than a decade they deployed a scheme to circumvent risk. Out of sheer greed, the banks and investment banks nearly tanked the world economy. To maneuver around the BIS requirements, the banks and the investment banks set up a kind of dual market. Almost every large financial institution set up independent, off-balance-sheet financial vehicles in a legal attempt to obscure risk. The outside world, including the bank regulators and credit rating agencies, thought the banks' balance sheets looked reasonably healthy. What the world couldn't see were the obscure, independent vehicles separate from the parent institution. But why would a bank set up a separate vehicle not under its own ownership or control? The answer is that the banks created their own private market--a kind of automatic, legal, dumping ground for asset-

91 backed securities with enormous fee income. But then things got complicated. The independent vehicles, using the just purchased mortgage-backed securities as collateral, issued commercial paper to the rest of the global financial market. When the global housing bubble burst in 2007, global markets suddenly became distrustful of the commercial paper issued by the independent vehicles. The commercial paper market collapsed. Now the world had a reason to hate America. The banks had made a foolish bet. If the paper went bad, they hoped, they could cut and run. Unfortunately for the banks, global traders tied the parent and independent vehicles together by reputation. When the crisis hit, Citigroup's stock went down almost as fast as the stock of its independent vehicles. Now the Obama Administration has come out with its financial regulatory plan, which is already being attacked by the left as too timid and by the right as downright onerous. But there is a third opinion--the view of the agnostic. Having worked daily with financial traders for nearly a quarter century, I'm not sure any government regulator is capable of going toe-to-toe with the Wall Street wizards and their lawyers who begin figuring legal ways around the regulations at times even before the regulations are promulgated. I recently asked a Goldman Sachs executive: "If you found a brilliant regulator, you'd hire her, right?" His response: "In a minute." Today a senior regulator at the SEC earns between $160,000 to $190,000 a year. Executive secretaries at Goldman earn $200,000 per year. Typically even relatively junior executives can earn in the millions. It is not an equal talent match. Washington is looking for a quick regulatory fix--a magic pill to make the financial headache go away--but the heart of today's regulatory problem may relate more to the crumbling of the fundamental ethical underpinnings of our society. The financial crisis may say a lot about what we have become as a people. Don't get me wrong. I still favor our Anglo-Saxon version of capitalism which tolerates the drive for individual self interest and shareholder value precisely because, in the end, this system historically has delivered. During the 1990s under Bill Clinton this system created 20 million net new jobs. During the same period, the German financial system of universal banking, for example, supposedly a system more concerned with serving the collective good, produced a dozen net new jobs. But make no mistake, our Anglo Saxon approach to markets is prone to abuse. It is the necessary evil we can live neither with nor without--no matter how clever Tim Geithner thinks he is in reforming the system of making and selling salad. For our regulators, this is an unfair fight which is why the public- private model of oversight may be our best recourse. The bankers along with the regulators need to watch each other because they all have skin in the game. A WORLD TOO EXPORT DEPENDENT Since the outbreak of the crisis, the global economy has experienced a brutal financial deleveraging not seen since the 1930s. The value of virtually every asset in the world has been reappraised downward, led by housing in the United States. The situation has been like an unstoppable force of nature, a swift downward tidal move--and it may not be over. From August 2007 until last September, we experienced a mere financial crisis. Then with the collapse of Lehman Bros. came a full-blown global panic. Nobody trusted anybody or any institution, forcing our policymakers to pull out all the stops, with almost certain unintended consequences in the future. The U.S. budget deficit has quadrupled and the Fed has doubled the liabilities on its balance sheet. Next year federal spending will reach 28 percent of GDP. Spending has exceeded 25 percent of GDP only four other times in American history--the Civil War, the Revolutionary War, and World Wars I and II. U.S. policymakers have had no choice but to enter uncharted waters in their efforts to thaw the credit markets and revive the economy. It is never wise to bet against the ingenuity of Americans, but the past 12 months have been a humbling experience for the economics profession. For decades, the common assumption has been that a second economic depression was impossible because today's policymakers won't make the mistakes of the past. This is the Milton Friedman thesis--that if policymakers in the 1930s had

92 carefully observed the monetary aggregates and had not run a restrictive monetary policy, things might have turned out differently. And it is also the Keynesian thesis--that had Congress not blundered in 1936 and tightened fiscal policy, a lot of pain could have been avoided. Today we are running unprecedented fiscal and monetary policies and the results to date have been disappointing. From August 2008 to June 2009, the Consumer Price Index (CPI) dropped from 5.3 percent to negative 1 percent--a 6.3 percentage point drop. During the same period in 1929-30, the CPI dropped from zero to negative 1.8 percent, a drop of only 1.8 percent. In other words, today's deflationary trend so far is ahead of the pace of the early 1930s. From July 2008 to June 2009, unemployment jumped from 5.8 to 9.5 percent, a rise of 3.7 percentage points. During the comparable period from 1929-30, the unemployment rate jumped from 2.3 to 5 percent, a rise of only 2.7 percentage points. The bottom line is that our fundamental theories about how different policies might have affected the outcome of the Great Depression are today facing a test of their credibility. Meanwhile, our current, extraordinarily aggressive fiscal and monetary policies are sure to have serious unintended consequences which I'll get to in a minute. But let me propose a new thesis about the broader aspects of the financial crisis, including the potential unintended consequences of a global economic and financial system out of balance. For the last 18 months, we have fixated on the financial crisis and collapse in global demand brought about by the devastation collectively of household wealth, with American households alone losing between $12-14 trillion in wealth. What we have missed is that the very model under which the world has operated the last two decades-- the emerging market export model--appears to be crash landing. We in America are fixated on our financial woes, yet this export model crack up threatens to dangerously heighten geopolitical risk. That means the world could become a lot more dangerous in coming years. It turns out that at the same time that overleveraged U.S. consumer had become the world's gluttonous consumer of last resort, large parts of the world became dangerously export dependent. Recently, Treasury Secretary Tim Geithner was at Beijing University to assure the Chinese that despite declining U.S. financial credibility, their dollar investments were safe. The audience broke into laughter. The Chinese should be wary of such hubris. While America's public finances are troubling, to say the least, Beijing and the rest of the world should examine the future for economies, including China's, that have become overwhelmingly dependent on exports. Their future looks as problematic as the future of the debt-ridden United States. As ugly as the credit markets have been, trade has been worse. Since World War II, global trade has grown twice as fast as gross domestic product. But things have shifted with the downturn. For starters, the exports of the world's three biggest exporters -- Germany, Japan and China -- are 35 percent lower than they were a year ago. With American imports down by roughly the same amount, two-way trade has contracted by $1.5 trillion. There are real questions as to whether this development is more than a temporary pullback and will evolve into a quiet shift toward a new era of deglobalization. Those in that snickering Chinese audience should consider that, on paper, the United States looks relatively immune to this trade collapse. American exports are 11 percent of GDP, according to the World Bank. Compare this to the exports-to-GDP ratios, for example, of China (42 percent), South Korea (46 percent), Germany (47 percent) and Thailand (73 percent). Policymakers from these economies need to ask themselves: What happens if the U.S. consumer--the world's consumer of last resort -- pulls back permanently, as seems distinctly possible? Recent surveys by the Harris Marketing Group and American Express show that Americans earning over $100,000 are responsible for 50 percent of retail sales and 70 percent of retrial profits. These individuals say they are finding pleasure in pulling back. They now want to be more like their neighbors. To a point, this pullback makes sense. We need more saving, but only to a point. A U.S. savings rate of 8 or 9 percent could make recovery any time soon extraordinarily difficult. True, the export-dependent countries are scrambling to stimulate domestic consumption. This will be tough, though, given their aging demographics almost across the board (as people age, they save more

93 and consume less). In China, with no social security system nor much in the way of a safety net of governmental services, families save significant amounts of their income. They'd save more except that the government and state-run corporations are even bigger savers, a situation which has left families with relatively low incomes. In Germany, policymakers have gone out of their way to limit consumption and reduce wage gains as a means of dramatically improving the economy's global competitiveness. Yet with global demand for German capital goods waning, Germany is in trouble with serious industrial overcapacity even as consumption remains modest. The Germans' secret hope? That the U.S. consumer locomotive starts moving again at full speed. Indeed, Europe's dirty little secret is that its banks are deeply exposed to loans made to emerging market trade financing, particularly to Eastern Europe. This is an exposure larger than the U.S. banks' exposure to subprime-related loans. But the Europeans won't fully acknowledge this exposure for one reason: They are betting on a U.S. recovery to come to the rescue. The Chinese secretly have the same hope. Beijing boasts of its big stimulus package. Yet the government's efforts to stimulate domestic consumption appear to be not much more than a large subsidized lending operation, a stimulus that, while producing a spike in growth now, is unlikely to be sustainable. Government lending, often noncollateralized lending, has reached a level equal to 50 percent of GDP. Remember the big $4 trillion stimulus around last year? A lot of that stimulus was supposed to derive from spending by regional and local governments that so far hasn't materialized. Moreover, transforming China into a consumer economy to compensate for lost exports will take years. Meanwhile, the theory that China's stimulus will rejuvenate the rest of Asia seems to be crash landing too. Last month, Japan's exports to China dropped by 30 percent, which was an accelerated decline from the previous month. China's exports to Asia declined by 36 percent, again an accelerated decline from the previous month. The Chinese leadership talks of having already emerged from the global recession, yet China's recent aggressive trade conflicts and provocative strategic positioning toward India indicate just the opposite. Trade is 42 percent of China's GDP. Global trade has collapsed. If this collapse in world trade is not a problem for China, I don't know what is. It is not surprising that geopolitical risk is soaring and China is hardly helping the situation, a fact that is underappreciated by global equity markets. China has contributed to a global commodities bubble with its massive commodities purchases and stockpiling since late last year. These purchases were intended as the ultimate inflation hedge as China waited for the U.S. consumer to come back. Here's the problem. Once China puts a halt to its panic- stricken lending practices, and that halt or slowdown is coming soon, today's commodity bubble will burst. The resulting deflationary after effects will prove to be a real headache to the world's central bankers. And the disillusioning fact is that China will continue to remain a mystery because of the severe censorship of economic data that began in June. But the important point here is after the outbreak of the financial crisis, the world proclaimed that the "Washington consensus is dead." The "Washington consensus" was the policy of the past two decades urging the excess saving/export-dependent economies to bolster their domestic sectors. The major governments of the G20 concluded that the financial markets, not global imbalances, were alone the cause of the crisis. And since then, these governments have spent more than $30 trillion (roughly 100 percent of the GDP of the United States, Europe, the United Kingdom, and Japan combined) attempting to reestablish the pre-crisis level of prices for financial assets before the global collapse in trade, consumption, and industrial production set in. Yet what have been the results of this new policy? From January to May 2009, the U.S. trade deficit halved. Personal savings jumped from nothing to nearly $800 billion. A year from now the U.S. trade deficit will likely have vanished. Let me put this in perspective. The world has spent more than $30 trillion to return capital and trade flows to their pre-crisis levels. Yet trade and industrial production have collapsed by rates worse than

94 during the first years of the Great Depression. And, comparatively speaking, this collapse has been less aggressive for the United States than for our trading partners. The G20 is committed to protecting an economic order that no longer exists. This is why analyst Criton Zoakos calls these nations "zombie governments." Today's policy paralysis will soon become tomorrow's political paralysis. Incumbent governments in Britain and Japan already are experiencing the lowest approval ratings in history. Global political paralysis may be just around the corner. COMING TREND TOWARD DEGLOBALIZATION Notice that we are already seeing a stealth-like shift toward deglobalization, which is not good for the world economy but is absolutely devastating for many emerging market economies. World governments should listen carefully to President Obama, a leader with an uncanny ability to make activist, even radical, proposals sound benign. At the recent Group of 20 Summit in London, for instance, Obama said the United States cannot be the world's consumer. On the surface, this sounds like a statement about the temporary condition of the business cycle. Actually, Obama was talking about something far more significant -- not outright Smoot-Hawley-style protectionism but the potential for a coming policy of small tax, spending and regulatory changes that will encourage this quiet trend toward deglobalization. Like it or not, this shift reflects a growing Washington mind-set that globalization has gone too far. Witness the 'Buy American' provisions on Capitol Hill and China's own new 'Buy China' policy. Obama is playing not only to his union supporters but also to a segment of the U.S. corporate community whose enthusiasm for the global supply chain and "just-in-time" inventory management is waning. The Europeans are following the same route. Indeed, in responding to the financial crisis, the European governments themselves found surprising difficulty arriving at a unified response and largely preferred go-it-alone approaches. And the coming rise in shipping costs has the potential to turbocharge this deglobalization process. The U.N. agreement last October on sulfur-burning levels for ships (not to mention California's own restrictions on ship emissions) could send shipping costs skyrocketing. A decade from now, it may be profitable to send by sea only items with relatively high value to weight, such as laptops. The net result could well be that a lot of low-wage jobs that moved to China, India and other emerging markets will move back to the West. This is already happening in the furniture industry. But here's the punch line: A capital-dependent America can't easily decouple from the world. Nor can we separate ourselves from geopolitical risk. For now America needs the world's capital as much as the world needs American consumers -- an economic situation tantamount to a policy of mutually assured destruction. True, the global system needs rebalancing. But until that happens, the Chinese should stop snickering at our Treasury Secretary and weigh the fact that in this interconnected world of finance and trade, there are no escape routes of independence. That's why the world's prominent economies need to think seriously about a joint effort to achieve a permanent worldwide recovery despite serious headwinds. GLOBALIZATION PARADOX In the end, globalization is the great paradox of our time. On the one hand, it produced unprecedented wealth creation and helped bring a billion people out of poverty. On the other hand, it distributed that wealth unequally, creating huge, troubling disparities in income. At the same time it sent us on a terrifying rollercoaster ride of financial terror that now could bankrupt us as our policymakers experiment with various remedies that are certain to have far reaching unintended consequences. My worry is also that our policymakers will attempt to achieve economic and financial stability as an end goal, but that stability itself in may not be enough to satisfy the American people. Talk about heightened expectations. The median age American was born in 1966. All he or she has known are economies with unusually low levels of joblessness with high levels of GDP growth. Now they are about to face potentially a world of diminished economic performance. Along the way, our policymakers will face some serious questions: Can we effectively roll back globalization? Or can we have "smart" globalization? And what level of financial risk from now on is considered reckless--or is dangerously inadequate? And who decides in today's economic system of enormous complexity how

95 much leverage is adequate? What wizard is smart enough to make the call? Last year I asked a friend, Bill Seidman, the former F.D.I.C. chairman who sadly has since passed away, who could decide this question of leverage? Seidman's answer was to be successful, that person would need almost supernatural powers--"a person with divine inspiration," he quipped. "Know anyone qualified for the job?" Nothing about the coming world will be easy. The big Wall Street banks deserve to be fitted with straitjackets. But having the banks become like water or electric utilities, while it is what they deserve, may limit the distribution of risk capital to business startups and small businesses which Barack Obama says are responsible for 70 percent of all net new jobs. The American financial system has been unique because of its ability to deliver financing to new startup ventures, the entrepreneurial risk- taking sector. Most of these risk-takers fail, but a few go on to become googles. Compare that to the European system with less tolerance of new innovative risk and thus less employment opportunities. But then can we ever trust Wall Street again? TROUBLING UNINTENDED CONSEQUENCES The question is where things go from here. The good news is that the world is not lacking in capital. Today there is plenty of capital--a lot of it still on the sidelines. This includes trillions in money market funds alone. Global stock markets have rebounded some, creating more than $10 trillion in corporate equity value. Corporate debt yields have fallen. This stock surge is encouraging as long as we remember the stock market in the 1930s rose by more than 20 percent on five separate occasions. The bad news is consumer spending, 70 percent of our economy, could continue in the doldrums for a long time. U.S. households are still shell-shocked having lost collectively $12 trillion in household wealth. People are spending just on what is essential. Neiman Marcus is down 30 percent; Walmart is up 3 percent. Sounds fine, unless you work for one of the suppliers to Neiman Marcus. The most troubling issue is interest rates. Since Christmas, U.S. long-term interest rates have nearly doubled. Rising rates make it difficult for housing prices to find a bottom. Rates have recently come down as the Federal Reserve has taken the unusual step of purchasing Treasury bonds. To many bond traders, this has been an early Christmas present, a huge wealth transfer from U.S. taxpayers to bond market short sellers. But this is a potentially explosive issue politically, so the Fed's purchases are not likely to continue permanently. Washington is struggling to find an answer to why rates have risen from last year's lows. The Administration says while we are still in recession, the depression scenario of last December is now off the table. Thus the market is simply adjusting rates to this new reality. The Chinese and others finger America's extraordinary budget deficits, some of which President Obama inherited. The Chinese fear the Federal Reserve will monetize Obama's quadrupled budget deficits eventually producing higher inflation. Either way, trying to have an economic recovery with rising long-term interest rates is like trying to sprint through an Olympic-sized swimming pool. It is a slow going, disappointing race. The truth is the deficit has been an unreliable economic predictor. The reason stems from this ocean of capital I've been talking about. For example, interest rates (10-year Treasury bond yields) never dropped below 5.25 percent the entire eight years of the Clinton Administration which produced budget surpluses. Yet at one point during the deficit-ridden George W. Bush Administration, long- term interest declined to nearly 3 percent--and at a time of relatively robust growth. Here's another oddity. When inflationary expectations rise, long-term interest rates are supposed to rise. In mid 2007, inflationary expectations were around 3.2 percent. A year later, still at a time of significant budget deficits, expectations had jumped to 5.2 percent, the highest level in 25 years. Yet long-term interest rates dropped. Running large budget deficits for long is a crazy way to operate an economy. It means sacrificing control to outside interests. But it is important as we work our way out of this deficit stranglehold, to understand the nature of this globalized financial system. Even the world's best minds sometimes have trouble figuring out this system. A few years ago, Warren

96 Buffett, concerned about America's budget deficits, bet big on a dollar freefall, arguing that foreign investors would flee the dollar in droves. Buffett called this trade a "slam dunk" and lost a reported billion dollars on the bet. Then the dollar completely reversed course which frankly is what happens to the reserve currency of an international system. There are continual periods of volatility. Why have even the experts at times been off the mark about the effect of deficits? A good guess is they underestimated America's ability to import capital and to innovate. Buffett was correct that foreigners were concerned about America's deficits. Turned out they cared even more about the attractiveness of U.S. asset markets relative to asset markets elsewhere. Yet just because the United States dodged the deficit bullet in the past is no guarantee for the future, particularly if there are concerns about the attractiveness of the United States as a target of investment. It will be interesting to see whether the Obama health care reforms produce the expected budgetary savings. I hope so. But as for keeping the U.S. economy an attractive magnet for global capital, Washington's recent heavy-handed effort to trample the rights of automobile company bond investors sent a troubling message worldwide. After the Second World War, America grew out from under a massive deficit. But that was after four years of pent up demand followed by unprecedented optimism. By contrast, consumers today are in a gloomy period of deleveraging. That leaves investment as the primary growth engine if we have any hope of both dealing with deficits and reviving our economy. The president wants government investment in new green technologies as the "game changer" for the 21st century. All well and good. We wouldn't have the Internet had there not been Pentagon investment. But my concern is with timing. It could take two, three or even four years to sort out the winners and losers in government investment efforts. That's a similar situation to what happened when, after the financial liberalization of the late 1970s, a lot of venture capital appeared in the 1980s. It took years to sort out the winners from the losers before the general investment community stepped in. That is why Barack Obama will have no choice but to try to stimulate private investment and innovation which are likely to have a far broader and more immediate impact. Without an explosion in innovation, Washington in trying to confront the deficit could be in a situation not unlike rearranging the chairs on the deck on the Titanic. But innovation entails risk-taking. And my great fear is that we are moving from a period of reckless financial risk-taking to a situation even more dangerous--no financial risk-taking as all our efforts focus on stability as a short-sighted end game. Economic depressions ironically often produce aggressive bouts of innovation. The Obama Administration needs to encourage this process by pivoting some strategically to help reignite the investment-led engines of our economy. If you listen to policymakers, they're always talking about liquidity. "We're providing liquidity," Ben Bernanke assures us even as the banks refuse to lend and companies refuse to borrow. But when all is said and done, economies are influenced by more than numbers, by more than the size of central bank liquidity injections or the size of a stimulus. They are ruled by psychology. That's why, at the end of the day, the definition of liquidity comes down to one word--CONFIDENCE. Liquidity is confidence. And if our leaders can restore confidence, the financial system will begin operating efficiently and eventually we'll rise out of today's quagmire. David M. Smick, is Chairman & CEO of Johnson Smick International and the author, most recently, of the book The World Is Curved: Hidden Dangers to the Global Economy. Portions if this article reflect remarks presented by the author June 30, 2009 at the Aspen Institute's "Ideas Festival." http://www.weeklystandard.com/Content/Public/Articles/000/000/016/763ixjus.asp?pg=1

Banks Goldman Stakes Pays Off for Buffett. No Duh. Lauren Tara LaCapra 07/24/09 - 03:48 PM EDT Big investments in Goldman Sachs (GS Quote) at the height of the financial crisis made a lot of money for Warren Buffett and much less for the federal government, but those results are actually not that surprising. A college professor's recent analysis showed that Buffett's preferred stake in Goldman has been much more profitable than the Treasury Department's. The results provided ammunition for critics who view big banks on Wall Street and wealthy counterparts elsewhere -- in Omaha, for instance -- as villains who took advantage of the government's largesse. But while the numbers might be fresh, the finding is not, since the terms of both agreements were hammered out and publicized nine or 10 months ago. It's also important to note the distinction between how the capital infusions came to be, since Goldman asked Buffett for money, while the government asked Goldman to accept federal funds. In late-September, Goldman and its banking brethren were starved for capital. The credit markets had seized up after the fall of Lehman Brothers -- soon followed to the brink by American International Group (AIG Quote) -- sending everyone on the hunt for cash. According to the Wall Street Journal, a Goldman investment banker with close ties to Buffett called him up, they hammered out details for a preferred-stock deal, and he was in bed by 10:30 p.m. Fast forward several weeks, and the heads of nine banking titans were sitting around a conference-room table in Lower Manhattan with Treasury Department officials, being told that they all would have to accept varying degrees of federal funding. In return for those cash infusions, the government would receive preferred stakes and warrants to buy common stock. Of course, some of the banks, which included Goldman, Citigroup (C Quote), Bank of America (BAC Quote), JPMorgan Chase (JPM Quote), Morgan Stanley (MS Quote), Merrill Lynch, Wells Fargo (WFC Quote), Bank of New York Mellon (BK Quote) and State Street (STT Quote), needed the funds more than others, but some of them still argue that they didn't need the funds at all. Therefore, it's little surprise that since the banks were accepting the cash under duress, and since the cash came with the stigma of corporate welfare and tighter oversight, it's little surprise that the government received an initial 5% annual dividend, vs. Buffett's 10% return. After five years, the TARP dividend rate jumps to 9%, but Goldman exited too quickly to face that hurdle. The terms Buffett mustered were more favorable because he was a private investor taking on a fair amount of risk. He handed over $5 billion to a bank whose competition was going belly up, before the government had pledged its support to institutions or the financial market.

98 Throughout the crisis, Buffett had been approached by several firms, including Bear Stearns, Lehman and AIG, but ultimately invested funds in Goldman and General Electric (GE Quote). (He also holds stakes in US Bancorp (USB Quote) and Wells Fargo (WFC Quote) through his company Berkshire Hathaway (BRK.A Quote).) Buffett chose Goldman as one of his investments because of its management, its history and his general gut feeling about the company. ("I didn't see a book. I just made a judgment," he told the Journal.) So far, it seems, he has been correct. Linus Wilson, who teaches finance at the University of Louisiana, determined that Buffett's preferred stake Goldman has increased in value by $4.1 billion, or 82%, in less than a year. If the oft-labeled Oracle of Omaha decides to cash in his perpetual preferred stock for common, giving him a sizeable stake in the firm, he would reap an annualized return of 111%. For its $10 billion investment, the government received $1.418 billion, an annualized return of 23%. Goldman also didn't haggle over the pricing of its warrants, putting a premium on haste rather than cost, in its effort to leave TARP behind. American taxpayers looking at 401(k) returns over the past seven months would likely be happy if all investments were as quick and tidy as the Goldman stake. Furthermore, for all the talk of TARP, the Federal Deposit Insurance Corp. is still allowing banks to make handsome profits by guaranteeing their debt cheaply, while private investors would charge a lot more for unprotected debt. The Federal Reserve has vastly expanded its balance sheet with riskier assets to foster liquidity in the same way. And several regulators have developed a plan called the Public-Private Investment Program with similar goals. While the government may have been able to get better terms, and taxpayers deserve to earn money for taking on risk, comparing federal programs to Buffett's investing prowess seems a bit silly. After all, the government's goal in the financial crisis is to get the private markets working properly again so it doesn't have to be involved at all. http://www.thestreet.com/print/story/10552961.html

99 Jul 24, 2009 What's at Stake for the U.S.-China Strategic and Economic Dialogue? Print Overview: Beginning in 2006, the U.S. and China have engaged in high-level dialogues on economic issues including trade, investment and energy policy. Under the Obama administration, this discussion, the first meeting of which will take place July 27-28, will widen to include geopolitical issues coordinated on the U.S. side by the State and Treasury departments. Some analysts suggest this could lead to more cooperation in the security realm, but there are a wide range of topics on the agenda. What's on the Agenda for the July Meeting? o President Obama will address the U.S.-China Strategic and Economic Dialogue (S&ED) meeting on day one, which is to be followed by a session on crosscutting issues like climate change before breakout sessions turn to specific economic and geostrategic issues. o Wang will raise China's concerns over the safety of its U.S. assets and seek assurances that the U.S. is committed to maintaining the stability of the U.S. dollar. (People's Daily) o The U.S. economic team is likely to focus on raising Chinese consumption, while the strategic team will turn its attention to North Korea, Iran and Afghanistan/Pakistan. (Center for Strategic and International Studies [CSIS]) o Likely to be off the agenda for now are trade issues (probably shelved for the Joint Commission on Commerce and Trade later this fall), China's exchange rate policy and military cooperation (June saw a resumption of high-level mil-to-mil talks). o Charles Freeman, Freeman Chair in China Studies at CSIS: "Expectations for the meeting are low, given the mismatch on the importance of key issues and the wide breadth of issues to be discussed. The success of the meeting will just be launching a closer dialogue on the issues." o Economist: The U.S. and China are "roughly in agreement" on economic policy responses. For example, both are involved in major stimulus efforts. Even the "upgrade" of adding the secretary of State may not bring the countries closer on issues like climate change where "posturing" has been on the increase. Mechanisms for Dialogue o Hu and Obama announced a new S&ED to be held annually, replacing the biannual Strategic Economic Dialogue (SED) launched in 2006. The economic dialogue will be led by Treasury Secretary Geithner and Vice Premier Wang Qishan, and the security dimension will be led by Secretary of State Clinton and State Councilor Dai Bingguo. (U.S.-China Business Council)

100 o CRS: The new administration "inherited more extensive policy mechanisms for pursuing U.S.-China policy, such as the strategic economic dialogue, and a relationship in which the stakes are higher and US action may increasingly be constrained." China is the second-largest trading partner and largest holder of government debt for the U.S., playing a crucial role in plans to address the recession, even as China has become reliant on U.S. demand. Bilateral issues include Taiwan, ongoing disputes over intellectual property rights and China's currency regime, food safety, foreign policy and military development. o The Obama administration widened the S&ED scope to include geostrategic as well as economic concerns. The State and Treasury departments will co-ordinate the dialogue together, whereas the departments led separate dialogues with China under the Bush administration. The geostrategic aspect has been upgraded to cabinet-level, from the previous, deputy-led Senior Dialogue. o Dennis Wilder, Visiting Fellow, Brookings Institution: The S&ED shows "more continuity than change," though climate change will be given greater importance. Upgrading the strategic component of the dialogue could deepen geopolitical cooperation beyond Taiwan and North Korea. "China analysts have some concern that the large, annual summit could turn into less of an intimate dialogue and more of a media event." o The crisis leaves the U.S. without the "high ground to lecture the Chinese on financial or macroeconomic policies," possibly helping to "turn their relationship into a more equal partnership, with less posturing on both sides." (Eswar Prasad, Senior Fellow, Brookings) Outcomes of the SED o The SED, an idea of former Treasury Secretary Paulson to ensure comprehensive economic discussions at a high level with China, was first launched in 2006. o The fifth and final SED took place in December 2008. Outcomes included a new agreement on energy cooperation and several financial agreements. The U.S. agreed to speed approval of investments by Chinese financial institutions. China was to allow foreign banks operating on the mainland to borrow capital from their affiliates overseas on a temporary basis to boost liquidity and confidence in the lenders to offset interbank challenges. Exchange rate policy concerns were left for the next administration. The meeting also produced a 10-year energy cooperation agreement and progress toward a Bilateral Investment Treaty (BIT), which would create an institution to manage investment disputes. (Reuters) o Paulson: China's leaders' prioritizing of economic growth presents the best means of influencing the country's emergence as a global power and encouraging its international integration. A productive relationship demands that U.S. and Chinese policymakers engage at the highest levels in ways that minimize misperceptions and miscommunications. http://www.rgemonitor.com/26/China?cluster_id=5908

101 Jul 24, 2009 Germany: Will the Economic Recovery Remain Technical or Prove Sustainable?

Overview: Economic data released for the month of July 2009 have been much more positive than for previous months, leading some analysts to announce the comeback of the German economy. In comparison with its neighbors, Germany is currently showing the strongest signs of stabilization in the eurozone. Concerns remain about the sustainability of the recovery. Germany's Economic Performance According to Recent Indicators Business Climate Index: The July reading of 87.3 is the highest since October 2008. The index, based on input from 7,000 executives, reached a 26-year low of 82.2 in March 2009. Economic Expectations Index: The index has increased for the seventh month in a row to 90.4, the highest reading since July 2008. The expectations index predicts the level of economic activity in six months. Current Conditions: In July 2009, the index stood at 84.3 down from 108.1 in July 2008. In June 2009, the index stood at 82.4.The index has been falling for two years. Consumer Confidence: The index for July rose from 2.6 to 2.9. Investor Confidence: After eight months of steady gains, the indicator fell unexpectedly in July from 44.8 to 39.5 due to rising concerns about the negative impact of a credit crunch on economic recovery. Composite PMI: In July the index stood at 48.9 up from 44.0 in June. This reading represents the largest monthly increase since the start of the survey. The number is rising closer to 50 which separates economic contraction from expansion. Manufacturing Orders: While orders rose by 4.4% m/m in May, their fastest pace in two years, they are still down 29.4% y/y for the year. Exports: Exports increased by 0.3% in May 2009. Compared to April 2008, exports dropped by 24.5% y/y. Industrial Production: While industrial production increased by 3.7% m/m in May 2009, the change on an annual basis was still -18.1% y/y. Unemployment: So far, the unemployment rate in Germany has only suffered a mild increase, from 7.8% in May 2008 to 8.3% in June 2009.

102 The Worst Is Over? "These latest very positive figures further increase the likelihood that the economy will pick up sharply in the third quarter of 2009. This shores up our view that German gross domestic product will increase strongly in Q3 compared with Q2. The drop on a year earlier will narrow to around -4%. The economy is over the worst." (Dr. Rolf Schneider, Allianz Research) “Germany has all of a sudden become the leader of the pack, showing stronger signs of stabilization than most other eurozone countries,” added Carsten Brzeski, European economist at ING in Brussels. (via Financial Times) Global inventories are almost used up, and stimulus programs all over the world will support global demand. Therefore, the demand for German exports will increase in the coming months. (FT Deutschland) "The sharp increase in Ifo expectations strengthens the case that there will be a strong rebound in Q3." (Danske Research) "A sharp increase in Ifo expectations has never failed to be accompanied by a sharp increase in German industrial production growth rates. We are confident that it will happen this time, too." (Danske Research) "The assessment of the experts indicates that the economic downturn dynamics are currently coming to rest. They further see tendencies for a recovery at the end of this year. This cautious optimism should not be destroyed by overly pessimistic projections," said ZEW research institute president Wolfgang Franz. "In terms of orders, we have come through the low point. Production probably hit a low in the second quarter," said economist Heinrich Bayer of Postbank on July 8. (via Forbes) More Still to Come "Economists warn that the effects of the global slowdown have still to feed through into unemployment figures – and of a delayed German “credit crunch” caused by the continuing weakness of the country’s banking system." (Financial Times) Timo Klein, a senior economist with IHS Global, commented on the recent drop in investor confidence: "What we will probably see is an interim recovery [of production now] but a renewed setback in the first half of 2010." (via Forbes) Unemployment has barely increased. Germany will see a spike in unemployment when short-term work schemes run out in fall 2009. Unemployment is expected to rise to 11% by 2011, and the consequences for consumption and government spending could be substantial. German workers that have not lost their jobs are overly optimistic about their retention throughout the rest of the recession. Hence the consumer confidence index has been improving too fast. "It is to be expected that the forecasted deterioration of the jobs market will increase these unemployment fears, and will place a great amount of strain on income expectations," the GfK Group, which conducts the consumer confidence surveys, wrote in a statement. "The real test is yet to come, given the likelihood of rising unemployment in the months ahead." On July 10, Gustav Horn, head of the IMK Institute, warned not to misinterpret the first signs of economic stabilization. He said one should remember the Japanese plight in the early 1990s, when the government cut the fiscal stimulus after the first signs of recovery.

103 There is now a danger that Germany could go Japan’s way into multi-year stagnation. (FT Deutschland via Eurointelligence) Reiner Sartoris of HSBC: "The survey results seem to suggest that by the end of the year we'll be back to a normal level of economic activity. We, however, do not share this view. The situation is still very difficult, and you should not rely on a recovery as strong as suggested by the survey." Jens-Oliver Niklasch, Landesbank Baden-Württemberg: "There is a risk that the improvement in the business sentiment index is solely expectation-driven and that it will not be followed by an improvement of the real economy." The German stock index (DAX) did not reflect the optimism of the business sentiment indexes. On June 22, the day the indexes were published, the stock market fell by 3% to a four-week low. Alexander Koch of HVB-UniCredit Group noted that "the current level of 89.5 still remains below the historical threshold level for zero annual growth in industrial production of 93." Capacity utilization in the German engineering sector is at a historical low of 72%. That would suggest that even though the pace of the downturn is slowing, German industry faces a long period of reduced demand. (FT) On July 8, Norbert Irsch, chief economist of the German state development bank KfW, warned of the danger of an overly optimistic "speculative bubble." (via Spiegel online)

104 UK Economy & Trade UK GDP shrinks at fastest rate for 60 years By Norma Cohen Published: July 24 2009 08:05 | Last updated: July 24 2009 11:14 Britain’s economy contracted in the second quarter, marking a full year of decline sharper than any since the 1930s barring that of second world war and its aftermath. Economic output fell by 0.8 per cent quarter-on-quarter in the three months to June, after a 2.4 per cent decline in the first quarter, according to the Office for National Statistics’ “flash” first estimate of gross domestic product on Friday. Although the economy is contracting at a much slower pace than earlier this year, the decline was far sharper than the average 0.3 per cent forecast by economists in a Thomson Reuters poll, and worse than even the most gloomy estimate in that survey. The contraction, which is the fifth consecutive quarterly decline in UK output, prompted economists to speculate that the Bank of England may expand its bond buying programme of quantitative easing. “The provisional UK GDP figures for Q2 are shockingly bad and firmly dash any hopes that the UK had already pulled out of recession,” said Vicky Redwood, economist at Capital Economics. The latest official data seemed to cast doubt on the widely followed CIPS/Markit surveys of purchasing managers, which have been decidedly upbeat in recent months, Ms Redwood said. Mike Saunders at Citigroup said that year-on-year the UK has just experienced the sharpest economic contraction in any year since the 1930s except for that seen during world war two and the wind down of the war economy. Colin Ellis, economist at Daiwa Securities, noted that the economy has now shrunk by 5.7 per cent from peak to trough. “Ignoring the spike in GDP in the second quarter of 1979 that distorts the true peak in activity, this is the largest peak-to-trough fall since the current data series started in 1955,” Mr Ellis said. “But the bottom line was that today’s number is pretty dire, and a sharp wake-up call for anyone who had already been dreaming of recovery.” Within broader GDP, the output of production industries declined by 0.7 per cent from their first quarter level, which itself was 5.1 per cent down on the last three months of 2008. Sterling fell by a cent against the dollar and euro following the release of the unexpectedly bad growth data. Interactive graphic

http://www.ft.com/cms/s/0/8ada2ad4-f3b9-11dd-9c4b-0000779fd2ac.html

105 How quantitative easing may be used to stimulate the economy The weak data prompted economists on Friday to speculate that the Bank’s monetary policy committee would consider at its next meeting in August whether it should expand the quantitative easing programme of security purchases to the full £150bn allocated to it, and may even seek authorisation to expand purchases beyond that level. Economists said that the main surprise in the data was the decline in services output, which fell by 0.6 per cent. The second quarter decline follows a 1.6 per cent drop in services output in the first quarter. Within that sector, business services and finance contributed most to the decline, falling 0.7 per cent, the ONS said. The drop in output in the service sector was underlined by the monthly index of services which was also released by the ONS on Friday. It showed output declined by 0.2 per cent in May compared to the previous month and by 1 per cent and in the three months to May, compared to the three months to April. In the growth figures distribution, hotels and restaurants fell by 0.5 per cent after contracting by 1.5 per cent in the first quarter. Within that, wholesale and motor trades contributed most to the decline. Indeed, the weakness of the motor industry was reflected in new data out Friday morning from the Society of Motor Manufacturers and Traders showing that production of cars fell by 30.2 per cent from its year ago level. Production of commercial vehicles – a component of business investment – showed a much sharper contraction, with production down by 60.4 per cent in June. Copyright The Financial Times Limited 2009 http://www.ft.com/cms/s/0/bb6b9d4e-77b8-11de-9713-00144feabdc0.html

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A $4 Billion Push for Better Schools Obama Hopes Funding Will Be Powerful Incentive in 'Race to the Top' By Michael D. Shear and Nick Anderson Washington Post Staff Writers Friday, July 24, 2009 President Obama is leaning hard on the nation's schools, using the promise of more than $4 billion in federal aid -- and the threat of withholding it -- to strong-arm the education establishment to accept more charter schools and performance pay for teachers. The pressure campaign has been underway for months as Education Secretary Arne Duncan travels the country delivering a blunt message to state officials who have resisted change for decades: Embrace reform or risk being shut out. "What we're saying here is, if you can't decide to change these practices, we're not going to use precious dollars that we want to see creating better results; we're not going to send those dollars there," Obama said in an Oval Office interview Wednesday. "And we're counting on the fact that, ultimately, this is an incentive, this is a challenge for people who do want to change." On Friday, Obama will officially announce the "Race to the Top," a competition for $4.35 billion in grants. He wants states to use funds to ease limits on charter schools, tie teacher pay to student achievement and move for the first time toward common academic standards. It is part of a broader effort to improve school achievement with a $100 billion increase in education funding, more money for community colleges and an increase in Pell Grants for college students. Duncan has used the Race to the Top fund, created through the economic stimulus law, as leverage to drive the president's education agenda in Rhode Island, Tennessee, Colorado and elsewhere. Never has an education secretary been given so much money by Congress with such open-ended authority, according to current and former federal education officials. Margaret Spellings, Duncan's predecessor under George W. Bush, had a tiny fraction of that amount at her disposal. Obama says stagnating student achievement is part of a "slow-rolling crisis" and represents a threat to the country's economic future. Stark achievement gaps remain for minority and low- income students. In some big cities, fewer than half of high school students graduate on time. The United States trails international competitors in math and science. In trying to reverse those trends, he faces the same decentralized educational system and resistance to change that hampered Bush's No Child Left Behind law, which required annual testing to hold schools accountable for closing achievement gaps. Like his predecessor, Obama is using the federal treasury to power through the obstacles. Unlike Bush, Obama must try to carefully bring along the teachers unions, a key Democratic constituency that so far has praised the president's goals but remains wary of the threat to members' paychecks and the promise of tenure. "There are going to be elements within the teachers union where they're just resistant to change, because people inherently are resistant to change," Obama said during the 20-minute

107 interview. "Teachers aren't any different from any politicians or corporate CEOs. There are going to be certain habits that have been built up that they don't want to change." Already, some legislatures, eager for a share of the massive federal money pot, have begun clearing the way for more charter schools and taking other steps to show they are pro-reform. The effort has helped Obama enlarge the federal role in an arena dominated by state and local governments, but there is deep skepticism about his approach. Congressional Republicans say the initiative, coupled with another $650 million for school reform under Duncan's control, is wasteful. "We just took a big old checkbook with a $5 billion total behind it and handed it to the secretary and said, 'Write a whole bunch of checks,' " said Rep. John Kline (Minn.), the top Republican on the House Education and Labor Committee. "I'm uncomfortable that we're doing that." Obama says the money will be distributed to states that can demonstrate results backed by data that show student scores and teacher performance are improving. "It's not based on politics, it's not based on who's got more clout, it's not based on what certain constituency groups are looking for, but it's based on what works," he said. "Now, what we're also doing, though, is we're saying this is voluntary. If there are states that just don't want to go in this direction, that's their prerogative." Leaders of the two largest teachers unions praise Obama's intentions to lift standards, raise teacher quality and turn around low-performing schools. But they acknowledge concerns about specifics. "We're absolutely in sync with where they're going," said Dennis Van Roekel, president of the National Education Association. Van Roekel said performance pay, charter schools and links between student and teacher data raise difficult issues for his union. On the data issue, Van Roekel said he told Duncan: "This is going to be a tough one for us." "The devil really is in the details," American Federation of Teachers President Randi Weingarten said. Many teachers fear they will be fired if they are judged unfairly on student test scores, Weingarten said. "You want to be respectful of an administration that believes in public education. And on the issues where you have differences, you try to work those out." For Duncan, the stimulus law has provided an opportunity to steer billions of dollars to school reform on his own terms. Duncan has broad control over the Race to the Top fund and the $650 million to spur innovation through local school systems and nonprofit groups. Since the law's enactment in February, states have inundated the department with queries about how to share in the bonanza. Duncan has dispensed plenty of tips: Lift restrictions on the growth of charter schools; build data systems that show individual student progress under specific teachers and principals; seek out new ways to turn around perennially struggling schools; and sign on to efforts to develop common academic standards that are tough enough to withstand international scrutiny. Today, the department will formally unveil its criteria for the competition. Applications will be accepted starting late this year for states that want to be first in line, or next spring, for those needing more time. (The District is also eligible.) Money will be awarded in two waves next year. Up to $350 million from the fund will be carved out to support a recently announced effort by 46 states to develop common academic standards.

108 But even before applications begin, Duncan has scored several policy victories around the country by making carefully worded statements designed to send signals to lawmakers and school officials. As the Rhode Island legislature debated $1.5 million in spending for two charter schools, Duncan said June 22 at a charter school conference in Washington: "We are fighting this on a state-by-state battle, that's the battleground. And places like Rhode Island that are thinking of underfunding charters are obviously going to put themselves at a huge competitive disadvantage going forward. So we don't think that's a smart thing for them to do, and we're going to make that very, very clear." The money was restored. In similar ways, Duncan has stepped into legislative debates in Indiana, Illinois, Tennessee and Massachusetts to advance or defend charter schools, though he points out that he wants to shut failing charter schools as much as he wants to open new ones. In Tennessee, a law was enacted in June to expand the pool of students eligible to attend charter schools. Tennessee Education Commissioner Tim Webb said Duncan's advocacy helped move the bill through a divided legislature. Without the intervention, Webb said, "I don't think it would have passed." Some are wary of the long arm from Washington. A Tennessee newspaper editorial railed against an "inappropriate threat" from federal officials. California officials are pushing back against suggestions that a state law on teacher evaluations could disqualify them from receiving funds. "Don't count California out," State Superintendent of Public Instruction Jack O'Connell said in a telephone interview. "We plan on vigorously attempting to secure this funding." Other states are maneuvering for advantage, too. The Colorado legislature passed three laws this year aimed at aligning state and federal goals on turning around low-performing schools, linking teacher and student data and helping students at risk of dropping out, according to Lt. Gov. Barbara O'Brien (D). One of the state laws "lifted language" verbatim from a federal education document, she said. "I have read every speech that Arne Duncan and President Obama have given on education like a literary critic," she said. O'Brien has noted it all on a spreadsheet, and she is aggressively reviewing policies and developing coalitions to maximize the state's chances. "We all know Colorado needs this money," she said. "Nobody wanted to be the group that threw up the roadblock that would kick us out of the competition." http://www.washingtonpost.com/wp- dyn/content/article/2009/07/23/AR2009072303881_pf.html

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Geithner Defends Financial Oversight Reform By Neil Irwin Washington Post Staff Writer Friday, July 24, 2009 11:54 AM Treasury Secretary Timothy F. Geithner took his campaign for an overhaul of financial regulation to Capitol Hill this morning, as the nation's top regulators prepared to square off on elements of his proposal and displayed fault lines within the government on how best to minimize the damage of future financial crises. Testifying before the House Financial Services Committee, Geithner acknowledged criticism of the Obama administration's plan to create a new regulator to protect consumers of financial products, give the Federal Reserve new power to oversee any institution that is large and complex enough to threaten the broader economy, and create a new council to monitor risks to the financial system. "We understand that on any issue this complex and this important there will be areas where parties genuinely disagree, and we look forward to refining our recommendations through the legislative process," Geithner said in prepared testimony. "But there should be no disagreement on the need to act." Some of those disagreements are set to be on display Friday afternoon, as leaders of several agencies involved -- Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairman Sheila C. Bair, and the leaders of the Office of the Comptroller of the Currency, Office of Thrift Supervision, and a representative of state bank regulators -- are set to testify. In prepared testimony, published online this morning, Bernanke offered reasons that the Fed should not be stripped of its powers to protect consumers, an approach proposed by Geithner and Democratic leaders in Congress but opposed by the financial industry. John C. Dugan, the comptroller of the currency, offered more pointed criticism of both the consumer protection regulator and the new authority granted the Fed to usurp the role of other bank regulators for certain institutions. "Unfortunately," Dugan said, the Obama administration's consumer protection regulator proposal "falls short in addressing the two fundamental consumer protection regulatory gaps," in that it would not apply rules uniformly to all financial institutions. States would be able to enact more restrictive standards, creating headaches for national banks. Moreover, he said, the proposal does not explain how the new regulator would enforce its rules. Dugan also objected to a new system in which the Fed could override other bank regulators, including his agency, in overseeing banks that are so large and complex as to be classified as "Tier 1 Financial Holding Companies." Bair, meanwhile, argued for a strong council to oversee financial regulation, going further than the Obama administration did in describing its powers. Geithner and Bernanke, in

110 contrast, have emphasized that the council could result in diffused responsibility and might not be effective at making major decisions in a crisis. "Some have suggested that a council approach would be less effective than having this authority vested in a single agency," Bair said, because it might "need additional time to address emergency situations." However, she said, if the council involves regulatory agencies it would offer "an appropriate system of checks and balances to ensure that decisions reflect the various interests of public and private stakeholders." http://www.washingtonpost.com/wp- dyn/content/article/2009/07/24/AR2009072401520_pf.html

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A Regulator Heeds Lessons From the Past Once an Opponent of Monitoring Derivatives, CFTC Chief Now Urges Tighter Rules By Zachary A. Goldfarb Washington Post Staff Writer Friday, July 24, 2009 When a meltdown on Wall Street threatened the financial system in 1998, Gary G. Gensler was still a newcomer at the Treasury Department. He was part of the government team that orchestrated the rescue of Long-Term Capital Management, a big hedge fund that had made bad bets on exotic financial contracts known as derivatives. But once the smoke cleared, Gensler closed ranks with others in the Clinton administration who decided against subjecting derivatives to tighter regulation. "Looking back now, it's clear we should have done more then," Gensler said in a recent interview. Since President Obama brought him back to government to lead the Commodity Futures Trading Commission (CFTC), Gensler has aggressively pushed for strict new rules to govern derivatives as the administration campaigns to revamp financial regulation. He has appeared frequently before Congress to press his case. This has meant confronting former colleagues at Goldman Sachs, where he began his career, and at other big banks that have profited from the agency's traditionally light touch. "Both the financial system and the regulatory system failed the American public," he said. "I want all options on the table." When Gensler discusses regulation, he speaks with a combination of candor reflecting his gritty Baltimore upbringing, confidence from his years as a senior executive on Wall Street and political caution born of more than a decade in Washington. At 51, he is balding but exceptionally fit, the result of his passion for running 50-mile ultramarathons. Gensler has faced skepticism about whether he is suited for the job after being part of the team that exempted derivatives from regulation a decade ago. Several senators held up his nomination for months out of concern that he was not committed to reining in Wall Street's use of derivatives. In just a few years, the derivatives trade has mushroomed into the world's largest market, estimated to be in the tens of trillions of dollars. Unregulated traders around the world have influenced and bet on just about anything -- including how much companies pay to borrow money, the value of currencies, and the prices of critical goods such as oil and cotton. The CFTC has long been a backwater, an agency important to certain financial and agricultural interests but lacking the stature of other financial regulators. With Gensler at the helm, it is emerging as a key player on two fronts. Using existing powers, Gensler is pushing for tighter regulation of the trade in oil, wheat and other commodities as evidence grows that speculators have been inflating prices. He also has been out in front in publicly advocating strict regulation of derivatives. Early on, he pushed for a requirement that derivatives be traded on exchanges, almost like stocks and

112 bonds. Later, the Obama administration offered that proposal, which if adopted would make it easier for regulators to monitor trading in derivatives and foster a more orderly market. To do the job, Gensler said, his agency needs more money. "This agency is sorely underfunded. We are smaller than we've been in a long time," he said. "It's 20 percent smaller than [in] 1999, and yet the volume in the marketplace has gone up fivefold." Yet to commissioner Bart Chilton, who had long been a lonely proponent at the CFTC of strict regulation, Gensler's appointment is already a relief. "I feel like reinforcements have been sent in," Chilton said. Gensler grew up in Pikesville, the son of a World War II veteran who sold candy and cigarettes around Baltimore. One of five children, including a twin brother, he was an overachiever who graduated at 21 with both a bachelor's and a master's degree in business from the University of Pennsylvania. At Goldman Sachs, he rose through the ranks and worked in mergers and acquisitions and trading groups. Although Gensler spent much of his career outside Washington, he has deep ties politically, professionally and personally in the area. During Senate confirmation hearings on his nomination in 1997 as an assistant Treasury secretary, Gensler sat at the same table as a then little-known official named Timothy F. Geithner, now Treasury secretary. In the wake of the Long-Term Capital debacle, he was at the center of a debate over whether new rules should be adopted for hedge funds and derivatives. The CFTC chairman, Brooksley Born, was pushing for regulation of derivatives. But Treasury Secretary Robert Rubin, Gensler's boss and former colleague at Goldman, opposed the measures. Gensler saw his role at the time as supporting Rubin. "Clearly, in hindsight we all should have pushed harder," Gensler said. At the end of the Clinton administration, Gensler decided to stay in the Washington area. Long involved in Democratic politics, he knew former senator Paul Sarbanes (D-Md.) and called him after the corporate accounting scandals of the early 2000s, volunteering to help write the landmark Sarbanes-Oxley legislation, which sought to reform American business practices. "He was enormously helpful to us, and he had terrific insights, and he understands very complex issues," Sarbanes said. In 2006, Gensler's wife died of breast cancer, turning Gensler for a time into a full-time, stay- at-home dad for his three daughters. After Hillary Clinton launched her run for president, Gensler spoke with her several times about joining the campaign. When Maryland Gov. Martin O'Malley held an event in Annapolis to endorse Clinton in May 2007, Gensler again told her he wanted to sign on. "But what about the girls?" she said, as she had on several occasions when he talked about joining the campaign. He eventually joined as a policy adviser. When Clinton's campaign ended, Gensler made his way to the Obama team. Obama adviser Pete Rouse, who had gotten to know Gensler when they both worked in the Senate, had approached him earlier. After Obama was elected, Gensler worked with Geithner, Lawrence Summers and other members of the economic team to review the performance of regulatory agencies.

113 At the CFTC, Gensler is planning to kick off a series of hearings next week to explore whether major financial firms have inflated the prices of energy and other commodities by amassing large holdings. And he remains adamant that the firms dealing in derivatives be tightly regulated. "We have to get all the dealers," Gensler said. "It's the one way you can be sure you are getting the whole market." http://www.washingtonpost.com/wp-dyn/content/article/2009/07/23/AR2009072303609.html

114 Opinion

July 24, 2009 OP-ED COLUMNIST Costs and Compassion By PAUL KRUGMAN The talking heads on cable TV panned President Obama’s Wednesday press conference. You see, he didn’t offer a lot of folksy anecdotes. Shame on them. The health care system is in crisis. The fate of America’s middle class hangs in the balance. And there on our TVs was a president with an impressive command of the issues, who truly understands the stakes. Mr. Obama was especially good when he talked about controlling medical costs. And there’s a crucial lesson there — namely, that when it comes to reforming health care, compassion and cost-effectiveness go hand in hand. To see what I mean, compare what Mr. Obama has said and done about health care with the statements and actions of his predecessor. President Bush, you may remember, was notably unconcerned with the plight of the uninsured. “I mean, people have access to health care in America,” he once remarked. “After all, you just go to an emergency room.” Meanwhile, Mr. Bush claimed to be against excessive government expenditure. So what did he do to rein in the cost of Medicare, the biggest single item driving federal spending? Nothing. In fact, the 2003 Medicare Modernization Act drove costs up both by preventing bargaining over drug prices and by locking in subsidies to insurance companies. Now President Obama is trying to provide every American with access to health insurance — and he’s also doing more to control health care costs than any previous president. I don’t know how many people understand the significance of Mr. Obama’s proposal to give MedPAC, the expert advisory board to Medicare, real power. But it’s a major step toward reducing the useless spending — the proliferation of procedures with no medical benefits — that bloats American health care costs. And both the Obama administration and Congressional Democrats have also been emphasizing the importance of “comparative effectiveness research” — seeing which medical procedures actually work. So the Obama administration’s commitment to health care for all goes along with an unprecedented willingness to get serious about spending health care dollars wisely. And that’s part of a broader pattern. Many health care experts believe that one main reason we spend far more on health than any other advanced nation, without better health outcomes, is the fee-for-service system in which hospitals and doctors are paid for procedures, not results. As the president said Wednesday, this creates an incentive for health providers to do more tests, more operations, and so on, whether or not these procedures actually help patients.

115 So where in America is there serious consideration of moving away from fee-for- service to a more comprehensive, integrated approach to health care? The answer is: Massachusetts — which introduced a health-care plan three years ago that was, in some respects, a dress rehearsal for national health reform, and is now looking for ways to help control costs. Why does meaningful action on medical costs go along with compassion? One answer is that compassion means not closing your eyes to the human consequences of rising costs. When health insurance premiums doubled during the Bush years, our health care system “controlled costs” by dropping coverage for many workers — but as far as the Bush administration was concerned, that wasn’t a problem. If you believe in universal coverage, on the other hand, it is a problem, and demands a solution. Beyond that, I’d suggest that would-be health reformers won’t have the moral authority to confront our system’s inefficiency unless they’re also prepared to end its cruelty. If President Bush had tried to rein in Medicare spending, he would have been accused, with considerable justice, of cutting benefits so that he could give the wealthy even more tax cuts. President Obama, by contrast, can link Medicare reform with the goal of protecting less fortunate Americans and making the middle class more secure. As a practical, political matter, then, controlling health care costs and expanding health care access aren’t opposing alternatives — you have to do both, or neither. At one point in his remarks Mr. Obama talked about a red pill and a blue pill. I suspect, though I’m not sure, that he was alluding to the scene in the movie “The Matrix” in which one pill brings ignorance and the other knowledge. Well, in the case of health care, one pill means continuing on our current path — a path along which health care premiums will continue to soar, the number of uninsured Americans will skyrocket and Medicare costs will break the federal budget. The other pill means reforming our system, guaranteeing health care for all Americans at the same time we make medicine more cost-effective. Which pill would you choose? http://www.nytimes.com/2009/07/24/opinion/24krugman.html?_r=1&th&emc=th

July 22, 2009, 9:45 pm Professor in chief I found Obama’s health care presentation so impressive — so much command of the issues — that it had me worried. If I really like a politician’s speech, isn’t that an indication that he lacks the popular touch? (A couple of points off for “incentivize” — what ever happened to “encourage”? — but never mind.) Seriously, it’s really good to see how much he gets it. Update: So Howard Fineman was unimpressed. And Fineman knows presidential greatness when he sees it: He’s the Texas Ranger of the world, and wants everyone to know it. He’s the guy with the silver badge, issuing warnings to the cattle rustlers. http://krugman.blogs.nytimes.com/2009/07/22/professor-in-chief/

116 July 19, 2009, 4:25 pm Ketchup and the housing bubble I’m working on the relationship between economic theory and the current crisis, and one thread obviously involves the role of efficient market theory in breeding complacency. So I ran across this revealing late-2007 interview with Eugene Fama. In it, Fama dismisses the whole idea of bubbles: Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient. The word “bubble” drives me nuts. For example, people say “the Internet bubble.” Well, if you go back to that time, most people were saying the Internet was going to revolutionize business, so companies that had a leg up on the Internet were going to become very successful. I did a calculation. Microsoft was an example of a corporation that came from the previous revolution, the computer revolution. It was hugely profitable and successful. How many Microsofts would it have taken to justify the whole set of Internet valuations? I think I estimated it to be something like 1.4. And he expresses confidence over housing (rather late in the game, wouldn’t you say?): Housing markets are less liquid, but people are very careful when they buy houses. It’s typically the biggest investment they’re going to make, so they look around very carefully and they compare prices. The bidding process is very detailed. What this made me think of was an old paper by Larry Summers On Economics and Finance Lawrence H. Summers The Journal of Finance, Vol. 40, No. 3, Papers and Proceedings of the Forty-Third Annual Meeting American Finance Association, Dallas, Texas, December 28-30, 1984 (Jul., 1985), pp. 633-635 (article consists of 3 pages) Stable URL: http://www.jstor.org/stable/2327785

mocking finance economists as the equivalent of “ketchup economists”, who believe that they’ve demonstrated market efficiency by showing that two-quart bottles of ketchup always sell for twice the price of one-quart bottles. In the case of housing, buyers do carefully compare prices — with the prices of other houses. That is, they make sure that two-quart bottles of ketchup are the same price as one-quart bottles. As we’ve seen, however, they don’t do a very good job of checking whether the overall level of housing prices makes sense. Yes, it was a bubble — and as Larry said way back when, the ketchup test just isn’t enough. July 19, 2009, 11:39 am Morning Joe I think this Michael Hirsch piece on Joe Stiglitz somewhat misses the point.

117 Yes, Joe should be playing a bigger role — he’s an insanely great economist, in ways you can’t really appreciate unless you’re deep into the field. I’d say that he’s more his generation’s Paul Samuelson than its John Maynard Keynes: as with Great Paul, almost every time you dig into some sub-field of economics — finance, imperfect competition, health care — you find that much of the work rests on a seminal Stiglitz paper. But the larger story is the absence of a progressive-economist wing. A lot of people supported Obama over Clinton in the primaries because they thought Clinton would bring back the Rubin team; and what Obama has done is … bring back the Rubin team. Even the advisory council, which is supposed to bring in skeptical views, does so by bringing in, um, Marty Feldstein. The point is that even if you think the leftish wing of economics doesn’t have all the answers, you’d expect some people from that wing to be at the table. Yet I don’t see Larry Mishel, or Jamie Galbraith … Jared Bernstein is it. Joe Stiglitz stands out because in addition to being on the progressive wing, he’s also, as I said, a giant among academic economists. But I think the real story is more about excluded points of view than excluded people. July 18, 2009, 8:54 am Summers at IIE The speech Larry Summers gave at the IIE was sensible and clear-headed. But his discussion of the stimulus and its size was disappointing — and, I hope, somewhat disingenuous. What Larry said: The size of the stimulus reflected a balance of several considerations: the size of the likely output gap that the economy was facing, the difficulties of ramping up spending and then ramping it back down after recovery in a high budget-deficit environment, the question of how much could be spent both quickly and productively, and the recognition that the Recovery Act was just one of several initiatives by the Administration that would have a dynamic impact on the state of the economy. Look: it was really clear, even in January, that the stimulus wasn’t remotely big enough to close the output gap. My analysis at the time here and here. It was also clear, at least to me, that the stimulus should, in fact, be aggressive — enough to achieve something close to full employment. Now, you can argue that given the political realities it just wasn’t possible to pass a bigger stimulus, which may or may not be true. But that’s not the argument Larry is making — he’s saying that the plan was just right in economic terms. And I can only hope they didn’t really think that. What about the argument that the stimulus was just one of “several initiatives”? Well, I did hear that at the time. But as we now know, not much is happening on other fronts. Foreclosure relief has been mostly a nonstarter; the PPIP has turned more or less into a joke; policy toward the banks is basically a muddle-through strategy, which might work out in terms of avoiding the need for further direct intervention, but certainly isn’t jump-starting lending. The point is that I can respect the argument that this was all the administration could do, politically. I can’t feel equal respect for the argument that this was all it should have done, economically.

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The Most Misunderstood Man in America Joseph Stiglitz predicted the global financial meltdown. So why can't he get any respect here at home? By Michael Hirsh | NEWSWEEK Published Jul 18, 2009 From the magazine issue dated Jul 27, 2009 Anya Stiglitz was in the middle of a Pilates class in Central Park on an April morning when her cell phone rang. Glancing down, she saw "202" pop up—no number attached—and knew it was the White House. An aide to Larry Summers was on the line, looking for her husband, the Nobel Prize–winning economist Joseph Stiglitz. Anya said she'd pass on the message to Joe—then went back to work on her abs. No big deal, she thought. People often call her when they want to talk to Joe, because even though he's spent four decades figuring out how the global economy works, he hasn't quite gotten the hang of voice mail. "He doesn't listen to his messages, so if you want to talk to him, keep calling," Anya says on his cell-phone recording. Anya figured Summers, Obama's chief economic adviser, was probably just calling to gripe about Joe's latest op-ed in The New York Times. Joe Stiglitz and Larry Summers, two towering intellects with egos to match, are not each other's favorite economist. "They respect each other, but they hate each other like poison," says Bruce Greenwald, Stiglitz's friend and academic collaborator at Columbia. ("I've got huge admiration for Joe as an economic thinker," Summers told NEWSWEEK.) Stiglitz had been hammering at Obama's economic team for its handling of the financial crisis. He wrote that the stimulus program was too small to be effective—a criticism that has since swelled into a chorus, though Obama says he's not adding more money. Stiglitz also had called the administration's bailout plan a giveaway to Wall Street, an "ersatz capitalism" that would save the banks' investors and creditors and screw the taxpayers. "I thought, Larry—he's just going to yell at Joe," Anya recalls. But Summers's aide soon called back, and this time he said it was urgent: could Professor Stiglitz come to Washington for a dinner hosted by the president—that same night? Anya patched him through to Joe's office at Columbia University; Stiglitz accepted, and jumped on an early train. He was a little miffed: the other eminent economists attending the dinner, like Princeton's Alan Blinder and Harvard's Kenneth Rogoff, had been invited the week before. Stiglitz, a former chairman of Bill Clinton's Council of Economic Advisers, had supported Barack Obama as a candidate as early as 2007. But until that day, four months into the administration, he had heard barely a word from the White House. Even now, when the president was making an effort to hear a range of economic voices, Stiglitz seemed to be an afterthought. (A White House spokesman said only that the president wished to include Stiglitz.) Such is the lot of Joe Stiglitz. Even in the contentious world of economics, he is considered somewhat prickly. And while he may be a Nobel laureate, in Washington he's seen as just another economic critic—and not always a welcome one. Few Americans recognize his name, and fewer still would recognize the man, who is short and stocky and bears a faint resemblance to Mel Brooks. Yet Stiglitz's work is cited by more economists than anyone else's in the world, according to data compiled by the University of Connecticut. And when he goes abroad—to Europe, Asia, and Latin America—he is received like a superstar, a modern-day oracle. "In Asia they treat him like a god," says Robert Johnson,

119 a former chief economist for the Senate banking committee who has traveled with him. "People walk up to him on the streets." Stiglitz has won fans in China and other emerging G20 nations by arguing that the global economic system is stacked against poor nations, and by standing up to the World Bank and International Monetary Fund. He is also the most prominent American economist to propose a long-term solution to the imbalances in capital flows that have wreaked havoc, from the Asian contagion of the late '90s to the subprime-investment craze. Beijing has more or less endorsed Stiglitz's idea for a new global reserve system to replace the U.S. dollar as the world currency. Chinese Prime Minister Wen Jiabao has been influenced by Stiglitz's work, especially when "he talks about the economics of poor people," says Fang Xinghai, the head of Shanghai's financial-services office. But his stature is huge in Europe as well: French President Nicolas Sarkozy recently featured him at a conference on rethinking globalization. And earlier this month, while traveling to Europe and South Africa, Stiglitz received a call from British Prime Minister Gordon Brown's office: could he return through London and help the P.M. get ready for the G20 meeting in Pittsburgh? Stiglitz is perhaps best known for his unrelenting assault on an idea that has dominated the global landscape since Ronald Reagan: that markets work well on their own and governments should stay out of the way. Since the days of Adam Smith, classical economic theory has held that free markets are always efficient, with rare exceptions. Stiglitz is the leader of a school of economics that, for the past 30 years, has developed complex mathematical models to disprove that idea. The subprime-mortgage disaster was almost tailor- made evidence that financial markets often fail without rigorous government supervision, Stiglitz and his allies say. The work that won Stiglitz the Nobel in 2001 showed how "imperfect" information that is unequally shared by participants in a transaction can make markets go haywire, giving unfair advantage to one party. The subprime scandal was all about people who knew a lot—like mortgage lenders and Wall Street derivatives traders—exploiting people who had less information, like global investors who bought up subprime- mortgage-backed securities. As Stiglitz puts it: "Globalization opened up opportunities to find new people to exploit their ignorance. And we found them." Stiglitz's empathy for the little guy—and economically backward nations—comes to him naturally. The son of a schoolteacher and an insurance salesman, he grew up in one of America's grittiest industrial cities—Gary, Ind.—and was shaped by the social inequalities and labor strife he observed there. Stiglitz remembers realizing as a small boy that something was wrong with our system. The Stiglitzes, like many middle-class families, had an African-American maid. She was from the South and had little education. "I remember thinking, why do we still have people in America who have a sixth-grade education?" he says. Those early experiences in Gary gave Stiglitz a social conscience—as a college student, he attended Martin Luther King's "I Have a Dream" speech—and led him to probe the reasons why markets failed. While studying at MIT, he says he realized that if Smith's "invisible hand" always guided behavior correctly, the kind of unemployment and poverty he had witnessed in Gary shouldn't exist. "I was struck by the incongruity between the models that I was taught and the world that I had seen growing up," Stiglitz said in his Nobel Prize lecture in 2001. In the same speech he declared that the invisible hand "might not exist at all." The solution, Stiglitz says, is to move beyond ideology and to develop a balance between market- driven economies—which he favors—and government oversight. Stiglitz has warned for years that pro-market zeal would cause a global financial meltdown very much like the one that gripped the world last year. In the early '90s, as a member of Clinton's Council of Economic Advisers, Stiglitz argued (unsuccessfully) against opening up

120 capital flows too rapidly to developing countries, saying those markets weren't ready to handle "hot money" from Wall Street. Later in the decade, he spoke out (without results) against repealing the Glass-Steagall Act, which regulated financial institutions and separated commercial from investment banking. Since at least 1990, Stiglitz has talked about the risks of securitizing mortgages, questioning whether markets and authorities would grow careless "about the importance of screening loan applicants." Malaysian economist Andrew Sheng says, "I think Stiglitz is the nearest thing there is to Keynes in this crisis." That would be John Maynard Keynes, the great 20th-century economist who rocketed to international renown in late 1919 when he published The Economic Consequences of the Peace. In his book, Keynes warned that the draconian penalties imposed on Germany after World War I would lead to political disaster. No one listened. The disaster he predicted turned out to be World War II. Like Stiglitz, Keynes was not a favorite at the White House. Keynes also believed that markets were imperfect: he invented modern macroeconomics—which calls for major government intervention to help ailing economies—in response to the Great Depression. But after meeting Keynes for the first time in 1934, FDR dismissed him as too abstract and intellectual, according to Robert Skidelsky, Keynes's biographer. Keynes himself fretted that Roosevelt was not spending enough. To his critics—and there are many—Stiglitz is a self-aggrandizing rock-thrower. Even some of his intellectual allies note that while Stiglitz is often right on the substance of issues, he tends to leap to the conclusion that government can make things better. Harvard economist Rogoff has called him intolerably arrogant—though he added that Stiglitz is a "towering genius." In a letter to -Stiglitz published in 2002, Rogoff recalled a moment when the two of them were teaching at Princeton and former Fed chairman Paul Volcker's name came up for tenure. "You turned to me and said, 'Ken, you used to work for Volcker at the Fed. Tell me, is he really smart?' I responded something to the effect of 'Well, he was arguably the greatest Federal Reserve chairman of the 20th century.' To which you replied, 'But is he smart like us?'" (Stiglitz says he can't remember the comment, but adds that he might have been referring to whether Volcker was an abstract thinker.) Stiglitz's defenders say one possible explanation for his outsider status in Washington is his ongoing rivalry with Summers. While they are both devotees of Keynes, Summers often has supported deregulation of financial markets—or at least he did before last year— while Stiglitz has made a career of mistrusting markets. Since the early '90s, when Summers was a senior Treasury official and Stiglitz was on the Council of Economic Advisers, the two have engaged in fierce policy debates. The first fight was over the Clinton admin-is-tration's efforts to pry open emerging financial markets, such as South Korea's. Stiglitz argued there wasn't good evidence that liberalizing poorly regulated Third World markets would make any one more prosperous; Summers wanted them open to U.S. firms. The differences between them grew bitter in the late 1990s, when Stiglitz was chief economist for the World Bank and took issue with the way Treasury Secretary Robert Rubin, and Summers, who was then deputy secretary, were handling the Asian "contagion" financial collapse. After World Bank president James Wolfensohn declined to reappoint him in 1999, Stiglitz became convinced that Summers was behind the slight. Summers denies this, and maintains that no rivalry exists between them. Summers's deputy Jason Furman says that Summers now "talks to [Stiglitz] a lot." "A lot" is an exaggeration, Stiglitz responds. "We've talked one or two times," he says.

121 Despite the Obama team's occasional efforts to reach out to him, Stiglitz remains deeply unhappy about the administration's approach to the financial crisis. Rather than breaking up or restructuring the big banks that failed, "the Obama administration has actually expanded the notion of 'too big to fail,' " he says. In a veiled poke at his dubious standing in Washington, Stiglitz adds: "In Britain there is a more open discussion of these issues." A senior White House official, responding to this critique, says that the Obama administration is most often criticized these days for intervening too much in the economy, not too little. In other respects, Obama is embracing some of Stiglitz's views, suggests Peter Orszag, director of the Office of Management and Budget—and a former Stiglitz protégé (he worked for Stiglitz during the Clinton administration). One example: Obama's new idea for reforming health care by creating a government-run program to compete with private-sector insurers. "There is an intellectual paradigm in health care that says you should move to purely private markets," says Orszag. "Joe's perspective would suggest major difficulties [with that]. That led to the thought that we need a mix: there is an important government role." Today, settled as a professor at Columbia, Stiglitz occasionally finds himself welcomed in the nation's capital, though usually at the other end of Pennsylvania Avenue, to testify before Congress. While he had no great desire to go back into government, friends say he was deeply disappointed when an offer didn't come from Obama last fall. Not surprisingly, Stiglitz believes his old rival was behind it, though Summers denies this. As for the invitation to dinner at the White House, there were a few theories kicked around the spacious Stiglitz household on Manhattan's Upper West Side as to why it came at the last minute: one was that Obama, in an interview posted online that week by The New York Times, had cited Stiglitz as one of the critics he listens to, so it would have seemed strange if he hadn't been invited to the dinner. While Stiglitz was flattered by the discussion over a dinner of roast beef and Michelle Obama's homegrown lettuce, he can't stop himself from complaining that an occasional meal with dissidents is not the best way for the president to formulate policy. "Some of the most difficult debates and judgments can't really be hammered out in an hour-and-a-half meeting covering lots of topics," he says. Stiglitz may a prophet without much honor in Washington, but he seems to be determined to keep the prophecies coming. http://www.newsweek.com/id/207390

122 The Road Ahead for the Global Economy Nouriel Roubini | Jul 23, 2009 The global recession may end towards the end of 2009 rather than sooner and the global recovery in 2010 will be anemic and well below trend as leveraged and income/profit-challenged households, firms and financial institutions are constrained in their ability to borrow, lend and spend. Meanwhile a perfect storm of... persistently large fiscal deficits and public debt accumulation, monetization of such deficits that will eventually increase expected inflation, rising government bond yields, soaring oil prices, weak profits, still falling jobs and stagnant growth has inched a little closer on the radar of this cloudy global economic outlook. It’s a storm that could blow the recovering world economy back into a double-dip recession by late 2010 or 2011. It doesn’t have to come to pass. But it is getting more likely unless a clear exit strategy from the massive monetary and fiscal stimulus is outlined even before it is implemented once a more sustained global recovery is achieved. After rising sharply for three months, asset markets in the mature economies have paused and started a tentative correction in the last few weeks. Risk investors that had driven up prices have partially taken profits, and suddenly they are wary. They are right to be wary. Before the recent correction started there was a very sharp rise in asset prices, starting around March 9. Equities rose, oil and energy prices rose, commodities rose. Credit spreads sharply contracted, indicating a surge of new confidence in the corporate sector. Long-term government interest rates shot up, as ten-year treasuries rose from 2% to 4% before retracing, suggesting that markets saw growth returning in the near future. The volatility of asset prices also fell, and that is always a sign of increasing confidence and lower risk aversion. Emerging market asset prices – equities, bonds and currencies - have if anything been more bullish. The broad indices of the BRICs showed that in early 2009 some investors again began to believe that these economies, starting with China, will recover and experience further rises in commodity prices. In other words, markets which only four months ago were pricing in an L-shaped global near-depression and a near financial meltdown were three weeks ago pricing in a rapid V-shaped recovery towards potential growth. And there are some good reasons for part of this rally. At the beginning of the year GDP was falling at a rate that suggested that something close to economic depression really was looming, and there was a widespread sense that many of the world’s biggest financial institutions were effectively insolvent. Today, both of those fears have been for now checked; the tail risk of a L-shaped near depression is significantly lower. We have seen policy action by the US, by Europe, by Japan, by China and many other economies that has been unprecedented, with interest rates reduced to near zero, with much bad debt ring-fenced (although not written off or worked out), with liquidity created by orthodox and unorthodox means and with final demand in many economies primed by central governments. The rate of output decline has shallowed dramatically, the ‘tail risk’ of a chronic slump has been suppressed, and financial institutions are recording profitable quarters, at least on paper as forbearance and public subsidies are for now hiding their mounting losses.

123 All this creates a moment when a rally to risk was to be expected. As tail risk is reduced, investors move back into equities, credit and commodities. But better fundamentals are not the only drivers at work. Some proportion of the market upturn is the result of liquidity itself – and governments have raised a massive wall of liquidity, a wave that is now surging into asset markets. Take China: most of the new credit that has been officially created has gone to state-owned enterprises that stockpiled raw materials and drove commodity prices higher. Fear of the expected inflation that is likely to be eventually caused by all this easy money is also a driver. When investors and companies see inflation coming they seek an inflation hedge, and they reason that commodities today will be better than cash tomorrow. Some argue that none of this matters. Who cares if credit spreads narrow, and asset prices - including equities - go up? After all that is good for wealth, and good for growth. But if it all happens too fast too soon, the effect may be the opposite: oil and energy prices rising too fast too soon are a negative shock to oil importing economies and the rally in risky assets may deflate if weaker than expected economic and financial news reemerge. A new and malign tipping point for the economy may be created. The effect of that tipping point depends on how optimistic markets have become about the medium-term prospects, and on how realistic that optimism is. Until recently, the level of optimism was not realistic. Markets were not just pricing in a realistic calculation of the reduction in risk and a reduced risk of an L-shaped near depression. They were pricing the expectation that the economies of the US and Europe were close to returning to their potential growth levels, a V-shaped recovery. That is not realistic at all as a weak, anemic U-shaped recovery is the most likely scenario for advanced economies. For one thing, the recession is not about to end, with unemployment still rising and house prices still falling: the contraction has at least five months to run until year end, and maybe a little longer. Secondly, the growth that will be achieved when the recession does end will be a U-shaped weak growth, and it will stay weak for an extended period. Trend growth in the US is around 3%, but with final demand so weak – as highly leveraged financial institutions restrain credit growth and as highly leveraged households and companies reduce their consumption and capex spending - growth of more like 1% is more likely for 2010-2011. Most importantly, weak growth prepares the ground for a second leg down, back into recession – the ‘W-shaped’ recession that may emerge in late 2010 or 2011, and that markets seem to have forgotten about. If oil prices rise too fast because of the wall of liquidity, and long-term government bond yields keep rising (because large fiscal deficits keep on being monetized leading to a rise in expected inflation after a long bout of deflation), all against a background of weak demand and continued consumer distress, markets and the broader economy will slide hand-in-hand down the next steep slope of recession. Two factors are especially important in the shorter-run. One is the employment-housing nexus. And the other is financial industry distress. Employment and housing are inextricably linked. Unemployment is growing – in the US almost half a million people lost their jobs in June, and on top of that a larger number are having their disposable income cut by shorter hours, lower hourly wages, or enforced furloughs and cuts in hours worked. The unemployment rate in the eurozone is equally weak – the figures are almost identical to the US. So income throughout the OECD is weak, which means consumption is weak, and no practical amount of temporary government tax rebates will change that – for example, most of last year’s $100 billion rebate in the US was saved not spent, and the same will be true this year.

124 This background of job losses and declining income guarantees that house prices will continue to fall to a cumulative decline of 40-45% from their peak; thus, another 13% to 18% fall in home prices is still ahead of us. Historically, house prices do not bottom while unemployment is rising. Already this crisis will see over 8 million mortgage holders in the US lose their jobs by year end and be unable to service their mortgages. Further declines in house prices will in turn help generate a new round of financial industry distress. Investor sentiment towards large lenders has improved greatly in the last four months, on the assumption that most of their housing- and consumption-related lending (two things that are impossible to disaggregate, because they are often the same thing) has been accurately re-priced. But it hasn’t. These loans have just been re-labeled as ‘stress-tested’, but that is the equivalent of putting a bill in the filing cabinet instead of paying it. The toxic content has not been purged, not least because the stress tests were so feeble. The worst-case assumption of the US stress tests were that unemployment could average 10.3% next year. The reality is clearly going to be worse as the unemployment rate is likely to peak around 11%. Banks are going to go on filing bills instead of paying them for a couple of quarters more. Reality will sink in eventually, and the reality is that a higher level of bad debt provision needs to be made for mortgages (whether sub-prime or prime), commercial real estate, personal loans, auto loans, credit cards and much more – but that may not happen until later this year or next year when provisions for loan losses cannot be further postponed. And when that does happen it is very likely that the financial institutions of Europe will suffer most. European banks have built up higher leverage, with risky lending and massive exposure especially to official and private borrowers in Eastern Europe (lending which also has foreign currency exposure, which as the Asian financial crisis showed is highly dangerous). By that time it will also be clear that expectations of corporate earnings will have to be downgraded again. Today the market consensus is that next year’s profits will be around one third higher than this year. That view is based on another expectation –that growth will recover rapidly to trend levels and deflationary pressures will disappear. But these expectations are very likely to be disappointed: for the next year and a half deflationary pressures will dominate in the mature economies as goods and labor markets remain very slack. Demand will be weak, most prices will be falling, and companies will therefore have little pricing power and their profit margins will remain squeezed. The expectation that in these conditions profits will rebound strongly is quite far-fetched. A correction of the prices of risky assets – equities, credit and commodity prices - therefore seems inevitable and has already partially started in July. In the second half of 2009 the correction will be driven by worse macro-economic performance than is currently expected. It will be driven by worse than expected shocks to financial institutions, with further writedowns of banking sector assets and greater than expected capital needs. And it will be driven by downside surprises on corporate profits when weak consumption will reemerge when the temporary effects of the tax rebates fizzled out over the summer. The world economy can withstand such a correction without falling into an L-shaped near depression. Near depression would means unemployment even higher than 11% and GDP growth negligible or negative for years. But while a near depression will be avoided the road ahead will be tough. Today markets think that a strong recovery is just around the corner. There will be a recovery but that it will take another six months for all the indicators to start pointing in the right direction. And in the larger picture it does not matter exactly when the turning point is reached: what matters is what kind of recovery we will see. An analysis of macro and financial fundamentals suggests that it will be weak for an extended period of time

125 (what the wise folks at PIMCO call "the new normal"). And the risk that weak recovery will relapse into a chronic stagnation, where inflation gradually takes over from deflation, is actually increasing as the most likely scenario is that large fiscal deficits will keep on being monetized for quite a while and eventually lead to higher expected inflation. Emerging market economies may fare better than advanced economies as - paradoxically - many of them have sounder macro and financial fundamentals than advanced economies. But the growth recovery of emerging markets will be constrained by the growth weakness in the G3 economies. Indeed, many emerging market economies - starting with China - still significantly rely on net external demand as a major source of economic growth and the structural policy changes that will lead to lower savings and greater private domestic demand - especially private consumption - will take many years to be implemented. Thus China and emerging market economies cannot fully decouple from the fortunes - or misfortunes - of the advanced economies. In conclusion, we are now closer than we were six months ago to the end of the worst financial crisis since the Great Depression and worst global recession in decades. But the road ahead will be very rough and bumpy: the recession in advanced economies will continue through year end, the recovery will be very anemic and well below trend, the risks of a double dip W-shaped recession are rising and the growth recovery of emerging market economies will be constrained by the weakness of advanced economies. These downside risks will imply volatile times ahead for financial markets: the lows of March will not be tested as they were associated with the risk of a near depression but a meaningful correction in a variety of risky assets is likely. http://www.rgemonitor.com/roubini- monitor/257350/the_road_ahead_for_the_global_economy

Can Japan Avoid Another Lost Decade?

Mikka Pineda| Jul 22, 2009 Today, following the release of our U.S. and China outlooks, we present another preview from the updated 2009/10 RGE Monitor Global Economic Outlook, which will be available by the end of next week to subscribers. This week we focus on Japan, which will not only underperform the U.S. and EU economically in 2009, but also faces political uncertainty. National elections, scheduled for the end of August, are quite likely to bring some changes to Japanese economic policy, and could also hold ramifications for the U.S. dollar. RGE Monitor expects the pace of Japanese economic contraction to ease from the sharp decline of Q1 2009, but the road to recovery will be long and bumpy. Inventory restocking is coming to an end and rising commodity prices could curtail a nascent recovery in consumer demand. Meanwhile, public spending is constrained by soaring public debt, and Japan’s export-oriented model of growth seems increasingly unsustainable, given the degree to which deleveraging is stifling external demand from the U.S. and Europe. Japan's Lost Decade might thus be more aptly called its “Lost Decades.” The sharp economic slowdown of the early 1990s culminated in a recession in 1998-1999, only to be followed by almost another decade of recessions and paltry growth. Being the most trade-dependent of major industrialized nations, Japan suffered the worst GDP contraction among these countries

126 in Q1 2009, and is on track to perform the worst of the G3 in 2009. Aggregate demand slid precipitously and deflation took hold once again, despite massive fiscal spending and monetary expansion. RGE projects Japan's recession will persist through 2009, then give way to gradual recovery in 2010. Feeble Aggregate Demand Though the pace of economic contraction has slowed since Q1 2009, the inventory-driven rebound in production and exports will at best make for stabilization at low levels, rather than a strong economic expansion. Japan's recovery will hinge on external demand from the U.S. and Europe--the main final consumers of Japanese goods. Chinese demand, which helped boost Japan in 2005-2007, may be of little help this time. China is the top destination for Japanese exports, but Chinese demand is mostly a function of U.S. and European demand. Most Japanese exports to China are inputs for goods bound for the U.S. and Europe, not finished goods bound for Chinese retail stores or raw materials needed for infrastructure projects. Meanwhile, domestic demand in Japan has suffered from the poor earnings outlook for both firms and households. Japan's overcapacity has curbed capital expenditure growth as firms see no need to expand or upgrade capacity when supply exceeds demand and capacity utilization is low. Moreover, falling earnings and tight credit reduce the affordability of new equipment and factories. Rising unemployment and the destruction of household wealth have kept household consumption weak, despite government handouts. Worse yet, wages are decreasing faster than the cost of living. Deflation... Again Japan, which suffered from falling prices from 1999 to 2005, is back in deflation and may be facing a protracted period of price declines due to anemic demand growth and falling wages.Consumer inflation will see its nadir in Q3 2009, due to base effects from lower oil prices, but both headline and core inflation may remain negative even beyond the autumn, given falling demand and wages. RGE Monitor expects annual CPI inflation to be negative in 2009 and 2010. And like the meager inflation in 2006-2008, any extant inflationary pressure will come predominantly from cost-push sources (rising energy and material costs) rather than domestic demand. Public Debt: Unsustainable? The sustainability of Japan's public finances has come under scrutiny in the wake of the ¥15.4 trillion fiscal stimulus package announced in April 2009--the biggest in Japan's history-- which will send public debt soaring to about 200% of GDP by 2010. Japan's heavy debt load led to the loss of its AAA sovereign rating in May 2009. Reluctant to burden a long-stagnant economy with higher taxes, social spending cuts and lower public investment, policymakers have put fiscal reform on hold until at least 2015. In the meantime, policymakers will probably cajole the Bank of Japan to continue monetizing the public debt. Locals hold most of Japan’s public debt, but a declining saving rate coupled with declining home bias could wreak havoc on Japanese government bonds. A New Ruling Party for Change? Due to Prime Minister Aso's severe unpopularity and his administration’s scandals and economic failings, the 2009 general elections may bring a shift in Japan's policies, ending fifty-plus years of de facto one-party rule under the Liberal Democratic Party (LDP). The LDP lost its majority of seats to the Democratic Party of Japan (DPJ) in Tokyo local elections in mid-July, foreshadowing a struggle in the August 30 general elections for the Lower House

127 of Parliament. Former LDP-member-turned-DPJ-leader Yukio Hatoyama has a strong chance of becoming Japan’s next Prime Minister. A DPJ win could bring looser fiscal policy and a greater willingness to use currency intervention, though contradictory remarks from DPJ officials suggest a disunited stance. Nonetheless, the DPJ could bring welcome changes that address Japan’s ailing consumer demand growth and falling birth rate, such as child support and an expanded social safety net. The DPJ also hopes to convert the policymaking process into a less bureaucrat-led cabinet system. Unions at large manufacturers, especially those that produce eco-friendly products and low-priced goods and services, may stand to benefit from the DPJ’s tougher environmental policies and support for low-income families. Unfortunately, a deeply negative output gap will dampen the economy in the medium-term no matter what policymakers do. A critical test for the winner will thus be attending to the longer-term ramifications of a rapidly aging population, such as a shrinking labor force and consumer market. With Japan's baby boomers reaching age 65 by the early 2010s, policymakers will need to act quickly to prevent public debt from spiraling out of control when the underfunded pension system meets an onslaught of retirees. Land use reforms that increased homeownership could encourage larger families and higher consumer spending against home equity. U.S. Dollar Dump a Danger Some members of the DPJ have vowed to shun U.S. debt, which suggests public pension funds and other quasi-government funds (such as the newly privatized Japan Post Holdings, whose shares are still held by the government) could move to higher-yielding assets if DPJ becomes the ruling party. Diversification of FX reserves and pension funds away from the U.S. dollar could mean sharp losses for the dollar. Japan is the second largest foreign holder of Treasuries after China. The reduction in Japan’s external surplus in 2009 may already have contributed to a reduction in Japanese reserve growth and U.S. debt holdings. Despite the decrease in the U.S. current account deficit and a higher U.S. savings rate, the U.S. would have a very difficult time meeting its financing needs if Japan stopped buying U.S. debt and sold off its dollar assets or signaled the intent to do so. Such a move could precipitate a disorderly decline in the U.S. dollar and the loss of its supremacy as a global reserve currency, especially if other reserve holders followed Japan’s lead. A dollar crash would be undesirable for Japan, though, due to its large U.S. dollar holdings and the desire of its policymakers to aid Japanese exporters through a weak domestic currency. Japanese reserve diversification is thus likely to remain gradual, but the chance of political change come August 2009 raises uncertainty on this point. Mikka Pineda Can Japan Avoid Another Lost Decade? Jul 22, 2009 http://www.rgemonitor.com/economonitor- monitor/257334/can_japan_avoid_another_lost_decade

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The Outlook for Energy July 23, 2009, 5:00PM EST text size: TT Can the Military Find the Answer to Alternative Energy? DARPA, the Defense Dept. agency that helped invent the Internet, is setting its sights on cleantech By Steve LeVine Nine years ago, Robert J. Nowak, an electro-chemicals expert for the Defense Dept., learned that senior generals weren't happy with their troops' electronic gear. While the night-vision, laser, and GPS devices worked well, the batteries that powered them weighed some 25 pounds per soldier, heavy enough to hurt some of the troops. So Nowak, who worked at the Defense Advanced Research Projects Agency (DARPA), the Defense Dept.'s famous research branch, solicited bids for a new device that would power a soldier's gear at a tenth of the weight and a fraction of the $100 cost of the batteries. Today, the original 18 companies that took up Nowak's challenge have been whittled down to two: Livermore (Calif.)-based UltraCell and Adaptive Materials of Ann Arbor, Mich. Their solution: small, sturdy fuel cells that can power a soldier's clutch of mobile devices for a week on a gallon or so of methanol or propane. Battle-ready versions of the fuel cells will be available this year. DARPA regards the result as a game-changer for the military—akin to the potential shift in the automobile market from gasoline-driven to hybrid or electric cars. Before the fuel cells, "If you were in Afghanistan and had a battery, you basically had to go to another country to get it recharged," says Nowak, now retired. U.S. consumers and businesses might someday gain as well. Both companies are testing models for the U.S. commercial market. First targets: city police forces and makers of recreational vehicles. The big drive to create a viable alternative-energy future— by Detroit, multinationals such as IBM (IBM) and BP (BP), and Silicon Valley startups—is well-known. But there's another serious player in this sphere: the U.S. military, and especially DARPA. Created at the height of the Cold War to bolster U.S. military technology following the Soviet Union's Sputnik satellite launch, the agency has a long history of innovation. Most famously, DARPA's researchers first linked together computers at four locations in the early 1960s to form the ARPANET, a computer network for researchers that was the core of what eventually grew into the Internet. Other breakthroughs have helped lead to the commercial development of semiconductors, GPS, and UNIX, the widely used computer operating system. There have been some serious gaffes as well, including mechanical elephants to carry troops through Vietnam's jungles and an ill-conceived search for people gifted with psychic powers. But on the whole, DARPA has a strong record of bringing ideas from the lab to the real world. Can DARPA now score another double success by changing how both the military and civilian worlds consume and produce energy? DARPA's first goal is always to magnify the might of the U.S. armed forces. That's why Arlington (Va.)-based DARPA is devoting an estimated $100 million of its $3 billion annual budget to alternative energy. The U.S. forces

129 deployed in Afghanistan and Iraq are voracious consumers of energy. As a result they have become perilously dependent on long, costly, and vulnerable convoys of diesel-fuel tankers. More vehicles are used to transport and guard the fuel—mostly for running generators for air conditioning, laptops, and other gear at U.S. bases and posts—than are deployed in actual combat, according to a May report by the Military Advisory Board. With the expense of convoys and guards thrown in, the cost of a gallon of fuel used at the front can range from $15 to several hundred dollars, says the same report. So the Army has set an overall goal of significantly reducing its fuel requirements. Under its plan, fuel and supply shipments to 5,000-troop brigades would be reduced from the current once every few days to just once a month. DARPA describes itself as an incubator of long-shot technologies too risky for almost anyone else to take on. The agency operates by issuing challenges to companies that are so tough they are called "DARPA-hard." Typically, DARPA requires contractors to come up with solutions that are orders of magnitude superior to current technology. It pays companies—from startups to IBM—as well as top universities to meet a goal. Then, other than imposing strict reporting requirements, the agency gets out of the way of the researchers' work. In addition to spurring the development of palm-size fuel cells, DARPA has contracted with companies to miniaturize solar cells that would supplant the need for generators. It now wants to develop inexpensive diesel and jet fuel from algae that could be produced in the battle zone. All three programs include the aim of accelerating the manufacture of any new product by private companies, from whom the military could buy. The agency certainly has no shortage of ambition. Take its solar panel program. Current technology converts into electricity just about 20% of the sunlight that hits meter-square silicon panels. DuPont (DD) and the University of Delaware are partners in a DARPA contract worth up to $100 million to elevate efficiency to 40%, at an affordable price. The idea is to capture the sunlight that would normally fall across an entire solar panel and concentrate it into a cell about the size of a fingernail. A number of those miniaturized cells would be arrayed across a panel that could be folded up and toted into battle, where it would power the needs of a half-dozen to a dozen soldiers. "It's an aggressive goal," says Brian Pierce, who is managing the DARPA program. In contrast, solar cell maker SolFocus of Mountain View, Calif., is working on similar technology for civilian applications but is aiming for much more modest efficiency gains. DARPA wants the cost of the new panel not to exceed $1,500—compared with the more than $15,000 DuPont recently spent on a working model of the panel and its cells. Dan Laubacher, DuPont's manager for the project, says the system is at least two years away from delivery to the military. But as production ramps up, he says, the ultimate cost "could be lower" than the $1,500 targeted by DARPA. Eventually, as costs come down, DuPont hopes to sell the panels to utilities. DARPA-inspired fuel efforts would change the military. How much the agency could change the commercial alternative energy industry is a matter of debate. Some in Silicon Valley welcome DARPA's commitment. Vinod Khosla, a co-founder of Sun Microsystems (JAVA) and one of the most active venture capitalists in alternative energy in the Valley, notes that so far both the private and public sectors have failed to make a definitive breakthrough in alternative energy. "Nobody knows the right answer. So the more the merrier," he says. In this context, "DARPA's ability to take a long-term view of research is positive." However, some argue that alternative energy is not similar to other DARPA efforts in the past, when the agency had a tremendous impact. In nurturing a proto-Internet, for example, DARPA was alone in the field. Now hundreds of companies are exploring solar panel

130 technology, doing advanced battery research, and experimenting with algae-based biofuels. This is also a global field, where Japan, Germany, and China already have the lead in critical areas. Others say DARPA's goals can be unrealistic. DARPA wants to reduce the current cost of algae-based fuel from $20-$30 per gallon down to $3. In January, DARPA awarded contracts worth up to $34.8 million to two companies to produce aviation fuel at $3 a gallon from algae. The competitors are General Atomics, best known as the maker of the Predator drone, and Science Applications International (SAI). They have three years to do it. Some doubt these companies—or any company—can achieve that goal. Chris Somerville, director of the BP-funded Energy Biosciences Institute at the University of California Berkeley, has specifically avoided investment in algae-based fuel because his team does not see costs dropping below $10 a gallon. "We're skeptical that that's going to be possible," Somerville says of the $3 price target. DARPA's answer, as expressed by Nowak, is simple: "If you want to change the world," he says, "set the bar high." LeVine is a correspondent in BusinessWeek's Washington bureau.

New Business July 23, 2009, 12:07AM EST text size: TT Europe's Jobless Youth With one in five Gen Yers unable to find work, a new "Lost Generation" may be in the making By Mark Scott London—On paper, Jerome Delorme seems like a pretty desirable job candidate. The 23- year-old has a master's degree in European studies from the prestigious Sciences Po university in Grenoble—once a sure ticket to a top company, even in hard times. And he spent a year studying in Dublin, speaks fluent English, and has already had several high-profile internships. But in three months of looking for work, Delorme has been able to land only another internship, at a nonprofit organization. "The crisis has made getting a real job very difficult," says the native of the southern French city of Valence. Delorme is typical of Europe's Gen Y these days. Most of his friends are also pounding the cobblestones in search of employment—as are about 5 million other young Europeans, or about 20% of the under-25 population, the European Union estimates. That's nearly a third higher than a year ago and well above the 8.9% unemployment rate for the EU as a whole. In some countries the situation is far worse. Nearly 37% of Spain's Gen Yers can't find work. In France, it's 24%, vs. 17% in the U.S. Policymakers worry prolonged unemployment will hurt an entire generation's ability to compete in the workplace. When the economy finally recovers, many of the under-25s will have become over-25s, and younger rivals will be nipping at their heels for entry-level jobs. The big fear: Europe's Gen Yers will suffer the fate of Japan's Lost Generation—young people who came of age in the recession-wracked 1990s but lacked the skills to find good jobs even after the economy started to pick up steam. Government Schemes If that happens, the Continent would struggle to cope with large numbers of jobless young people. Violent protests over lousy job prospects earlier this year in Eastern Europe made politicians acutely aware of mounting social problems. "Most countries are moving in the

131 right direction, but there's still a risk that unemployment will last for years," says Stefano Scarpetta, head of employment analysis at the Organization for Economic Cooperation & Development in Paris. Governments are spending billions to keep the young busy via college grants and vocational courses until the economy recovers. On June 29, British Prime Minister Gordon Brown unveiled a $1.6 billion scheme to create 100,000 jobs for young people, with a special emphasis on helping those who've been out of work for more than a year. And on Apr. 24, French President Nicolas Sarkozy announced a $1.9 billion plan to find work for 500,000 young people by June 2010. That includes grants to companies that employ Gen Yers and a 12% increase in new government-funded apprenticeships in plumbing, carpentry, and other trades. Some wonder how much good those programs will do given the severity of the downturn. "There's pressure on governments to find employment for young people, but I don't see how that's going to happen in the short term," says Giorgio S. Questa, a professor at City University's Cass Business School in London. Business groups, meanwhile, fret that new apprenticeships could take jobs away from older workers and may prove unsustainable if government funding dries up. Neil Carberry, head of employment policy at the Confederation of British Industry, says similar programs in the 1980s failed because they simply kept young people busy without giving them sufficient skills to land more interesting work when the economy recovered. "People digging ditches and painting walls just doesn't add value," he says. Spain's Setback Lavish welfare systems ease some of the strain for Europe's Gen Y. With state-sponsored health care and ample jobless benefits, Europeans have fewer worries than unemployed twentysomethings in the U.S. And young Europeans are more likely to bunk with Mom and Dad than their American counterparts are, so it's easier for them to make ends meet while looking for a job. In Spain, for instance, more than half of people under 30 still live at home. But that has done little to ease the pain of the crisis for many Spaniards. When the country's construction and real estate industries were booming, under-25s often skipped college to go straight to work, cashing in on the credit-fueled bonanza. Since 2007, though, the economy has imploded and may contract by 3.2% this year. Many young people were on short-term contracts, so they were first to be laid off when times got tough. And skipping further education in favor of employment, they often lack such skills as foreign languages, IT knowhow, and advanced math that employers demand. Says Carlos Serrano, a 25-year-old electronic engineer from northern Spain who has been looking for a job for a year, with no luck: "The crisis has trapped us graduates at the worst possible time." Scott is a reporter in BusinessWeek's London bureau .

132 Jul 23, 2009 Asia's Recovery Prospects Hinge on the G-3 Recovery Growth Outlook for 2009 and 2010: o Asian Development Bank (ADB): Emerging East Asia has entered the transition from recession to recovery. The decline in growth moderated in Q2 2009 after falling sharply in Q1 thanks to domestic stimulus measures. East Asia is expected to have a V-shaped recovery with growth dipping sharply to 3% in 2009 before regaining 2008's pace of 6% in 2010. Returning to their full growth potential will take time. Risks include a prolonged recession and sluggish recovery in developed countries and premature tightening of fiscal and monetary stimulus. (ADB Outlook, July 2009) o International Monetary Fund (IMF): Growth forecast of Emerging Asia has improved driven by better prospects in both China and India and a faster-than-expected turnaround in capital flows. But the acceleration in growth hinges critically on the recovery in developed economies. Emerging Asia is forecast to grow 5.5% in 2009 and 7% in 2010. Japan will contract sharply at 6% in 2009 but will grow 1.7% in 2010 due to aggressive fiscal policies and strong performance in neighboring Asian economies. (IMF Outlook, July 2009) o World Bank: Despite aggressive government measures, growth in East Asia and Pacific will slow to 5% in 2009 from 8% in 2008 due to weak exports and slowdown in domestic demand. Yet, the region will grow the fastest in the world helped by China. Ultimate recovery depends on the pace of recovery in advanced economies. Growth in 2010 will be relatively subdued at 6.6%. Output gap will persist for several years because of weak labor markets and sluggish consumption. (World Bank Outlook, June 2009) o Economic Intelligence Unit (EIU): Asia's growth will slow sharply to 2.4% in 2009 due to high export dependence and risks to investment and employment. The recovery will be subdued in 2010, growing by a mere 4.6%. This will be due to given weak demand in advanced economies, tight access to credit and risk of capital flight despite some improvement in global risk appetite. Aggressive loosening of monetary and fiscal policies will support growth and ensure a U-shaped recovery in the region. o Nomura: The sharp contraction in Asian exports has moderated helped by easy macro policies. Sound fundamentals in the region are attracting large capital inflows. However, the recovery is still fragile due to high unemployment and overcapacity, the risk of a double-dip in advanced economies and risk of an exodus of foreign capital. o Citigroup: Asia's recovery will be steeper-than-expected supported by improving economic dynamics in the U.S., Japan and China and accommodating monetary and fiscal policies across the region. o Development Bank of Singapore (DBS): A V-shaped recovery is taking place in Asia as the drivers of downturn were "one-off" in nature not the "fundamental weakness." o Morgan Stanley: Growth will bottom in H1 2009 with muted recovery in H2 2009. o Macquarie: U.S. recession will have a greater impact on Asia than the 2001 recession with Asian exports and countries with high external financing needs (South Korea, India and China) taking a big hit.

133 o 2009 AXJ GDP growth forecasts: Nomura: 4.7% | Citi: 4.6%| EIU: 2.4% | RGE Monitor: 4.3% o 2010 AXJ GDP growth forecasts: Nomura: 7.7% | Citi: 7%| EIU: 4.6% | RGE Monitor: 6.2% Risks to Growth: o Domestic demand: Consumer spending has improved in some countries owing to stimulus measures. But in most Asian Tigers and ASEAN countries consumption is contracting or slowing sharply due to negative wealth effects, large job losses in manufacturing and export- related sectors. Investment is contracting or slowing sharply in most Asian Tigers and ASEAN countries due to plunging foreign direct investment (FDI) and exports, lower corporate earnings and tight credit. o Exports: Exports contracted sharply across Asia in H1 2009 due to lower demand from the G- 3 though industrial production turned around in many Asian countries. China's stimulus spending in 2009 is mostly geared towards infrastructure. So most Asian countries who export parts and components to China for re-export to the G-3 countries will not benefit. Benefit to Malaysia, Indonesia and Vietnam will be limited as they manufacturing-intensive commodities to China are countries. Asia's exports will remain under pressure until final demand in advanced economies show a strong and sustain improvement. o Tight financial conditions: Despite aggressive monetary easing and improvement in liquidity conditions, private lending rates remain elevated and banks see high credit risk is lending to corporates and households. Capital raising activity remains subdued. On the other hand, in countries like Vietnam and China, government stimulus measures are fueling asset bubbles. o Capital flows: Foreign institutional investor (FII) inflows are fueling market rally but are still prone to global risk aversion and volatility in the U.S. markets. FDI will drop in most Asian economies in 2009. Debt inflows are already under pressure because of declining interest rate differential with the U.S. and rising debt downgrades. Global liquidity crunch is sharply reducing Asia's access to foreign bank capital. Easing external balances and capital outflows may lead to currency depreciation in the region. (Nomura) o Deflation: Excess capacity in manufacturing, rising unemployment, slowing or contracting domestic demand in many countries are causing deflationary pressures. China, Hong Kong, Malaysia, Singapore, Taiwan, Thailand and Japan are in technical deflation. Some impact is due to base effects as food and commodity prices are lower relative to 2008. Deflationary pressures might persist until late 2009/early 2010 due to sluggish economic recovery and large output gap. o Fiscal deficit: Increasing stimulus spending amid withering income tax and commodity related revenues are raising fiscal deficits and public debt. Investor concerns over rising bond issuance and higher longer-end yields are posing risk to debt auctions. Debt ratings of many countries have been downgraded (Japan, India, Taiwan, Thailand, Malaysia, Pakistan and Vietnam) or are at risk. o Political risk: Political stability have strengthened after elections in India and Indonesia. Thailand and Japan are witnessing increasing political instability exacerbated by the economic downturn. China and Vietnam face the risk of greater social unrest from job losses among migrant workers and factory closures. http://www.rgemonitor.com/10010/Asia?cluster_id=5362

134

Press Release Federal Reserve proposes significant changes to Regulation Z (Truth in Lending) intended to improve the disclosures consumers receive in connection with closed-end mortgages and home-equity lines of credit

Release Date: July 23, 2009

For immediate release The Federal Reserve Board on Thursday proposed significant changes to Regulation Z (Truth in Lending) intended to improve the disclosures consumers receive in connection with closed-end mortgages and home-equity lines of credit (HELOCs). These changes, offered for public comment, reflect the result of consumer testing conducted as part of the Board's comprehensive review of the rules for home-secured credit. The amendments would also provide new consumer protections for all home-secured credit. "Consumers need the proper tools to determine whether a particular mortgage loan is appropriate for their circumstances," said Federal Reserve Chairman Ben S. Bernanke. "It is often said that a home is a family's most important asset, and it is the Federal Reserve's responsibility to see that borrowers receive the information they need to protect that asset." To shop for and understand the cost of credit, consumers must be able to identify and understand the key terms of the mortgage. In formulating the proposed revisions to Regulation Z, the Board used consumer testing to ensure that the most essential information is provided at a suitable time using content and formats that are clear and conspicuous. "Our goal is to ensure that consumers receive the information they need, whether they are applying for a fixed-rate mortgage with level payments for 30 years, or an adjustable-rate mortgage with low initial payments that can increase sharply," said Governor Elizabeth A. Duke. "With this in mind, the disclosures would be revised to highlight potentially risky features such as adjustable rates, prepayment penalties, and negative amortization." Closed-end mortgage disclosures would be revised to highlight potentially risky features such as adjustable rates, prepayment penalties, and negative amortization. The Board's proposal would: • Improve the disclosure of the annual percentage rate (APR) so it captures most fees and settlement costs paid by consumers; • Require lenders to show how the consumer's APR compares to the average rate offered to borrowers with excellent credit; • Require lenders to provide final Truth in Lending Act (TILA) disclosures so that consumers receive them at least three business days before loan closing; and

135 • Require lenders to show consumers how much their monthly payments might increase, for adjustable-rate mortgages. The Board will also work with the Department of Housing and Urban Development to make the disclosures mandated by TILA, and HUD's disclosures, required by the Real Estate Settlement Procedures Act, complementary; potentially developing a single disclosure form that creditors could use to satisfy both laws. In developing the proposed amendments, the Board recognized that disclosures alone may not always be sufficient to protect consumers from unfair practices. To prevent mortgage loan originators from "steering" consumers to more expensive loans, the Board's proposal would: • Prohibit payments to a mortgage broker or a loan officer that are based on the loan's interest rate or other terms; and • Prohibit a mortgage broker or loan officer from "steering" consumers to transactions that are not in their interest in order to increase the mortgage broker's or loan officer's compensation. The rules for home-equity lines of credit would be revised to change the timing, content, and format of the disclosures that creditors provide to consumers at application and throughout the life of such accounts. Currently, consumers receive lengthy, generic disclosures at application. Under the proposal, consumers would receive a new one-page Board publication summarizing basic information and risks regarding HELOCs at application. Shortly after application, consumers would receive new disclosures that reflect the specific terms of their credit plans. In addition, the Board's proposal would: • Prohibit creditors from terminating an account for payment-related reasons unless the consumer is more than 30 days late in making a payment. • Provide additional protections related to account suspensions and credit-limit reductions, and reinstatement of accounts. The Federal Register notices are attached. The comment periods end 120 days after publication of the proposals in the Federal Register, which is expected shortly. Highlights of Proposed Rules Regarding Home-Secured Credit (14 KB PDF) Statement by Chairman Ben S. Bernanke Statement by Governor Elizabeth A. Duke Board Memorandum--Proposed Amendments to Regulation Z (Truth in Lending) (183 KB PDF) Regulation Z--HELOC: Draft Federal Register notice, Regulation Z--HELOC (5.4 MB PDF) Key Questions to Ask About Home Equity Lines of Credit (Attachment A) (68 KB PDF) Summary of Findings: Design and Testing of Truth in Lending Disclosures for Home Equity Lines of Credit (1.06 MB PDF) Model forms and samples: 1. G-14(A) (152 KB PDF) Early Disclosure Model Form (Home-equity Plans) 2. G-14(B) (165 KB PDF) Early Disclosure Model Form (Home-equity Plans) 3. G-14(C) (217 KB PDF) Early Disclosure Sample (Home-equity Plans) 4. G-14(D) (212 KB PDF) Early Disclosure Sample (Home-equity Plans) 5. G-14(E) (209 KB PDF) Early Disclosure Sample (Home-equity Plans) 6. G-15(A) (212 KB PDF) Account-Opening Disclosure Model Form (Home-equity Plans) 7. G-15(B) (221 KB PDF) Account-Opening Disclosure Sample (Home-equity Plans) 8. G-15(C) (224 KB PDF) Account-Opening Disclosure Sample (Home-equity Plans)

136 9. G-15(D) (219 KB PDF) Account-Opening Disclosure Sample (Home-equity Plans) 10. G-24(A) (131 KB PDF) Periodic Statement Transactions; Interest Charges; Fees Sample (Home-equity Plans) 11. G-24(B) (188 KB PDF) Periodic Statement Sample (Home-equity Plans) 12. G-24(C) (158 KB PDF) Periodic Statement Sample (Home-equity Plans) 13. G-25 (10 KB PDF) Change-in-Terms Sample (Home-equity Plans) 14. G-26 (8 KB PDF) Rate Increase Sample (Home-equity Plans) Regulation Z--Closed-end Mortgages: Draft Federal Register notice, Regulation Z--Closed-end Mortgages (8.2 MB PDF) Key Questions to Ask About Your Mortgage (Attachment A) (68 KB PDF) Fixed vs. Adjustable Rate Mortgages Early Disclosure (Attachment B) (73 KB PDF) Summary of Findings: Design and Testing of Truth in Lending Disclosures for Closed-end Mortgages (2.8 MB PDF) Model forms and samples: 1. H–4(B) (91 KB PDF) Adjustable-Rate Loan Program Model Form 2. H–4(D) (86 KB PDF) Adjustable-Rate Loan Program Sample (Hybrid ARM) 3. H–4(E) (86 KB PDF) Adjustable-Rate Loan Program Sample (Interest Only ARM) 4. H–4(F) (87 KB PDF) Adjustable-Rate Loan Program Sample (Payment Option ARM) 5. H-4(G) (58 KB PDF) Adjustable-Rate Adjustment Notice Model Form 6. H–4(I) (99 KB PDF) Adjustable-Rate Adjustment Notice Sample (Interest Only ARM) 7. H–4(J) (99 KB PDF) Adjustable-Rate Adjustment Notice Sample (Hybrid ARM) 8. H–4(K) (49 KB PDF) Adjustable-Rate Annual Notice Model Form 9. H–4(L) (107 KB PDF) Negative Amortization Monthly Disclosure Model Form 10. H-19(A) (150 KB PDF) Fixed Rate Mortgage Model Form 11. H-19(B) (140 KB PDF) Adjustable-Rate Mortgage Model Form 12. H-19(C) (158 KB PDF) Mortgage with Negative Amortization Model Form 13. H-19(D) (169 KB PDF) Fixed Rate Mortgage with Balloon Payment Sample 14. H-19(E) (215 KB PDF) Fixed Rate Mortgage with Interest Only Sample 15. H-19(F) (164 KB PDF) Step-Payment Mortgage Sample 16. H-19(G) (218 KB PDF) Hybrid Adjustable-Rate Mortgage Sample 17. H-19(H) (204 KB PDF) Adjustable-Rate Mortgage with Interest Only Sample 18. H-19(I) (151 KB PDF) Adjustable-Rate Mortgage with Payment Option Sample http://www.federalreserve.gov/newsevents/press/bcreg/20090723a.htm Release Date: July 24, 2009 Federal Reserve announces that amounts of Term Auction Facility (TAF) credit offered at each of the two August auctions will be reduced to $100 billion For release at 10:00 a.m. EDT The Federal Reserve on Friday announced that the amounts of Term Auction Facility (TAF) credit offered at each of the two auctions in August will be reduced to $100 billion from $125 billion in July. Specifically, the Federal Reserve will offer $100 billion of 84-day credit on Monday, August 10 and $100 billion of 28-day credit on Monday, August 24. This reduction is consistent with the expectation indicated in the Federal Reserve's June 25 press release that TAF auction amounts would be reduced gradually further in coming months if market conditions continue to improve.

137

Obama Seeks to Calm Fears on Health

Reform Major Initiative Stalled as Parties Struggle to Reach Consensus By Ceci Connolly and Michael D. Shear Washington Post Staff Writers Thursday, July 23, 2009 President Obama confronted increasing doubts about the impact of widespread changes to the health-care system, seeking to assure middle-class Americans on Wednesday that the landmark legislation he envisions would improve their quality of life and is essential to curing the nation's economic ills. "This is not just about 47 million Americans who have no health insurance," he said in a prime-time televised news conference, the fourth of his presidency. "Reform is about every American who has ever feared that they may lose their coverage." Six months after his inauguration, Obama finds his signature domestic issue stalled on Capitol Hill, where House Democratic leaders are working to quell dissension and the second-ranking Democrat in the Senate acknowledged that action probably will be delayed until September. Addressing what he called "entirely legitimate" skepticism, the president vowed that health- care reform would drive down costs, eventually saving families thousands of dollars. But he struggled to explain how any of the measures under consideration would fulfill that promise. For the past week, Obama has engaged in a two-pronged campaign to woo recalcitrant lawmakers and sell nervous voters from the bully pulpit. The news conference seemed to be intended less to stake out new ground than to calm a nation still reeling from the economic meltdown. "The American people are understandably queasy about the huge deficits and debt that we're facing right now," he said. The president has been under pressure to explain how far-reaching legislation would translate into eventual savings for families, businesses and the government. He said the plans would squeeze "waste" out of a system that is dominated by insurance companies making large gains. "Right now, at the time when everybody's getting hammered, they're making record profits and premiums are going up," he said. Over the long term, Obama said, he anticipates slowing the rate of health-care spending by digitizing medical records, eliminating duplication and waste, and revolutionizing the way doctors are paid. He rejected the idea that reform would require sacrifice for most, and dismissed suggestions that Medicare spending might decrease, raising costs for seniors. "No. No," he said. "It's not going to reduce Medicare benefits. What it's going to do is to change how those benefits are delivered so that they're more efficient." Doctors and hospitals would order fewer repetitive tests under his ideal system, Obama said. And he added that providers would turn to less expensive drugs that work as well as their costly alternatives, though he did not explain how that would be encouraged or enforced.

138 "Our proposals would change incentives so that doctors and nurses are free to give patients the best care, just not the most expensive care," he said. Polls show that most Americans think there is a need to improve a system that is among the costliest and least effective in the world, but there is widespread unease about how the changes might affect those who are generally satisfied with their care. Obama attempted to shift the discussion Wednesday from legislative haggling to an appeal aimed at Americans' everyday lives. "I realize that with all the charges and criticisms being thrown around in Washington, many Americans may be wondering, 'What's in this for me? How does my family stand to benefit from health insurance reform?' " he said in setting the theme of his remarks. "Tonight I want to answer those questions." He promised that virtually every American would benefit from a system that provides "more security and more stability." He pledged insurance market changes that would enable all to obtain coverage, regardless of health status, and suggested that everyone would be guaranteed preventive care, such as checkups and mammograms. In an interview with The Washington Post's editorial page editor earlier in the day, he also said that meaningful reform must tackle the twin challenges of covering the uninsured and containing skyrocketing medical costs. "I think that it's important to do both," he said. "I think it's important for us to make sure that 46 million people who don't have health insurance get it. And I think it's important for us to bend the cost curve, separate and apart from coverage issues." Obama said he is open to a proposal in the House that would increase taxes on couples earning more than $1 million a year, saying "that meets my principles." As his fellow Democrats on Capitol Hill wrestled with intraparty divisions over the legislative details, the president took up the partisan battle with Republicans who have battered the legislation's costs and have suggested that Democrats are attempting to rush its passage. "I understand how easy it is for this town to become consumed in the game of politics, to turn every issue into a running tally of who's up and who's down," he said. The battle, he argued, is not about politics, but about the people who write him letters and show up at town hall meetings fretting about their medical care. "This debate is not a game for these Americans, and they cannot afford to wait for reform any longer," he said. "They are counting on us to get this done." From the outset of his presidency, Obama has pressed for quick action on legislation that extends health insurance to the vast majority of Americans, raises the quality of care nationwide and clamps down on cost increases that he has described as "unsustainable." He has demanded votes on the House and Senate floor before the August recess. On Capitol Hill, House Speaker Nancy Pelosi (D-Calif.) expressed confidence she will have the votes to pass a health bill. But she declined to commit to meeting Obama's timetable as she attempts to tamp down a series of brush fires within her own diverse Democratic caucus. On the Senate side, progress slowed in the bipartisan talks convened by Finance Committee Chairman Max Baucus (D-Mont.) when Sen. Orrin G. Hatch (R-Utah) withdrew from the negotiations. And Senate Majority Whip Richard J. Durbin (D-Ill.) told the Hill newspaper that the measure would not reach the Senate floor until after Labor Day.

139 In recent days, the House has become bogged down in negotiations, with several factions inside the Democratic caucus unhappy with the 1,000-page bill drafted by three committee chairmen. "I think the speaker was well intentioned because she was hearing optimistic things, but I don't believe there are the votes on the floor as of right now," said Rep. Baron P. Hill (Ind.), a centrist Democrat. Two House panels approved the legislation in little more than a day, but action in the Energy and Commerce Committee came to an abrupt halt when conservative Democrats said they had the votes to defeat it. Obama said Wednesday that he is pushing for an Independent Medicare Advisory Council that would set Medicare reimbursement rates based on physician performance rather than the number of procedures performed. Beyond health care, Obama made clear that he believes the banking and financial systems will return to risky behavior unless the government takes steps to prevent them. And he seemed to favor fees on banks that continue risky practices. In the Post interview, Obama used stark language to describe how dire he thinks the situation was earlier this year. "I walked in when we were about to slip into the Great Depression -- or the next Great Depression," he said. Staff writer Perry Bacon Jr. and staff researcher Madonna Lebling contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/22/AR2009072203504_pf.html

140

Goldman Agrees to Higher Price in Buying Back Taxpayers' Stake By David Cho Washington Post Staff Writer Thursday, July 23, 2009 Goldman Sachs said Wednesday that it had paid $1.1 billion to buy back the ownership stakes it had handed over to the government when it received a federal bailout package last year, acceding to Treasury Department demands for a higher price on the securities. The investment giant initially offered to pay $650 million, sources familiar with the negotiations said. Some administration officials have expressed frustration that some of Wall Street's biggest banks are seeking to pay less for the stakes, just as these companies are reporting a tremendous surge in profits, according to two of the sources, who spoke on condition of anonymity because the negotiations were private. Goldman Sachs this week reported a record quarterly profit and set aside nearly half of its revenue to pay employees. Many major banks that received federal aid are seeking to exit the Troubled Assets Relief Program. To completely sever ties with the program, the companies must also buy back these ownership stakes, known as stock warrants, which were given to the government in exchange for aid. Last month, Goldman repaid the $10 billion in bailout funds it received. The Goldman deal may put political pressure on other banks that so far have refused to meet the government's price for the warrants. J.P. Morgan Chase has declined the Treasury's offer, and its warrants are now set to face a public auction. Last week, the company's chief financial officer said the Treasury is using a "convoluted appraisal process" in pricing the warrants. "This is good news for the American taxpayer," said Rep. Carolyn B. Maloney (D-N.Y.), who chairs the Joint Economic Committee. "Going forward, we can hope that this sets a pattern for other warrants outstanding at other firms that received aid." Stock warrants give their owner the right to buy a company's stock after a set period of time at a predetermined price. The Goldman warrants allow the holder to buy 12.2 million shares at $122.90 apiece 10 years from now. If Goldman's stock price rises to $200 a share after 10 years, the holder would net nearly $1 billion in profit. Goldman Sachs's shares closed Wednesday at $160.46. But the long-term nature of the warrants makes them difficult to value because no one knows what the stock price will be after a decade. Treasury spokesman Andrew Williams said the government received an annualized return of 23 percent on the $10 billion in rescue funds it gave to Goldman Sachs last year. That return factors in the $1.1 billion payment made Wednesday, as well as $318 million in dividends the bank has paid to the government, he said. "The capital infusion has helped drive greater stability in the financial system, private capital has replaced taxpayer investments at many banks, and the taxpayers have gotten a good return on their investment," he said.

141 Meanwhile, the administration also announced that it had nominated Jeffrey Goldstein, a managing director of the private-equity firm Hellman & Friedman, to be the Treasury's undersecretary for domestic finance. If confirmed by the Senate, Goldstein would oversee a critical office in the Treasury that develops the agency's policy for banks and the rest of the financial system. It has been without a senior manager since the new administration took office. Lee Sachs, a counselor to Treasury Secretary Timothy F. Geithner, has been running the office on an informal basis. Sachs initially expressed interest in the post and was vetted by the White House, but he removed himself from consideration for the job in the spring. Goldstein previously worked at the World Bank's management committee before joining the private-equity business. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/22/AR2009072202980_pf.html

142 Business

July 23, 2009 Government Takes Over Delphi’s Pensions By MARY WILLIAMS WALSH The federal government said Wednesday that it would take over the pension plans of the Delphi Corporation at a cost of $6.2 billion, after years of demanding that the assets of the company and its former corporate parent, General Motors, be used instead.

Taking over Delphi’s pension plans will add greatly to the deficit at the Pension Benefit Guaranty Corporation, a government body that collects premiums from companies to insure their pensions. Though it has enough money to keep paying claims for a number of years, the insurer reported an overall deficit of $33.5 billion in May, meaning it does not have enough to cover its long-term promises, and many analysts fear that taxpayers will have to bail it out one day. The big shortfall at Delphi shows how quickly a pension plan can deteriorate. That is especially true when a company stops putting in money, even as it increases pension benefits — something that has been happening lately at G.M. as well as Delphi. Recent market losses probably compounded the problem at Delphi.

When the auto parts maker filed for bankruptcy in 2005, it all but stopped making pension contributions. At the same time, cash payouts soared, because thousands of workers were being laid off as Delphi restructured, and many claimed their pensions early. Delphi’s plan for the United Automobile Workers offers a supplement to workers who retire before they are old enough to collect Social Security. So laying off workers in their 50s and early 60s imposes sudden additional costs on the pension fund. Spotting these trends, the federal pension guarantor began putting liens on Delphi’s offshore affiliates, which are not in bankruptcy. As recently as last September, the insurer was warning that it would fight in court to make the healthy parts of Delphi’s corporate family cover the pension costs. It was also counting on a promise made 10 years ago by G.M. to take over the union plan if necessary, since the plan was not fully funded when Delphi was spun off. But the P.B.G.C. appears to have backed down, because its hard line interfered with the Obama administration’s goal of revamping the auto industry quickly. Delphi is an important supplier to G.M., which wants the company to emerge stable from bankruptcy and has already committed about $12 billion to help it. The Delphi pension failure has another unusual twist. Normally, when a company pension fund is taken over by the government, workers may lose part of their benefits because pension

143 insurance is limited. But it appears in Delphi’s case that one group of workers and retirees will be spared cuts — the ones represented by the U.A.W. G.M. issued a statement on Tuesday saying that it would “top up” the pension benefits for those in the union whose payments could be shrunk to the government limit. The statement cited the agreement G.M. negotiated with the union in 1999, in which the automaker had promised not just to pay a supplement but in fact to take back the union pension plan if Delphi could not run it. “As with other union agreements that it has assumed from the old G.M., General Motors Company will honor those commitments,” the company said in its statement. There is no precedent for a company making workers whole once their pension plan has failed and the government’s insurance limits apply, according to the federal insurer. Typically, the P.B.G.C. places a claim on any remaining assets in the affiliates of a bankrupt company to help cover its own costs. It was not clear whether G.M. would “top up” the retired U.A.W. members with corporate assets or money from its own pension fund. A spokesman declined to provide a cost estimate. But word that Delphi’s union retirees would get a special break provoked outrage from Delphi’s nonunion retirees. Delphi filed for bankruptcy in 2005 under the leadership of Robert S. Miller, who said one of his highest priorities would be to curb the company’s “uncompetitive labor cost structure.” Three years earlier, he had shut down the big, struggling pension plan at Bethlehem Steel, making the steel company an attractive target that was swiftly snapped up by Wilbur L. Ross. Observers expected Mr. Miller to do something similar in restructuring Delphi. That prospect prompted the P.B.G.C. to place liens on Delphi’s offshore affiliates, and warn that if Delphi tried to dump its pension obligations onto the government, it would lay claim to those assets and use them to recover its costs. “We will act forcefully,” said Charles E. F. Millard, the insurer’s executive director at the time. “We will draw down certain letters of credit and keep liens in place on the company’s assets until Delphi has successfully emerged and made its pension plans whole.” An agency spokesman said that the insurer had been as robust in its case for as long as possible, throughout a process that included the credit crisis last fall. G.M. said in a bankruptcy court filing this month that as long as the P.B.G.C. was rattling its sabers, no one was willing to put fresh money into Delphi’s businesses. During its nearly four years in bankruptcy, Delphi kept both the salaried and union employees’ pension plans going, allowing thousands of workers to keep building up their benefits until last October. At that point Delphi froze both plans. The argument for ending the process appears to have won out this summer, as the Treasury’s auto task force was ushering G.M. through a fast-track bankruptcy in keeping with the Obama administration’s goal of revamping the auto industry and reviving the economy over all. Under a deal with G.M. and its lender group, Delphi hopes to receive court approval next week for its plan to emerge from bankruptcy. G.M. has agreed to compensate the pension guarantor modestly for assuming Delphi’s unfunded obligations. The automaker also has agreed to pay $70 million outright to the insurer. In addition, it will share the proceeds from any future public offering of Delphi stock with the P.B.G.C., in a series of payments referred to in bankruptcy court filings as “the waterfall.” No one has estimated what the government’s share would be. http://www.nytimes.com/2009/07/23/business/23pension.html?th&emc=th

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Subprime-Mortgage Loss Forecast Is Raised by Standard & Poor’s By Jody Shenn July 22 (Bloomberg) -- Standard & Poor’s again boosted its projections for losses from U.S. subprime mortgages backing securities, reflecting increasing delinquencies and defaults amid slumping home prices and growing unemployment. Losses on loans backing 2006 securities will reach an average of about 32 percent of the original balances, while losses for similar 2007 bonds will total about 40 percent, the New York-based ratings firm said in a statement today. In February, S&P said the losses would total an average of 25 percent for 2006 bonds and 31 percent for 2007 securities. Rising defaults on subprime mortgages since 2006 helped spark what Federal Reserve Chairman Ben S. Bernanke today told Congress might have become “the worst global financial crisis since the 1930s and perhaps including the 1930s.” The loans went to borrowers with poor or limited credit records or high debt. Rating companies have cut all but 16 percent of U.S. home- loan securities without government backing to grades below AAA since late 2007, when 80 percent of the debt carried top rankings, according to an investor letter last month from Los Angeles-based TCW Group Inc. To contact the reporter on this story: Jody Shenn in New York at [email protected] http://www.bloomberg.com/apps/news?pid=20601087&sid=aGpyUsUSL6_0

145 Jul 22, 2009 Chinese Reserves to Help Companies Go Global? Outward Investment Still Government-Led Overview: While the Chinese government continues to have limitations on portfolio capital inflows and outflows, Chinese state owned firms and government investors like the central bank and sovereign fund have stepped up foreign direct investment abroad, particular in the resource sector. Chinese officials now suggest that reserves will be deployed to help support government investment abroad, an even stronger statement consistent with recent investment trendsMeanwhile foreign investment by private corporations and retail investors remains relatively limited but could be quite significant over the next decade. o Wen Jiabao suggested that China use its reserves to support foreign investments of state companies. While China has encouraged the foreign investment by state companies for some time, analysts like Qu Hongbin, of HSBC suggest that July 2009 statements are the strongest of statement of the "policy to directly support corporations to buy offshore assets.” (via Anderlini, Financial Times) Foreign Direct Investment On the Rise o China's Go Global policies are focused on encouraging outbound FDI. Plans for more outbound retail investment investment languished in 2008 as returns suffered. Chinese corporate investment abroad rose rapidly in 2008 and 2009 as China sought higher returns on its assets, much of which continue to be in U.S. government debt o Outbound FDI has been roughly doubling each year since 2005. Chinese FDI rose to $52 billion in 2008, from $26 billion in 2007. However, China's stock of outward FDI ($170 billion as of the end of 2008) is much smaller than China's total stock of foreign investment ($2.5 trillion) or the net FDI of other countries in China ($876 billion) (Via Wheatley, NYT) o Mckinsey: Based on 2008 research, Chinese acquirers, mostly state-owned seem to have overpaid in over half of all deals and the capital markets tend to discount the value of the combined entities. o Deutsche Bank: China's economic size, growth, large external surpluses and political- strategic incentives, have contributed to its large outward FDI, the largest potential among BRIC countries. But China's outward FDI stock is only 3% of GDP as of 2008. China's equity inflows (incl. FDI) will generate persistent capital account surpluses over the medium term (partly thanks to restrictions on capital outflows) with a share of the surplus recycled in the form of FDI o Green: Liberalizing Chinese outflows will push up global asset prices 'Private' Flows Lagging o Rosen/Hanemann: The rebalancing of China’s economy toward consumption will affect China’s outward FDI. Chinese firms will be left decide how to use the dollars they earn, rather than being forced to exchange them for renminbi onshore, and investments will

146 flow more toward advanced economies. Greater liberalization is needed including a pullback of government intervention from corporate investment decisions, allowing a broader range of companies to invest abroad and liberalization of access to foreign exchange. o Jen: Official funds (ie CIC, SAFE), have dominated Chinese outflows; large scope for private investor diversification (only 2% of financial assets in foreign currency) o From mid 2008 and early 2009, CIC was primarily focused on domestic financial sector recapitalization with only around $70 billion available for external holdings. It has now started to invest more of those funds abroad but unallocated foreign investments are limited o QDII plans: China pulled back on Qualified Domestic International Investor program in which retail investors could invest in approved funds in approved countries abroad given concerns about outflows and weak performance of such markets and funds. Such initiatives could restart but will lag official investment o DeWoskin: The NDRC approved 10 new industrial investment funds ($1-4b) to provide local and provincial governments a PE-like entity to fund local growth, New local municipal funds, and aggressive industrial investors such as Bao Steel, Shanghai Industrial Investment, Pingan Insurance and Cosco are becoming more active in domestic and international markets. http://www.rgemonitor.com/26/China?cluster_id=6498

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Harvard’s Feldstein Sees Risk of ‘Double- Dip’ Recession in U.S. By Bob Willis and Betty Liu

July 21 (Bloomberg) -- The U.S. recession may not be coming to an end and there is a risk the economy may experience a “double-dip” contraction, said Martin Feldstein, a professor of economics at Harvard University. “There is a real danger this is going to be a double dip and that after six months or so we’ll have some more bad news,” Feldstein, the former head of the National Bureau of Economic Research and Reagan administration adviser, said today in an interview on Bloomberg Television. “We could slide down again in the fourth quarter.” The economy could “flatten out” or “even be positive” in the third quarter, and then it’s likely to contract again in the last three months of the year as the effects of the federal stimulus program wear off and companies finish rebuilding inventories, he said. “There isn’t going to be enough to sustain a really solid recovery,” he said, even though recent data has provided some “good news” on the economy. Feldstein said Federal Reserve Chairman Ben S. Bernanke, whose term in office as chairman expires Jan. 31, should be reappointed to a second four-year term by President Barack Obama. Bernanke has “done a very good job and I think he should be reappointed,” Feldstein said. Bernanke is due to present his semi-annual monetary-policy testimony to Congress today. Feldstein said Bernanke in his testimony today would have to “reassure the Congress and the public” that inflation won’t be allowed to get out of control following the reduction in interest rates and the addition of liquidity to credit markets. He said there “are a number of technical ways” that the Fed can contain inflation and that it would be politically difficult to increase borrowing costs at a time of high unemployment, Feldstein said. To contact the reporters on this story: Bob Willis in Washington [email protected]. Last Updated: July 21, http://www.bloomberg.com/apps/news?pid=20601087&sid=a3IpfKeeveVM

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Bernanke: The Fed’s Exit Strategy by CalculatedRisk on 7/21/2009 08:57:00 AM Note: Federal Reserve Chairman Ben Bernanke testifies at 10AM today in front of the House Financial Services Committee. I'll post a video link ...

From Fed Chairman Ben Bernanke: The Fed’s Exit Strategy

The depth and breadth of the global recession has required a highly accommodative monetary policy. Since the onset of the financial crisis nearly two years ago, the Federal Reserve has reduced the interest-rate target for overnight lending between banks (the federal-funds rate) nearly to zero. We have also greatly expanded the size of the Fed’s balance sheet through purchases of longer-term securities and through targeted lending programs aimed at restarting the flow of credit.

These actions have softened the economic impact of the financial crisis. They have also improved the functioning of key credit markets, including the markets for interbank lending, commercial paper, consumer and small-business credit, and residential mortgages.

My colleagues and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. The Federal Open Market Committee, which is responsible for setting U.S. monetary policy, has devoted considerable time to issues relating to an exit strategy. We are confident we have the necessary tools to withdraw policy accommodation, when that becomes appropriate, in a smooth and timely manner.

emphasis added There is much more, but clearly the Fed expects policy to be accommodative for some time, and when the appropriate time comes, the Fed believes they have an exit strategy to avoid inflation. http://www.calculatedriskblog.com/2009/07/bernanke-feds-exit-strategy.html

149 Jul 21, 2009 EU and IMF Diverge over Latvia: Loan Disbursements in Doubt? Latvia appears to have averted default/devaluation, at least for the time being, by passing painful budget cuts to comply with the terms of its EU and IMF-led bailout package. Nevertheless, Latvia is still waiting for disbursement of the funds and pitfalls remain. The IMF has been less encouraging than the EU in its support for Latvia and its peg and as some analysts have noted, more spending cuts could be required in 2010 to continue to obtain international financial support and to qualify for euro adoption by the 2013 target date. IMF-EU Rift over Latvia o The IMF and EU are at a deadlock over Latvia and appear to diverge on issues like devaluation vs. internal deflation in securing the country's macroeconomic adjustment. o Where the EU appears ready to continue disbursing funds to Latvia to prevent the country's economic collapse and to ensure Latvia remains in the Exchange Rate Mechanism-2, the IMF seems more concerned about the viability of Latvia's euro peg and and how support of the peg could damage its reputation. o The EU has announced plans to disburse the next EUR1.2 billion tranche of its loan to Latvia, while the IMF has not yet approved the release of its EUR200 million tranche to Latvia. Can Latvia Get by without IMF Support? o Latvia's budget deficit is wider than previously expected, but the goverment's need for financing is lessened by the fact that the country is no longer running a current account deficit. o EIU: Latvia needs IMF support for two reasons - 1) although the current account is in surplus, there is now a large deficit in the financial account, largely because the Swedish banks that dominate the banking sector are pulling back on lending, so the risk of a balance-of-payments crisis remains, 2) EU is the largest donor in the bailout program, but it has now disbursed most of its cash; other donors (i.e. Nordic governments, World Bank) could take notice of the IMF's stance and follow suit. Bailout Package Disbursements in Doubt? o June 26: EU gives green light for EUR1.2 billion (US$1.7 billion) for Latvia, which should be disbursed within weeks; in July, Christian Keller of Barclays Capital said the IMF’s posture of continuing to withhold funds, even after the approval of the spending cuts, shows that the rift between the IMF and EU has widened (via AFOE) o Izabella Kaminska: EU instalments should be enough to cover Latvia's short-term liabilities.

150 o June 16: Parliament voted through cuts of US$1 billion, equal to 10% of spending (Bloomberg) o Prime Minister Valdis Dombrovskis in March warned that Latvia needs to agree budget cuts to secure the continued release of installments of its IMF-led loan, or it faces the risk of running out of money in late June o Apr 1: Latvia did not receive a transfer of about EUR200 million euros ($265 million) from the IMF in March after it failed to push through budget cuts; news caused the credit default swaps on Latvian debt to rise 71 basis points to 930 o See related spotlight issue: Is devaluation in Latvia inevitable? Growth o Latvia's GDP contracted 18% y/y in Q1 2009 – sharpest decline ever recorded, raising concerns that fiscal deficit target of around 7% of GDP will be very difficult to achieve (Danske) o Tighter credit and a property-market collapse have led to a rout in consumer sentiment; swing from boom to bust has been made worse by heavy use of mortgages in euros, Swiss francs, and yen o Exports unlikely to rescue economic growth, as demand is softening in key export mkts; as Estonia and Lithuania are Latvia’s most important trading partners, downturn in these countries will transmit directly to Latvian economy through weaker export demand o European Commission: Despite public commitments by the financial institutions and supporting efforts by the authorities, the banking system continues to reduce credit to the private sector, thereby worsening the recession Growth Forecasts o 2009 GDP Growth Forecasts: -20% (Danske), -18% (FinMin), -13% (European Commission), o 2010 GDP Growth Forecasts: -3% (European Commission) o Danske doesn't see a recovery to annual trend growth (3-4%) until 2012-13 EU and IMF-led Bailout Package o Dec 19: IMF announced plans to lend about €1.7 billion ($2.4 billion) to Latvia. Program includes measures to stabilize the financial sector and restore depositor confidence. It will also require substantial fiscal tightening; Latvia will be able to maintain its tight currency band to the euro, according to the agreement (See related spotlight issue: The Baltics: Will They Be Forced To Give Up Their Pegs?) o Loan from IMF supplemented by financing from EU (loan of €3.1 bn), the World Bank (€400 mn) and several Nordic countries (including Denmark, Estonia, Norway, and Sweden) for a total package of €7.5 billion ($10.5 bn) Inflation o EIU: Inflation to ease to an average 3% in 2009

151 Public Finances o Kenneth Orchard of Moody's/European Commission: Gross government debt may rise to as much as 50% of GDP in 2010 from 10% in 2007. Government borrowing will rise significantly over next few years to smooth the adjustment and prevent a major economic crisis Current Account o UniCredit: "(A)djustment process of the C/A (which stood at -12.6% to GDP in 2008) happened more quickly than anticipated and led us to revise our full-year 2009 C/A forecast to a 1.1% of GDP surplus." Background o Latvia was forced to seek international assistance in November after government rescued Parex Bank, country’s 2nd largest bank, triggering pressure on the currency and raising fears that its exchange rate peg would not hold http://www.rgemonitor.com/708/Baltics?cluster_id=5859

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22.07.2009 The Fed’s exit strategy in full – and why not many people believe it

Ben Bernanke’s statement about the exit strategy was the main economic news item almost everywhere. This is the strategy in full: First, draining excess liquidity through reverse repos. Second, selling bills. Third, offer interest-bearing term deposits. Forth, selling long-term securities. Fifth, there is no fifth. The comments seemed to have impressed some not very bright people in the bond markets, where long yields fell. Professor James Hamilton, writing in his Econbrowser blog, has perhaps the most lucid response. We quote the relevant section in full: “My specific worry is that we will eventually face a crisis of confidence in the Treasury and the dollar itself. It is true, as Bernanke suggests, that raising the interest rate paid on reserves in such a setting would be a policy tool that could be used in response. But it would be an unattractive measure to the point of perhaps being impossible to use in practice, for the same reason other countries have dreaded raising interest rates in the face of collapsing real economic activity and a flight from their currency. I fear that the United States government is mistakenly assuming that it can borrow essentially unlimited sums without undermining confidence in the dollar itself. “ Mohamed El-Erian (hat tip Mark Thoma) makes a similar point when he said that the fiscal policy is the large elephant in overall policy – and that Bernanke’s statement lacks credibility for that reason.

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German institute calls for wealth tax The DIW economic institute said Germany could easily solve its fiscal problems if raised its wealth taxes to a level close to the EU and OECD average. Following a ruling by the constitutional court, the country does not impose a wealth tax, and the local property tax, which goes to local administrations, is woefully too small. More realistic tax levels could raise some €25bn a year, which is about 1% of GDP. FT Deutschland notes that with its latest research DIW effectively supports the position of Oskar Lafontaine and his Left Party, which has been calling for higher wealth and business taxes. In a separate article, FTD also writes that the Social Democrats want to raise taxes for higher earners. A German bank says it will cut credit There is more and more evidence of an oncoming credit crunch. FT Deutschland has an article in which a senior manager of HVB says that he expects credit bottleneck in the second half of this year, as the ratings of customers decline. The head of a banking federation is also quoted as saying that there was no credit crunch at the moment, but the situation was clearly deteriorating. The bankers say that this deterioration is a natural consequence of the recession. He dismissed threats by finance minister Peer Steinbruck who had warned, among other things, to use the state-owned KfW bank to lend directly to companies, bypassing the traditional banking sector. This would heap excessive risks on this one institution, they say. China is using its forex reserves to buy foreign equity stakes The FT reports that China is planning to use part of its $2 trillion forex reserves to help Chinese companies buy equity stakes in foreign companies, partly in an attempt to diversify out of dollar fixed income securities, the asset class in which most of China’s foreign reserves are held. Brad Setser makes the point, when commenting on this story, that this has consequences as it will no longer be possible to claim that a China’s purchase of a non-Chinese company has purely commercial motives, as it may be driven by Chinese state capitalism. Protectionism through the front door Les Echos obtained the information that the French government wants to dedicate an important part of its super-bond resources to prop up the funds of medium sized enterprises (MSE). This sector employs 21% of all employees and contributes one quarter of the national wealth. The capital of these companies, in many cases from families, is considered insufficient to finance development and growth through acquisition. One source from the finance ministry is quoted saying that the MSEs could help the state to protect some industrial pearls against foreign takeovers (this is protectionism pure, and it is every time amazing how candid the French are about it). Lipponen for EU president? Former Finnish prime minister Paavo Lipponen told the Finnish News Agency that he had been contacted over the post of president of the European Council, a post pending ratification of the Lisbon treaty. He thus confirmed Wolfgang Munchau’s assertion in his news column in

154 the FT on Monday. Erkki Tuomioja, a former foreign minister, wrote in his blog that only unsuitable candidates had been put forward thus far. Austria’s state financing agency accused of speculation In Austria there is a hefty discussion going on about the state financing agency which stands accused of having speculated with tax payers money to yield higher returns, reports Der Standard. The Austrian government is now to consult with central bank and the court of auditors about how to stop speculation. Defenders argue that these papers became risky only with the financial crisis, accusing rating agencies instead, while critics say that the agency should have its independent risk evaluations. Former finance minister Molterer defended those transactions in question which happened under his term in office, but for the Greens Molterer is out as candidate for EU commissioner. The fallacy of exporting an export model Jorg Bibow has written an interesting paper for the New America Foundation on Germany’s pernicious influence in the euro area. He says German economic policy wisdom may have served the old West Germany well in the post-war period. But it failed the country in what was supposed to be its hour of glory: the export of the German model to Europe through the euro. “The German model relies on competitiveness gains through price stability as fueling the export motor of an economy otherwise unassisted by growth-friendly macroeconomic policies. Essentially the more difficult part in macroeconomic policy is thereby left to those who have the courtesy to stimulate German exports. Exporting the German model has not only undermined the model's working at home by requiring what are Germany's key export markets to converge to the German model. Its export has also created an economic giant that fails to pull its global weight by being overly reliant on exports to pull it along. “ Paul de Grauwe on economics Paul de Grauwe has a terrific column in the FT this morning, about his own profession. This is the nutgraph: “The basic error of modern macro-economics is the belief that the economy is simply the sum of microeconomic decisions of rational agents. But the economy is more than that. The interactions of these decisions create collective movements that are not visible at the micro level. It will remain difficult to model these collective movements. There is much resistance. Too many macro-economists are attached to their models because they want to live in the comfort of what they understand – the behaviour of rational and superbly informed individuals. To paraphrase Isaac Newton, macroeconomists can calculate the motions of a lonely rational agent but not the madness of the crowds.” On Iceland Vox has two column on Iceland this morning. One, by Thorvaldur Gylfason, blames a corrupt and inept political class running the country for the crisis, which is the main reason why the country is now seeking EU membership. The other, by Jon Danielsson argues that EU membership was far from certain as significant issues remain on both sides. The key ones are fishing, the Icesave deal (relating to honouring obligations by Icelandic banks), and the consistent opposition of the Icelandic population to EU membership. Accession of Iceland into the EU is very much in doubt, he concludes.

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Munchau on cars and typewriters In his FT Deutschland column, Wolfgang Munchau compares today’s car industry, on which Germany relies, with the American typewriter industry in the 1980s and 1990s. The two products have a lot in common, including the false belief that they are indispensible to a modern society forever, a flattening curve of innovation, a much longer life-span of individual products due to technological improvements, falling profits margins, and overcapacities that need to be reduced through M&A. The various recent developments in the German car industry are a case in point, including the power battle between Volkswagen and Porsche.

COMMENT Economics is in crisis: it is time for a profound revamp By Paul De Grauwe Published: July 21 2009 22:27 | Last updated: July 21 2009 22:27

There can be little doubt. The science of macroeconomics is in deep trouble. The best and the brightest in the field fight over the most basic problems. Take government budget deficits, which now exceed 10 per cent of gross domestic product in countries such as the US and the UK. One camp of macroeconomists claims that, if not quickly reversed, such deficits will lead to rising interest rates and a crowding out of private investment. Instead of stimulating the economy, the deficits will lead to a new recession coupled with a surge in inflation. Wrong, says the other camp. There is no danger of inflation. These large deficits are necessary to avoid deflation. A clampdown on deficits would intensify the deflationary forces in the economy and would lead to a new and more intense recession. Or take monetary policy. One camp warns that the build-up of massive amounts of liquidity is the surest road to hyperinflation and advises central banks to prepare an “exit strategy”. Nonsense, the other camp retorts. The build-up of liquidity just reflects the fact that banks are hoarding funds to improve their balance sheets. They sit on this pile of cash but do not use it to increase credit. Once the economy picks up, central banks can withdraw the liquidity as fast as they injected it. The risk of inflation is zero.

156 Both camps line up an impressive list of Nobel prize-winners to buttress their arguments. Economists have often disagreed in the past, but this time the tone is different. The protagonists do not hesitate to accuse the other camp of ignorance or bad faith. I have never seen anything like this. So what? Does it matter that economists disagree so much? It does. Take the issue of government deficits. If you want to forecast the long-term interest rate, it matters a great deal which of the two camps you believe. If you believe the first one, you will fear future inflation and you will sell long-term government bonds. As a result, bond prices will drop and rates will rise. You will have made a reality of the fears of the first camp. But if you believe the story told by the second camp, you will happily buy long-term government bonds, allowing the government to spend without a surge in rates, thereby contributing to a recovery that the second camp predicts will follow from high budget deficits. Most people are not sure which camp is right. They hesitate. One day, when green shoots are popping up here and there, they believe the story warning about inflation; the next day, when the shoots turn brownish, they believe the other story. Disagreements among economists take away the intellectual anchors around which market participants interpret events and forecast the future. Ultimately, all our forecasts use a particular economic model to interpret data and to forecast their future course. The existence of wildly different models takes away this intellectual anchor and this translates into more market volatility. This conflict matters not only for market participants, but also for policymakers. The two camps of economists have wildly different estimates of the effect of a 1 per cent permanent increase in government spending on real US GDP over the next four years. According to the first camp, the Ricardians, the multiplier is closer to zero than to one, ie 1 per cent extra spending generates much less than 1 per cent of extra GDP, producing little extra tax revenue. Thus budget deficits surge and become unsustainable. By contrast, the second camp, the Keynesians, predict that the same 1 per cent of extra government spending multiplies into significantly more than 1 per cent of extra GDP each year until the end of 2012. This is the stuff of dreams for governments, because such multiplier effects are likely to generate additional tax income so that budget deficits decline. With so much disagreement it is no surprise that policymakers are unsure and vacillate. Some countries, such as the US and France, go all out for the Keynesian story; others, such as Germany, put more faith in the Ricardians. Personally I think the Keynesians are right, but my opinion is irrelevant. The point is that the cacophony of analysis helps to explain why policymakers react in different ways to the same crisis and why it is so difficult for them to come up with co-ordinated action. How to resolve this crisis in macro-economics? The field must be revamped fundamentally. Some of its shortcomings are obvious. Before the financial crisis, most macroeconomists were blinded by the idea that efficient markets would take care of themselves. They did not bother to put financial markets and the banking sector into their models. This is a major flaw. There is a deeper problem, though, that will be more difficult to resolve. This is the underlying paradigm of macroeconomic models. Mainstream models take the view that economic agents are superbly informed and understand the deep complexities of the world. In the jargon, they have “rational expectations”. Not only that. Since they all understand the same “truth”, they all act in the same way. Thus modelling the behaviour of just one agent (the “representative” consumer and the “representative” producer) is all one has to do

157 to fully describe the intricacies of the world. Rarely has such a ludicrous idea been taken so seriously by so many academics. (Other fields of economics have not been deluded by this implausible idea and therefore do not face the same criticism.) We need a new science of macroeconomics. A science that starts from the assumption that individuals have severe cognitive limitations; that they do not understand much about the complexities of the world in which they live. This lack of understanding creates biased beliefs and collective movements of euphoria when agents underestimate risk, followed by collective depression in which perceptions of risk are dramatically increased. These collective movements turn uncorrelated risks into highly correlated ones. What Keynes called “animal spirits” are fundamental forces driving macroeconomic fluctuations. The basic error of modern macro-economics is the belief that the economy is simply the sum of microeconomic decisions of rational agents. But the economy is more than that. The interactions of these decisions create collective movements that are not visible at the micro level. It will remain difficult to model these collective movements. There is much resistance. Too many macro-economists are attached to their models because they want to live in the comfort of what they understand – the behaviour of rational and superbly informed individuals. To paraphrase Isaac Newton, macroeconomists can calculate the motions of a lonely rational agent but not the madness of the crowds. Yet if macroeconomics wants to become relevant again, its practitioners will have to start calculating this madness. It is going to be difficult, but that is no excuse not to try. The writer is professor of economics at the University of Leuven and the Centre for European Policy Studies Paul De Grauwe “Economics is in crisis: it is time for a profound revamp”, FT July 21 2009 http://www.ft.com/cms/s/0/478de136-762b-11de-9e59-00144feabdc0.html

Chairman Ben S. Bernanke Semiannual Monetary Policy Report to the Congress Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. July 21, 2009 Chairman Frank, Ranking Member Bachus, and other members of the Committee, I am pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. Economic and Financial Developments in the First Half of 2009 Aggressive policy actions taken around the world last fall may well have averted the collapse of the global financial system, an event that would have had extremely adverse and protracted consequences for the world economy. Even so, the financial shocks that hit the global economy in September and October were the worst since the 1930s, and they helped push the global economy into the deepest recession since World War II. The U.S. economy contracted sharply in the fourth quarter of last year and the first quarter of this year. More recently, the

158 pace of decline appears to have slowed significantly, and final demand and production have shown tentative signs of stabilization. The labor market, however, has continued to weaken. Consumer price inflation, which fell to low levels late last year, remained subdued in the first six months of 2009. To promote economic recovery and foster price stability, the Federal Open Market Committee (FOMC) last year brought its target for the federal funds rate to a historically low range of 0 to 1/4 percent, where it remains today. The FOMC anticipates that economic conditions are likely to warrant maintaining the federal funds rate at exceptionally low levels for an extended period. At the time of our February report, financial markets at home and abroad were under intense strains, with equity prices at multiyear lows, risk spreads for private borrowers at very elevated levels, and some important financial markets essentially shut. Today, financial conditions remain stressed, and many households and businesses are finding credit difficult to obtain. Nevertheless, on net, the past few months have seen some notable improvements. For example, interest rate spreads in short-term money markets, such as the interbank market and the commercial paper market, have continued to narrow. The extreme risk aversion of last fall has eased somewhat, and investors are returning to private credit markets. Reflecting this greater investor receptivity, corporate bond issuance has been strong. Many markets are functioning more normally, with increased liquidity and lower bid-asked spreads. Equity prices, which hit a low point in March, have recovered to roughly their levels at the end of last year, and banks have raised significant amounts of new capital. Many of the improvements in financial conditions can be traced, in part, to policy actions taken by the Federal Reserve to encourage the flow of credit. For example, the decline in interbank lending rates and spreads was facilitated by the actions of the Federal Reserve and other central banks to ensure that financial institutions have adequate access to short-term liquidity, which in turn has increased the stability of the banking system and the ability of banks to lend. Interest rates and spreads on commercial paper dropped significantly as a result of the backstop liquidity facilities that the Federal Reserve introduced last fall for that market. Our purchases of agency mortgage-backed securities and other longer-term assets have helped lower conforming fixed mortgage rates. And the Term Asset-Backed Securities Loan Facility (TALF), which was implemented this year, has helped restart the securitization markets for various classes of consumer and small business credit. Earlier this year, the Federal Reserve and other federal banking regulatory agencies undertook the Supervisory Capital Assessment Program (SCAP), popularly known as the stress test, to determine the capital needs of the largest financial institutions. The results of the SCAP were reported in May, and they appeared to increase investor confidence in the U.S. banking system. Subsequently, the great majority of institutions that underwent the assessment have raised equity in public markets. And, on June 17, 10 of the largest U.S. bank holding companies--all but one of which participated in the SCAP--repaid a total of nearly $70 billion to the Treasury. Better conditions in financial markets have been accompanied by some improvement in economic prospects. Consumer spending has been relatively stable so far this year, and the decline in housing activity appears to have moderated. Businesses have continued to cut capital spending and liquidate inventories, but the likely slowdown in the pace of inventory liquidation in coming quarters represents another factor that may support a turnaround in activity. Although the recession in the rest of the world led to a steep drop in the demand for U.S. exports, this drag on our economy also appears to be waning, as many of our trading partners are also seeing signs of stabilization.

159 Despite these positive signs, the rate of job loss remains high and the unemployment rate has continued its steep rise. Job insecurity, together with declines in home values and tight credit, is likely to limit gains in consumer spending. The possibility that the recent stabilization in household spending will prove transient is an important downside risk to the outlook. In conjunction with the June FOMC meeting, Board members and Reserve Bank presidents prepared economic projections covering the years 2009 through 2011. FOMC participants generally expect that, after declining in the first half of this year, output will increase slightly over the remainder of 2009. The recovery is expected to be gradual in 2010, with some acceleration in activity in 2011. Although the unemployment rate is projected to peak at the end of this year, the projected declines in 2010 and 2011 would still leave unemployment well above FOMC participants' views of the longer-run sustainable rate. All participants expect that inflation will be somewhat lower this year than in recent years, and most expect it to remain subdued over the next two years. Policy Challenges Monetary Policy In light of the substantial economic slack and limited inflation pressures, monetary policy remains focused on fostering economic recovery. Accordingly, as I mentioned earlier, the FOMC believes that a highly accommodative stance of monetary policy will be appropriate for an extended period. However, we also believe that it is important to assure the public and the markets that the extraordinary policy measures we have taken in response to the financial crisis and the recession can be withdrawn in a smooth and timely manner as needed, thereby avoiding the risk that policy stimulus could lead to a future rise in inflation.1 The FOMC has been devoting considerable attention to issues relating to its exit strategy, and we are confident that we have the necessary tools to implement that strategy when appropriate. To some extent, our policy measures will unwind automatically as the economy recovers and financial strains ease, because most of our extraordinary liquidity facilities are priced at a premium over normal interest rate spreads. Indeed, total Federal Reserve credit extended to banks and other market participants has declined from roughly $1.5 trillion at the end of 2008 to less than $600 billion, reflecting the improvement in financial conditions that has already occurred. In addition, bank reserves held at the Fed will decline as the longer-term assets that we own mature or are prepaid. Nevertheless, should economic conditions warrant a tightening of monetary policy before this process of unwinding is complete, we have a number of tools that will enable us to raise market interest rates as needed. Perhaps the most important such tool is the authority that the Congress granted the Federal Reserve last fall to pay interest on balances held at the Fed by depository institutions. Raising the rate of interest paid on reserve balances will give us substantial leverage over the federal funds rate and other short-term market interest rates, because banks generally will not supply funds to the market at an interest rate significantly lower than they can earn risk free by holding balances at the Federal Reserve. Indeed, many foreign central banks use the ability to pay interest on reserves to help set a floor on market interest rates. The attractiveness to banks of leaving their excess reserve balances with the Federal Reserve can be further increased by offering banks a choice of maturities for their deposits. But interest on reserves is by no means the only tool we have to influence market interest rates. For example, we can drain liquidity from the system by conducting reverse repurchase agreements, in which we sell securities from our portfolio with an agreement to buy them back at a later date. Reverse repurchase agreements, which can be executed with primary dealers, government-sponsored enterprises, and a range of other counterparties, are a

160 traditional and well-understood method of managing the level of bank reserves. If necessary, another means of tightening policy is outright sales of our holdings of longer-term securities. Not only would such sales drain reserves and raise short-term interest rates, but they also could put upward pressure on longer-term interest rates by expanding the supply of longer- term assets. In sum, we are confident that we have the tools to raise interest rates when that becomes necessary to achieve our objectives of maximum employment and price stability. Fiscal Policy Our economy and financial markets have faced extraordinary near-term challenges, and strong and timely actions to respond to those challenges have been necessary and appropriate. I have discussed some of the measures taken by the Federal Reserve to promote economic growth and financial stability. The Congress also has taken substantial actions, including the passage of a fiscal stimulus package. Nevertheless, even as important steps have been taken to address the recession and the intense threats to financial stability, maintaining the confidence of the public and financial markets requires that policymakers begin planning now for the restoration of fiscal balance. Prompt attention to questions of fiscal sustainability is particularly critical because of the coming budgetary and economic challenges associated with the retirement of the baby-boom generation and continued increases in the costs of Medicare and Medicaid. Addressing the country's fiscal problems will require difficult choices, but postponing those choices will only make them more difficult. Moreover, agreeing on a sustainable long-run fiscal path now could yield considerable near-term economic benefits in the form of lower long-term interest rates and increased consumer and business confidence. Unless we demonstrate a strong commitment to fiscal sustainability, we risk having neither financial stability nor durable economic growth. Regulatory Reform A clear lesson of the recent financial turmoil is that we must make our system of financial supervision and regulation more effective, both in the United States and abroad. In my view, comprehensive reform should include at least the following key elements: • a prudential approach that focuses on the stability of the financial system as a whole, not just the safety and soundness of individual institutions, and that includes formal mechanisms for identifying and dealing with emerging systemic risks; • stronger capital and liquidity standards for financial firms, with more-stringent standards for large, complex, and financially interconnected firms; • the extension and enhancement of supervisory oversight, including effective consolidated supervision, to all financial organizations that could pose a significant risk to the overall financial system; • an enhanced bankruptcy or resolution regime, modeled on the current system for depository institutions, that would allow financially troubled, systemically important nonbank financial institutions to be wound down without broad disruption to the financial system and the economy; • enhanced protections for consumers and investors in their financial dealings; • measures to ensure that critical payment, clearing, and settlement arrangements are resilient to financial shocks, and that practices related to the trading and clearing of derivatives and other financial instruments do not pose risks to the financial system as a whole; and

161 • improved coordination across countries in the development of regulations and in the supervision of internationally active firms. The Federal Reserve has taken and will continue to take important steps to strengthen supervision, improve the resiliency of the financial system, and to increase the macroprudential orientation of our oversight. For example, we are expanding our use of horizontal reviews of financial firms to provide a more comprehensive understanding of practices and risks in the financial system. The Federal Reserve also remains strongly committed to effectively carrying out our responsibilities for consumer protection. Over the past three years, the Federal Reserve has written rules providing strong protections for mortgage borrowers and credit card users, among many other substantive actions. Later this week, the Board will issue a proposal using our authority under the Truth in Lending Act, which will include new, consumer-tested disclosures as well as rule changes applying to mortgages and home equity lines of credit; in addition, the proposal includes new rules governing the compensation of mortgage originators. We are expanding our supervisory activities to include risk-focused reviews of consumer compliance in nonbank subsidiaries of holding companies. Our community affairs and research areas have provided support and assistance for organizations specializing in foreclosure mitigation, and we have worked with nonprofit groups on strategies for neighborhood stabilization. The Federal Reserve's combination of expertise in financial markets, payment systems, and supervision positions us well to protect the interests of consumers in their financial transactions. We look forward to discussing with the Congress ways to further formalize our institution's strong commitment to consumer protection. Transparency and Accountability The Congress and the American people have a right to know how the Federal Reserve is carrying out its responsibilities and how we are using taxpayers' resources. The Federal Reserve is committed to transparency and accountability in its operations. We report on our activities in a variety of ways, including reports like the one I am presenting to the Congress today, other testimonies, and speeches. The FOMC releases a statement immediately after each regularly scheduled meeting and detailed minutes of each meeting on a timely basis. We have increased the frequency and scope of the published economic forecasts of FOMC participants. We provide the public with detailed annual reports on the financial activities of the Federal Reserve System that are audited by an independent public accounting firm. We also publish a complete balance sheet each week. We have recently taken additional steps to better inform the public about the programs we have instituted to combat the financial crisis. We expanded our website this year to bring together already available information as well as considerable new information on our policy programs and financial activities.2 In June, we initiated a monthly report to the Congress (also posted on our website) that provides even more information on Federal Reserve liquidity programs, including breakdowns of our lending, the associated collateral, and other facets of programs established to address the financial crisis.3 These steps should help the public understand the efforts that we have taken to protect the taxpayer as we supply liquidity to the financial system and support the functioning of key credit markets. The Congress has recently discussed proposals to expand the audit authority of the Government Accountability Office (GAO) over the Federal Reserve. As you know, the Federal Reserve is already subject to frequent reviews by the GAO. The GAO has broad authority to audit our operations and functions. The Congress recently granted the GAO new authority to conduct audits of the credit facilities extended by the Federal Reserve to "single and specific" companies under the authority provided by section 13(3) of the Federal Reserve

162 Act, including the loan facilities provided to, or created for, American International Group and Bear Stearns. The GAO and the Special Inspector General have the right to audit our TALF program, which uses funds from the Troubled Assets Relief Program. The Congress, however, purposefully--and for good reason--excluded from the scope of potential GAO reviews some highly sensitive areas, notably monetary policy deliberations and operations, including open market and discount window operations. In doing so, the Congress carefully balanced the need for public accountability with the strong public policy benefits that flow from maintaining an appropriate degree of independence for the central bank in the making and execution of monetary policy. Financial markets, in particular, likely would see a grant of review authority in these areas to the GAO as a serious weakening of monetary policy independence. Because GAO reviews may be initiated at the request of members of Congress, reviews or the threat of reviews in these areas could be seen as efforts to try to influence monetary policy decisions. A perceived loss of monetary policy independence could raise fears about future inflation, leading to higher long-term interest rates and reduced economic and financial stability. We will continue to work with the Congress to provide the information it needs to oversee our activities effectively, yet in a way that does not compromise monetary policy independence.

Footnotes 1. For further discussion of the Federal Reserve's "exit strategy" from its current policy stance, see "Monetary Policy as the Economy Recovers" in Board of Governors of the Federal Reserve System (2009), Monetary Policy Report to the Congress (Washington: Board of Governors, July), p. 34-7. Return to text 2. See "Credit and Liquidity Programs and the Balance Sheet" on the Board's website. Return to text 3. See the monthly reports on the Board's website at "Credit and Liquidity Programs and the Balance Sheet," Congressional Reports and Other Resources, Federal Reserve System Monthly Reports on Credit and Liquidity Programs and the Balance Sheet. Return to text http://www.federalreserve.gov/newsevents/testimony/DBBB5C9F26B6440AA4A21E104A61 577A.htm

US Bernanke outlines Fed’s exit strategy

By Sarah O’Connor and Tom Braithwaite in Washington and Michael Mackenzie in New York and Dave Shellock in London Published: July 21 2009 16:28 | Last updated: July 21 2009 22:32 Yields on US Treasuries fell sharply on Tuesday as Ben Bernanke outlined the Federal Reserve’s plan to extricate itself from its policy of near-zero interest rates but stressed the economy was too fragile to implement it soon.

163 Following increasing pressure from investors and politicians, the Fed chairman set out the central bank’s “exit strategy” for its policies, which have pumped huge amounts of liquidity into the economy and prompted fears about inflation. Mr Bernanke stressed however that in spite of glimmers of improvement in the economy, the Fed intended to keep interest rates extremely low for an “extended period”. “I want to be clear that we have a very long haul here because, even if the economy begins to turn up in terms of production, unemployment is going to stay high for quite a while, so it’s not going to feel like a really strong economy,” he said in his biannual report to Congress. The Fed expects the economy to start growing again at the end of this year but thinks the unemployment rate – now at 9.5 per cent – will remain elevated through 2011. His testimony boosted Treasury prices and saw the yield on the 10-year note fall by 12 basis points to 3.46 per cent as investors were persuaded that rates would stay low for a long time. Marco Annunziata, chief economist at UniCredit, said that reaction might not last. “Long-term yields will again face upward pressures from a combination of inflation fears and recovery hopes,” he said. Mr Bernanke’s comments came as relief at the strength of US quarterly profits helped the UK’s FTSE 100 index record a seventh successive advance – its best winning run for four years. Encouraging data from Caterpillar and Merck added to the positive mood fostered last week by a string of investment banks, most notably Goldman Sachs, and chipmaker Intel. The S&P 500 rose 0.4 per cent to close at 954.58 after matching last month’s high for the year. Continental European shares have also risen for seven straight sessions, with the FTSE Eurofirst 300 index on Tuesday rising 0.8 per cent. Outlining the Fed’s exit plans, Mr Bernanke said the bank could raise the interest paid on reserve balances to help set a floor under interest rates, and use “reverse-repo” agreements in which it would sell securities from its portfolio with an agreement to buy them back later. Mr Bernanke also mounted a defence of the independence of the Fed amid calls for greater scrutiny. http://www.ft.com/cms/s/0/6317cbc4-7608-11de-9e59-00144feabdc0.html

164

CRE Losses Piling Up by CalculatedRisk on 7/20/2009 08:13:00 AM From Lingling Wei and Maurice Tamman at the WSJ: Commercial Loans Failing at Rapid Pace U.S. banks have been charging off soured commercial mortgages at the fastest pace in nearly 20 years ... losses on loans used to finance offices, shopping malls, hotels, apartments and other commercial property could reach about $30 billion by the end of 2009. ... Many of the most troubled [regional] banks have heavy exposure to commercial real estate. ... In contrast to home loans, the majority of which were made by about 10 lenders, thousands of U.S. banks, especially regional and community banks, loaded up on commercial-property debt. ... Some analysts, meanwhile, worry that banks aren't sufficiently recognizing losses on their commercial real-estate loans, thereby exposing themselves to bigger losses later. ..."Net charge-offs to date have been highly inadequate," said Richard Parkus, head of commercial mortgage-backed securities research at Deutsche Bank. "This is clearly a problem that is being pushed out into the future." Many regional and community banks had excessive loan concentrations in Construction & Development (C&D) and CRE loans. The FDIC identified this as an emerging risk in 2006 - so it is no surprise. These smaller banks have been slow to recognize the related losses - possibly because many of the deals had interest reserves that mask the performance of the commercial building until the reserve runs dry. Then there is just more work for the FDIC ... http://www.calculatedriskblog.com/2009/07/cre-losses-piling-up.html

165

21.07.2009 Moody’s is unimpressed by German bad bank scheme

The rating agency Moody’s said yesterday that Germany’s bad bank scheme will have no effect on ratings of German banks, FT Deutschland reports. This means that, de facto, the scheme will have no effect at all, as it will leave the financial conditions in which the banks operate, unchanged. So far, the banks have been profiting from cheap central bank money, but once the central banks reverse their operations, the banks will once again have to refinance themselves via the market. Moody’s made it clear that there is no prospect for a change of the ratings, which determine the refinancing conditions. The article also mentioned that the Grand Coalition is divided over the future strategy. While the SPD wants US-style forced recapitalisation through the government, the CDU rejects this idea. (so the story from Sueddeutsche, as we reported yesterday, was a trial balloon. It is not going happen, unless the SPD were to win the next elections, which nobody believes is going to happen) Bloomberg (hat tip Calculated Risk) has an article according to which banks worldwide, and especially in the US, have made inadequate loan provisions. It said US banks may incur additional losses of $470bn by the end of 2010. Moody’s is quoting as saying that it would be a mistake to believe that the crisis was over. The German government’s strategic mistakes regarding the banking sector In a comment in FT Deutschland, Tim Bartz says that Germany failed, for largely ideological reasons, to do what others did last year, and economists have suggested back at the time, to force the banks to accept higher capital. The credit crunch under which Germany has been suffering, and which is now getting worse, is the logical consequence of that decision. The sequential comments by Peer Steinbruck and his finance ministry, who have been trying to bully the banks into increasing their credit, is only a sign of desperation, aimed at impressing the public. The truth is that the policy had failed, and a full-flown credit crunch is the result. Fall in potential output to justify French super bond The fall in investment and the rise in unemployment will reduce potential output in France

166 significantly, writes Les Echos. Less future capital and a reduced active labour force concerns the government, and serves as a legitimate argument for Sarkozy’s super bond to finance “investments into the future”. Budget minister Eric Woerth said that budget consolidation is to come with the improvement of the economic cycle.

Paris and Berlin oppose further stimulus The FT has a story contrasting the transatlantic policy debate at the moment, as Washington is pondering another stimulus package. Both France and Germany are currently firmly ruling out any further discretionary spending. The article quotes Christine Lagarde as saying that the emphasis was on implementing existing measures, not on providing news one. The article also quotes a German economist as saying that the situation in Berlin might change after the elections. The W scenario Frankfurter Allgemeine says there is a real danger that the recent stabilisation of the economy could give way to a second leg of the recession. Presently, the economy is sustain by good consumer demand, but that is going to change in the autumn when companies are going to start reducing their workforce, as their production capacity exceeds demand. So this looks increasingly like a W. The economists hit back Following the debate triggered by the Economist, Menzie Chinn, writing in the Econbrowser blog, gives a personal defence of modern macroeconomics, saying that criticisms were a caricature, according to which macroeconomists were wedded to defunct models. The debate was triggered by the Economist magazine, which had a large coverage on the difficulties of macroeconomics. Chinn said he was never taught to use only one type of model, and he does not teach in this spirit either. The Economist clearly seems to have rattled the profession. Another feisty response came from Marc Gertler, who makes the point that the profession was reacting to this crisis, as it reacted to the Great Depression. He makes the point that the critics confuse failure to predict the crisis with availability of models to explain it. Economists and others failed to predict the crisis, because they did not have the data from the shadow banking system. But they have the models to comprehend it. Irish central bank must take the blame The Irish Independent blames central bank governor John Hurley for not having done enough to prevent the financial crisis. It was Hurley who prevented the creation of an independent financial regulator and opted for a ‘two headed monster’ instead, with the central bank in a dominant position. “The failures of the Central Bank and the regulator were more to do with a cultural failure. There seemed to be an obsession with not upsetting the banks, even if that meant the entire financial system was put at risk and consumers/taxpayers ended up being huge losers.” It is not only that the financial regulator failed but also John Hurley, as well as Brian Cowen as former finance minister. The case for Blair – from Le Figaro! Pierre Rousselin in Le Figaro makes the case for Blair as the first EU president under the Lisbon Treaty (and on behalf of Sarkozy, as Le Figaro would not do such a move without his blessing). With a job description yet to be defined, a 2.5 years renewable contract and a prestigious title,

167 the job would suit Blair perfectly. But the question is why this urgency? Early nominated candidates are often out of the game even before they had a chance to be considered by the council. Rousselin argues that Blair would be a good counterpart to the British Europhobe conservative leader Cameron, who is likely to take over from Brown after the next elections. This argument was not yet relevant when Sarkozy was the first to suggest. http://www.eurointelligence.com/article.581+M5652fef7523.0.html

Econbrowser

July 20, 2009 The Failure of Macroeconomics? Menzie Chinn This must be the period of soul searching, with the Economist engaging upon multi-article exegeses on where mainstream macro went wrong [1], [2], [3]. Alternatively, I think this is a happy time for some economists outside the (perceived) mainstream, who can now chortle "I told you so". One recent example is by Mario Rizzo. The objective facts are far easier to handle in the models than the shifting, subjective expectations of people trying to deal with radically uncertain futures. This is what may get reflected in financial markets. Attempting to understand all of this requires conceding that some knowledge will be imprecise and will lie outside of the box (model). The model is simply a toy that can be thrown out when it no longer suits. This means that it is indeed possible to have valuable knowledge outside of hyper-models (although, of course, all thinking proceeds in terms of assumptions and simplifications). But this will give the "scientists" among us headaches. As John Maynard Keynes famously said about the econometrician Jan Tinbergen, "[H]e is much more interested in getting on with the job than in spending time in deciding whether the job is worth getting on with." As long as this is the dominant attitude, macroeconomics will remain "other- wordly." Instead, the way to greater realism is through more attention to the methodology of science and to whether "the job is worth getting on with." Paradoxically, greater philosophical sophistication would put economists is closer touch with the real world. (Or so I hope.) Lean, mean DSGE machines? Reading the recent characterizations of Ph.D. education in our top departments, one would conclude that all one ever learned in a program is how to write out and calibrate dynamic stochastic general equilibrium (DSGE) models, or for the older among us, calibrate a real business cycle model. I have to say that this all seems a little like an all too convenient caricature (and, as I have said repeatedly in the past, these types of models have led to important insights for issues besides crises [4]). I won't deny that in the past 20 years, I haven't seen more than a few models that struck me as pretty irrelevant for analysis of real world issues. But I think that some mathematical training, and the use of models, is essential to economic analysis. After all, one can think of completely irrelevant frameworks for looking at the world even without a model, just as one can with a model.

168 Furthermore, perhaps my experience in a Ph.D. program is atypical but I don't remember being forced into a particular mode of analysis in writing my dissertation (University of California, Berkeley, 1985-1991). In macro/international/econometrics, my teachers included Roger Craine, George Akerlof, Jeffrey Frankel, Andy Rose, and Richard Meese. We studied Euler equations as well as the market for lemons. We knew what Arrow-Debreu markets were, but we also learned about the Great Depression (from Bernanke's paper as well as Friedman and Schwartz). The time series econometrics taught did not presuppose optimizing behavior. We even studied models with sticky prices (gasp!). Doesn't sound too doctrinaire to me. So what was a common theme in the curriculum? For me, the defining feature in thinking about what model to use was whether the analysis answered the question posed, and whether the question posed was of interest. Now, whenever I read a dissertation prospectus, the key question I ask the student is: "What is the question being asked?", not "What is the methodology?" (Admittedly, the subdisciplines have different "characters", as alluded to by Paul Krugman; my focus was open economy macroeconomics, rather than macroeconomics/monetary economics.). How monolithic? I wonder if indeed the macroeconomic mainstream is as monolithic as conveyed by various observers. For instance, one certainly perceives a certain homogeneity amongst Ph.D.'s trained at certain universities. And there's a certain similarity in the mode of analysis preferred by economists in financial firms. Since the financial press tends to focus on Wall Street economists, one gets a misleading impression regarding the degree of uniformity of views. To make this more concrete, let's consider whether academic economists differ in their views regarding the economy, as compared to those in the financial sector. I have some indirect evidence, pulled from Dilbert's survey of economists in the American Economics Association (see also [5]). Scott Adams, with the assistance of Joshua Libresco of the OSR Group, was kind enough to have the stats pulled. Last summer, academic economists believed that a President Obama administration would promise more progress on the economy than a McCain administration, by a 2 to 1 margin (n=314); in contrast financial sector economists were equally split. The sample in the latter case is quite small (n=29) (I dropped the undecided/no difference responses). Nonetheless, a difference in means test (recalling the variance of a binomial is (1/4)/n) rejects the null hypothesis of equality at 6%, using a two tailed test. (As an aside, this finding further suggests that when the WSJ says most economist oppose a second stimulus, that probably characterizes Wall Street economists better than all AEA economists. Even for Wall Street economists, it's interesting to note that a majority of economists feel the stimulus package has already improved economics prospects, and will have a bigger impact in subsequent months. Hence, opposition to a second stimulus among WSJ- surveyed economists is not necessarily rooted in skepticism about the aggregate demand enhancing effect of the ARRA. (One would need a cross-tabulation of responses to verify that assertion.)) Concluding thoughts If my conjecture is correct, then the supposed failure of macroeconomics is more the failure of macroeconomics as described in the popular press, rather than of the discipline itself (after all, Joseph Stiglitz is as much of the economics discipline, if not more, than Eugene Fama.) My conclusion: Not quite time to jettison the apparatus of modern macroeconomics. For a less personal perspective, see Brad Delong and Paul Krugman, as well as my April post on "macroeconomic schisms". Update 9am 7/21: See also Mark Thoma's observations.

169 Posted by Menzie Chinn at July 20, 2009 03:43 PM http://www.econbrowser.com/archives/2009/07/the_failure_of.html

Grasping Reality with Both Hands July 18, 2009 The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World The Economist's Take on the State of Macroeconomics Once More... Paul Krugman thinks that the Economist doesn't give the Pragmatists enough credit for the analyses of financial crises that they did in the late 1990s and early and mid 2000s: Views on shape of macroeconomics differ: [T]he common claim that economists ignored the financial side and the risks of crisis seems not quite fair--at least from where I sit. In international macro, one of my two home fields, we’ve worried about and tried to analyze crises a lot. Especially after the Asian crisis of 1997- 98, financial crises were very much on everyone’s mind. There was a substantial empirical literature from economists like Carmen Reinhart and Graciela Kaminsky (with Ken Rogoff joining in latterly); there was modeling from Guillermo Calvo, Jose Andres (grrr) Velasco, Nouriel Roubini, Paolo Pesenti, and others, including yours truly.... I saw the housing bubble and expected the bust; but I hadn’t appreciated in advance either the vulnerability of the shadow banking system or the leverage of American consumers. Once the crisis was underway, however, I had a more or less ready-made intellectual framework to accommodate these revelations: at a meta level, this was very much the same kind of crisis as Indonesia 1998 or Argentina 2002.... [T]he prevailing trend now is to assert that there are more risks in the economy than were dreamed of in our philosophy; I don’t think that’s fair. At least where I sat, the prevailing view was that the U.S. housing bubble was (a) not very big and (b) could be easily managed by the Federal Reserve, because (c) a panic and a domestic surge in demand for high-quality assets could be easily met by the Federal Reserve's printing money. The prevailing view was that the truly dangerous financial crisis would be one produced by the unwinding of "global imbalances"--a collapse in the dollar and a panicked flight not toward but away from dollar-denominated cash--that could not be handled by the Federal Reserve because in such a crisis the assets that it would create would be assets that nobody wanted to hold. So I think--surprise, surprise--that Paul Krugman is right here: Pragmatists weren't ignoring the risks of crisis, but they were watching out for the wrong crisis because we had no clue how bad the state of risk management in America's investment banks had become and we overestimated the power of the Federal Reserve. Our analyses were wrong, but not because we were cluelessly off the page. But Paul has a more serious bone to pick with the Economist: The Economist reaches, I think, for a false symmetry [between Pragmatists and Purists], and glosses over too easily the sheer ignorance that has become obvious in the debates over fiscal policy...

170 Here too I think Paul Krugman is right (I really should just abbreviate the phrase "HtItPKir"). When I first ran into the "Purists" back when I was in graduate school, they were gathered under the banner of the so-called "policy ineffectiveness result": maintaining that neither systematic fiscal nor systematic monetary policies could have any effect on production or employment, and that the only thing that either the fiscal or the monetary authority could do was to add pointless and welfare-reducing variance to production and employment by randomly and destructively injecting surprise disturbances into the economy. The underlying argument went something like this: (i) There is no sense talking about anything like "involuntary unemployment": markets clear, and at all times people work as much as they want to work and firms produce as much as they want to produce. (ii) Workers work more relative to trend when they think their real wages are high, and firms produce more relative to trend when they think real prices for their products are high. (iii) Workers work less relative to trend when they think their real wages are low, and firms produce less relative to trend when they think real prices for their products are low. (iv) Workers and firms have rational expectations, so if they expect government fiscal or monetary policies to expand (or contract) nominal demand they will expect nominal wages or prices to rise (or fall) accordingly. (v) Thus if a predicted government-driven expansion (or contraction) raises (or lowers) nominal demand and thus their nominal wages or prices, they will understand that their real wages or prices have remained unchanged--and hence will not work more or less, and will not produce more or less. (vi) Only if nominal wages or prices rise (or fall) in an unexpected fashion will workers or firms get confused, and work and produce more (or less) than the trend. (vii) But with rational expectations the only cases in which government policy produces unexpected rises or falls in wages and prices is if the government policy is random. (viii) In which case its effects are random. (ix) And so government policies--not just fiscal but monetary policies too--cannot be stabilizing but only destabilizing. (x) Hence the best of all policies sets a predictable and constant rule for monetary and fiscal policy and does not deviate from it no matter what. The "Purist" position left it unclear what exactly the rule should be: Should the monetary rule be a gold standard, a price-level target, an inflation-rate target, a nominal GDP target, a nominal GDP growth rate target, a nominal wage level target, a nominal wage growth rate target, a money-stock level target, or a money-stock growth target? A floating exchange rate? A fixed exchange rate? They did not have a view: any one should work just about as well as any other. Should the fiscal rule be a budget balanced all the time? A budget balanced on average over the cycle? A budget with a constant deficit that produced a stable debt-to GDP ratio? A budget that swung into surplus in booms and deficit in recession that produced a debt-too-GDP ratio that was stable over the cycle? The Purists did not have a view: any one should work just about as well as any other. The key was to be predictable, and not to deviate from the plan no matter what. The absolute condemnation of discretionary, seat-of-the-pants policy interventions that were not part of a previously well-known and well-specified rule--absolute condemnation of both discretionary fiscal and discretionary monetary policy tuned to the state of the business cycle--was the bedrock principle of the "Purists." Critics of the Purists asked why--if fiscal and monetary policies could not have systematic stabilizing effects--we had business cycles, and why we had smaller business cycles than had been the case back before World War II. The Purists answered: (a) we had smaller business cycles because central banks and governments had learned their lessons and did less destructive discretionary policy to randomly disturb and surprise the economy; (b) we still had some cycles because policy was still somewhat discretionary, no completely rule-bound, and hence not properly predictable; and (c) we had some cycles because of cyclical fluctuations in productivity--that booms were booms because productivity was then high and people ought to

171 be working harder and longer, and recessions were recessions because productivity was then low and people ought to be working shorter and lighter--the real business cycle wing's "great vacation" theory of high business-cycle unemployment. We Pragmatists did not find these answers very convincing, or think that they were going to lead to a constructive research program. So when the financial crisis began in the summer of 2007, we Pragmatists largely ignored the Purists, for they seemed to have nothing to say. The financial crisis was not accompanied by any sharp fall in productivity that reduced real wages, so the theories of the Purists' "real business cycle" wing had no purchase on what was going on. And the financial crisis was not associated with any sudden collapse in nominal demand--government-caused or otherwise--that pushed nominal wages and prices down and made workers and firms conclude that they should be working or producing less, and so the "monetary misperceptions" wing of the Purists had no purchase on what was going on. And for the first year or so the Purists largely remained silent. I would have expected them to rail against all of the extraordinary policy actions that Ben Bernanke's Federal Reserve was undertaking--these actions were not part of any pre-planned or generally-expected rule of behavior, and the bedrock Purist principle was that government policies that deviated from pre-planned and generally-expected rules of behavior were destabilizing and destructive. But the Purists remained quiet--the only peep I saw was Chari, Christiano, and Kehoe's (2008), "Facts and Myths About the Financial Crisis of 2008": an assertion that the Federal Reserve was making a tempest in a teapot, a mountain out of a molehill, criticized the Federal Reserve for making "mistaken inferences," and argued that: even if current increase in [interest rate] spreads indicate increases in the riskiness of the underlying projects, by itself, this increase does not necessarily indicate the need for massive government intervention. We call for policymakers to articulate the precise nature of the market failure they see, to present hard evidence that differentiates their view of the data from other views which would not require such [aggressive discretionary] intervention, and to share with the public... logic and evidence... [supporting] the particular intervention they are advocating... Then, in the late fall of 2008, the Purists surfaced again. But the Purists did not condemn the aggressively expansionary and highly discretionary monetary policy emergency moves that Ben Bernanke and his colleagues were putting into effect--they endorsed them. Somehow, discretionary monetary policy had become good. Yet there was no symmetry: the Purists did not endorse the aggressively expansionary discretionary fiscal policy moves that the incoming Obama administration was planning (and that the incoming McCain administration would have been planning had the election dice rolled differently)--they condemned them. Why the Purists endorsed discretionary monetary and condemned discretionary fiscal policy moves never became clear. It wasn't the standard policy-ineffectiveness Purist position: that would have led to a condemnation of discretionary monetary policy as well. It was--well, it wasn't clear what it was. As Paul Krugman wrote last January, and htItPKir: Economists, ideology, and stimulus: This has not been one of the profession’s finest hours.... What’s been disturbing... is the parade of first-rate economists making totally non-serious arguments.... John Taylor arguing for permanent tax cuts as a response to temporary shocks.... John Cochrane going all Andrew- Mellon-liquidationist on us.... Eugene Fama reinventing the long-discredited Treasury View.... Gary Becker apparently unaware that monetary policy has hit the zero lower bound. And you’ve got Greg Mankiw--well, I don’t know what Greg actually believes, he just seems to be approvingly linking to anyone

172 opposed to stimulus, regardless of the quality of their argument.... [They] have... drop[ped] their usual quality-control standards when it comes to economic analysis. Has there been any comparable outbreak of mass bad economics from good liberal economists? I can’t think of one, although maybe that’s my own politics showing. In any case, what’s happening now is pretty disturbing... It is in summarizing this episode, I think, that the Economist does its readers bad service, writing only that: Economics: What went wrong with economics: [T]he financial crisis has blown apart the fragile consensus between purists and Keynesians that monetary policy was the best way to smooth the business cycle.... [S]hort-term interest rates are near zero... in a banking crisis monetary policy works less well. With their compromise [monetary policy] tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness... I would say that the Purists are ignoring not just the ideas of John Maynard Keynes but of Chicago-School patriarchs like Jacob Viner and Milton Friedman as well. And I would say that us Pragmatists are not ignoring the Purists' ideas--I would say that I don't know what ideas the Purists have. For the life of me I don't. The basic quantity theory of money: M * V(i) = PY tells us that nominal demand PY depends on (a) the nominal money stock M, and (b) the velocity of money V, which (c) is an increasing function of the short-term nominal interest rate on government securities i. Monetary policy changes M, and so changes PY (but may, in circumstances like those of today, induce offsetting changes in i and V that neutralize its expansionary effect). Fiscal policy--government deficits--change the quantity supplied of government bonds, and by supply-and-demand things that change the quantity of something change its price, and the price of government bonds is this interest rate i, and so fiscal policy changes the velocity of money V, and so changes PY with no offsetting changes in M to neutralize its effect.[1]

[1] It is true that Robert Barro has an argument that deficits caused by transitory tax cuts ought to create offsetting increases in desired private savings (because the marginal utility of private consumption does not change) that neutralize the effect on bond prices of increasing the supply of government bonds. But I know of no argument that claims the same for deficits caused by transitory government-spending increases (increasing savings then lowers private consumption and raises the marginal utility of private consumption, unless the goods the government buys and distributes with its spending are perfect substitutes for private consumption) for which there is no such neutralization effect... http://delong.typepad.com/sdj/2009/07/the-economists-take-on-the-state-of-macroeconomics- once-more.html

173 July 20th

Economics not without success

This week, we will be posting some reponses to our pieces on the failings and future of economics. The following is an emailed contribution by Mark Gertler, the Henry and Lucy Moses Professor of Economics at New York University. THE current crisis has naturally led to scrutiny of the economics profession. The intensity of this scrutiny ratcheted up a notch with The Economist’s interesting cover story this week on the state of academic economics. I think some of the criticism has been fair. The Great Moderation gave many in the profession the false sense that we had handled the problem of the business cycle as well as we could. Traditional applied macroeconomic research on booms and busts and macroeconomic policy fell into something of a second class status within the field in favor of more exotic topics. At the same time, from the discussion thus far, I don’t think the public is getting the full picture of what has been going on in the profession. From my vantage, there has been lots of high quality “middle ground” modern macroeconomic research that has been relevant to understanding and addressing the current crisis. Here I think, though, that both the mainstream media and the blogosphere have been confusing a failure to anticipate the crisis with a failure to have the research available to comprehend it. Predicting the crisis would have required foreseeing the risks posed by the shadow banking system, which were missed not only by academic economists, but by just about everyone else on the planet (including the ratings agencies!). But once the crisis hit, broadly speaking, policy-makers at the Federal Reserve made use of academic research on financial crises to help diagnose the situation and design the policy response. Research on monetary and fiscal policy when the nominal interest is at the zero lower bound has also been relevant. Quantitative macro models that incorporate financial factors, which existed well before the crisis, are rapidly being updated in light of new insights from the unfolding of recent events. Work on fiscal policy, which admittedly had been somewhat dormant, is now proceeding at a rapid pace. Bottom line: as happened in both the wake of the Great Depression and the Great Stagflation, economic research is responding. In this case, the time lag will be much shorter given the existing base of work to build on. Revealed preference confirms that we still have something useful to offer: demand for our services by the ultimate consumers of modern applied macro research—policy makers and staff at central banks—seems to be higher than ever. http://www.economist.com/blogs/freeexchange/2009/07/economics_not_without_success.cfm

174 The state of economics The other-worldly philosophers Jul 16th 2009 From The Economist print edition Although the crisis has exposed bitter divisions among economists, it could still be good for economics. Our first article looks at the turmoil among macroeconomists. Our second (see article) examines the foundations of financial economics ROBERT LUCAS, one of the greatest macroeconomists of his generation, and his followers are “making ancient and basic analytical errors all over the place”. Harvard’s Robert Barro, another towering figure in the discipline, is “making truly boneheaded arguments”. The past 30 years of macroeconomics training at American and British universities were a “costly waste of time”. To the uninitiated, economics has always been a dismal science. But all these attacks come from within the guild: from Brad DeLong of the University of California, Berkeley; Paul Krugman of Princeton and the New York Times; and Willem Buiter of the London School of Economics (LSE), respectively. The macroeconomic crisis of the past two years is also provoking a crisis of confidence in macroeconomics. In the last of his Lionel Robbins lectures at the LSE on June 10th, Mr Krugman feared that most macroeconomics of the past 30 years was “spectacularly useless at best, and positively harmful at worst”. These internal critics argue that economists missed the origins of the crisis; failed to appreciate its worst symptoms; and cannot now agree about the cure. In other words, economists misread the economy on the way up, misread it on the way down and now mistake the right way out. On the way up, macroeconomists were not wholly complacent. Many of them thought the housing bubble would pop or the dollar would fall. But they did not expect the financial system to break. Even after the seizure in interbank markets in August 2007, macroeconomists misread the danger. Most were quite sanguine about the prospect of Lehman Brothers going bust in September 2008. Nor can economists now agree on the best way to resolve the crisis. They mostly overestimated the power of routine monetary policy (ie, central-bank purchases of government bills) to restore prosperity. Some now dismiss the power of fiscal policy (ie, government sales of its securities) to do the same. Others advocate it with passionate intensity. Among the passionate are Mr DeLong and Mr Krugman. They turn for inspiration to Depression-era texts, especially the writings of John Maynard Keynes, and forgotten mavericks, such as Hyman Minsky. In the humanities this would count as routine scholarship. But to many high-tech economists it is a bit undignified. Real scientists, after all, do not leaf through Newton’s “Principia Mathematica” to solve contemporary problems in physics. They accuse economists like Mr DeLong and Mr Krugman of falling back on antiquated Keynesian doctrines—as if nothing had been learned in the past 70 years. Messrs DeLong and Krugman, in turn, accuse economists like Mr Lucas of not falling back on Keynesian economics—as if everything had been forgotten over the past 70 years. For Mr Krugman, we are living through a “Dark Age of macroeconomics”, in which the wisdom of the ancients has been lost. What was this wisdom, and how was it forgotten? The history of macroeconomics begins in intellectual struggle. Keynes wrote the “General Theory of Employment, Interest and Money”, which was published in 1936, in an “unnecessarily controversial tone”, according to some

175 readers. But it was a controversy the author had waged in his own mind. He saw the book as a “struggle of escape from habitual modes of thought” he had inherited from his classical predecessors. That classical mode of thought held that full employment would prevail, because supply created its own demand. In a classical economy, whatever people earn is either spent or saved; and whatever is saved is invested in capital projects. Nothing is hoarded, nothing lies idle. Keynes appreciated the classical model’s elegance and consistency, virtues economists still crave. But that did not stop him demolishing it. In his scheme, investment was governed by the animal spirits of entrepreneurs, facing an imponderable future. The same uncertainty gave savers a reason to hoard their wealth in liquid assets, like money, rather than committing it to new capital projects. This liquidity-preference, as Keynes called it, governed the price of financial securities and hence the rate of interest. If animal spirits flagged or liquidity-preference surged, the pace of investment would falter, with no obvious market force to restore it. Demand would fall short of supply, leaving willing workers on the shelf. It fell to governments to revive demand, by cutting interest rates if possible or by public works if necessary. The Keynesian task of “demand management” outlived the Depression, becoming a routine duty of governments. They were aided by economic advisers, who built working models of the economy, quantifying the key relationships. For almost three decades after the second world war these advisers seemed to know what they were doing, guided by an apparent trade-off between inflation and unemployment. But their credibility did not survive the oil-price shocks of the 1970s. These condemned Western economies to “stagflation”, a baffling combination of unemployment and inflation, which the Keynesian consensus grasped poorly and failed to prevent. The Federal Reserve, led by Paul Volcker, eventually defeated American inflation in the early 1980s, albeit at a grievous cost to employment. But victory did not restore the intellectual peace. Macroeconomists split into two camps, drawing opposite lessons from the episode. The purists, known as “freshwater” economists because of the lakeside universities where they happened to congregate, blamed stagflation on restless central bankers trying to do too much. They started from the classical assumption that markets cleared, leaving no unsold goods or unemployed workers. Efforts by policymakers to smooth the economy’s natural ups and downs did more harm than good. America’s coastal universities housed most of the other lot, “saltwater” pragmatists. To them, the double-digit unemployment that accompanied Mr Volcker’s assault on inflation was proof enough that markets could malfunction. Wages might fail to adjust, and prices might stick. This grit in the economic machine justified some meddling by policymakers. Mr Volcker’s recession bottomed out in 1982. Nothing like it was seen again until last year. In the intervening quarter-century of tranquillity, macroeconomics also recovered its composure. The opposing schools of thought converged. The freshwater economists accepted a saltier view of policymaking. Their opponents adopted a more freshwater style of modelmaking. You might call the new synthesis brackish macroeconomics. Pinches of salt Brackish macroeconomics flowed from universities into central banks. It underlay the doctrine of inflation-targeting embraced in New Zealand, Canada, Britain, Sweden and several emerging markets, such as Turkey. Ben Bernanke, chairman of the Fed since 2006, is a renowned contributor to brackish economics. For about a decade before the crisis, macroeconomists once again appeared to know what they

176 were doing. Their thinking was embodied in a new genre of working models of the economy, called “dynamic stochastic general equilibrium” (DSGE) models. These helped guide deliberations at several central banks. Mr Buiter, who helped set interest rates at the Bank of England from 1997 to 2000, believes the latest academic theories had a profound influence there. He now thinks this influence was baleful. On his blog, Mr Buiter argues that a training in modern macroeconomics was a “severe handicap” at the onset of the financial crisis, when the central bank had to “switch gears” from preserving price stability to safeguarding financial stability. Modern macroeconomists worried about the prices of goods and services, but neglected the prices of assets. This was partly because they had too much faith in financial markets. If asset prices reflect economic fundamentals, why not just model the fundamentals, ignoring the shadow they cast on Wall Street? It was also because they had too little interest in the inner workings of the financial system. “Philosophically speaking,” writes Perry Mehrling of Barnard College, Columbia University, economists are “materialists” for whom “bags of wheat are more important than stacks of bonds.” Finance is a veil, obscuring what really matters. As a poet once said, “promises of payment/Are neither food nor raiment”. In many macroeconomic models, therefore, insolvencies cannot occur. Financial intermediaries, like banks, often don’t exist. And whether firms finance themselves with equity or debt is a matter of indifference. The Bank of England’s DSGE model, for example, does not even try to incorporate financial middlemen, such as banks. “The model is not, therefore, directly useful for issues where financial intermediation is of first-order importance,” its designers admit. The present crisis is, unfortunately, one of those issues. The bank’s modellers go on to say that they prefer to study finance with specialised models designed for that purpose. One of the most prominent was, in fact, pioneered by Mr Bernanke, with Mark Gertler of New York University. Unfortunately, models that include such financial- market complications “can be very difficult to handle,” according to Markus Brunnermeier of Princeton, who has handled more of these difficulties than most. Convenience, not conviction, often dictates the choices economists make. Convenience, however, is addictive. Economists can become seduced by their models, fooling themselves that what the model leaves out does not matter. It is, for example, often convenient to assume that markets are “complete”—that a price exists today, for every good, at every date, in every contingency. In this world, you can always borrow as much as you want at the going rate, and you can always sell as much as you want at the going rate. Before the crisis, many banks and shadow banks made similar assumptions. They believed they could always roll over their short-term debts or sell their mortgage-backed securities, if the need arose. The financial crisis made a mockery of both assumptions. Funds dried up, and markets thinned out. In his anatomy of the crisis Mr Brunnermeier shows how both of these constraints fed on each other, producing a “liquidity spiral”. What followed was a furious dash for cash, as investment banks sold whatever they could, commercial banks hoarded reserves and firms drew on lines of credit. Keynes would have interpreted this as an extreme outbreak of liquidity-preference, says Paul Davidson, whose biography of the master has just been republished with a new afterword. But contemporary economics had all but forgotten the term. Fiscal fisticuffs The mainstream macroeconomics embodied in DSGE models was a poor guide to the origins of

177 the financial crisis, and left its followers unprepared for the symptoms. Does it offer any insight into the best means of recovery? In the first months of the crisis, macroeconomists reposed great faith in the powers of the Fed and other central banks. In the summer of 2007, a few weeks after the August liquidity crisis began, Frederic Mishkin, a distinguished academic economist and then a governor of the Fed, gave a reassuring talk at the Federal Reserve Bank of Kansas City’s annual symposium in Jackson Hole, Wyoming. He presented the results of simulations from the Fed’s FRB/US model. Even if house prices fell by a fifth in the next two years, the slump would knock only 0.25% off GDP, according to his benchmark model, and add only a tenth of a percentage point to the unemployment rate. The reason was that the Fed would respond “aggressively”, by which he meant a cut in the federal funds rate of just one percentage point. He concluded that the central bank had the tools to contain the damage at a “manageable level”. Since his presentation, the Fed has cut its key rate by five percentage points to a mere 0-0.25%. Its conventional weapons have proved insufficient to the task. This has shaken economists’ faith in monetary policy. Unfortunately, they are also horribly divided about what comes next. Mr Krugman and others advocate a bold fiscal expansion, borrowing their logic from Keynes and his contemporary, Richard Kahn. Kahn pointed out that a dollar spent on public works might generate more than a dollar of output if the spending circulated repeatedly through the economy, stimulating resources that might otherwise have lain idle. Today’s economists disagree over the size of this multiplier. Mr Barro thinks the estimates of Barack Obama’s Council of Economic Advisors are absurdly large. Mr Lucas calls them “schlock economics”, contrived to justify Mr Obama’s projections for the budget deficit. But economists are not exactly drowning in research on this question. Mr Krugman calculates that of the 7,000 or so papers published by the National Bureau of Economic Research between 1985 and 2000, only five mentioned fiscal policy in their title or abstract. Do these public spats damage macroeconomics? Greg Mankiw, of Harvard, recalls the angry exchanges in the 1980s between Robert Solow and Mr Lucas—both eminent economists who could not take each other seriously. This vitriol, he writes, attracted attention, much like a bar- room fist-fight. But he thinks it also dismayed younger scholars, who gave these macroeconomic disputes a wide berth. By this account, the period of intellectual peace that followed in the 1990s should have been a golden age for macroeconomics. But the brackish consensus also seems to leave students cold. According to David Colander, who has twice surveyed the opinions of economists in the best American PhD programmes, macroeconomics is often the least popular class. “What did you learn in macro?” Mr Colander asked a group of Chicago students. “Did you do the dynamic stochastic general equilibrium model?” “We learned a lot of junk like that,” one replied. It takes a model to beat a model The benchmark macroeconomic model, though not junk, suffers from some obvious flaws, such as the assumption of complete markets or frictionless finance. Indeed, because these flaws are obvious, economists are well aware of them. Critics like Mr Buiter are not telling them anything new. Economists can and do depart from the benchmark. That, indeed, is how they get published. Thus a growing number of cutting-edge models incorporate one or two financial frictions. And economists like Mr Brunnermeier are trying to fit their small, “blackboard” models of the crisis into a larger macroeconomic frame. But the benchmark still matters. It formalises economists’ gut instincts about where the best analytical cuts lie. It is the starting point to which the theorist returns after every ingenious

178 excursion. Few economists really believe all its assumptions, but few would rather start anywhere else. Unfortunately, it is these primitive models, rather than their sophisticated descendants, that often exert the most influence over the world of policy and practice. This is partly because these first principles endure long enough to find their way from academia into policymaking circles. As Keynes pointed out, the economists who most influence practical men of action are the defunct ones whose scribblings have had time to percolate from the seminar room to wider conversations. These basic models are also influential because of their simplicity. Faced with the “blooming, buzzing confusion” of the real world, policymakers often fall back on the highest-order principles and the broadest presumptions. More specific, nuanced theories are often less versatile. They shed light on whatever they were designed to explain, but little beyond. Would economists be better off starting from somewhere else? Some think so. They draw inspiration from neglected prophets, like Minsky, who recognised that the “real” economy was inseparable from the financial. Such prophets were neglected not for what they said, but for the way they said it. Today’s economists tend to be open-minded about content, but doctrinaire about form. They are more wedded to their techniques than to their theories. They will believe something when they can model it. Mr Colander, therefore, thinks economics requires a revolution in technique. Instead of solving models “by hand”, using economists’ powers of deduction, he proposes simulating economies on the computer. In this line of research, the economist specifies simple rules of thumb by which agents interact with each other, and then lets the computer go to work, grinding out repeated simulations to reveal what kind of unforeseen patterns might emerge. If he is right, then macroeconomists, like zombie banks, must write off many of their past intellectual investments before they can make progress again. Mr Krugman, by contrast, thinks reform is more likely to come from within. Keynes, he observes, was a “consummate insider”, who understood the theory he was demolishing precisely because he was once convinced by it. In the meantime, he says, macroeconomists should turn to patient empirical spadework, documenting crises past and present, in the hope that a fresh theory might later make sense of it all. Macroeconomics began with Keynes, but the word did not appear in the journals until 1945, in an article by Jacob Marschak. He reviewed the profession’s growing understanding of the business cycle, making an analogy with other sciences. Seismology, for example, makes progress through better instruments, improved theories or more frequent earthquakes. In the case of economics, Marschak concluded, “the earthquakes did most of the job.” Economists were deprived of earthquakes for a quarter of a century. The Great Moderation, as this period was called, was not conducive to great macroeconomics. Thanks to the seismic events of the past two years, the prestige of macroeconomists is low, but the potential of their subject is much greater. The furious rows that divide them are a blow to their credibility, but may prove to be a spur to creativity.

179 Financial economics Efficiency and beyond Jul 16th 2009 | NEW YORK From The Economist print edition The efficient-markets hypothesis has underpinned many of the financial industry’s models for years. After the crash, what remains of it? IN 1978 Michael Jensen, an American economist, boldly declared that “there is no other proposition in economics which has more solid empirical evidence supporting it than the efficient-markets hypothesis” (EMH). That was quite a claim. The theory’s origins went back to the beginning of the century, but it had come to prominence only a decade or so before. Eugene Fama, of the University of Chicago, defined its essence: that the price of a financial asset reflects all available information that is relevant to its value. From that idea powerful conclusions were drawn, not least on Wall Street. If the EMH held, then markets would price financial assets broadly correctly. Deviations from equilibrium values could not last for long. If the price of a share, say, was too low, well-informed investors would buy it and make a killing. If it looked too dear, they could sell or short it and make money that way. It also followed that bubbles could not form—or, at any rate, could not last: some wise investor would spot them and pop them. And trying to beat the market was a fool’s errand for almost everyone. If the information was out there, it was already in the price. On such ideas, and on the complex mathematics that described them, was founded the Wall Street profession of financial engineering. The engineers designed derivatives and securitisations, from simple interest-rate options to ever more intricate credit-default swaps and collateralised debt obligations. All the while, confident in the theoretical underpinnings of their inventions, they reassured any doubters that all this activity was not just making bankers rich. It was making the financial system safer and the economy healthier. That is why many people view the financial crisis that began in 2007 as a devastating blow to the credibility not only of banks but also of the entire academic discipline of financial economics. That verdict is too simple. Granted, financial economists helped to start the bankers’ party, and some joined in with gusto. But even when the EMH still seemed fresh, economists were picking holes in it. A strand of sceptical thought, behavioural economics, has been booming. There are even signs of a synthesis between the EMH and the sceptics. Academia thus moved on, even if Wall Street did not. Nonetheless, the extent to which politicians and regulators trying to reform finance can trust financial economists is an open question. The EMH, to be sure, has loyal defenders. “There are models, and there are those who use the models,” says Myron Scholes, who in 1997 won the Nobel prize in economics for his part in creating the most widely used model in the finance industry—the Black-Scholes formula for pricing options. Mr Scholes thinks much of the blame for the recent woe should be pinned not on economists’ theories and models but on those on Wall Street and in the City who pushed them too far in practice. Financial firms plugged in data that reflected a “view of the world that was far more benign than it was reasonable to take, emphasising recent inputs over more historic numbers,” says Mr Scholes. “Apparently, a lot of the models used for structured products were pretty good, but the inputs were awful.” Indeed, the vast majority of derivative contracts and securitisations have

180 performed exactly as their models said they would. It was the exceptions that proved disastrous. Mr Scholes knows whereof he speaks. Long-Term Capital Management (LTCM), a hedge fund he founded with, among others, Robert Merton, a fellow Nobel laureate, skidded off the road in 1998. Since then, he has been pointing out dangers ignored or underestimated in the finance industry, such as the risk that liquid markets can dry up far faster than is typically assumed. (That did not stop Platinum Grove, the latest hedge fund in which he is involved, taking a big hit during the recent meltdown.) He has also been “criticising for years” the “value-at-risk” (VAR) models used by institutional investors to work out how much capital they need to set aside as insurance against losses on risky assets. These models mistakenly assume that the volatility of asset prices and the correlations between prices are constant, says Mr Scholes. When, say, two types of asset were assumed to be uncorrelated, investors felt able to hold the same capital as a cushion against losses on both, because they would not lose on both at the same time. However, as Mr Scholes discovered at LTCM and as the entire finance industry has now learnt for itself, at times of market stress assets that normally are uncorrelated can suddenly become highly correlated. At that point the capital buffer implied by VAR turns out to be woefully inadequate. Even as financial engineers were designing all sorts of clever products on the assumption that markets were efficient, academic economists were focusing more on how markets fall short. Even before the 1987 stockmarket crash gave them their first real-world reminder of markets’ capriciousness, some of them were examining the flaws in the theory. In 1980 Sanford Grossman and Joseph Stiglitz, another subsequent winner of a Nobel prize, pointed out a paradox. If prices reflect all information, then there is no gain from going to the trouble of gathering it, so no one will. A little inefficiency is necessary to give informed investors an incentive to drive prices towards efficiency. For Mr Scholes, it is the belief that markets tend to return prices to their efficient equilibrium when they move away from it that gives the EMH its continuing relevance. Economists also began to study “institutional frictions” in markets. For instance, the EMH’s devotees had assumed that smart investors would be able to trade against less well-informed “noise traders” and overwhelm them by driving prices to reflect true value. But it became clear that there were limits to their ability to arbitrage folly away. Andrei Shleifer, a Harvard economist, among others, pointed out that it could be too costly for informed investors to borrow enough to bet against the noise traders. Once it is admitted that prices can move away from fundamentals for a long time, informed investors may do best by riding the trend rather than fighting it. The trick then is to get out just before momentum shifts the other way. But in this world, rational investors may contribute to bubbles rather than preventing them. In the early years of the EMH, researchers spent little time worrying about the workings of financial institutions—a weakness of macroeconomics too. In 2000, in his presidential address to the American Finance Association, Franklin Allen, of the University of Pennsylvania’s Wharton School, asked: “Do financial institutions matter?” Lay people, he said, “might be surprised to learn that institutions play little role in financial theory.” Indeed they might. Mr Allen’s explanation was partly that the dominant theories had been shaped at a time when America, especially, was spared financial crises. In the past decade or so, financial economists have been paying more attention to institutional questions, such as how bankers should be paid. Many of these researchers broadly accept the EMH, but see their role as uncovering sources of inefficiency that can be addressed to make markets more efficient. However, a second branch of financial economics is far more sceptical about markets’ inherent

181 rationality. Behavioural economics, which applies the insights of psychology to finance, has boomed in the past decade. In particular, behavioural economists have argued that human beings tend to be too confident of their own abilities and tend to extrapolate recent trends into the future, a combination that may contribute to bubbles. There is also evidence that losses can make investors extremely, irrationally risk-averse—exaggerating price falls when a bubble bursts. Behavioural economists were among the first to sound the alarm about trouble in the markets. Notably, Robert Shiller of Yale gave an early warning that America’s housing market was dangerously overvalued. This was his second prescient call. In the 1990s his concerns about the bubbliness of the stockmarket had prompted Alan Greenspan, then chairman of the Federal Reserve, to wonder if the heady share prices of the day were the result of investors’ “irrational exuberance”. The title of Mr Shiller’s latest book, “Animal Spirits” (written with George Akerlof, of the University of California, Berkeley), is taken from John Maynard Keynes’s description of the quirky psychological forces shaping markets. It argues that macroeconomics, too, should draw lessons from psychology. “In some ways, we behavioural economists have won by default, because we have been less arrogant,” says Richard Thaler of the University of Chicago, one of the pioneers of behavioural finance. Those who denied that prices could get out of line, or ever have bubbles, “look foolish”. Mr Scholes, however, insists that the efficient-market paradigm is not dead: “To say something has failed you have to have something to replace it, and so far we don’t have a new paradigm to replace efficient markets.” The trouble with behavioural economics, he adds, is that “it really hasn’t shown in aggregate how it affects prices.” Yet EMH-ers and behaviouralists are increasingly asking the same questions and drawing on each other’s ideas. For instance, Mr Thaler concedes that in some ways the events of the past couple of years have strengthened the EMH. The hypothesis has two parts, he says: the “no-free- lunch part and the price-is-right part, and if anything the first part has been strengthened as we have learned that some investment strategies are riskier than they look and it really is difficult to beat the market.” The idea that the market price is the right price, however, has been badly dented. Mr Thaler also says that only some of the recent problems were behavioural. Many were due to things that are open to non-behavioural economics, “like better risk analysis, how we identify hidden correlations.” It will be no surprise if, thanks to the catalytic power of the bubble and market meltdown, the distinctions between the two camps disappear and a new paradigm emerges. One economist leading the effort to define that new paradigm is Andrew Lo, of the Massachusetts Institute of Technology, who sees merit in both the rational and behavioural views. He has tried to reconcile them in the “adaptive markets hypothesis”, which supposes that humans are neither fully rational nor psychologically unhinged. Instead, they work by making best guesses and by trial and error. If one investment strategy fails, they try another. If it works, they stick with it. Mr Lo borrows heavily from evolutionary science. He does not see markets as efficient in Mr Fama’s sense, but thinks they are fiercely competitive. Because the “ecology” changes over time, people make mistakes when adapting. Old strategies become obsolete and new ones are called for. The finance industry is in the midst of a transformative period of evolution, and financial economists have a huge agenda to tackle. They should do so quickly, given the determination of politicians to overhaul the regulation of financial markets. One task, also of interest to macroeconomists, is to work out what central bankers should do

182 about bubbles—now that it is plain that they do occur and can cause great damage when they burst. Not even behaviouralists such as Mr Thaler would want to see, say, the Fed trying to set prices in financial markets. He does see an opportunity, however, for governments to “lean into the wind a little more” to reduce the volatility of bubbles and crashes. For instance, when guaranteeing home loans, Freddie Mac and Fannie Mae, America’s giant mortgage companies, could be required to demand higher down-payments as a proportion of the purchase price, the higher house prices are relative to rents. Another priority is to get a better understanding of systemic risk, which Messrs Scholes and Thaler agree has been seriously underestimated. A lot of risk-managers in financial firms believed their risk was perfectly controlled, says Mr Scholes, “but they needed to know what everyone else was doing, to see the aggregate picture.” It turned out that everyone was doing very similar things. So when their VAR models started telling them to sell, they all did—driving prices down further and triggering further model-driven selling. Several countries now expect to introduce a systemic-risk regulator. Financial economists may have useful advice to offer. Many of them see information as crucial. Data should be collected from individual firms and aggregated. The overall data should then be published. That would be better, they think, than a system based solely on the micromanagement of individual institutions deemed systemically significant. Mr Scholes favours relying less on VAR to calculate capital reserves against losses. Instead, each category of asset should have its own risk-capital reserves, which could not be shared with other assets, even if prices had not been correlated in the past. As experience shows, correlations can change suddenly. Financial economists also need better theories of why liquid markets suddenly become illiquid and of how to manage the risk of “moral hazard”—the danger that the existence of government regulation and safety nets encourages market participants to take bigger risks than they might otherwise have done. The sorry consequences of letting Lehman Brothers fail, which was intended to discourage moral hazard, showed that the middle of a crisis is not the time to get tough. But when is? Mr Lo has a novel idea for future crises: creating a financial equivalent of the National Transport Safety Board, which investigates every civil-aviation crash in America. He would like similar independent, after-the-fact scrutiny of every financial failure, to see what caused it and what lessons could be learned. Not the least of the difficulties in the continuing crisis is working out exactly what went wrong and why—and who, including financial economists, should take the blame. Economics What went wrong with economics Jul 16th 2009 From The Economist print edition And how the discipline should change to avoid the mistakes of the past OF ALL the economic bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself. A few years ago, the dismal science was being acclaimed as a way of explaining ever more forms of human behaviour, from drug-dealing to sumo-wrestling. Wall Street ransacked the best universities for game theorists and options modellers. And on the public stage, economists were seen as far more trustworthy than politicians. John McCain joked

183 that Alan Greenspan, then chairman of the Federal Reserve, was so indispensable that if he died, the president should “prop him up and put a pair of dark glasses on him.” In the wake of the biggest economic calamity in 80 years that reputation has taken a beating. In the public mind an arrogant profession has been humbled. Though economists are still at the centre of the policy debate—think of Ben Bernanke or Larry Summers in America or Mervyn King in Britain—their pronouncements are viewed with more scepticism than before. The profession itself is suffering from guilt and rancour. In a recent lecture, Paul Krugman, winner of the Nobel prize in economics in 2008, argued that much of the past 30 years of macroeconomics was “spectacularly useless at best, and positively harmful at worst.” Barry Eichengreen, a prominent American economic historian, says the crisis has “cast into doubt much of what we thought we knew about economics.” In its crudest form—the idea that economics as a whole is discredited—the current backlash has gone far too far. If ignorance allowed investors and politicians to exaggerate the virtues of economics, it now blinds them to its benefits. Economics is less a slavish creed than a prism through which to understand the world. It is a broad canon, stretching from theories to explain how prices are determined to how economies grow. Much of that body of knowledge has no link to the financial crisis and remains as useful as ever. And if economics as a broad discipline deserves a robust defence, so does the free-market paradigm. Too many people, especially in Europe, equate mistakes made by economists with a failure of economic liberalism. Their logic seems to be that if economists got things wrong, then politicians will do better. That is a false—and dangerous—conclusion. Rational fools These important caveats, however, should not obscure the fact that two central parts of the discipline—macroeconomics and financial economics—are now, rightly, being severely re- examined (see article, article). There are three main critiques: that macro and financial economists helped cause the crisis, that they failed to spot it, and that they have no idea how to fix it. The first charge is half right. Macroeconomists, especially within central banks, were too fixated on taming inflation and too cavalier about asset bubbles. Financial economists, meanwhile, formalised theories of the efficiency of markets, fuelling the notion that markets would regulate themselves and financial innovation was always beneficial. Wall Street’s most esoteric instruments were built on these ideas. But economists were hardly naive believers in market efficiency. Financial academics have spent much of the past 30 years poking holes in the “efficient market hypothesis”. A recent ranking of academic economists was topped by Joseph Stiglitz and Andrei Shleifer, two prominent hole-pokers. A newly prominent field, behavioural economics, concentrates on the consequences of irrational actions. So there were caveats aplenty. But as insights from academia arrived in the rough and tumble of Wall Street, such delicacies were put aside. And absurd assumptions were added. No economic theory suggests you should value mortgage derivatives on the basis that house prices would always rise. Finance professors are not to blame for this, but they might have shouted more loudly that their insights were being misused. Instead many cheered the party along (often from within banks). Put that together with the complacency of the macroeconomists and there were too few voices shouting stop. Blindsided and divided

184 The charge that most economists failed to see the crisis coming also has merit. To be sure, some warned of trouble. The likes of Robert Shiller of Yale, Nouriel Roubini of New York University and the team at the Bank for International Settlements are now famous for their prescience. But most were blindsided. And even worrywarts who felt something was amiss had no idea of how bad the consequences would be. That was partly to do with professional silos, which limited both the tools available and the imaginations of the practitioners. Few financial economists thought much about illiquidity or counterparty risk, for instance, because their standard models ignore it; and few worried about the effect on the overall economy of the markets for all asset classes seizing up simultaneously, since few believed that was possible. Macroeconomists also had a blindspot: their standard models assumed that capital markets work perfectly. Their framework reflected an uneasy truce between the intellectual heirs of Keynes, who accept that economies can fall short of their potential, and purists who hold that supply must always equal demand. The models that epitomise this synthesis—the sort used in many central banks—incorporate imperfections in labour markets (“sticky” wages, for instance, which allow unemployment to rise), but make no room for such blemishes in finance. By assuming that capital markets worked perfectly, macroeconomists were largely able to ignore the economy’s financial plumbing. But models that ignored finance had little chance of spotting a calamity that stemmed from it. What about trying to fix it? Here the financial crisis has blown apart the fragile consensus between purists and Keynesians that monetary policy was the best way to smooth the business cycle. In many countries short-term interest rates are near zero and in a banking crisis monetary policy works less well. With their compromise tool useless, both sides have retreated to their roots, ignoring the other camp’s ideas. Keynesians, such as Mr Krugman, have become uncritical supporters of fiscal stimulus. Purists are vocal opponents. To outsiders, the cacophony underlines the profession’s uselessness. Add these criticisms together and there is a clear case for reinvention, especially in macroeconomics. Just as the Depression spawned Keynesianism, and the 1970s stagflation fuelled a backlash, creative destruction is already under way. Central banks are busy bolting crude analyses of financial markets onto their workhorse models. Financial economists are studying the way that incentives can skew market efficiency. And today’s dilemmas are prompting new research: which form of fiscal stimulus is most effective? How do you best loosen monetary policy when interest rates are at zero? And so on. But a broader change in mindset is still needed. Economists need to reach out from their specialised silos: macroeconomists must understand finance, and finance professors need to think harder about the context within which markets work. And everybody needs to work harder on understanding asset bubbles and what happens when they burst. For in the end economists are social scientists, trying to understand the real world. And the financial crisis has changed that world. http://www.economist.com/displaystory.cfm?story_id=14030288 http://www.economist.com/displaystory.cfm?story_id=14030296 http://www.economist.com/opinion/displaystory.cfm?story_id=14031376

185

PPourquoi Blair ferait un bon président de l'Europe Pierre Rousselin 20/07/2009 |

«Tony Blair a souvent été présenté comme le Britannique le plus proeuropéen. Pourtant, en dix ans, il n'a pu mettre son pays «au cœur de l'Europe» comme il l'avait promis». Crédits photo : AFP L'analyse de Pierre Rousselin, directeur adjoint de la rédaction du Figaro. Tony Blair ferait un bon président de l'Union européenne. Il serait, assurément, plus efficace à ce poste qu'il ne l'est depuis qu'il est censé s'occuper du Moyen-Orient en tant que représentant spécial du Quartette. Un mandat de deux ans et demi renouvelable, un titre ronflant de «président de l'Europe» pour des attributions qui restent à définir : cela conviendrait très bien à Tony Blair. Gordon Brown, dont la rivalité avec l'ancien premier ministre est légendaire, vient de lancer la campagne en faveur de sa candidature au nouveau poste qui découle du traité de Lisbonne, traité dont on ne sait pas encore s'il entrera un jour en vigueur. On peut se demander pourquoi Gordon Brown ressent une telle urgence. Est-ce pour être sûr que l'idée n'aboutisse pas ? L'expérience des nominations européennes, notamment à la Commission, montre que les candidatures parties de loin ont du mal à tenir la distance. Elles soulèvent des oppositions qui ont tout le temps de s'organiser et se font souvent coiffer au poteau par des personnalités moins tranchées. C'est ainsi que José Manuel Barroso s'était imposé, il y a cinq ans, aux dépens de Guy Verhofstadt, Londres ayant, à l'époque, réussi à bloquer le choix initial de Paris et de Berlin. Dans le cas présent, la décision ne sera prise qu'après le référendum irlandais sur le traité

186 de Lisbonne - et à condition que la réponse soit positive - lors du Conseil européen de la fin octobre. Encore faudra-t-il obtenir le paraphe des présidents tchèque et polonais. À ce propos, la perspective de voir un atlantiste comme Blair à la tête de l'Europe devrait encourager Vaclav Klaus et Lech Kaczynski à surmonter leur allergie au traité de Lisbonne. Du moins faut-il l'espérer. Sinon, c'est la catastrophe annoncée. Compte tenu des déboires de Gordon Brown, tout indique que le conservateur eurosceptique David Cameron entrera au 10 Downing Street l'année prochaine. Le chef des Tories a promis un référendum - par définition négatif - sur le traité de Lisbonne, si celui-ci n'est pas ratifié avant son arrivée au pouvoir. Quoi qu'il en soit et compte tenu de l'alternance annoncée au Royaume-Uni, avoir un Britannique présentable à la tête de l'Union européenne permettrait de limiter les dégâts. Cet argument n'existait pas lorsque Nicolas Sarkozy avait été le premier à suggérer que Blair pourrait être un bon président de l'Union européenne. Gordon Brown paraissait alors assuré de suivre les traces de son prédécesseur. Tony Blair a souvent été présenté comme le Britannique le plus proeuropéen. Pourtant, en dix ans, il n'a pu mettre son pays «au cœur de l'Europe» comme il l'avait promis, ou faire adopter l'euro aux Britanniques. Sera-t-il en mesure de les réconcilier avec la bureaucratie bruxelloise ? On peut en douter. Mais l'épouvantail que représente Cameron peut lui servir, dans la mesure où la perspective d'une Grande-Bretagne europhobe obsède, en ce moment, les chancelleries européennes. D'autres possibilités existent. Avec le départ de Javier Solana, l'hypothèse Felipe Gonzalez gagne en crédibilité. Comme Tony Blair, l'ancien président du gouvernement espagnol, artisan de la transition démocratique dans son pays, est indiscutablement une personnalité de premier plan, de celles qui, si elles le souhaitent, peuvent donner à l'Europe un visage et une voix reconnus tout autour de la planète. Le choix du président de l'Union se fera dans le cadre d'un marchandage global comprenant aussi les têtes d'affiche de la Commission. Le nouveau poste de vice- président, chargé de la diplomatie européenne, sera aussi très convoité. Il faudra respecter le dosage habituel entre représentants des grands et des petits pays, du Nord et du Sud, de la gauche et de la droite. Au cours des prochains mois, les spéculations ne vont pas manquer. http://www.lefigaro.fr/debats/2009/07/14/01005-20090714ARTFIG00376-pourquoi-blair-ferait- un-bon-president-de-l-europe-.php

20.07.2009 Placebo Effects: Part 1 By: Satyajit Das Mixed Metaphors…

187 Botanical commentators are finding ‘green shoots’. The astronomically minded have seen ‘glimmers’. The meteorologically minded have spoken about the storms ‘abating’. Strong rallies in equity and debt markets have confirmed the recovery for the ‘true believers’. The Global Financial Crisis ("GFC") crisis is over! It is useful to remember Winston Churchill’s observation after the British expeditionary force’s escape from Dunkirk: "[Britain] must be very careful not to assign to this deliverance the attributes of a victory". There may be confusion between ‘stabilisation’ and ‘recovery’. The ‘green shoots’ theory is based on a slowdown in the rate of decline in key economic indicators, improvements in the financial system, unprecedented government support for the banking system, near-zero interest rates and large fiscal stimulus packages. The recovery of emerging markets and a renewed belief in Decoupling (Release 2.0) also underpin hopes of a swift return to growth. Receiving the Messengers… The puzzling thing is that real economy indicators continue to be poor. Growth forecast for 2009 have steadily deteriorated with world growth expected to be negative 2.00 to 3.00% with especially poor prospects for Japan and the Euro Zone. Industrial output, employment, consumption, investment and global trade continue to be weak. Even China expected to grow between 6% and 8% in 2009 experienced a fall in exports of over 20% over the last year. The ‘wealth effects’ of the GFC on economic activity are unclear. In the U.S. alone $30 trillion of value has been destroyed. Combined with declines in housing prices and reduced dividends and investment income, the sharp decline in wealth may not be yet to fully flow through into consumption. The financial system has stabilised but not returned to the ‘rude good health’ that current executive compensation levels within banks would suggest. Asset quality remains vulnerable to more bad debts from the normal recessionary credit cycle that is working through the economy. Profitability is patchy and reliant on risky trading income and large underwriting revenues from capital raisings by financial institutions and companies who are deleveraging aggressively. Bank risk levels have returned to near pre-crisis levels. Capital remains scarce and bank balance sheets are at best not growing and at worst shrinking. Some estimates suggest that the bank capital shortfall could be in range of $1 to $2 trillion, equivalent to a credit contraction of around 20-30% from previous levels. Proposed bank regulations, primarily the increased levels of capital and lower permitted leverage, will also affect the ability of the financial system to extend credit. The link between debt and economic growth is well established. The global economy probably needs around $4 to $5 of debt to create $1 of GDP growth. IMF researchers Tamin Bayoumi and Ola Melander, in a study of the economic impacts of an adverse shock to bank capital ((2008) "Credit Matters:Empirical Evidence on U.S. Macro-Financial Linkages" IMF Working Paper 08/169) found that in the U.S. a 1% point fall in Tier 1 risk-weighted capital ratios reduces real GDP by 1.5%. This means that global bank capital shortage may restrain credit creation thereby reducing economic activity and sustainable growth levels. The impact of fiscal stimulus packages has been variable. In some jurisdictions, the payments have been saved or applied towards debt reduction rather than consumption. Targeted measures, such as the ‘cash for clunkers’ deals (cleverly packaged as ‘green’ environmental initiatives) have boosted immediate demand for cars but the long-term demand effects are unclear. The multiplier effect of the fiscal initiatives is likely to be low. Major infrastructure initiatives

188 will take time to implement. Few projects are ‘shovel ready’. The rate of return on government spending programs, some of which are politically motivated, is unclear. Government spending increasing capacity is likely to create problems in a world where many industries are operating with surplus capacity. Government bailout packages for various industries, such as the auto and housing industries, however well intentioned, are delaying much needed capacity adjustments and risk prolonging the problems. The phoenix-like recovery in emerging markets is primarily driven by panicked government spending and loose monetary policies increasing available credit. Estimates suggest that around 6% of the growth of around 8% is attributable to government spending and increased bank lending. The extraordinary growth in lending in China is fuelling unsustainable growth. In the first half of 2009, new loans totalled over $1 trillion. This compares to total loans for the full 2008 year of around $600 billion. Current lending is running at around three times 2008 levels and at a staggering 25% of China’s GDP. The combination of government spending and bank loanshas resulted in sharp increases in fixed asset investments (over 30% up on 2008). Government incentives, in the form of rebates for purchases of high value durables such as cars and white goods, have also increased consumption (up 15% on 2008). Even Chinese government officials have admitted that the recovery is "unbalanced". The increase in industrial production in the absence of real end demand for products could result in a rapid build up in inventory. The availability of credit is also fuelling rampant speculation in stocks, property and commodities. The price rise in emerging market shares, debt and currencies also reflects a blind belief that anywhere must be safer and more promising than the U.S., Japan or Europe. This misses the point that these markets have a strong trading and export orientation or are external capital dependent. While some have bright long-term futures, they will need to make difficult and slow adjustments to their growth models to return to trend growth. The recovery in emerging markets has, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. A significant part of this is inventory restocking but there is a speculative element. Availability of abundant and low cost bank finance combined with a deep seated fear of the long term prospects of U.S. Treasury bonds and the dollar has encouraged speculative stockpiling of certain commodities artificially boosting demand. In reality, the global economy has, in all probability, entered a period of stability after a fairly big decline. Market sentiment seems to be shaped less by facts than the Doors’ song: "I've been down for so long, it feels like up to me." Government Largesse… A key risk remains the ability of governments to finance their burgeoning government deficits. A wretched combination of declining tax revenues, increased government spending to cushion the economy from recession and bailout packages for banks and other ‘worthies’ means that many countries face large and continuing budget deficits. Even countries with relatively healthy ‘balance sheets’ such as Australia do not anticipate balancing their books for many years. If the problems of an aging population and unfunded liabilities such as public sector pensions, healthcare and social security arrangements are included, then the budgetary position looks considerably worse. In 2009, total sovereign debt issues are expected to total over $5 trillion of which the U.S. alone will need to finance around $3 trillion. The increases in sovereign debt issuance are

189 astonishing – U.S. around 300%, U.K. over 400%, Euro Zone around 50%. Government debt-to-GDP ratios for many developed countries are projected to reach and remain at levels in excess of 100%. Overall government deficits in major economies through the recession are estimated to total around $10 trillion (around 27% of GDP of these economies). The work of economists Kenneth Rogoff and Carmen Reinhart on previous recessions suggests that the deficit estimates are conservative and the amount that will need to be financed will be between $15 trillion (40% of GDP) and $33 trillion (86% of GDP). As a comparison, the total amount of global investment assets under management, according to one estimate is around $120 trillion. This provides some idea of the funding task ahead. To date, sovereign debt issuance programs have been successful. There have been some auction problems (in Germany, U.K. and U.S.) but these have been manageable. Long-term interest rates have risen sharply reflecting supply pressures. The U.S. 30 year rate has increased by around 1.50% p.a. since the start of 2009. Maturities have also shortened increasing the re-financing challenges ahead. Participation of central banks in the U.S. and the U.K. bonds, under their quantitative easing mandates, has helped keep interest rate rises down creating a somewhat artificial market. A key issue over the coming months is the continued demand for increased sovereign debt issues. China, Japan and Europe historically have been major buyers of U.S. Treasury bonds. As their own fiscal position changes and their current account surplus shrinks, the ability of these investors to absorb the increased supply is unclear. China’s foreign exchange reserves are growing more slowly than before. China has continued to purchase U.S. Treasury bonds but some purchases represent a switch from U.S. Agency paper. As the U.S. has increased its issuance program, China’s purchases are now a smaller portion of the total. In the best case the government debt issuance programs is accommodated but squeezes out other borrowers. In the worst case, governments find themselves unable to finance their deficits setting of a new stage of the GFC. The markets ability to avoid consideration of these issues reflects Mark Twain’s observation that: "Ignorance more frequently begets confidence than does knowledge http://www.eurointelligence.com/article.581+M5365c7b4461.0.html#

190 Business

July 20, 2009 BACK TO BUSINESS Cashing In, Again, on Risky Mortgages By PETER S. GOODMAN LOS ANGELES — From the ninth floor of a downtown office building on Wilshire Boulevard, Jack Soussana delivered staggering numbers of mortgages to homeowners during the real estate boom, amassing a fortune. By Mr. Soussana’s own account, his customers fared less happily. He specialized in the exotic mortgages that have proved most prone to sliding into foreclosure, leaving many now scrambling to save their homes. Yet the dangers assailing Mr. Soussana’s clients have yielded fresh business for him: Late last year, he and his team — ensconced in the same office where they used to broker mortgages — began working for a loan modification company. For fees reaching $3,495, with most of the money collected upfront, they promised to negotiate with lenders to lower payments on the now-delinquent mortgages they and their counterparts had sprinkled liberally across Southern California. “We just changed the script and changed the product we were selling,” said Mr. Soussana, who ran the Los Angeles sales office of Federal Loan Modification Law Center. The new script: You got a raw deal, and “Now, we’re able to help you out because we understand your lender.” Mr. Soussana’s partners at FedMod, as the company is known, were also products of the formerly lucrative world of high-risk lending. The managing partner, Nabile Anz, known as Bill, previously co-owned Mortgage Link, a California subprime lender, now defunct, that once sold $30 million worth of loans a month. Jeffrey Broughton, one of FedMod’s initial partners, served as director of business development at Pacific First Mortgage, a lender that extended so-called Alt-A mortgages for borrowers with tarnished credit for Countrywide Financial, which lost billions of dollars on bad mortgages before being rescued in an acquisition. FedMod is but one example of how many of the same people who dispensed risky mortgages during the real estate bubble have reconstituted themselves into a new industry focused on selling loan modifications. Despite making promises of relief to homeowners desperate to keep their homes, FedMod and other profit making loan modification firms often fail to deliver, according to a New York Times investigation based on interviews with scores of former employees and customers, more than 650 complaints filed with the Better Business Bureau, and documents filed by the Federal Trade Commission in a lawsuit against the company. The suit, filed in California federal court, asserts that FedMod frequently exaggerated its rates of success, advised clients to stop making their mortgage payments, did little or nothing to modify loans and failed to promptly refund fees. The suit seeks an end to FedMod’s practices, and compensation for customers. “Our job was to get the money in and then we’re done,” said Paul Pejman, a former sales agent who worked out of FedMod’s two-story headquarters in Irvine, Calif. He recounted his experience, he said, because “I really feel bad.”

191 “I had people calling me crying, and we were telling them, ‘You can pay me or you can lose your house,’ ” Mr. Pejman said. “People were giving me every dime they had, opening credit cards. But I never saw one client come out of it with a successful loan modification.” Mr. Anz, who is challenging the F.T.C. lawsuit, acknowledged that FedMod’s business went “horribly wrong,” but he maintains the company made genuine efforts to help delinquent borrowers. He said FedMod has refunded fees to 3,000 dissatisfied customers, while modifying 1,500 mortgages. A New Mission FedMod is among dozens of similar companies that have been accused by state and federal authorities of fraudulent business practices. On the same day in April that the F.T.C. sued FedMod, it brought action against four similar companies and sent letters of warning to 71 others. Last week, the commission brought lawsuits against four more loan modification companies, advancing an enforcement campaign involving 23 states. Many of the companies formerly operated as mortgage brokers, The Times found. Since October, the California Department of Real Estate has ordered 210 businesses and individuals to stop offering loan modification or foreclosure prevention services, because they lacked a real estate license, as required by the state. In fact, nearly half the people have roots in the mortgage industry or other areas of real estate, according to public records. Debt Barter Inc. is among them. A loan modification company based in Irvine that was cited by the state in January for collecting upfront fees without a license, it is owned by Sean R. Roberts, who formerly headed Instafi, a mortgage broker that closed $2 billion worth of loans a year at its peak. Since February, customers have filed 17 complaints against Debt Barter with the Better Business Bureau. Most accused the company of charging upfront fees, then failing to lower their payments. “We can’t please everyone all the time,” said Mr. Roberts, who added that the company had modified loans for nearly 300 of its roughly 500 clients. In Aliso Viejo, Calif., the Citywide Mortgage Corporation, which previously brokered Alt-A and subprime loans, last year became a loan modification company, USMAC. The company has not received a cease and desist order, but complaints on numerous consumer Web sites assert that it fails to deliver. “I’m saving homes,” said the company’s president, Scott Gimbel, who claimed a success rate above 70 percent. Chris Mozilo, nephew of Angelo R. Mozilo, the former chief executive of Countrywide Financial — a name synonymous with the subprime disaster — recently started a new business, eModifyMyLoan. It sells software that homeowners can use to apply for loan modifications. Chris Mozilo worked at Countrywide for 16 years. “I’m very proud of my career in mortgage lending,” he said. “We helped millions of people achieve the goal of homeownership.” From its inception in the middle of 2008, FedMod aimed to dominate the loan modification industry, growing swiftly with the aid of a national advertising campaign. Mr. Broughton, 49, had worked in the mortgage industry since the mid-1980s. As the market ground to a halt in 2008, he founded FedMod with two Los Angeles entrepreneurs, Steven Oscherowitz and Boaz Minitzer. Mr. Broughton sought to distinguish his company from the unscrupulous ventures that dominate the industry. “You had a lot of these modification companies that were subprime guys,” he said. “All they cared about was making quick dollars.”

192 But the partners behind FedMod had their own questionable backgrounds. In the mid-1990s, Mr. Oscherowitz settled an F.T.C. lawsuit that accused his company, Universal Merchants, of falsely marketing the weight-loss benefits of a dietary supplement. The partners entrusted Mr. Soussana with FedMod’s Los Angeles sales office precisely because he had proved adept at selling the sorts of loans that now required modification. In 2006, Mr. Soussana, then 30, was listed as the nation’s sixth most prolific mortgage broker by Mortgage Originator, a trade magazine, brokering $318 million worth of loans. The same year, he paid $1.8 million for a house near Beverly Hills. “He was one of the biggest guys in subprime mortgages,” Mr. Minitzer said. “He basically wanted to get back to his old days of 50, 60, 70 guys in his office, and we could help because we were basically taking over the market.” Bringing in the Law The three original partners brought in Mr. Anz to gain a crucial asset: his law license. Having a lawyer in charge enabled them to market their venture as a law firm and thus collect upfront payments under California rules. “Jeff asked me how I could, for lack of a better word, legitimize it,” Mr. Anz said. The California Department of Real Estate warns consumers that many dubious loan modification companies have organized themselves as law firms solely to allow them to collect upfront fees, even though the lawyers have little, if anything, to do with the services provided. The department cautions consumers against hiring such companies. In its lawsuit against FedMod, the F.T.C. contends that the company’s advertisements implied it had the backing of the federal government. “If you’re like the millions of Americans out there who are struggling to pay a mortgage, you may be eligible for the Federal Loan Modification Program,” radio ads beckoned. Aggressive marketing ensured that Mr. Pejman, 22, never lacked for calls when he started at the Irvine sales office in January. He had worked at three wholesale mortgage brokerages. Now, a trainer emphasized he was at a law center. “Our big sales pitch was that an attorney could do a better job with your loan modification,” Mr. Pejman said. “If you told them these were basically washed-up people from the mortgage industry, or just people sending in paperwork, they would say, ‘Well, why bother? I might as well do this myself.’ ” He went on: “It was misleading to the client. Attorneys never touched those files.” Among the 700-plus full-time employees who worked for FedMod this spring, only nine were lawyers, Mr. Anz said, though the company retained a lawyer in every state. Mr. Pejman and his fellow agents urged homeowners to send FedMod $3,495; the agents were promised a 30 percent commission for fees they took in. Most clients could not come up with more than $1,000 and agreed to a payment schedule for the rest. Assurances of relief from a homeowner’s loan terms were typically extravagant, Mr. Pejman said. “A big grabber was that your loan will be reduced to 2.5 percent to 5 percent on a 30-year fixed rate loan,” he said. “They’d print out all these mythical success stories for us to read over the phone.” Under FedMod’s policies, agents were prohibited from making false claims, counseling clients not to pay their mortgages or providing success rates, Mr. Anz said. New clients received follow-up compliance calls to ensure they understood nothing was guaranteed. But sales agents were told of such policies with a wink, Mr. Pejman said.

193 “They basically told us, ‘Do whatever you need to do,’ ” he said. “ ‘It’s a sales floor. You’re here to sell.’ People would quote success rates and just pull them out of thin air. People would say 60 percent, 80 percent, 90 percent. To the average Joe in Kansas, that sounded great. But the reality is that 50 percent were immediately declined by the lender.” What shocked Mr. Pejman was how readily customers handed over their credit card numbers. Sales agents tapped into a deep vein of anxiety. “I’d hear people say, ‘Would you pay $1,000 to save your home? To save your marriage? Your kids’ education?’ ” he recalled. “I’d hear people say, ‘Yeah, we’re the federal government.’ There were a lot of corrupt people working there.” In Charlotte, N.C., Joshua Garland telephoned FedMod in March after seeing one of its television commercials. Mr. Garland’s wife had been laid off from her hospital job. He had lost his job as a chef and was now bartending. Their monthly income had plunged from $3,200 to less than $1,000. They were already three months behind on their mortgage. A FedMod agent confidently described how his company could cut their monthly payments from $1,200 to $532, Mr. Garland recalled. But first, he had to pay a $995 “retainer fee.” This was nearly as much as Mr. Garland earned in two weeks. Dental bills were piling up for his three children. He was behind on his utilities. “I told him, ‘We have $1,200 left to make our mortgage payment, and if we give that money to you, we’re going to get further behind,’ ” Mr. Garland recalled. “He said, ‘Go ahead and make the $995 payment, because once you’re under our plan, the bank can’t foreclose on you.’ ” After several follow-up calls from the agent, Mr. Garland paid. Then, months passed with no contact from FedMod, he said. He left countless messages seeking updates, demanding a refund. His lender foreclosed on his house, scheduling a sale for Aug. 26. “This guy hounds me for the $1,000, and then as soon as I pay him he disappears,” Mr. Garland said. “I usually don’t fall for stuff like this. I can usually tell if it’s a scam. But this guy, I mean he came with his guns loaded.” Overwhelmed by Cases FedMod was drowning in cases. The pipeline swelled by 8,000 clients from December to March, according to Mr. Anz. Once sales agents took in applications, they passed files on to the processing department, where case managers were supposed to assemble documents and submit them to lenders. But their offices were hopelessly underequipped. “The owners didn’t want to invest in software, so everything was tracked manually,” said Rachelle Cochems, who took over as operations manager on Jan. 19 and left the company in May after FedMod stopped paying her. “We couldn’t handle the volume we were taking in. The system was broken.” Each case manager was responsible for as many as 200 files at a time, Ms. Cochems said, making it impossible to keep in regular touch with customers. Some files floated in limbo, because sales agent did not bother handing them over. “You’re paying the sales agent upfront,” Ms. Cochems said. “So what motivation does he have to get it closed?” In February, Mr. Anz shut the Los Angeles sales office, uncomfortable with reports that Mr. Soussana had filled it with “unsavory types” from the mortgage industry, he said. “I’m not a shady person,” Mr. Soussana said.

194 By March, sales agents were inundated by calls from furious clients who had paid long ago, but not heard from anyone. Some called from motels, their belongings piled in boxes, weeping as they recounted losing their homes. The agents let most calls go to voicemail, playing the most dramatic messages over speakerphones for communal amusement, Mr. Pejman said. “Guys would sit there and laugh,” he said. “ ‘This lady’s going crazy,’ that sort of thing.” The next month, Mr. Anz took full control of the company, banishing his partners and blaming them for “a train wreck.” He ceased marketing, he said, and concentrated on processing the backlog of files. In April, the F.T.C. filed its lawsuit, prompting credit card companies to freeze their accounts with FedMod. The court imposed a temporary restraining order, barring FedMod from acquiring new customers. By the time Rana Hajjar began working there on April 13 as a client representative, she found the company utterly chaotic. “They just handed me 70 files and told me to call these people because they’re very upset,” Ms. Hajjar recalled. “The majority of them had paid three or four months earlier and had never heard from anyone. I was yelled at from today until tomorrow.” Several times a week, clients called to report that the police were at their door, ordering them out for foreclosure sales, Ms. Hajjar said. When she alerted negotiators, they sometimes called banks and postponed sales, but usually they ignored her messages, she said. When Ms. Hajjar cashed her first paycheck, it bounced, she said. Over the next three weeks, she never received payment. On Monday, May 11, her manager told her and dozens of other employees to take the rest of the week off because the company had no money for payroll. She was never called back, later adding her name to a file of more than 120 wage disputes leveled against FedMod with the California Labor Commissioner. Today, FedMod has only 40 employees, said Mr. Anz, pledging to plow through the company’s 4,200 remaining files. “We’re doing what we can,” he said. “I’m the bad boy of loan mods.” Yet as television advertisements attest, many other companies remain aggressive in what amounts to perhaps the last growth industry left in American real estate. Toby Lyles and Jack Styczynski contributed research from New York, and Rebecca Cathcart contributed reporting from Los Angeles. http://www.nytimes.com/2009/07/20/business/20modify.html?_r=1&th&emc=th

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20.07.2009 German government is considering bank nationalisation

This is a cracking story if true. Sueedeutsche Zeitung reports this morning that the German government realises that its current bank rescue strategy is not working, and is considering to nationalise parts of the country’s banking sector by force. The change of mind appears to reflect acute fears by finance minister Peer Steinbruck in particular of a credit crunch to coincide with the general election. Germany’s bad bank scheme, which is essentially cost-free, stands no chance of increasing credit flows, the report says, so Germany is increasingly looking at the US and the UK of ways to make banks increase credit. The banks would receive new capital, whether they want it or not, in return for a government stake in those banks, which would allow the governments to influence banking policy. Banks think EU stress tests too severe French banks consider the macroeconomic parameters the ECB delivered for the stress tests are more severe than the US, reports Les Echos. Twenty banks are to conduct a stress tests throughout the summer, with results to be ready by September right in time for the Ecofin. Ireland stuck with existing recapitalisation scheme –for the better or worse In the Irish Independent Brendan Keenan says that compared to the UK, Ireland lacks a clear recapitalisation strategy : One has to “wait for NAMA to find out the final state stake in AIB or Bank of Ireland, when the state will have bought the banks' development loans and then invested in the banks to cover the known losses.” The chances of restoring a reduced banking system to normality are as uncertain as ever. But it is too late to contemplate alternatives of full nationalisation or bank fallouts as the opposition and some economists do. These discussions often ignore the systemic risks that a bankruptcy would entail for the Irish economy. Iceland to recapitalise banks The FT reports that Iceland will today announce on Monday a €1.5bn recapitalisation scheme of its banking sector that includes a deal to hand control of two of the country’s healthy new banks to foreign creditors. The steps mark an important milestone in efforts to rebuild

196 Iceland’s shattered banks and reintegrate the north Atlantic island nation into the international financial system, the article says. A provisional agreement was reached on Friday after weeks of difficult negotiations. Bavaria wants to block Iceland Ok, the silly season has started, and European newspapers are full of stories that would not make it on a normal day. The one silly story which interests us is that insistence by Bavaria that Iceland should first sort out its financial mess, before becoming a member state. The statement by CSU chief Horst Seehofer is not so much interesting in its own right, but in view of his recent insistence that the German parliament should have co-decision rights in all aspects of EU policy. The leaders of other parties, including Angela Merkel and Frank-Walter Steinmeier, have rejected Seehofer’s ideas. Nobody wants to constrain the government’s freedom of manoeuvre. (full codecision is not going to happen, but what we find interesting, and disturbing, is that one of Germany’s most populist leaders – who is right up there with Oskar Lafontaine on that score – believe he get win votes by railing against Europe). Jean Pierre Jouyet warns on European derivatives Jean-Pierre Jouyet, former French European minister and now France’s stock market regulator, told the Financial Times that rivalries between London, Paris and Frankfurt were blocking the emergence of an effective European market for credit derivatives, and driving business to the US. He said London had to accept that Paris will play a role in this market, and that failure to do so will only benefit the US, which has established a central clearing house, and the regulatory environment. (We find this comment very strange indeed. Here we are, still reeling from the economic damage caused by these instruments, and market regulators are already competing about who should run this very profitable industry. This is a good example of our persistent criticism why a joint response to the crisis is not the sum of individual responses. A joint global response would be to curtail those instruments. But if you leave to individual governments, you get the kind of interview Jouyet just gave.) Belgium postpones budget negotiations The Belgian budget negotiations for 2010 and 2011 are postponed until September after no agreement could be reached about the distribution of consolidation efforts between the state versus the federal and local entities, reports Le Soir. The Dutch speaking Flanders announced earlier that it targets a balanced budget by 2011 or 2012, while Wallonia wants to follow the federal trajectory. On September 20 the government has to submit its reviewed stability programme specifying the repartition of the budget consolidation efforts between the entities. Munchau on Barroso and Blair In his FT column, Wolfgang Munchau writes that he can just about understand why somebody might want Jose Manual Barroso as president of the European Commission, or why somebody else might like Tony Blair to be president of the European Council, but to have both simultaneously is a touch one-sided, and does not reflect Europe’s diversity. Munchau argues that Blair amplifies all of Barroso’s weakness – the most important one being the failure to fill the EU’s leadership vacuum – which became evident during this crisis, as leaders resorted to national responses. Munchau also says that Blair probably misjudges the nature of this job. http://www.eurointelligence.com/article.581+M541320487e5.0.html

197 Les Echos[ 20/07/09 ] Stress tests : les banques françaises jugent les scénarios plus sévères qu'aux Etats-Unis Les hypothèses macroéconomiques permettant aux banques européennes de faire tourner les tests de résistance cet été ont été transmises aux établissements français au début du mois de juillet. Elles sont jugées par certaines maisons comme plus conservatrices que celles appliquées aux banques américaines. C'est parti. Depuis le début de l'été, les trois banques françaises qui doivent faire l'objet des tests de résistance paneuropéens - Société Générale, BNP Paribas et Crédit Agricole, planchent sur les hypothèses macroéconomiques de la Banque centrale européenne. Celles-ci étaient très attendues, depuis que le projet de soumettre une vingtaine d'établissements européens à des tests de résistance avait été mis sur pied en mai dernier. Les tests devaient être lancés pendant l'été, et les résultats connus à la rentrée, mais les régulateurs avaient tardé à se mettre d'accord sur les hypothèses retenues. Au final, les scénarios retenus par la Banque centrale européenne, et transmis aux banques début juillet, sont jugés par certaines maisons comme plus sévères que celles utilisées par les autorités américaines. Elaborés en janvier, certains des postulats retenus outre-Atlantique ont de fait été rapidement dépassés par l'ampleur de la crise économique, comme celui d'un taux de chômage de 8,9 % en 2009. La Fed les avait pourtant présentés à l'époque comme des hypothèses « dures ». En Europe, les autorités n'ont pas, pour le moment, rendu public leur scénario. « C'est délicat », se contente-t-on d'expliquer dans l'entourage de la Banque de France, chargée de faire l'intermédiaire avec les banques françaises. Certains acteurs concernés estiment que faire des comparaisons entre les deux zones économiques ne serait pas pertinent compte tenu de leurs spécificités. Dilemme Les autorités européennes sont enfin confrontées à un cruel dilemme : faut-il ou non rendre publics les résultats ? Christian Noyer, gouverneur de la Banque de France, s'y est montré favorable, du moins pays par pays. Mais l'Angleterre et l'Allemagne, dont les systèmes bancaires sont plus fragilisés par la crise, continuent de s'y opposer. Les banques françaises font parallèlement l'objet de tests effectués par la Commission bancaire. Toutefois, le régulateur français aurait préféré renoncer à solliciter les banques concernées pour les tests globaux qu'elle effectue chaque année (« test top-down »). Il s'agit pour l'autorité de permettre aux directions financières de plancher sereinement sur les tests européens pendant l'été. L'objectif est clair : elles devront fournir les résultats avant l'Ecofin, qui doit se tenir en septembre, quelques jours avant le prochain G20 (24 et 25 septembre). REJANE REIBAUD, Les Echos REJANE REIBAUD « Stress tests : les banques françaises jugent les scénarios plus sévères qu'aux Etats-Unis », Les Echos 20/07/09, http://www.lesechos.fr/info/finance/02072775858-stress-tests-les-banques- francaises-jugent-les-scenarios-plus-severes-qu-aux-etats-unis.htm

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Industry Cash Flowed To Drafters of Reform Key Senator Baucus Is a Leading Recipient By Dan Eggen Washington Post Staff Writer Tuesday, July 21, 2009 As liberal protesters marched outside, Sen. Max Baucus sat down inside a San Francisco mansion for a dinner of chicken cordon bleu and a discussion of landmark health-care legislation under consideration by his Senate Finance Committee. At the table on May 26 were about 20 donors willing to fork over $10,000 or more to the Democratic Senatorial Campaign Committee, including executives of major insurance companies, hospitals and other health-care firms. "Most people there had an agenda; they wanted the ear of a senator, and they got it," said Aaron Roland, a San Francisco health-care activist who paid half price to attend the gathering. "Money gets you in the door. The only thing the other side can do is march around and protest outside." As his committee has taken center stage in the battle over health-care reform, Chairman Baucus (D-Mont.) has emerged as a leading recipient of Senate campaign contributions from the hospitals, insurers and other medical interest groups hoping to shape the legislation to their advantage. Health-related companies and their employees gave Baucus's political committees nearly $1.5 million in 2007 and 2008, when he began holding hearings and making preparations for this year's reform debate. Top health executives and lobbyists have continued to flock to the senator's often extravagant fundraising events in recent months. During a Senate break in late June, for example, Baucus held his 10th annual fly-fishing and golfing weekend in Big Sky, Mont., for a minimum donation of $2,500. Later this month comes "Camp Baucus," a "trip for the whole family" that adds horseback riding and hiking to the list of activities. To avoid any appearance of favoritism, his aides say, Baucus quietly began refusing contributions from health-care political action committees after June 1. But the policy does not apply to lobbyists or corporate executives, who continued to make donations, disclosure records show. Baucus declined requests to comment for this article. Spokesman Tyler Matsdorf said the senator "is only driven by one thing: what is right for Montana and the country. And he will continue his open process of working together with the president, his colleagues in Congress, and groups and individuals from across the nation to get this legislation passed." Baucus's fundraising prowess underscores the enduring political strength of the health-care lobby, which led all other sectors in donations to federal candidates during the last election cycle and has shifted its giving to Democrats as the party has tightened its control of Congress. The sector gave nearly $170 million to federal lawmakers in 2007 and 2008, with 54 percent going to Democrats, according to data compiled by the Center for Responsive Politics, which tracks money in politics. The shift in parties was even more pronounced during the first three months of this year, when Democrats collected 60 percent of the $5.4 million donated by health-care companies and their employees, the data show.

199 Many of these contributions have been focused on Baucus, Charles E. Grassley (R-Iowa) and other senators in the moderate camps of their respective parties, whose votes could prove crucial in a final health-care reform deal, as well as the leaders of five key committees leading the debate. Grassley, the Finance Committee's ranking Republican, received more than $2 million from the health and insurance sectors since 2003. House Ways and Means Chairman Charles B. Rangel (D-N.Y.) took in $1.6 million from the health sector and its employees over the past two years; ranking Republican Dave Camp (Mich.) received nearly $1 million. But Baucus, a senator from a sparsely populated and conservative Western state who is serving his sixth term, stands out for the rising tide of health-care contributions to his campaign committee, Friends of Max Baucus, and his political-action committee, Glacier PAC. Baucus collected $3 million from the health and insurance sectors from 2003 to 2008, about 20 percent of the total, data show. Less than 10 percent of the money came from Montana. Top out-of-state corporate contributors included Schering-Plough, New York Life Insurance, Amgen, and Blue Cross and Blue Shield; individual executives such as Richard T. Clark, chief executive and president of drugmaker Merck, have also made regular donations. Most of these companies, particularly major insurers, strongly oppose a public insurance option, which is favored by President Obama and top House Democrats but has not received support from Baucus's committee. Baucus is a longtime centrist in the Democratic caucus, and his committee chairmanship has made him a key broker in the health-reform debate. Many former Baucus staff members, including two chiefs of staff, lobby on behalf of the pharmaceutical industry and other health- care players and have been closely involved in negotiations on the legislation. John Jonas, a Patton Boggs health-care lobbyist who has attended a Baucus fly-fishing event and other fundraisers, said the Montana senator is "key to getting anything done" when it comes to health-care legislation. "This is not an overwhelmingly liberal Congress, and it's certainly not a liberal Senate," said Jonas, whose clients include Bristol-Myers Squibb, Pfizer and Northwestern Mutual. "I think Max is uniquely situated to try to accomplish that, because he's more of a centrist and moderate Democrat than others are." But Jerry Flanagan, a health-care analyst with Consumer Watchdog, a California-based advocacy group, said the tide of campaign contributions amounts to "a huge down payment" by companies that expect favorable policies in return. "That is the cold reality of big-money politics," he said. Baucus won easy reelection in the fall, but he has continued to hold fundraisers since then. In addition to the fly-fishing event, he held his "Eighth Annual Ski and Snowmobile Weekend" in Big Sky in February and celebrated the start of his sixth term with a $10,000-a-table dinner at the Washington Court Hotel later that month. Aides say another fundraiser scheduled for July 7 at Bistro Bis in Capitol Hill was scrapped. Baucus's office declined to provide attendance and donation details about his fundraising events, and federal records laws do not require such disclosures. Starting in June, aides say, Baucus adopted an internal office policy to refuse contributions from health-care PACs and to continue doing so until after Congress passes reform legislation. But new Federal Election Commission documents filed last week show that individual lobbyists and others with health-care connections continued to make contributions to Baucus committees throughout June. Examples from Baucus's Glacier PAC include $5,000 from the

200 Independent Insurance Agents and Brokers of America and $2,500 from lobbyists with U.S. Strategies, which represents numerous health-care firms. Overall, half of the $110,000 in donations to the PAC from April to June came from health-care firms and lobbyists, including Schering-Plough, Medtronic and New York Life. Craig Holman, government affairs lobbyist for the Public Citizen advocacy group, said the continued fundraising by Baucus during the health-care debate is "very troubling." "He's doing all this fundraising right in the middle of this effort to mark up a bill," Holman said. "When you put these events close to matters concerning these lobbyists, clearly it's a signal. You are expected to show up with a check." Baucus and his aides strongly dispute any assertion that campaign contributions have an impact on the senator's policy views and proposals. Aides say he has frequently backed policies opposed by health-care companies, including support for greater availability of generic drugs, allowing drug imports from Canada and cutting payments to the Medicare Advantage plan. During an interview earlier this year with the Missoulian newspaper, Baucus said that "no one gets special treatment." He added: "Your word is your bond back there." Research editor Alice Crites contributed to this report. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/20/AR2009072003363_pf.html

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UK and France told to agree on regulation of OTC derivatives By Peggy Hollinger and Scheherazade Daneshkhu in Paris Published: July 20 2009 03:00 | Last updated: July 20 2009 03:00 Rivalry between Paris and London could jeopardise Europe's competitiveness in the vast "over-the-counter" derivatives markets, France's stock market regulator has warned. Jean-Pierre Jouyet, chairman of the Autorité des Marchés Financiers, the French regulator, told the Financial Times that disagreement between the two countries over how to regulate trading in these complex products - some of which have been blamed for exacerbating the financial crisis - could hinder a European solution and drive business to the US. "In the US they have seen the threat. They are creating centralised clearing houses, but in Europe we are not there because there is disagreement between Paris, London and Frankfurt," he said. London had "to accept that Paris has a role" in clearing trades in euro-denominated derivatives, while Frankfurt was more neutral in the debate. "If Europe cannot agree and falls behind, trading will be done with the clearing system of the US. . . Europe has to know what it wants." Mr Jouyet also said pension top-ups for French executives were likely to be capped next year when France reformed its public pension regime: "Managers and chief executives have to understand that if a collective effort is being asked of the French people, then they have to take part." Politicians have tried to calm public anger at pension payoffs and executive remuneration, particularly in the financial sector, by calling for tighter rules on pay and compensation to discourage the excessive risk-taking seen to have contributed to the global financial crisis. This is expected to be discussed at the G20 meeting in Pittsburgh in September. Mr Jouyet, former secretary of state for European affairs, warned of severe consequences if the G20 lost the will to push through reforms. "The risk is that we return to business as usual. It's a risk that is illustrated by what is happening, for example, at Goldmans [where bonuses this year will hit a record high]. "If we haven't learned the lesson of what happened, there will not be much time before the economic and financial crisis becomes a social and moral crisis." Earlier this month, the European Commission called for more standardisation in the OTC markets and increased use of clearing houses, as is under way in the US. A clearing house steps in when a party to a trade defaults, ensuring that a transaction is completed. Most OTC trades are not cleared, exposing firms to so-called counterparty risk - such as default. Europe wants its own clearing for OTC credit derivatives, with Eurex Clearing, owned by Deutsche Börse, and ICE, the US futures exchange, nearing launch by a July 30 deadline set by the European Commission.

202 French concern at UK dominance in OTC markets emerged this year in a leaked Banque de France document. It said European clearing should be based in the eurozone. That alarmed London as it implied a sidelining of UK-based clearers such as LCH.Clearnet, which handles OTC derivatives already. Mr Jouyet said the Börse, Euronext and the London Stock Exchange needed to agree there was a "systemic risk" from the lack of transparency in offexchange trading on all products, not just OTC derivatives.

Additional reporting by Jeremy Grant in London http://www.ft.com/cms/s/0/afd3c6ca-74c3-11de-8ad5-00144feabdc0.html Published: July 19 2009 22:05

Warning to UK and France on derivatives

By Peggy Hollinger and Scheherazade Daneshkhu in Paris | Last updated: July 20 2009 07:28 Rivalry between Paris and London could jeopardise Europe’s competitiveness in the vast “over-the-counter” derivatives markets, France’s stock market regulator has warned. Jean-Pierre Jouyet, chairman of the Autorité des Marchés Financiers, the French regulator, told the FT that disagreement between the two countries over how to regulate trading in these complex products could hinder a European solution and drive business to the US. French executives face pension capping - Jul-19 “In the US they have seen the threat. They are creating centralised clearing houses. But in Europe we are not there because there is disagreement between Paris, London and Frankfurt,” he said. London had “to accept that Paris has a role” in clearing trades in euro-denominated derivatives, while Frankfurt was more neutral in the debate. “If Europe cannot agree and falls behind, trading will be done with the clearing system of the US. Because they have the technology, they have the savoir faire, and they will have the regulation. Europe has to know what it wants.” This month the European Commission called for more standardisation in the OTC markets and increased use of clearing houses, which is under way in the US. A clearing house steps in when a party to a trade defaults, ensuring that a transaction is completed. Most OTC trades are not cleared, exposing firms – and the financial system – to so-called “counterparty risk” such as default. Europe wants to establish clearing for OTC credit derivatives, with Eurex Clearing, owned by Deutsche Börse, and Ice, the US futures exchange, nearing launch by a July 30 deadline set by the EC. Additional reporting by Jeremy Grant in London

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TRIBUNA: SANTIAGO RONCAGLIOLO América Latina, la democracia abre fuego Los últimos sucesos en Guatemala, Perú y Honduras restan credibilidad a la democracia liberal y refuerzan la popularidad de Chávez. Millones de pobres e indígenas constatan que el liberalismo no les ofrece justicia SANTIAGO RONCAGLIOLO 20/07/2009 La víctima de un asesinato vuelve de la muerte para culpar al presidente de su país. Un grupo de militares armados saca a otro presidente de su cama y lo mete en un avión en pijama. Las fuerzas del orden se enfrentan a un grupo de campesinos pobres y matan a decenas de ellos. No, esto no es la película de James Bond contra un temible dictador aliado del terrorismo. Es sólo la actualidad política de América Latina. El primer caso se registró en mayo, cuando un vídeo del abogado Rodrigo Rosenberg acusó desde la tumba al presidente de Guatemala Álvaro Colom y a su entorno de haber planeado su asesinato. Semanas después, en la localidad peruana de Bagua, las protestas de los indígenas contra la aprobación de leyes que permitían privatizar sus tierras se saldó con una decena de muertos, según el Gobierno -los líderes indígenas cuentan más de 30-, y la renuncia del ministro del Interior. Y a comienzos de julio, en Honduras, los enfrentamientos entre las fuerzas antidisturbios y los seguidores del depuesto presidente Manuel Zelaya se cobraron la vida de un joven manifestante. Las consecuencias políticas y judiciales de estos casos están por determinar. Pero en términos de opinión pública, marcan un giro crucial en el discurso político de la región. Durante años, las mayores alarmas de la gobernabilidad democrática en América Latina habían saltado en Venezuela, Bolivia y Ecuador, contra cuyos gobernantes se suceden periódicamente denuncias por manipulación de instituciones judiciales, legislativas, ejecutivas e incluso electorales. Y sin embargo, en los tres casos señalados, son esas instituciones las involucradas. Es la democracia la que ha abierto fuego contra la población civil. Sin duda, el caso de Guatemala tiene matices distintos. En su vídeo póstumo, Rosenberg no acusa de su muerte a la institución del poder ejecutivo sino al presidente, y el caso aún está en investigación. Pero aún así, la autoridad de un cadáver para señalar a su ejecutor tiene una potencia mediática descomunal. Ninguna sentencia judicial podrá borrar el mensaje que ha transmitido el abogado desde las pantallas de televisión o Internet: el poder se ejerce a balazos. Sea quien sea el asesino de Rosenberg, el sistema político ha perdido ante la población -si aún lo tenía- el crédito de la transparencia y el imperio de la ley. Para muchos guatemaltecos, el sistema democrático no sirve para combatir a las mafias, sólo para darles puestos públicos. Por su parte, el caso de Bagua pone de relieve las limitaciones de una democracia para garantizar justicia. La mayoría de las constituciones vigentes en la región garantizan la propiedad privada y remiten a los tribunales en caso de conflicto. Ahora bien, uno de los conflictos sociales más delicados es el que enfrenta a las comunidades nativas con las grandes empresas que desean explotar los recursos naturales de sus tierras. Con el actual ordenamiento jurídico, cuando una empresa daña el medio ambiente o incumple la legislación laboral tiene muchas posibilidades de salir impune por una razón muy sencilla: los costes del proceso legal. Incluso un poder judicial confiable -lo que no siempre está disponible- enfrentará al estudio

204 de abogados de una multinacional contra los delegados de un caserío de campesinos sin luz eléctrica. El litigio puede extenderse durante años, y si hay apelaciones, se resolverán en tribunales de la capital, a días de camino de las comunidades campesinas. El resultado no suele tener mucho misterio. Una institucionalidad impecable deja en indefensión legal a millones de personas. Esta paradoja explica la popularidad de Evo Morales y Hugo Chávez entre los sectores más pobres de muchos países. Para sus detractores, los proyectos constitucionales que estos gobernantes impulsan sólo son un camino hacia su reelección indefinida. Pero sus defensores los consideran herramientas imprescindibles para la protección legal de los sectores más indefensos de la población. Sus textos establecen nuevos modelos de propiedad pública, refuerzan el papel del Estado ante los operadores económicos privados y defienden el derecho de los indígenas a decidir sobre sus tierras. Por contraste, los enfrentamientos de Bagua declaran que en un Estado democrático los campesinos tienen que morir y matar para defender ese derecho. Pero si un caso ha dotado de legitimidad al discurso caudillista latinoamericano, ha sido el de Honduras. El nuevo gobernante, Roberto Micheletti, se ha esmerado en calificar su toma de mando como una "sucesión constitucional", basado en una sentencia del poder judicial contra el presidente electo, Manuel Zelaya. El motivo de esa sentencia fue la convocatoria de un referéndum. En efecto, el encaje constitucional de ese referéndum era bastante dudoso. Pero la imagen de un batallón evitando unos comicios a balazos no resulta mucho más digerible. Al expulsar al presidente electo, las instituciones ponen en cuestión la definición misma de la democracia: el gobierno del pueblo, el sistema en que los ciudadanos pueden participar en las decisiones que les afectan, algunas de ellas tan elementales como quién es su presidente. Si Micheletti temía que Hugo Chávez ganase poder en Honduras, puede estar tranquilo. Gracias a él, Chávez ha ganado legitimidad en toda la región. El presidente venezolano fue el primero en imponer sanciones económicas a Honduras, y ha exigido una actitud más resuelta de los tibios Estados Unidos, con lo cual ha invertido los papeles habituales. Como si fuera poco, sus advertencias de asesinatos y conjuras, que hasta junio se podían descartar como paranoias, se han vuelto realidad. Nadie podría haberle hecho un favor tan grande y tan bolivariano como el de Micheletti. El discurso de Chávez es el principal beneficiario de los hechos de Guatemala, Perú y Honduras porque todos ellos restan credibilidad a las instituciones democráticas. El sistema de equilibrio de poderes y sufragio universal es deseable porque permite que los cambios sociales se realicen sin sangre. Por eso, cuando necesita derramar sangre para defenderse es señal de que algo funciona muy mal. La aplastante victoria del PRI en los últimos comicios mexicanos parece confirmar el agotamiento ciudadano ante las promesas incumplidas de un sistema que a comienzos de los noventa se presentó como la vía directa al desarrollo y la prosperidad. En su acta de nacimiento de la Revolución Francesa, la democracia nació con un lema triple: "Libertad, Igualdad, Fraternidad". La fraternidad ya era demasiado pedir, pero el conflicto entre la libertad y la igualdad, entre liberalismo y socialismo, definió el siglo XX, y sigue dividiendo hoy a la región con la mayor desigualdad social del planeta. El proyecto político de Hugo Chávez es crear un sistema igualitario aun a costa de las instituciones que garantizan las libertades individuales. En cambio, el proyecto político liberal se ha concentrado en garantizar las libertades individuales -crucialmente, la propiedad privada- incluso a costa de la igualdad social.

205 Ambos valores podrían conciliarse, entre otras cosas, con reformas fiscales que distribuyesen más equitativamente la riqueza. No es imposible. Lo ha hecho Lula en Brasil, donde la clase media aumenta sin comprometer el crecimiento económico, equilibrando estabilidad institucional con justicia social. Sin embargo, en los países andinos y centroamericanos, los defensores de la democracia no han defendido justo esa parte de la democracia. Para masas de ciudadanos pobres, tengan razón o no, el proyecto de Chávez cristaliza una serie de aspiraciones concretas que las instituciones democráticas les niegan. Quienes creemos que la democracia liberal es el sistema de gobierno más eficaz, tenemos que incorporar a esas masas en el proyecto de Estado que defendemos. Para retirarlas de la órbita de los caudillos, hace falta demostrarles que la democracia puede ofrecer justicia social, es decir, derechos básicos y una distribución más justa de la riqueza. Tendremos que demostrarles que pueden vivir mejor en una democracia liberal que con un caudillo socialista. Pero si nuestro argumento para ello son las fuerzas antidisturbios, todo lo que hagamos sólo servirá para darle la razón a esos caudillos. Al fin y al cabo, si eso es lo mejor que se nos ocurre, tampoco hace falta dispararle a nadie más: podemos dar esta batalla por perdida desde el principio. http://www.elpais.com/articulo/opinion/America/Latina/democracia/abre/fuego/elpepuopi/200 90720elpepiopi_11/Tes

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TRIBUNA: Laboratorio de ideas JOSÉ A. HERCE y ARTURO ROJAS Financiación de 'pymes' y contexto recesivo JOSÉ A. HERCE y ARTURO ROJAS 19/07/2009 El contexto recesivo actual está caracterizado decisivamente por una fuerte restricción crediticia global, causante general, aunque no único factor, de dicha recesión. Esta condición ha llevado a las empresas al límite de su capacidad para afrontar sus obligaciones de pagos tanto financieros como corrientes con la liquidez que son capaces de generar por su operativa convencional. La operativa convencional de las empresas, a su vez, también se ha visto seriamente dañada por la imposibilidad, para muchas empresas, de mantener abiertos los canales habituales de financiación mediante el descuento ante las entidades de crédito de su "papel comercial", esto es, los pagarés generados como consecuencia del desfase de pagos y cobros entre empresas clientes y empresas proveedoras. Aunque normalmente se piensa en los créditos ordinarios concedidos por las entidades financieras a las empresas para la financiación de sus proyectos de inversión como la quintaesencia de la financiación empresarial, lo cierto es que muchas empresas dependen más de las líneas de descuento que de los préstamos ordinarios. Otro rasgo poco conocido por el público no especializado es que muchas grandes superficies, que suelen pagar a sus proveedores a plazos más largos de los que ellas afrontan en sus cobros de clientes (en buena medida al instante, en la línea de caja), acaban realizando un tipo de intermediación financiera mucho más amplia que la mayoría de las entidades de crédito. En este caso, se da la paradoja de que estas grandes superficies, y los comercios en general, se financian con cargo a sus proveedores, a los que pagan a plazos que en ocasiones rondan el medio año. Las empresas proveedoras reciben a cambio la promesa de pago por parte de sus clientes, y esta promesa, un pagaré, de hecho, puede cobrarse por anticipado en una entidad financiera a través de una línea de descuento. A un coste y con cuantos avales sean necesarios, naturalmente, pues la garantía de que el cliente acabe pagando al proveedor en la fecha estipulada en el pagaré es, como todo en este mundo, contingente. Pero, al menos, la empresa proveedora puede disponer de liquidez para ir afrontando su operativa cotidiana. Para que esta aparentemente compleja mecánica de pagos, cobros y garantías pueda funcionar suavemente, se han ido desarrollando entidades y productos especializados debidamente ubicados en una tupida red de relaciones descentralizadas, bilaterales y basadas en la confianza mutua y sistémica entre los millones de empresas y docenas de intermediarios financieros que normalmente operan en una economía de cierto tamaño, como es el caso de la economía española. Junto a las líneas troncales de esta red se han desarrollado canales extremadamente finos y sensibles que dotan de capilaridad, por lo general eficiente, a todo el sistema de financiación a la empresa. Pero bajo las duras condiciones actuales de los mercados de crédito, toda esta red ha parado en seco su dinamismo, creando considerables problemas de liquidez a las empresas que están desembocando en graves problemas de solvencia. Especialmente en el caso de las pequeñas y medianas empresas (pymes). No es fácil reemplazar mediante esquemas públicos centralizados y con escasa estructura, por muy eficiente que sea su funcionamiento y abundantes sus recursos, a los esquemas privados, descentralizados y cortados a la medida de sus clientes existentes, pero, como decíamos,

207 colapsados por la desconfianza del mercado en el valor de sus activos. Tampoco es posible crear la escala adecuada, ni reproducir las relaciones con los clientes, de la red crediticia privada en el ámbito público, al menos en un lapso de tiempo menor del que llevaría, con lo que sabemos hoy, restaurar el pleno funcionamiento de la red privada. La solución del problema crediticio de las pymes llevará tiempo, mientras no suceda algo que desatasque radicalmente el colapso del crédito ordinario. Las entidades representativas de las pymes no dejan de transmitir sus necesidades a las instancias públicas de las que dependen las políticas hacia estas empresas, al tiempo que dichas instancias públicas tratan de impulsar las soluciones oportunas dentro de sus competencias. El problema es que, habiendo dejado de funcionar eficientemente la red fina y tupida de las entidades financiadoras convencionales, no existe otra estructura equivalente que pueda sustituirla. Claro que todos los impulsos que está dando el Gobierno para crear los fondos de avales a través del ICO y otras entidades públicas están más que indicados y seguirán aumentando los recursos a ello destinados, pero la transmisión final a las pymes se debe hacer con la participación de la red de entidades privadas. Lo que se precisa entonces es encontrar la manera de que esta colaboración entre las agencias públicas reforzadas, tanto en recursos como en competencias, y las entidades privadas funcione de la manera más eficiente posible. También deben encontrarse nuevos instrumentos de financiación que hagan solventes frente a las entidades privadas los ingentes compromisos de pagos y cobros que existen entre las empresas y que ahora se encuentran atascados por fallo en los instrumentos convencionales (o en sus garantías). Ello, por sí sólo, podría evitar el concurso de acreedores y la liquidación de innumerables pymes. La renovación de los servicios de factoring y confirming de las entidades financieras a las empresas, o su reforzamiento con garantías adicionales, es una vía para ello. La potenciación de la Sociedad de Garantía Recíproca (SGR) es otra vía. Para las entidades financieras, la vía para reducir el peso de la morosidad en sus carteras de préstamos no es dejar de otorgar financiación, sino precisamente lo contrario, es decir, conceder préstamos de calidad. En este sentido, la garantía de la SGR, que a su vez cuenta con el respaldo del sistema de reafianzamiento de la sociedad estatal CERSA, cobra mayor valor tanto para la pyme como para la entidad financiera. Frente a la escasez de crédito, el coste extra del aval de la SGR es ciertamente asumible por la pyme y, además, la intervención de la SGR como avalista es el elemento decisivo del que dispone la pyme en su negociación con las entidades financieras. La SGR, por su presencia en todo el territorio, su cercanía a las empresas y su función de bisagra entre las pymes y las entidades financieras, es una buena palanca de transmisión de líneas de ayudas públicas vinculadas a un aumento, fácilmente medible, de las empresas avaladas. Su potenciación sobre bases renovadas de gestión y alcance sectorial y territorial es una de las claves para hacer más eficaces los esfuerzos en curso destinados a desbloquear la financiación de las empresas en el actual contexto recesivo. http://www.elpais.com/articulo/semana/Financiacion/pymes/contexto/recesivo/elpepueconeg/ 20090719elpneglse_12/Tes?print=1

208 Versión para imprimir TRIBUNA: coyuntura nacional ÁNGEL LABORDA Son las empresas, estúpido ÁNGEL LABORDA 19/07/2009 Los datos sobre la economía española conocidos esta semana abundan en la idea de que el ritmo de caída de la demanda y la producción se aminora, pero que aún queda mucho para hablar de recuperación. Las tasas de variación de las cifras de negocios en la industria y los servicios y de las entradas de pedidos de mayo no fueron peores que las de los cuatro primeros meses del año, pero tampoco mejores. En todo caso, desde hace unos meses estamos en una nueva fase del ciclo que podríamos denominar la antesala de la recuperación. En lenguaje matemático diríamos que hasta ahora estábamos en una fase (la peor de todo el ciclo completo) en la que tanto la primera derivada de la evolución temporal de los indicadores como la segunda eran negativas, y ahora hemos pasado a otra en la que la primera derivada sigue siendo negativa, pero la segunda ya es positiva. En román paladino, antes caíamos y la velocidad de la caída iba a más; ahora seguimos cayendo, pero la velocidad de la caída va a menos. Esto se ha reflejado rápidamente en las previsiones de los analistas de la coyuntura. El consenso del Panel de Funcas, formado por 14 instituciones de investigación económica españolas, ha dado en julio una caída del PIB para 2009 del 3,6%, y para 2010, del 0,6%. En ambos casos, la cifra es una décima menos negativa que en la encuesta anterior, lo cual es la primera vez que sucede desde que se pidieron estas previsiones [gráfico superior izquierdo]. Algo similar a lo que hizo el FMI hace dos semanas para la economía mundial (no para la española, por cierto) en la actualización de sus perspectivas de primavera. La recuperación aún se ve lejana, y mientras, a las empresas y a sus trabajadores (incluidos los autónomos, de los que pocos sindicatos y ministerios se acuerdan) aún les queda un buen purgatorio que pasar, lo ponen de manifiesto los resultados de la Central de Balances Trimestral que publicó el Banco de España en su Boletín Económico de julio. En el gráfico superior derecho podemos observar la profunda caída (-13% interanual) del valor añadido bruto (VAB) de las empresas no financieras en el primer trimestre del año, superando con mucho la de 2008 en su conjunto. Los gastos de personal también cayeron, debido enteramente a la reducción de las plantillas, pero mucho menos que el VAB, por lo que el Resultado Económico Bruto de Explotación (REBE) se redujo un 22%. Por cierto, estas cifras nada tienen que ver con las que se deducen de la Contabilidad Nacional de los Sectores que comentamos en esta página la pasada semana. Según ésta, en el primer trimestre, el VAB de las empresas no financieras aumentó un 0,1%, y el Excedente Bruto de Explotación (EBE), un 10,2%. Parece que estamos analizando dos países diferentes. Al hablar con los empresarios y trabajadores me parece que la Central de Balances, aunque no podamos considerarla plenamente significativa del conjunto de las empresas, refleja mejor que la Contabilidad Nacional la coyuntura por la que atraviesan éstas. Para pasar del REBE al Resultado Ordinario Neto (RON), que es la mejor aproximación a la evolución de las cuentas de las empresas, tenemos que restar los gastos financieros y las amortizaciones y sumar los ingresos financieros. Todas estas partidas caen, pero los ingresos lo hacen más que los gastos financieros, por lo que el RON disminuye un 30,5%. Mención especial merecen las cuentas de las empresas industriales, cuyo VAB cae un 29,5%, y el RON, un 68,2%, lo nunca visto, según los analistas del Banco de España.

209 Quizá más significativas que las tasas de variación de los resultados sean las ratios de rentabilidad del activo neto y su comparación con el coste financiero de los recursos ajenos. En los gráficos inferiores se ve cómo ambas ratios se reducen, pero la rentabilidad lo hace mucho más, de forma que la diferencia se reduce a un punto porcentual para el conjunto de empresas y pasa a ser negativa (-2,3 puntos) en el caso de las industriales. ¿Quién invierte así? No son los empresarios o los trabajadores los que necesitan ayudas con carácter general, como parece ser el enfoque de las negociaciones sociales en curso (sí, por supuesto, los que estén en una situación de desprotección total), "son las empresas, estúpido". http://www.elpais.com/articulo/economia/empresas/estupido/elpepueconeg/20090719elpnege co_4/Tes?print=1

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TRIBUNA: ANTONI ZABALZA Estadísticas que cuentan historias

ANTONI ZABALZA 19/07/2009 La estadística del crédito bancario cuenta una larga historia de regularidad y aburrimiento, y otra más reciente de desenfreno y autoengaño. Augura también un porvenir de arrepentimiento y penitencia; un porvenir que, como en todo buen drama, nos hará sufrir. Como muestra el gráfico adjunto, hasta 1998 el patrón de crecimiento del crédito bancario a empresas y familias ha sido cíclico y muy regular. Después de alcanzar un máximo en 1980, el crecimiento del crédito dibuja dos ciclos muy claros: el que va de 1981 a 1989 y el que va de 1990 a 1998. Ambos tienen una duración de nueve años, una forma similar y un crecimiento anual medio muy parecido una vez tenida en cuenta la mayor inflación de los años ochenta.

La gente desconoce este comportamiento cíclico tan regular, pero intuye que poco crédito y baja actividad económica acostumbran a ir de la mano. Y está en lo cierto. En 1984 (punto mínimo del ciclo 1981-1989), el crédito bancario creció un 2,4% y el PIB real lo hizo en un 1,5%. Más contundentemente, en 1993 (punto mínimo del ciclo 1990-1998), el crédito creció un 1,2% y el PIB real descendió un 1,2%. Episodios de poco crédito como éstos no son excepcionales. Para que se produzcan, no es preciso que exista una crisis financiera internacional como la presente, ni que los bancos estén faltos de capital como ahora. Son parte del comportamiento cíclico del crédito. Hasta aquí casi veinte años de regularidad y aburrimiento, como debe ser con el quehacer bancario. Pero pasemos al siguiente ciclo, que va de 1999 a 2005, y las cosas cambian radicalmente. Su tasa de crecimiento anual medio es muy superior a la de los dos ciclos anteriores y tiene una forma peculiar: después del máximo de 1998, el crédito sigue creciendo a tasas muy altas durante dos años y, después de una pausa en 2001, retoma la carrera al alza

211 hasta registrar en 2005 un máximo histórico, con un crecimiento anual del 27,2%. La historia aquí es una de desenfreno crediticio y de autoengaño acerca del precio de las cosas. En realidad hay dos historias. La primera se produce en 1999 y 2000 a raíz de la burbuja de las empresas punto.com; y la segunda es la larga burbuja inmobiliaria, que se inicia a partir de 2002 y no se deshincha hasta después de 2007. El ciclo 1999-2005 no sólo es anómalo, sino también insostenible. La fuerte expansión crediticia de este periodo se asienta más en el ahorro externo que en el interno, como lo atestigua el deterioro espectacular que durante estos años ha tenido el déficit por cuenta corriente. Si el mercado internacional de capitales no acepta de forma indefinida el nivel de endeudamiento que este desequilibrio implica, y existen señales de que no lo está aceptando, las tasas pasadas de crecimiento del crédito no pueden ser mantenidas. Es más, aun basada exclusivamente en el ahorro interno, la expansión crediticia tampoco se habría mantenido. En tal caso, la economía española habría tenido que experimentar una reasignación sectorial de la inversión, a favor del inmobiliario y en contra de otros sectores productivos, muy fuerte y difícil de asumir. Quienes creen que la última expansión inmobiliaria es una respuesta de equilibrio a un cambio en las preferencias o necesidades de los españoles deben explicar por qué existe alrededor de un millón de viviendas acabadas y no vendidas. Este abultado exceso de oferta pone de manifiesto la existencia de un grave desequilibrio que necesariamente deberá ser corregido. La desaceleración que ahora estamos observando es está corrección. Es la historia de arrepentimiento que aparece después del pico de 2005, cuando el crecimiento de crédito se precipita por una pendiente particularmente pronunciada, con descensos de 8,7 puntos de 2006 a 2007, y de 10,5 puntos de 2007 a 2008. ¿Hasta dónde puede llevarnos esta bajada? Nadie puede predecir el futuro con certeza, pero estos datos contienen información valiosa que puede ser explotada. Supongamos que después del ciclo 1999-2005 el mercado crediticio vuelve a la normalidad, y que esta normalidad la definimos por las características del último ciclo regular 1990-1998. Es decir, supongamos que después de 2005 se inicia un ciclo de nueve años de duración, con un mínimo a determinar, un crecimiento anual medio del 8,7% y un máximo del 16,8% que se alcanza en 2014. El gráfico muestra tres posibles ciclos que cumplen estas características. Hay más posibilidades, pero todas ellas comparten un patrón común. Podemos pensar en ciclos con una suave bajada, pero necesariamente van a ser ciclos con un prolongado periodo de estancamiento. O podemos pensar en ciclos que en un par de años vuelvan a situarnos en tasas razonables de crecimiento del crédito, pero van a ser ciclos que tendrán que digerir el ajuste de forma inmediata. El escenario A evita caer en tasas negativas, pero a costa de deambular a lo largo de los próximos tres años alrededor de tasas muy bajas que no llegan a promediar el 1%. El escenario B alcanza ya a partir de 2012 la cota del 7%, pero a costa de entrar en 2009 y 2010 en tasas negativas de crecimiento que no son despreciables (3,2% y 1,5%). Y el escenario C presenta, en comparación con el anterior, una recuperación más decidida y temprana, pero a costa de una fuerte contracción del crédito en 2009 y 2010, con tasas del -7,7% y -3,7%, respectivamente. El escenario A es poco probable. Para que se cumpliera, 2009 debería acabar con un aumento del crédito y es difícil que esto suceda. La demanda se ha retraído y, anticipando el debilitamiento de la economía, los bancos se muestran muy cautos. Asociada al escenario C subyace la idea de un ajuste rápido y profundo de la economía, que previsiblemente abre el

212 camino a una pronta y sólida recuperación. Se trata de un escenario por diseño extremado, pero en absoluto descartable. El escenario B toma un camino intermedio, pero no hay razones para pensar que la virtud de la centralidad sea suficiente para convertirlo en mejor o más probable que el escenario C. Es imposible saber la trayectoria concreta que este ciclo crediticio va a tomar y tampoco es fácil traducir de forma precisa sus efectos sobre el PIB. El crecimiento medio del crédito es el mismo en los tres escenarios. Pero el efecto que cada uno de ellos tenga sobre la senda del PIB puede ser muy distinto. Dicho esto, caben pocas dudas acerca de la gravedad de esta crisis. Si algo puede concluirse de esta reflexión es que, sea cual sea el patrón exacto del nuevo ciclo económico, el ajuste requerido va a ser mucho mayor y más prolongado que el de 1993. Ni siquiera el escenario A, el más gradual de los tres, puede ser calificado de previsión tranquilizadora. Cualquiera de las tres posibilidades es compatible con caídas significativas del PIB no sólo a lo largo de este año, sino también del siguiente. Ésta es la historia de penitencia y sufrimiento que se avecina. El pronóstico es adverso, pero no exagerado si tenemos en cuenta las dos siguientes razones. Los escenarios previstos están basados en una tasa media de inflación del 4,4% (la observada en el ciclo 1990-1998). En las circunstancias presentes no es fácil predecir la inflación futura. Hoy nos embarga el temor a la deflación y mañana, una vez iniciada la recuperación, nos preocupará el efecto que la liquidez inyectada en la economía y no oportunamente retirada pueda tener sobre la inflación. Pero es perfectamente posible que la inflación media del nuevo ciclo sea inferior a este 4,4%. Y una menor inflación reduciría todavía más las tasas estimadas; es decir, haría que la caída del crédito fuera todavía mayor. Por último, los tres escenarios previstos derivan sus características del excesivo crecimiento del crédito, de la necesidad de reducir sustancialmente el endeudamiento resultante y de las regularidades históricas del ciclo crediticio. En ninguno de los ciclos anteriores existió una crisis financiera internacional del alcance de la actual. Por tanto, el efecto añadido de esta crisis es un factor que no ha sido tenida en cuenta en este ejercicio. Es difícil anticipar en qué medida la crisis financiera puede alterar los escenarios previstos, pero no hay duda de que este efecto añadido, si se produce, será negativo.

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REPORTAJE: DINERO & INVERSIONES Los 'osos' asoman en máximos Las apuestas bajistas repuntan pese al escenario de euforia que reina en la Bolsa DAVID FERNÁNDEZ 19/07/2009 Con el comienzo del rebote a principios de marzo, los osos, calificativo con el que se conoce a los inversores bajistas -en contraposición a los toros o alcistas-, retornaron a sus cuevas. Cuatro meses de hibernación a la espera de nuevas oportunidades para ganar dinero con la caída de las acciones. Ese momento parece que ha llegado; o así al menos lo sugiere el repunte de las posiciones cortas por parte de los hedge funds. El florecimiento de las apuestas bajistas coincide con los máximos anuales alcanzados por las Bolsas esta semana. Puede parecer una contracción, aunque muchos expertos creen que es una consecuencia lógica si se tiene en cuenta que el rebote de la renta variable en los últimos meses ha sido demasiado rápido dentro de un escenario económico aún muy incierto. "Los inversores tendrán que prepararse para una época de turbulencias", advertían los analistas de Saxo Bank en el informe de perspectivas para el tercer trimestre que han publicado esta semana. El banco asegura que el optimismo que reina en el mercado está fuera de lugar. "Los desequilibrios que han empujado al mundo desarrollado a la crisis siguen sin solucionarse. La recuperación que nos espera será plana o en forma de W", concluyen. En España, el despertar del letargo de los bajistas es especialmente visible en el sector de banca mediana, principalmente en el Banco Popular. En las últimas semanas, varios fondos especulativos han comunicado a la CNMV un aumento en sus apuestas bajistas en el capital de la entidad financiera. Con estos últimos movimientos, la parte del capital del Popular vendida a corto alcanza ya el 5,65%. Mediante esta estrategia, los hedge funds piden prestados títulos de una compañía para venderlos en el mercado con la esperanza de que la cotización caiga y así poderlos recomprar más baratos y embolsarse la plusvalía. "Nuestra recomendación sobre la banca mediana española sigue siendo de reducir. Las perspectivas económicas y las valoraciones de las entidades con respecto a sus homólogos europeos justifican esta decisión", explica una analista del sector financiero en una de las principales casas de Bolsa del país. "El Popular no es que esté ni mejor ni peor que otros bancos medianos. Lo que ocurre es que es más fácil para los bajistas tomar posiciones cortas en este valor por su liquidez y volumen de contratación. Pedir prestados títulos en otros bancos sale mucho más caro", señala esta experta. El retorno de los osos no es un caso aislado del mercado español. De hecho, en EE UU las apuestas que prevén una caída del índice S&P 500 han alcanzado su nivel más alto desde abril pasado. A 30 de junio pasado, últimos datos disponibles, había 10.000 millones de acciones de compañías del índice vendidas a corto, según cifras recopiladas por las Bolsas estadounidenses y Bloomberg. "Todavía hay mucho bajista en el mercado, reflejo de la brutal recesión en la que nos encontramos. Domina la incertidumbre", ha declarado James Paulsen, gestor de Wells Capital, a Bloomberg. Las principales apuestas bajistas en EE UU se centraban a finales de junio en el sector farmacéutico, tecnología y financieras.

214 Desde septiembre pasado, coincidiendo en el tiempo con la quiebra de Lehman Brothers, los supervisores estrecharon el cerco sobre los inversores bajistas. En el caso de España, la CNMV obliga desde septiembre a comunicar toda posición corta que exceda del 0,25% del capital en las entidades financieras cotizadas. Sin embargo, el organismo que preside Julio Segura apuesta por dotar al mercado de mayor transparencia en este tipo de operativa, por lo que apoya la propuesta del Comité Europeo de Reguladores de Valores (CESR) que, de prosperar, obligaría a los bajistas a comunicar al supervisor cualquier posición corta en cualquier valor (no sólo financieros) que supere el 0,1% e informar al mercado cuando traspase el 0,5% del capital. Arranca el fondo cotizado inverso Sea por mala suerte o por retrasos burocráticos y políticos, lo cierto es que en España el aterrizaje de algunos productos financieros ha llegado en el peor momento posible. El último ejemplo fueron los hedge funds. La comercialización de los fondos de alto riesgo coincidió con el fin del ciclo alcista en las Bolsas y con el estrangulamiento de liquidez en determinados activos utilizados por los hedge. Ahora, en pleno rebote alcista de los índices, llega a nuestro mercado el primer fondo cotizado inverso (ETF) sobre el Ibex 35. Este producto, gestionado por Lyxor, permite a los pequeños inversores aprovecharse de las caídas de la Bolsa española sin la necesidad de realizar operaciones que exigen más conocimientos sobre los mercados, como pueden ser el préstamo de títulos, los derivados o los contratos por diferencias. Aparte de apuestas bajistas, este instrumento facilita estrategias de cobertura, así como apuestas a corto y largo (por ejemplo, se apuesta por caídas del Ibex y subidas del Dow Jones). El objetivo del Lyxor ETF Ibex 35 Inverso es dar la rentabilidad de una posición corta sobre una cartera compuesta por las 35 acciones del Ibex. Como todo fondo cotizado, replica el índice de forma diaria en tiempo real. La particularidad de este ETF es que difiere en una cosa del selectivo porque refleja el comportamiento diario del Ibex, pero con dividendos. Es decir, para su cálculo se descuenta el dividendo que paguen las compañías del índice. La comisión de gestión del fondo es del 0,4% sobre el patrimonio. -

DAVID FERNÁNDEZ Las apuestas bajistas repuntan pese al escenario de euforia que reina en la Bolsa 19/07/2009 http://www.elpais.com/articulo/dinero/osos/asoman/maximos/elpepueconeg/20090719elpneg din_1/Tes?print=1

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TRIBUNA: Laboratorio de ideas JOSEPH E. STIGLITZ La ONU coge las riendas JOSEPH E. STIGLITZ 19/07/2009 Mientras que, en Estados Unidos, las discusiones sobre los brotes verdes económicos siguen sin amainar, en muchos países, y especialmente en los que están en vías de desarrollo, los problemas están empeorando. En Estados Unidos, la crisis empezó con un fallo en el sistema financiero que rápidamente se tradujo en una ralentización de la economía real. Pero en los países en vías de desarrollo ha sido justo al revés: el declive de las exportaciones, la reducción de las remesas de dinero, la disminución de la inversión extranjera directa y las caídas en picado de los flujos de capital han llevado al debilitamiento económico. Como consecuencia, hasta los países con buenos sistemas reguladores tienen que hacer frente a problemas en sus sectores financieros. El 23 de junio, una conferencia de Naciones Unidas que analizó la crisis económica mundial y su impacto en los países en vías de desarrollo llegaba a un consenso tanto sobre las causas de la crisis como sobre los motivos por los que estaba afectando hasta ese punto a dichos países. La conferencia esbozó algunas de las medidas en las que debería pensarse y creó un grupo de trabajo para explorar las posibilidades futuras, posiblemente con el asesoramiento de un grupo de expertos recién creado. El acuerdo se salió de lo habitual; al establecer lo que, en muchos sentidos, es una exposición más clara de la crisis y lo que es necesario hacer aparte de lo propuesto por el G-20, la ONU ha mostrado que la toma de decisiones no tiene que limitarse a un club autoelegido sin legitimidad política y en su mayoría dominado por quienes han tenido una responsabilidad considerable en el origen de la crisis. De hecho, el acuerdo demuestra el valor de un planteamiento más inclusivo (por ejemplo, haciendo preguntas clave que, desde el punto de vista político, podrían ser demasiado delicadas para que las planteasen algunos de los países más grandes, o señalando problemas que son habituales para los más pobres, aunque sean menos importantes para los más ricos). Se podría haber pensado que Estados Unidos habría asumido una función de liderazgo, dado que la crisis se originó en ese país. De hecho, el Tesoro de Estados Unidos (incluidos algunos funcionarios que actualmente son miembros del equipo económico del presidente Barack Obama) fomentó la liberalización del capital y del mercado financiero, lo que tuvo como consecuencia la rápida propagación de los problemas estadounidenses al resto del mundo. Aunque hubo menos liderazgo estadounidense de lo que uno habría esperado, y supuesto, dadas las circunstancias, muchos participantes se sintieron sencillamente aliviados al ver que Estados Unidos no ponía impedimentos para alcanzar un consenso mundial, como habría sucedido si George W. Bush todavía fuese presidente. Se podría haber esperado que Estados Unidos fuese el primero en ofrecer grandes sumas de dinero para ayudar a las muchas víctimas inocentes de las políticas que el país había defendido. Pero no fue así, y Barack Obama tuvo que pelear mucho para sacarle al Congreso incluso unas cantidades limitadas para el Fondo Monetario Internacional. Pero muchos países en vías de desarrollo acaban de liberarse de la carga de sus deudas y no quieren pasar por eso otra vez. La consecuencia es que necesitan subvenciones, no préstamos.

216 El G-20, que ha recurrido al Fondo Monetario Internacional para proporcionar la mayoría del dinero que los países en vías de desarrollo necesitan para afrontar la crisis, no ha tenido esto en cuenta suficientemente; la conferencia de la ONU, sí. El asunto más delicado que se trató durante la conferencia de la ONU (demasiado delicado para discutirlo en el G-20) fue la reforma del sistema de reserva mundial. La acumulación de reservas contribuye a los desequilibrios mundiales y a una demanda total mundial insuficiente, ya que los países ahorran cientos de miles de millones de dólares como precaución ante la inestabilidad mundial. No es sorprendente que a Estados Unidos, que ingresa billones de dólares gracias a los préstamos de los países en vías de desarrollo (ahora casi sin interés), no le entusiasmase demasiado este debate. Pero, le guste o no a Estados Unidos, el sistema de reserva del dólar se está deteriorando; la única pregunta es si pasaremos del actual sistema a otro alternativo de manera desordenada, o de una forma más cuidadosa y estructurada. Quienes ahora poseen grandes cantidades de reservas saben que acumular dólares es un mal negocio: poco o ningún beneficio y un alto riesgo de inflación o devaluación de la moneda, cosas que reducirían el valor real de los ahorros. El último día de la conferencia, mientras Estados Unidos expresaba sus reservas ante el mero hecho de debatir en el marco de la ONU este asunto que afecta al bienestar de todos los países, China repetía una vez más que había llegado la hora de empezar a trabajar en una moneda de reserva mundial. Dado que la moneda de un país sólo puede ser una moneda de reserva si otros están dispuestos a aceptarla como tal, puede que al dólar se le esté agotando su tiempo. El debate sobre el secreto bancario fue muy representativo de las diferencias entre la conferencia de la ONU y la del G-20: mientras que el G-20 se centró en la evasión de impuestos, la conferencia de la ONU también abordó la corrupción, que algunos expertos afirman que genera unos flujos de salida de capital desde los países más pobres que son mayores que los flujos de la ayuda extranjera que reciben. Estados Unidos y otros países industrializados han fomentado la globalización. Pero esta crisis ha demostrado que no han gestionado la globalización tan bien como deberían. Si queremos que la globalización funcione para todos, las decisiones sobre la manera de gestionarla deben tomarse de una manera democrática e inclusiva, con la participación tanto de las víctimas de los errores como de quienes los cometen. La ONU, a pesar de todos sus fallos, es la institución inclusiva internacional por excelencia. Esta conferencia de la ONU (como otra anterior sobre financiación para países en vías de desarrollo) ha puesto de manifiesto la función que la ONU debe desempeñar en cualquier discusión mundial sobre la reforma del sistema financiero y económico mundial. -

Joseph E. Stiglitz “ La ONU coge las riendas”, 19/07/2009 http://www.elpais.com/articulo/semana/ONU/coge/riendas/elpepueconeg/20090719elpneglse _7/Tes

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TRIBUNA: Laboratorio de ideas CARMEN ALCAIDE Corresponsabilidad y transparencia

CARMEN ALCAIDE 19/07/2009 El nuevo modelo de financiación de las comunidades autónomas (excluidas el País Vasco y Navarra) eleva considerablemente la corresponsabilidad fiscal de las mismas con el Estado. Participarán en el 50% de la recaudación del IRPF, el 50% del IVA y el 58% de los impuestos especiales cuando en el modelo anterior la participación era del 33%, 35% y 40% respectivamente. La mayor ventaja, para el sistema en su conjunto, de este aumento de la corresponsabilidad es que los ciudadanos podrán comparar la relación directa entre los impuestos que pagan y la gestión partiendo del gasto que realicen sus representantes políticos en las competencias transferidas. Pero para ello sería necesario exigir algo que, de momento, nadie pone sobre la mesa y es una mayor transparencia de la información sobre los gastos realizados por las Comunidades Autónomas (CCAA), con detalle suficiente y puntualidad de la información como para poder analizarlos y compararlos. Pero no parece que este conocimiento detallado de los gastos suscite interés entre los poderes públicos. Por mi experiencia en el campo de los datos, estoy en condiciones de afirmar que así como existe transparencia en la información de los ingresos y gastos del Estado, con detalle y puntualidad (sólo rota en algunas ocasiones) que permite analizar su evolución y estudiar las causas de los déficit obtenidos, también conozco de las dificultades para obtener información puntual y detallada de los gastos de las CC AA. Ni siquiera el Ministerio de Economía y Hacienda dispone de esta información detallada del gasto para cada una de las CC AA. Incluso es difícil explicar con exactitud y detalle el déficit de las mismas. La participación y gestión del 50% de la recaudación del IRPF y la capacidad normativa en temas tan importantes como la fijación de los tipos impositivos, el número de tramos a aplicar, la fijación de mínimos personales y familiares y las posibles deducciones, como la vivienda, otorga una autonomía fiscal a las comunidades autónomas que debería ir acompañada de desarrollo y mejoría de los órganos de control del gasto. Es inevitable que haya asimetrías entre ellas pero ahora que se habla tanto de los órganos de supervisión financiera y de los mercados, no debería dejarse de lado el control y sobre todo el conocimiento detallado de los gastos de las CC AA. De los tres fondos que componen el nuevo modelo: 1) Fondo de garantía de los servicios públicos fundamentales (80%); 2) Fondo de suficiencia global (16,5%); y 3) Fondo de convergencia (3,5%), el primero es el más importante por su cuantía y por referirse a los servicios fundamentales transferidos de educación, sanidad y servicios sociales. El 75% se proveerá de la recaudación obtenida antes comentada y un 5% de transferencias directas del Estado. Lo que nos lleva a otra ventaja importante del modelo. Las economías que sean más dinámicas obtendrán más recursos porque recaudarán más. Claro que alguna puede caer en la tentación de subir los tipos del IRPF para recaudar más pero tendría que explicárselo a los votantes. Pero no todo son ventajas. Como en otros campos está sucediendo, la descentralización del Estado a favor de las CC AA choca con la tendencia de armonización dentro de la Unión Europea. Es cierto que en materia de política fiscal la armonización europea es escasa, provocando tratamientos competitivos que inciden en los precios relativos de los bienes y los

218 servicios. Pero es de esperar que dicha armonización fiscal tenderá en el futuro a aumentar para evitar esas consecuencias perversas y cuando ocurra, para España, las diferencias entre los tratamientos fiscales de las CCAA, será una complicación adicional. Ésta es la razón fundamental por la que en el nuevo modelo no se otorga a las CC AA capacidad normativa sobre el IVA. Otro problema adicional es la incidencia del modelo en el déficit público. Recordemos que en los criterios de la Unión Europea se considera el déficit total de las Administraciones Públicas: Estado, CC AA, corporaciones locales y Seguridad Social. Como es bien sabido el déficit del Estado está aumentando como consecuencia de la crisis, tanto por la caída de la recaudación de impuestos como por el aumento del gasto. Se dice que el déficit público total no aumentará sensiblemente con el nuevo modelo porque el déficit de las CC AA se reducirá al disponer de más recursos. Pero no hay que ser muy optimistas. Los ingresos de las comunidades autónomas van a depender en gran manera de la recaudación (que está descendiendo) y, sin embargo, los gastos en educación y sanidad continúan aumentando por el crecimiento y envejecimiento de la población. Durante los próximos años va a ser especialmente delicada la evolución, conocimiento y cálculo del déficit de las CC AA. Otra vez chocamos con la transparencia. Si se quiere que el modelo sea eficaz, y que la correspondencia fiscal tenga un efecto positivo para los ciudadanos, es necesario insistir, acordar y exigir esa transparencia de la información de los gastos de las CC AA, detallada y puntual, que permita juzgar la eficacia de la gestión de los dirigentes públicos. Si no se hace podemos encontrarnos que al salir de la crisis tengamos un problema adicional con el déficit público y una nueva burbuja con el gasto y endeudamiento de las CC AA.

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14 mitos caídos tras dos años de crisis Los controles fallaron, pero el furor por las reformas se apaga a medida que se inicia la recuperación - Los banqueros han cobrado millones y no han sido juzgados ÍÑIGO DE BARRÓN - Madrid - 19/07/2009 La crisis cumple ahora su segundo aniversario sin mostrar el final del túnel. Una travesía mucho más oscura desde que, en septiembre pasado, EE UU dejó caer una entidad tan interconectada con todo el mundo como Lehman Brothers, un error monumental en opinión de la mayoría de los economistas consultados. La crisis cumple ahora su segundo aniversario sin mostrar el final del túnel. Una travesía mucho más oscura desde que, en septiembre pasado, EE UU dejó caer una entidad tan interconectada con todo el mundo como Lehman Brothers, un error monumental en opinión de la mayoría de los economistas consultados. La crisis ha sacudido al capitalismo, que necesita reformas urgentes que tardan en llegar. Incluso existe el riesgo de que el poderoso lobby financiero atenace a las autoridades para que sólo hagan cambios cosméticos, ante la tímida recuperación de las cuentas. Los expertos creen que la confianza sólo regresará cuando los supervisores y reguladores consigan entidades más transparentes. Evitar el espejismo de la liquidez ilimitada y que la banca pueda transferir riesgo al sistema, como hizo con las subprime, apunta José Carlos Díez, economista jefe de Intermoney, son otras lecciones de la debacle. De todas formas, como dicen los economistas Xavier Sala i Martí y Jaques Attali, las nuevas normas no evitarán la siguiente crisis, sólo cambiará su naturaleza. "Las nuevas crisis financieras mundiales utilizarán todos los recursos de las nuevas tecnologías de la comunicación", dice Attali. Esta crisis se ha llevado por delante un puñado de mitos: - Más mercado y menos Estado. Antes de la crisis, en plena vorágine de crecimiento alocado, se pedía que dejaran manos libres al mercado, al que se consideraba justo repartidor de riquezas. "En sectores que son sistémicos, no sólo la banca, es absurdo que el Estado se retire del todo. Si por volumen de empleo o el peso en la economía, una empresa no puede caer, el Estado debe tener controles y supervisión", comenta Alfonso García, socio de Analistas Financieros Internacionales (AFI). En esta crisis los Estados han sido los paganos, con una factura de más de tres billones de euros. - La supervisión escasa impulsa al mercado libre. En el mundo financiero anglosajón, la normativa se tomaba como una pesada carga que frenaba la creación de riqueza. A la vez, persistía la creencia de que la autoridad supervisora británica, la Financial Services Authority, y la norteamericana, la Securities Exchange Commission, eran implacables con los que se saltaban la ley. La crisis ha demostrado que las entidades van por delante de los reguladores. Crearon una banca en la sombra sin ningún control y organizaron un mercado de hipotecas subprime sin asumirlas en sus balances. Pese a los anuncios de mayor control al sector, Estados Unidos ha renunciado a dar más poder a los supervisores como se planteó en un principio. En el mercado existe el convencimiento de que es un problema de cantidad (escaso número de funcionarios) y de calidad (tienen menor preparación que los ejecutivos). Luis

220 Garicano, profesor de la Universidad de Chicago e impulsor de un nuevo departamento en la London School of Economics, opina que: "La clave es regular sin estrangular al mercado". - Los banqueros son profesionales de prestigio y deben tener salarios elevados. Ha quedado demostrado que los ejecutivos y los consejeros aprobaban productos de los que desconocían su riesgo real, como ha dicho Juan Ramón Quintas, presidente de la CECA. Es decir, no hicieron bien su trabajo. Sin embargo, cobraban unos sueldos estratosféricos que les hace responsables de lo ocurrido, aunque al final la factura la han pagado los ciudadanos y los accionistas. La UE ha decidido atacar los sueldos que fomenten el riesgo al fomentar la subida de beneficios a corto plazo. En Reino Unido, el Gobierno ha pedido conocer los salarios para que no se relacionen con operaciones de riesgo. En EE UU sigue abierto el debate. "Ni siquiera alguien con la capacidad de siete personas se merecería esos salarios", apunta Pablo Fernández, del IESE, "los bonus por beneficios fuerzan a mentir a la gente para cobrar más". - El que la hace, la paga. Este axioma ha mutado en "al que la hace, le pagan", porque los pocos altos ejecutivos que han perdido su puesto se han ido a casa con muchos millones. Hasta ahora, la lista de bajas de presidentes o consejeros delegados es esta: Fred Goodwin, del Royal Bank of Scotland; Charles Prince, de Citigroup; Stanley O'Nelly, de Merrill Lynch; Marcel Ospel, de UBS; Martin Sullivan, de AIG; Ferry Killinger, de Washington Mutual... y pocos más. Luis de Guindos, responsable financiero de PriceWaterhouseCoopers cree que si los culpables (y sus entidades) no asumen las responsabilidades, se trasladará la idea de que cuando hay beneficios son para las empresas, y si hay pérdidas, las paga el Estado. - La banca comercial es aburrida. El dinero está en la banca de inversión. Hace sólo unos años, las entidades dedicadas a la banca comercial, la que obtiene resultados céntimo a céntimo eran consideradas atrasadas financieramente, menos rentables y ausentes de glamour. Algunos Gobiernos y supervisores alentaron el crecimiento de la banca de inversión, que protagonizaba grandes operaciones internacionales y movía el tejido empresarial. La crisis ha demostrado que detrás de todo esto había más ingeniería financiera y burbujas de liquidez que otra cosa. "Hay que volver a la banca aburrida, la más próxima al cliente, para recomponer el sistema" ha dicho Paul Krugman, premio Nobel de Economía de 2008. Las autoridades quieren que, en el futuro, las grandes entidades combinen el negocio comercial con el de inversión. "Lo que se ha llevado esta crisis es el modelo de banca que ganaba un 25% más cada año por el fuerte endeudamiento. Cuando el mercado va mal, estas entidades son las que peor lo pasan", apunta De Guindos, ex secretario de Estado de Economía. Garicano añade: "Nada es gratis. Retornos excepcionales casi siempre proceden de asumir riesgos excepcionales". - Los grandes mercados están supervisados y regulados. Las hipotecas basura y los CDS (seguros de impago) movían miles de millones pero no estaban regulados ni supervisados. Además, las entidades los tenían fuera de sus balances. "Este tipo de productos ha demostrado ser vulnerables a la incertidumbre. Sus mercados se cerraron hasta el punto de que no hubo ni una transacción", comenta García, de AFI. Para evitarlo, la UE quiere que, a partir de 2011, la banca que trabaje con productos fuera de balance tenga más capital. - El mercado es eficiente y pone precio a los activos. Este largo ciclo de crecimiento alentó la creencia de que el mercado siempre da precio a los activos. En mitad de esa carrera alcista, los bancos norteamericanos insistieron en la utilización del mark to market, es decir, que los activos se valoren a precio de mercado, recogido en las Normas Internacionales de Contabilidad (NIC). El resultado fue que los activos se hincharon en paralelo a la burbuja.

221 Esta filosofía también está en la reforma internacional de Basilea II. Ambas están en profunda revisión. Ahora, la banca norteamericana y británica ha conseguido que el supervisor elimine la valoración de mercado para no castigar sus cuentas, en un movimiento que algunos consideran "maquillaje" y que puede favorecer otra burbuja futura. Sin embargo, la UE ha suavizado la normativa, pero la mantiene. Los expertos piden utilizar otros modelos, pero con transparencia. "Sobre Basilea II hemos aprendido que los propios bancos no pueden decidir el riesgo crediticio y por lo tanto las reservas usando sus propios modelos", dice Garicano. - No hay que preocuparse de la liquidez, casi es ilimitada. "La idea de que siempre había liquidez acabó con el principio del medir el riesgo real. Parecía que había dinero para todo", apunta Robert Tornabell, catedrático y profesor del Departamento de Dirección Financiera de ESADE. Lo cierto es que se ha pasado de golpe, de la inundación a la sequía. - No hay ciclos en la economía. En mitad de la borrachera de crecimiento, algunos economistas sostuvieron que los ciclos habían desaparecido. Tras superar, sin graves problemas, la crisis de las divisas latinoamericanas y de las empresas puntocom de principios del 2001, algunos apuntaron que la experiencia pasada, junto a la interconexión entre las autoridades internacionales, podía mitigar la virulencia de ciclos pasados. Lejos de eso, la globalización ha demostrado que hace sobrereaccionar a los mercados, amplifica las noticias negativas y la desconfianza. Emilio Ruiz, economista, especializado en la Gran Depresión del 29, dijo en diciembre de 2004: "El uso generalizado de las comunicaciones, ¿nos hace suponer la desaparición o, por lo menos, admitir que los ciclos se desenvolverán dentro de una mayor estabilidad? Si admitimos la existencia de grandes ciclos en la dinámica de la economía capitalista, la duración de cierta estabilidad llegaría hasta 2020". En mayo de 2006, Juan José Toribio, director del IESE de Madrid, comentó: "Creo que al vivir en una economía más globalizada, las recesiones de una zona vienen compensadas por las aceleraciones de otra". - Los bancos, cuanto más grandes, más seguros. Nadie osaría hacer este comentario en presencia de los presidentes de Citigroup, Bank of America, Royal Bank of Scotland o del ex presidente del difunto Lehman Brothers... Precisamente las víctimas de esta crisis están, en parte, en la lista de los gigantes del sector, con la excepción de los españoles. El Banco de Inglaterra y el BIS han dicho que si las entidades son demasiado grandes para quebrar, son demasiado grandes para existir. El BCE pide que sean controlados por colegios de supervisores, no sólo por el de su país. - Con la globalización, no importa donde esté la sede social. Parte del negocio ruinoso de Citigroup o de Lehman estaba en Asia o Europa. El Royal Bank tuvo pérdidas en Nueva York... pero al final han sido los Gobierno norteamericano y británico los que han pagado la factura del rescate. Cuando una entidad cae, el lugar donde está la sede social es clave para las ayudas. Por eso, los políticos quieren "campeones nacionales" y ha resurgido el nacionalismo económico. - Estamos a salvo con las nuevas normas: las NIC y Basilea II. Poco ha durado el prestigio de ambas normativas. Están en revisión completa para reforzar cuatro aspectos: las provisiones, que deberán hacerse en momentos de bonanza aunque no haya morosidad (el modelo español); el capital, que deberá aumentar, sobre todo si hay operaciones de riesgo; el principio de consolidación dentro del balance de todos los productos (para evitar la venta de subprime a terceros) y vigilancia de la liquidez, que apenas se tenía en cuenta.

222 - Las agencias de 'rating' y los auditores vigilan. El oligopolio de las tres grandes agencias de calificación financiera, Moody's, Standard&Poo's y Fitich ha fracasado y se prepara una profunda revisión. Han demostrado no tener sistemas fiables para medir los créditos basados en activos basura. Los auditores también han sido criticados por mezclar sus servicios con los de consultoría. "No aprendieron de la crisis de Enron", dicen en AFI. Tornabell, de Esade, cree que no pueden cobrar de los clientes a los que tienen que juzgar. Fernández, del IESE, cree que hay empresas que consideran que los auditores no te pueden criticar porque les estás pagando. - Los 'hedge funds' y los productos sofisticados dinamizan la economía. La titulización de activos (que es una forma de empaquetar y revender productos), los derivados y los hedge funds fueron los protagonistas de la época dorada. Ahora se les considera responsables de buena parte de la burbuja y del sobreendeudamiento. Warren Buffet advirtió de que "los derivados son verdaderas armas de destrucción masiva". De Guindos opone que "el origen de la burbuja de liquidez no son tanto los derivados como el mantenimiento de los tipos de la FED en niveles muy bajos durante mucho tiempo". ÍÑIGO DE BARRÓN Los controles fallaron, pero el furor por las reformas se apaga a medida que se inicia la recuperación - Los banqueros han cobrado millones y no han sido juzgados 19/07/2009 http://www.elpais.com/articulo/economia/mitos/caidos/anos/crisis/elpepieco/20090719elpepieco_1/Tes?print=1

223

F OR IMMEDIATE RELEASE July 16, 2009

STATEMENT ON U.S. ECONOMIC OUTLOOK BY DR. NOURIEL ROUBINI

The following is a statement from Dr. Nouriel Roubini, Chairman of RGE Monitor and Professor, New York University, Stern School of Business:

“It has been widely reported today that I have stated that the recession will be over “this year” and that I have “improved” my economic outlook. Despite those reports - however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

“I have said on numerous occasions that the recession would last roughly 24 mon ths. Therefore, we are 19 months into that recession. If as I predicted the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year’s end.

“Indeed, last year I argued that this will be a long and deep and protracted U-shaped recession that would last 24 months. Meanwhile, the consensus argued that this would be a short and shallow V-shaped 8 months long recession (like those in 1990-91 and 2001). That debate is over today as we are in the 19th month of a severe recession; so the V is out of the window and we are in a deep U-shaped recession. If that recession were to be over by year end – as I have consistently predicted – it would have lasted 24 months and thus been three times longer than the previous two and five times deeper – in terms of cumulative GDP contraction – than the previous two. So, there is nothing new in my remarks today about the recession being over at the end of this year.

“I have also consistently argued – including in my remarks today - that while the consensus predicts that the US economy will go back close to potential growth by next year, I see instead a shallow, below-par and below-trend recovery where growth will average about 1% in the next couple of years when potential is probably closer to 2.75%.

“I have also consistently argued that there is a risk of a double-dip W-shaped recession toward the end of 2010, as a tough policy dilemma will emerge next year: on one side, early exit from monetary and fiscal easing would tip the economy into a new recession as the recovery is anemic and deflationary pressures are dominant. On the other side, maintaining large budget deficits and contin ued monetization of such deficits would eventually increase long term interest rates (because of concerns about medium term fiscal sustainability and because of an increase in expected inflation) and thus would lead to a crowding out of private demand.

“While the recession will be over by the end of the year the recovery will be weak given the debt overhang in the household sector, the financial system and the corporate sector; and now there is also a massive re-leveraging of the public sector with unsustainable fiscal deficits and

224 public debt accumulation.

“Also, as I fleshed out in detail in recent remarks the labor market is still very weak: I predict a peak unemployment rate of close to 11% in 2010. Such large unemployment rate will have negative effects on labor income and consumption growth; will postpone the b ottoming out of the housing sector; will lead to larger defaults and losses on bank loans (residential and commercial mortgages, credit cards, auto loans, leveraged loans); will increase the size of the budget deficit (even before any additional stimulus is implemented); and will increase protectionist pressures.

“So, yes there is light at the end of the tunnel for the US and the global economy; but as I have consistently argued the recession will continue through the end of the year, and the recovery will be weak and at risk of a double dip, as the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing will be daunting.

“RGE Monitor will soon release our updated U.S. and Global Economic Outlook. A preview of the U.S. Outlook is available on our website: www.rgemonitor.com”

225 Opinion

July 17, 2009 OP-ED COLUMNIST The Joy of Sachs By PAUL KRUGMAN The American economy remains in dire straits, with one worker in six unemployed or underemployed. Yet Goldman Sachs just reported record quarterly profits — and it’s preparing to hand out huge bonuses, comparable to what it was paying before the crisis. What does this contrast tell us? First, it tells us that Goldman is very good at what it does. Unfortunately, what it does is bad for America. Second, it shows that Wall Street’s bad habits — above all, the system of compensation that helped cause the financial crisis — have not gone away. Third, it shows that by rescuing the financial system without reforming it, Washington has done nothing to protect us from a new crisis, and, in fact, has made another crisis more likely. Let’s start by talking about how Goldman makes money. Over the past generation — ever since the banking deregulation of the Reagan years — the U.S. economy has been “financialized.” The business of moving money around, of slicing, dicing and repackaging financial claims, has soared in importance compared with the actual production of useful stuff. The sector officially labeled “securities, commodity contracts and investments” has grown especially fast, from only 0.3 percent of G.D.P. in the late 1970s to 1.7 percent of G.D.P. in 2007. Such growth would be fine if financialization really delivered on its promises — if financial firms made money by directing capital to its most productive uses, by developing innovative ways to spread and reduce risk. But can anyone, at this point, make those claims with a straight face? Financial firms, we now know, directed vast quantities of capital into the construction of unsellable houses and empty shopping malls. They increased risk rather than reducing it, and concentrated risk rather than spreading it. In effect, the industry was selling dangerous patent medicine to gullible consumers. Goldman’s role in the financialization of America was similar to that of other players, except for one thing: Goldman didn’t believe its own hype. Other banks invested heavily in the same toxic waste they were selling to the public at large. Goldman, famously, made a lot of money selling securities backed by subprime mortgages — then made a lot more money by selling mortgage-backed securities short, just before their value crashed. All of this was perfectly legal, but the net effect was that Goldman made profits by playing the rest of us for suckers. And Wall Streeters have every incentive to keep playing that kind of game. The huge bonuses Goldman will soon hand out show that financial-industry highfliers are still operating under a system of heads they win, tails other people lose. If you’re a banker, and you generate big short-term profits, you get lavishly rewarded — and you don’t have to give the

226 money back if and when those profits turn out to have been a mirage. You have every reason, then, to steer investors into taking risks they don’t understand. And the events of the past year have skewed those incentives even more, by putting taxpayers as well as investors on the hook if things go wrong. I won’t try to parse the competing claims about how much direct benefit Goldman received from recent financial bailouts, especially the government’s assumption of A.I.G.’s liabilities. What’s clear is that Wall Street in general, Goldman very much included, benefited hugely from the government’s provision of a financial backstop — an assurance that it will rescue major financial players whenever things go wrong. You can argue that such rescues are necessary if we’re to avoid a replay of the Great Depression. In fact, I agree. But the result is that the financial system’s liabilities are now backed by an implicit government guarantee. Now the last time there was a comparable expansion of the financial safety net, the creation of federal deposit insurance in the 1930s, it was accompanied by much tighter regulation, to ensure that banks didn’t abuse their privileges. This time, new regulations are still in the drawing-board stage — and the finance lobby is already fighting against even the most basic protections for consumers. If these lobbying efforts succeed, we’ll have set the stage for an even bigger financial disaster a few years down the road. The next crisis could look something like the savings- and-loan mess of the 1980s, in which deregulated banks gambled with, or in some cases stole, taxpayers’ money — except that it would involve the financial industry as a whole. The bottom line is that Goldman’s blowout quarter is good news for Goldman and the people who work there. It’s good news for financial superstars in general, whose paychecks are rapidly climbing back to precrisis levels. But it’s bad news for almost everyone else. http://www.nytimes.com/2009/07/17/opinion/17krugman.html?th&emc=th

227 Global Business

July 17, 2009 Two Giants Emerge From Wall Street Ruins By GRAHAM BOWLEY A new order is emerging on Wall Street after the worst crisis since the Great Depression — one in which just a couple of victors are starting to tower over the handful of financial titans that used to dominate the industry. On Thursday, JPMorgan Chase became the latest big bank to announce stellar second-quarter earnings. Its $2.7 billion profit, after record gains for Goldman Sachs, underscores how the government’s effort to halt a collapse has also set the stage for a narrowing concentration of financial power. “One theme here is that Goldman Sachs and JPMorgan really have emerged as the winners, as the last of the survivors,” said Robert Reich, a professor at the University of California, Berkeley, who was secretary of labor in the Clinton administration. Both banks now stand astride post-bailout Wall Street, having benefited from billions of dollars in taxpayer support and cheap government financing to climb over banks that continue to struggle. They are capitalizing on the turmoil in financial markets and their rivals’ weakness to pull in billions in trading profits. For the most part, the worst of the financial crisis seems to be over. Yet other large banks, including Citigroup and Bank of America, are still struggling to return to health. Both are expected to report a more profitable quarter on Friday, but a spate of management changes and looming losses from credit cards and commercial real estate have thwarted a stronger recovery. And then there are the legions of regional and small banks that are falling in greater numbers across the country. While many have racked up large losses, they stand to bleed more red ink if the recession wears on. Fifty-three have failed this year, and the Federal Deposit Insurance Corporation is girding for scores to follow. Uncertainties over the economy mean that Goldman and JPMorgan may be enjoying a fragile dominance, industry experts said. JPMorgan reported big declines in its consumer business on Thursday, and it has set aside more than $30 billion to cover future losses from surging credit card charge-offs and mortgage and home equity losses. “Nobody is through this until unemployment turns around,” said Moshe Orenbuch, a Credit Suisse banking analyst. And if regulation being considered in Washington is passed, banks would face new limits on the amount of their own capital they may trade. That could limit the profits that banks like Goldman and JPMorgan make from their trading businesses, and level the playing field, experts say. Other former Wall Street stars like Morgan Stanley, which was hurt more by the crisis and has avoided taking big risks in the new era, may also rebound and begin to take on old rivals.

228 But for now, Goldman Sachs and JPMorgan are surging. “The stronger players are positioned to take advantage of the crisis and they will dominate clearly in the near term,” said James Reichbach, the head of Deloitte’s United States financial practice. JPMorgan’s renewed strength, like Goldman’s, comes as it vaults ahead of longtime rivals, especially in investment banking, including bond and equity trading, and underwriting debt to help companies issue shares and bonds. Traders took advantage of big market swings and less competition to post big gains in fixed-income and equities. Michael J. Cavanagh, the chief financial officer at JPMorgan, said its profit and fees from this business were “a record for us in a quarter and a record for anybody at any firm in any quarter.” The bank, he added, was “so very proud of those results.” It has also profited from the demise of weaker banks to enlarge its market share in mortgages and retail banking. On Tuesday, as the CIT Group, a lender to many small businesses, negotiated with the government to avoid collapse, JPMorgan signaled that it was watching. “It would be an opportunity for us in these states if CIT was unable to continue lending to borrowers,” Tom Kelly, a spokesman at Chase, was quoted by Dow Jones Newswires as saying. And revenue from the retail bank Washington Mutual, which JPMorgan acquired last fall, is starting to help earnings. Morgan is also profiting from its government-assisted purchase of Bear Stearns last year. JPMorgan is now No. 1 globally in equity and debt capital markets, according to Dealogic. Amid the surge, Jamie Dimon, JPMorgan’s chief executive, has cemented his status as one of America’s most powerful and outspoken bankers. He has vocally distanced himself from the government’s financial support, calling the $25 billion in taxpayer money the bank received in December a “scarlet letter” and pushing with Goldman Sachs, Morgan Stanley and others to repay the money swiftly. Those three banks repaid the money last month. Yet JPMorgan’s transformation into one of the industry’s strongest players is underpinned by the shelter it received from the government: The bank used the money as a cushion until it was able to raise new capital. “There is no doubt all of us benefited from the government help — all of us,” said a senior executive at another Wall Street bank. A spokesman for JPMorgan said the bank accepted aid at the request of the government but would not comment beyond that. Few banks have undergone such a turnaround. Only a few years ago, JPMorgan was struggling after years of poor management and a failure to digest a series of big acquisitions. But under Mr. Dimon, it cut costs and strengthened its balance sheet. The payoff began last year. With the industry teetering on the verge of collapse, JPMorgan snapped up Bear Stearns in March 2008 and Washington Mutual last fall in two government- assisted transactions. Clients say that its growing dominance has given it more leverage to charge for lending and other services. After aggressively lobbying to repay its taxpayer money, Mr. Dimon has also been driving a hard bargain over the repurchase of warrants the government received from the bank last autumn in exchange for taxpayer support. JPMorgan is now planning to let the Treasury Department auction off the warrants to private investors after the two sides failed to agree on a price.

229 Mr. Dimon is also gearing up for a series of battles in Washington. One is over tighter regulations for derivatives, a business where the bank generates lucrative fees as one of the industry’s largest players. Another is the creation of a new consumer protection agency, which could threaten the profitability of the bank’s mortgage and credit card businesses if it introduces tougher regulations. JPMorgan’s stock has risen 20 percent since early March. It closed Thursday at $35.76. Eric Dash and David Jolly contributed reporting. GRAHAM BOWLEY Two Giants Emerge From Wall Street Ruins July 17, 2009 http://www.nytimes.com/2009/07/17/business/global/17bank.html

230

17.07.2009 Data show credit crunch already started in Germany

FT Deutschland did a useful statistical exercise by disaggregating one of the most important financial statistics at the moment –credit to the non-banking sector. The official aggregated data show that there is no credit crunch, but this includes insurance companies and investment funds. If you take them out, you get the credit to the non-financial sector, and this shows that credit was already declining moderately in the first quarter this year. (We expect that the rate of decline will have gone up since then, and companies expect a further wave of credit tightening in the autumn.) So this really is a credit crunch. Doubts persist on Barroso’s reelection Jean Quatremer reports that there are growing doubts about whether or not Jose Manuel Barroso will get a majority if a vote of investituture is held in September. He says numerous Christian Democrat MEPs have told that they would not vote under any circumstances for Barroso. (Remember this is a secret ballot!) Also the announcement of Blair’s candidature for the presidency of the European Council might complicate things. Cohn-Bendit pointed out that it is unreasonable to have supporters of the Irak War at the Commission, the Council and Nato. Iceland’s parliament casts narrow vote in favour of EU membership negotiations Iceland took a first big step towards EU membership, when the country’s parliament voted with a narrow majority of 33 to 28 to start membership negotiations with the EU. The FT writes that this is a controversial issue in Iceland, as the Greens, a member of the new centre- left government, vigorously oppose EU membership. The polls suggest a narrow majority of people are in favour, but there are significant obstacles ahead, such as a necessary change in the constitution and a referendum. A big issue is fisheries, now the most important income source after the collapse of banking.

231 Steinbruck’s empty threats FT Deutschland has a critical article about the German finance ministry’s tactics to get the banks to lend more to companies. They quote a finance ministry spokesman as saying: “First, we threaten. If the banks do as we say, we don’t need to do anything.” The problem is that experts believe the threats are empty. Steinbruck threatened that the Bundesbank or the state- owned KfW bank would lend to companies directly, thus bypassing the traditionally banking sector. Experts are saying that this would only alleviate the pain of a small fraction of the corporate sector. (The fact is that German industry is too dependent on traditional banking that the creation of alternative financial infrastructures would take too long to build) Cross-border share trading costs in EU down, but still elevated The FT reports that the cost of share trading by transaction has come down across Europe since 2006 but measured by value of transaction it remains high, citing a study commissioned by the European Commission. On a per transaction basis, trading costs were down by 52% in the UK, between 2006 and 2008; in Ireland, by a hefty 82%; in Germany by more than a third; and in France by about 18%. Yet measured by value of transaction, equities trading costs were up 1% in the UK; up 36% in the Netherlands; and by the same amount in France. Leparmentier on Germany In a feature for Le Monde, Arnaud Leparmentier looks at Germany today, proud of its economic model and in peace with its history, a country that no longer needs Europe to advance. Germans are convinced that their economic model based on export growth and austerity is superior; also politically Germany became more self-confident and more introspective as it gets to terms with its past. The ruling of the German constitutional court on the Lisbon treaty and the parliamentary decision to write a balanced budget rule into the constitution are landmarks of this new Germany and are effectively ending the dream of a federal Europe. http://www.eurointelligence.com/article.581+M57a4fab5dcc.0.html#

232

L'Allemagne apaisée enterre le rêve européen LE MONDE | 16.07.09 | 15h15 • Mis à jour le 16.07.09 | 15h15 ien ne va plus en Allemagne. L'impression du catalogue Quelle, La Redoute allemande, a été interrompue, pour cause de faillite. Aux sauvetages bancaires succèdent les défaillances industrielles. La récession va atteindre 6 % du produit intérieur brut (PIB) en 2009, la production industrielle et les exportations se sont effondrées de plus d'un quart, le chômage va s'envoler à l'automne... Rien ne va plus, et pourtant les Allemands se sentent étonnamment bien dans leur peau. Mieux que jamais, soixante ans après la fondation de la République fédérale et vingt ans après la chute du mur de Berlin. "Heureux comme Dieu en France", serine, un brin envieux, le dicton germanique. Les citoyens allemands n'en demandent plus tant, satisfaits de vivre entre Rhin et Oder. Ils se remettent même à consommer ! Convaincus que leur modèle économique est le meilleur en ces temps troublés. Enfin apaisés sur leur passé. Tant pis pour l'Europe et le rêve fédéral que la Cour constitutionnelle vient d'enterrer. A moins de trois mois des élections législatives, cette sérénité s'incarne dans les deux responsables politiques les plus populaires du pays : la chancelière chrétienne-démocrate Angela Merkel et son nouveau ministre de l'économie, Karl-Theodor von und zu Guttenberg. La première reflète l'Allemagne telle qu'elle est : modeste, protestante, de formation scientifique, un peu terne, prudente à l'excès, plutôt sociale, soulagée d'avoir enfin traversé les épreuves de la RDA et de la réunification. Le second, c'est l'Allemagne qui rêve de flamboyance, après des décennies de retenue : Karl-Theodor zu Guttenberg est jeune (37 ans), catholique, riche et bavarois. Issu d'une famille dont l'arbre généalogique remonte à 1149, père de deux filles et marié à l'élégante comtesse Stephanie von Bismarck-Schönhausen, il enjambe le drame du IIIe Reich : un de ses grands-oncles a été exécuté pour avoir conspiré en juillet 1944 avec le baron Claus von Stauffenberg contre Hitler. Ce conservateur féru de philosophie redonne au pays ses racines intellectuelles du XIXe siècle, quand le destin de l'Allemagne n'était pas écrit. A eux deux, ils gèrent les contradictions d'un pays pas toujours lucide, qui voudrait être orthodoxe mais où le gouvernement est contraint d'intervenir tous azimuts (garanties bancaires multiples, primes à la casse automobile, chômage partiel) en espérant être sauvé, à l'automne, par la reprise du commerce mondial. Le sauvetage d'Opel, qui emploie 25 000 salariés, en témoigne. Dans la nuit du 29 mai, au cours d'une réunion de crise à la chancellerie, Guttenberg s'oppose au plan de sauvetage de la filiale de General Motors par des Russes. Trop risqué pour le contribuable. Il offre sa démission à Angela Merkel, qui la refuse. L'ancien chancelier social-démocrate (SPD) Gerhard Schröder, qui avait renfloué en 1999 Holzmann, un groupe de bâtiment et de travaux publics en faillite, avec les deniers publics, attaque gaillardement "ce baron de Bavière", décidément bien peu sensible aux emplois des ouvriers. Sans succès, comme en témoigne le revers historique du SPD aux élections

233 européennes du 7 juin : les Allemands ont retenu que Holzmann avait fini par péricliter. Dans un pays où l'on parle impôts en famille comme on s'étripe sur Nicolas Sarkozy en France, un sou est un sou. Les Allemands font de Guttenberg leur mascotte, le garant de l'"Ordnungspolitik", chère au ministre de l'économie Ludwig Erhard, père du miracle économique dans les années 1950 : l'Etat est là pour fixer les règles du jeu de l'économie sociale de marché, pas pour sauver les entreprises défaillantes. Une aubaine pour la chancelière, qui a habilement autorisé son ministre à faire entendre sa voix dissidente : elle a trouvé une solution de sauvetage pour Opel mais l'orthodoxie de son jeune ministre rejaillit sur elle. Car l'essentiel est de retrouver l'atmosphère de miracle économique qui soufflait sur l'Allemagne avant que n'éclate la crise en septembre 2008. Le pays avait digéré la réunification, retrouvé sa compétitivité à force de modération salariale, engrangé des excédents commerciaux record et assaini ses finances publiques. Il est urgent que tout redevienne comme avant. La campagne est propice aux promesses en tous genres. Angela Merkel propose des baisses d'impôts auxquelles les Allemands ne croient pas, alors que le retour à l'équilibre des finances publiques est sans cesse reporté. Qu'à cela ne tienne. Les responsables politiques décident de se protéger d'eux-mêmes et de mettre les déficits hors la loi. Le Parlement vient d'inscrire dans la Constitution la limitation du déficit public fédéral à 0,35 % du PIB en 2016 et l'interdiction pour les régions de recourir, sauf exception, à l'endettement, à partir de 2020. Et dès que la reprise pointera son nez, l'Allemagne, qui veut ne douter de rien, compte refaire la course en tête grâce à ses exportations. "Nous n'avons pas d'alternative pour assurer notre prospérité. Le marché intérieur est trop faible compte tenu du vieillissement et de la diminution de la population", explique Ulrich Wilhelm, porte-parole d'Angela Merkel. Et tant pis pour les Français qui accusent l'Allemagne d'égoïsme. Parce qu'elle lamine les salaires et la consommation en Europe en faisant la course à la compétitivité. Parce qu'elle crée de graves déséquilibres macroéconomiques en engrangeant des excédents commerciaux colossaux placés imprudemment sur les marchés financiers. Parce que sa politique de délocalisation en Europe de l'Est sera moins efficace quand ces pays auront achevé leur rattrapage économique et verseront des salaires comparables à ceux d'Europe occidentale. "Les Allemands vont continuer de consolider leur compétitivité. Ils ne vont pas ralentir. Cela fait consensus à presque 100 %. Que la France ne se fasse pas d'illusion", met en garde le Vert Joschka Fischer, ancien ministre des affaires étrangères de Gerhard Schröder (1998-2005). Les Allemands avanceront, avec ou sans l'Europe. Les plus avisés ne se faisaient depuis longtemps plus d'illusions. L'ancien ministre des affaires européennes français Jean- Pierre Jouyet, alors directeur du Trésor, l'avait prédit dès 2004 : l'alliance Paris-Berlin, scellée pour faire voler en éclats les règles du pacte de stabilité de l'euro, s'évanouira dès que l'Allemagne aura entrepris ses réformes. Alors, elle n'aura plus besoin de la France et de l'Europe. C'est chose faite depuis le 30 juin. Ce mardi matin, le gratin de la République fédérale s'est déplacé à Karlsruhe. Les télévisions publiques retransmettent l'événement en direct. A 10 heures, les huit juges de la Cour constitutionnelle, vêtus de rouge, font leur entrée solennelle. Son vice-président, Andreas Vosskuhle, entame pour deux heures trente la lecture d'un arrêt historique. La Cour donne son feu vert au traité de Lisbonne, s'empressent les plus optimistes. En réalité, elle vient de mettre un point final à l'intégration européenne.

234 Faute de peuple européen, le Parlement de Strasbourg n'a pas de vraie légitimité politique. Celle-ci émane des populations des Etats, donc des Etats. La Cour prend un malin plaisir à énumérer tous les domaines qui doivent leur être "réservés" : la politique pénale, policière, militaire, fiscale, sociale, culturelle, cultuelle, d'éducation ou de média... Pour transférer ces compétences à l'Europe, il faudra changer de Constitution allemande. Par référendum. C'en est fini de l'"union sans cesse plus étroite" prônée par le traité de Rome de 1957. Un mois plus tôt, la chancelière allemande avait, elle aussi, fermé le ban. Dans l'indifférence quasi générale, elle se rend le 27 mai à l'université Humboldt de Berlin pour prononcer un discours sur l'Europe. Elle réitère les poncifs habituels : "L'Allemagne a toujours considéré que l'unification de l'Europe faisait partie de sa raison d'Etat", explique-t-elle. Mais elle se refuse explicitement à évoquer les "finalités de l'Europe" - en clair, le rêve fédéral. Officiellement, ce serait rendre plus compliqués les pas politiques suivants. En réalité, la chancelière estime qu'il est impossible d'aller plus loin dans l'intégration, le traité de Lisbonne, qui accroît fortement le poids de l'Allemagne dans les institutions européennes, étant "un optimum". "Nous n'introduirions plus l'euro aujourd'hui", déplore Joschka Fischer, qui avait inauguré en 2000 la tradition des discours à l'université Humboldt, esquissant pour la dernière fois un rêve fédéral allemand. "Nous devenons gaullistes. Comme la France, nous voyons de plus en plus l'Europe comme un moyen et pas un projet." Mme Merkel cherche le juste équilibre pour son pays en Europe. Qu'elle n'assume pas son leadership, on accuse l'Allemagne d'être une grande Suisse. Qu'elle défende ses intérêts, et on l'accuse d'impérialisme. "C'est le destin du pays le plus grand. On ne fait jamais bien les choses, c'est toujours trop ou pas assez. Il faut prendre cela avec philosophie", estime M. Wilhelm, le porte-parole de la chancelière. La crainte française d'un Hinterland allemand, d'une arrière-cour en Europe de l'Est, s'est révélée infondée. "Les pays de l'élargissement ont adhéré à l'Union européenne pour des raisons économiques, mais ils prennent leurs décisions politiques avec les Américains", commente le secrétaire d'Etat à l'intérieur, le chrétien- démocrate Peter Altmaier. Ce Sarrois déplore l'absence d'amitié germano-polonaise ou germano-tchèque. Au niveau mondial, l'Allemagne s'est prouvé qu'elle était normalisée en envoyant en 1999 des soldats combattre hors de ses frontières - pour la première fois depuis 1945 - au Kosovo. Mais dix ans plus tard, la population renâcle à les voir rester en Afghanistan et conserve, selon Joschka Fischer, de profondes tendances pacifistes et isolationnistes. "L'Allemagne n'a aucune prétention à l'universalité", résume un haut diplomate français, qui identifie un unique cavalier seul allemand - sa relation avec la Russie - et une vraie ambition - la lutte contre le réchauffement climatique. Ce repli sur soi, ce "cocooning" allemand s'explique aussi parce que les Allemands sont enfin apaisés sur leur passé. Dans le restaurant du Reichstag, à Berlin, l'on peut deviser Histoire sans nécessairement s'attarder à la case Hitler. "Le IIIe Reich a terrifié les Alliés une dernière fois dans le contexte de la réunification", évacue le fédéraliste Peter Altmaier, qui préfère s'attarder sur Bismarck, le chancelier de l'unité allemande. Ce ne sont pas les erreurs du XXe siècle, mais celle du XIXe siècle qu'il convient de ne pas réitérer. "L'Allemagne ne peut pas se comporter comme l'a fait Bismarck en 1878 au Congrès de Berlin en se présentant comme le roi de l'Europe", devise M. Altmaier. Ce n'est pas un hasard si la statue du chancelier de fer, qui trônait jadis en face du Reichstag, n'a jamais été remise à sa place. Elle reste perdue dans les bois du Tiergarten.

235 Les Allemands ne sont pas tous passionnés d'histoire comme M. Altmaier, mais ils sont eux aussi moins obsédés par le nazisme. La dernière étape du travail sur le passé fut la réconciliation de la mémoire nationale avec celle des familles. Il fallait admettre que les Allemands, responsables du plus grand crime, avaient aussi souffert de la guerre. C'est chose faite avec le destin des déplacés, raconté par Günter Grass (En Crabe, éd. du Seuil, 2002, qui relate le torpillage d'un navire de réfugiés allemand) ou celui des femmes berlinoises violées en 1945 par les soldats russes (Seules dans Berlin, un film de Max Färberböck, inspiré du livre Une femme à Berlin, Gallimard, 2006). "Toutes les familles avaient des victimes. Mais c'était un tabou, qui a provoqué un refoulement des sentiments", explique Matthias Matussek, chroniqueur au Spiegel. Il est ravi que les consciences morales de l'Allemagne, à commencer par Günter Grass, aient dû en rabattre, après avoir concédé qu'elles avaient elles-mêmes été enrôlées par les nazis. Matthias Matussek, lui, a fini par être exaspéré par ces Anglais, qui lui crachaient encore le nazisme à la figure au début des années 2000. Il a écrit il y a trois ans un livre, Nous les Allemands, vous pouvez nous aimer (éd. Saint-Simon, 2007). Il ne lui est rien arrivé. Il a même connu le succès avec 80 000 exemplaires vendus. Dans son appartement de Hambourg, heureux de la chute du mur qui lui a permis de rencontrer sa femme originaire d'Allemagne de l'Est, il se sent mieux. La dernière "une" du Spiegel sur Hitler n'a pas fait recette. M. Matussek s'en réjouit. Et il se met à rêver du poète-journaliste Heinrich Heine (1797-1856), juif converti au catholicisme, chassé d'une Allemagne des princes qui rata les révolutions mais dont il avait la nostalgie. Il en est sûr : "Heinrich Heine serait fier de cette Allemagne, pacifique et décontractée au coeur de l'Europe."

Arnaud Leparmentier

Article paru dans l'édition du 17.07.09 Arnaud Leparmentier, “L'Allemagne apaisée enterre le rêve européen”, Le Monde, 17.07.09 http://www.lemonde.fr/web/imprimer_element/0,40-0@2-3214,50-1219539,0.html

236 le blog de Georges Ugeux, PDG de Galileo Global Advisors, une mini banque d'affaires internationale a New York. De 1996 a 2003, il a été Executive Vice President International du New York Stock Exchange. 17 juillet 2009 Les hedge funds: un conflit de règlementation. Pour une fois, nous nous trouvons devant des initiatives des deux cotés de l’Atlantique qui ont été déposées presque simultanement par le gouvernement americain et la commission européenne. Le panorama des hedge funds a beaucoup changé : leur taille a baisse de moitié, atteignant maintenant $ 1,3 milliard. Une goutte dans l’océan de la finance. Quant aux nombres de fonds, ils sont à peu près 8.000 répartis par moitié aux Etats Unis, suivis pour environ 3000 fonds au Royaume Uni, le solde etant en Europe continentale. Le premier conflit se situe au niveau de la Commission européenne qui a propose a travers le Commissaire Mc Creevy, un projet d’encadrement de l’activité des hedge funds, essentiellement influencé par les pays membres du continent. Les Britanniques sont loin d’approuver les restrictions mises à la création de nouveaux fonds et leur pré-approbation. Les champions de cette action sont évidemment la France et l’Allemagne qui ont des opinions fermes et négatives sur le sujet. La où le bât blesse, c’est qu’en imposant cette règlementation, ils s’attaquent essentiellement à la City de Londres. Inutile de le dire, les réactions londoniennes ont été virulentes. On parle même d’un gestionnaire d’un important fonds britanniques qui a fait le tour des cantons suisses pour décider dans lequel incorporer ses activités en fuyant l’Union Européenne. Mais au-delà du folklore, existe un vrai débat. Les hedge funds britanniques ont accepté une forme d’enregistrement et de règlementation de leur plein gré. Que ceux qui rêvent d’un exode qui affaiblirait la City ne croient pas avoir abouti à leurs fins. Les fonds britanniques, après des sautes d’humeur, sont bien décidés à rester à Londres et à Edinbourg. A peu pres au même moment, le dépôt par le Président Obama du projet de règlementation des hedge funds a fait apparaitre une proposition qui, quoique prévoyant l’enregistrement et une forme de supervision des hedge funds, est en deca des exigences européennes. Toutefois, on sent que les objectifs des deux cotés de l’Océan sont fondamentalement les mêmes : surveiller les actifs, leur qualité, l’endettement des fonds, gouvernance, qualité des contreparties. Bref, éviter que les hedge funds ne puissent (re)devenir une menace à la stabilité du système financier. Quoi qu’en pensent les défenseurs du libéralisme, le fait que les hedge funds n’étaient pas règlementés est une des causes de la débâcle que nous avons connue : ils étaient les principaux acheteurs des produits « toxiques » et autres modes de titrisation. Leur volatilité, l’absence de transparence, et l’utilisation sur une grande échelle des positions à découvert ont clairement rendu la crise, dont ils ne sont pas directement coupables, plus grave qu’elle ne méritait d’être. Le danger pour l’Europe n’est dès lors pas facile à éviter : les règles proposées par la commission risquent d’affaiblir la City de Londres, mais surtout de donner un avantage concurrentiel significatif aux Etats-Unis. Les gestionnaires américains ont poussé un soupir de soulagement, félicitant le Président Obama de ne pas avoir tue la poule aux œufs d’or, tout en ayant imposé un cadre réglementaire. Ce que le commissaire Mc Creevy prépare apparait dès lors comme ce qu’ils appelaient un « regulatory overkill ».

237 L’homme de la situation, qui parviendra peut-être à éviter que les conflits dégénèrent, n’est autre que le Ministre des services financiers de Sa Majesté, Paul Myners, devenu Lord Myners, qui a passé toute sa carrière a…gérer des fonds. Il sait de quoi il parle, et il est engagé dans un exercice difficile qui consiste à se trouver des alliés sur le continent, préparer des amendements acceptables pour la Commission et tenir compte de ce qui vient d’être proposé aux Etats-Unis. C’est du travail d’orfèvre. Une chose est certaine, l’industrie fera l’objet d’une règlementation qui permettra à la fois de les enregistrer et de surveiller leur évolution. Le moment est important, parce que c’est des « améliorations » de la proposition europeenne que dépendra le maintien de l’Europe comme un important acteur dans ces marchés. Le G8 d’Aquila ne nous a-t-il pas annoncé qu’il existait un consensus sur une structure cohérente de règlementation ? C’est un peu hâtif. Le diable est dans les détails, et il existe des solutions qui permettraient de réaliser une « première » : ne règlementation semblable (mais pas identique) entre les Etats-Unis et l’Europe. Quelles que soient les solutions, les hedge funds devront être surveillés dans le cadre des initiatives visant a contrôler les institutions qui représentent un risque systémiques. http://finance.blog.lemonde.fr/2009/07/17/les-hedge-funds-un-conflit-de-reglementation/

238 Jul 16, 2009 TIC Data and the U.S. Current Account Deficit: Foreigns Back to T-Bills in May

Overview: According to the data on capital flows to the U.S. released monthly by the treasury department, foreign investors are continuing to buy U.S. debt, but they have shifted from the riskiest assets into short-term bills in early 2009. However the share of foreign purchases of total treasuries has been reduced. At the same time the U.S. Current account deficit has also fallen, led by a collapse of imports, meaning the U.S. requires less foreign investment even as the financing needs of the government have climbed Most Recent Data (May) o Net foreign purchases of U.S. long-term U.S. securities were $7.9 billion (down from $34.2 billion in April and $56.6bn in March) private foreign investors bought $31.3 billion ($18.3billion in April) and foreign official institutions had net sales of $23.4 billion) (+$16billion in April) o Japan and Russia led the net sales by foreign official investors, while China kept adding to long-term holdings. China also added $34 billion in U.S. T-bills o Foreign holdings of short-term U.S. securities rose 9.8 billion (reversal from the $39.4billion decrease in April) as investors bought the most liquid US government assets. Foreign holdings of T-bills rose $ 39.2 billion (after net sales of $44.5 billion in April) with China buying $34 billion. Total TIC flows (ST+LT) were negative $66.6 billion with net sales from foreign private holders offsetting net increases by the public sector. o China added about $4 billion in long-term treasuries and $24 billion in short-term treasuries for a total of $801.5 billion in U.S. treasury holdings. This addition is consistent with China's reserve growth in the month of May and suggests China has been unable to diversify from the dollar. China remains the largest foreign holder of U.S. treasury securities and accounts for almost 20% of total foreign holdings of US treasuries, almost as much as Russia and Japan combined (via Treasury) o In April, Foreigners sold net $22.6 billion in Treasury bonds (from +$41.9 billion in April), bought 12.8 billion in agency bonds (reversing the selling trend since July 2008) adding $1 billion corporate bonds and bought $16.8 billion in equities. Implications of Recent trends o BNY: it is clear that foreign investors are liquidating USD-denominated cash positions and redeploying these funds into riskier, non-US assets. The foreign purchase of USD- denominated deposits accumulated during Q4 amidst the height of the market crisis, continued to be unwound in Q2 as risk appetite continued to improve. o Setser: The rise in China’s Treasury holdings — even after the adjustments for the holdings through London— was modest. China’s overall US portfolio isn’t rising at

239 anywhere like the pace it did in 2006, 2007 or even 2008. Ultimately that is a healthy adjustment - the more unwanted dollars China ends up holding, the bigger the ultimate risk of a disruptive shift out of the dollar. o In January and February, the deterioration in the TICS data was largely due to an alleviation in risk averse, safe-haven purchases of USD-denominated deposits o Wieting: Official data show foreign central bank holdings of Treasuries increasing despite a diminished external financing need now that the U.S. trade deficit has halved. The rise in U.S. and global bond yields has occurred as the Fed has purchased Treasuries, with these purchases failing to prevent the rise. o Danske: In February, US investors stopped repatriating foreign investments, for the first time since June 2008. Long-term capital flows are still broadly sufficient to fund the US current account deficit. While Asian demand for US Treasuries remained intact, UK investors (transit point for e.g. Middle East investors) were large sellers o Monthly Treasury International Capital (TIC) data tracks capital flows to and from the US including the net purchases and sales of US financial assets government and private debt and equity by foreigners. It thus provides an indication of whether such inflows cover the US current account deficit - though it does not include FDI and some other flows. o Bertaut: recent record foreign inflows into U.S. securities have not materially altered the relative allocations between U.S. and other foreign securities in foreign portfolios. In fact most countries continue to be more underweight in U.S. assets according to the standard model of international asset allocation. http://www.rgemonitor.com/96/Global_Current_Account_Imbalances?cluster_id=6911

240 Jul 4, 2009 Renminbi Politics: Changing Tone About the RMB From the U.S. and IMF? o Overview: Despite the fact that the U.S. government and the IMF (as well as many economists) believe that the Chinese currency is undervalued given Chinese growth and productivity, a more conciliatory tone has emerged in recent reports. In fact the IMF will no longer label any currencies as fundamentally misaligned. Views From the IMF o Divides over the language to be used regarding the currency have meant that China has not had an Article IV consultation (conducted every year for most countries) since 2006. IMF guidance to staff suggests that the institution no longer use the term "fundamentally misaligned. " It hopes the new guidance will increase the quality of collaboration with its members. o A draft of the Article IV to be released in mid July suggests that the RMB is “substantially undervalued.” An unnamed IMF official suggested that the slowing of Chinese reserve accumulation lessened the case for fundamental misalignment in any case (Bloomberg) o China is set to purchase as much as $50 billion of bonds to meet IMF funding needs. The country also seeks more voting power in the institution o China has also suggested that reserve currency issuers like the U.S. receive more scrutiny from the IMF and other insitutions given the critical role they play in the global economy U.S. Views o Following Treasury Secretary Geithner's written testimony at his confirmation hearing when he suggested China way manipulating its currency, the administration has avoided using the term currency manipulation and has instead emphasized cooperation. o Geithner at the release of the semi-annual exchange rate report in April 2009: "No U.S. trading partner manipulated its exchange rate for the purposes of preventing effective balance of payments adjustment or to gain unfair competitive advantage" in H2 2008. "Although the Treasury believes that the Renminbi is undervalued, China has taken steps to enhance exchange rate flexibility and the Chinese currency appreciated by 16.6% in real effective terms between June 2008 and February 2009, appreciating slightly against the dollar when most other EM and other currencies fell sharply. China's fiscal stimulus package should help spur domestic demand growth and rebalance the Chinese economy." o One of the new US officials coordinating with China is David Dollar, previously the World Bank's country director for China and Mongolia. He has emphasized the changes that China might make in order rebalance its economy. His selection might indicate the ways in which the administration is trying to work with China to boost its domestic demand and global aggregate demand

241 o US and Chinese policymakers seem to be trying to repair ties given that negative rhetoric would be counterproductive to both and in responding to global crises o Treasury Secretary Timothy Geithner's congressional testimony suggested that Obama believes China is “manipulating” its currency but provided no details of how it might accomplish this. Geithner: "The new economic team will forge an integrated strategy on how best to achieve currency realignment in the current economic environment.” o Although many economists believe Chinese currency remains undervalued, urging China to revalue its currency at this time might exacerbate Chinese economic slowdown - IMF currency surveilance process has been deadlocked for years o With global trade contracting, the chances of trade friction between the U.S. and China, among others, are on the rise. China's response though has been muted, likely in part because it wants to do little to undermine the value of its existing stock of US assets in the midst of the first sustained USD uptrend in eight years(BNY) o The Bush administration was reluctant to label China a currency manipulator which would have required trade retaliation, instead urging China to speed appreciation of the currency to alleviate domestic imbalances. Chinese RMB appreciated at a faster pace from late 2007-early 2008 but has since reverted to a virtual repeg to the dollar as Chinese exports and growth slowed. It is unlikely to allow much appreciation lest it weaken exports o Buiter: Should the US Treasury officially determine China to be a currency manipulator, the Administration can unleash a range of remedies, including antidumping measures, countervailing duties, and safeguards. Although the WTO permits certain retaliatory responses from importing nations who prove material injury from unfair trade practices, much of what Congress and some members of the administration have in mind may violate WTO obligations. Any bilateral trade war could easily spread to the EU, Japan and emerging markets outside China. o Congress has been unimpressed with RMB band widening, appreciation, limited SED outcomes. may reintroduce legislation on currency manipulation such as those introduced in the 110th congress dealing with aspects of the trade relationship o US-China BC: A single-minded focus on China’s currency is a distraction. China’s exchange rate is not as significant in the bilateral trade balance as o Henning: Congress should amend the Exchange Rates and International Economic Policy Coordination Act of 1988 to increase coverage of reports, increase accountability of Treasury and clearer definition of currency manipulation to include fx intervention or official lending, exchange restrictions or actions with effect if not the intention of preventing external adjustment o CRS: The IMF and WTO approach the issue of currency manipulation differently. IMF prohibits countries from manipulating currency to obtain unfair trade advantage but cannot force a country to change is fx policies. WTO has narrow policies that do not seem to deal with currency manipulation Renminbi Politics: Changing Tone About the RMB From the U.S. and IMF? Jul 4, 2009 http://www.rgemonitor.com/96/Global_Current_Account_Imbalances?cluster_id=6911

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Cover Story July 15, 2009, 10:50PM EST China Revs Up Its Dealmaking Machine The Chinese are in the midst of an M&A craze, doubling overseas investments last year. Could the deals benefit the global economy? By Dexter Roberts and Frederik Balfour Is China Inc. intent on buying the world? It sure looks that way. Just in June and July, Chinese companies from oil refiner Sinopec (SNP) to carmaker Beijing Automotive and appliance giant Haier have invested or shown interest in investing in oil fields in Iraq, GM's Opel car business in Germany, an upscale appliance maker in New Zealand, and a Japanese department store. The sums involved range from tiny ($50 million for Haier's 20% stake in the New Zealand appliance maker) to hefty, at least by Chinese standards: Sinopec paid more than $7 billion for a Swiss oil company. A rumored bid for a Spanish-owned Argentine oil producer would be twice that. China's total investments abroad, at $170 billion, come to only one-thirtieth the capital that the U.S. has spent on foreign factories, real estate, and other assets. But the Chinese have definitely been revving up their deal machine. China's overseas investments doubled last year, to $52 billion, and the Chinese government's economic planners have predicted a 13% increase this year, despite a slight slowdown last winter. In the crisis, "prices are getting better," says Daniel H. Rosen, a partner at New York advisory firm Rhodium Group and author of a recent report on China's outward investment. "That creates opportunities for China to go bottom-fishing." Beijing is also making it easier to acquire abroad. And non-energy companies are rushing overseas to buy skills in design and engineering. The mergers-and-acquisitions craze is good news for lawyers, accountants, and investment bankers. JPMorgan Chase (JPM) and Morgan Stanley (MS) have both worked on high-profile China bids. PricewaterhouseCoopers has been involved with more than 125 transactions, and Bain & Co. has consulted for Chinese suitors, too. "It's a huge market not only for Bain but for many advisors," says Philip Leung, a Bain partner in Shanghai. A big buildup in Chinese overseas M&A actually might benefit the global economy because it would recycle the dollars and other currencies earned by Chinese exporters in a healthier way. Right now, Chinese exporters don't have much use for the foreign exchange they earn. So the dollars pile up at China's central bank, which invests them in U.S. Treasury bills and the like. Meanwhile, the yuan that the exporters get for their dollars and euros feeds internal speculation and could stoke inflation. A flood of bids from the Chinese could also help put a floor under the prices of all kinds of companies. Triggering Backlashes Yet the deals will be no smooth ride for either Chinese acquirers or their targets. Although they are learning fast, the Chinese are not yet pros at M&A, and they often trigger backlashes from investors or voters in the countries where they show up. Plenty of blowups and setbacks are likely. China has many incentives to keep playing the M&A game, however. China's companies are often flush with cash. Loans are not an issue when state-connected enterprises have Beijing's approval to invest overseas. "Most Chinese banks are state-owned, of course," says Zhou

243 Chunsheng, a professor of finance at Cheung Kong Graduate School of Business in Beijing. "So companies find it very easy to raise money to expand their business into other countries." Officials also want to stem the resentment evident in Internet forums and campus seminars against parking most of China's $2.1 trillion in foreign exchange reserves in low-yield, inflation-sensitive U.S. Treasuries. "Why would we want to keep subsidizing irresponsible U.S. behavior that will inflate the dollar and hurt us?" asks Wenran Jiang, a political science professor at the University of Alberta. Better, says Jiang, to purchase companies. Beijing has backed overseas expeditions before. But "there's been a step-up of support since early this year," says Robert L. Kuhn, an American China consultant who knows the senior leadership well. "The support extends all the way to the Politburo." On Mar. 16 the Commerce Ministry announced that, starting in May, only provincial-level approval would be needed for overseas investments below $100 million. After Aug. 1 companies can more easily purchase foreign exchange to fund foreign acquisitions. Regulators "are giving the green light," says Guo Tianyong, a professor at the Central University of Finance & Economics in Beijing. They're prodding companies to act, too. At a July 4 Beijing conference of top politicos, Li Rongrong, the head of the agency responsible for China's top state enterprises, publicly complained that too few companies had reached global scale. "We must encourage our top enterprises to go out and enter overseas markets and expand their business," he told his audience. Avoiding Too Much Competition The biggest investments have been in natural resources companies that can help slake China's energy thirst. Such deals require precise handling. "To avoid potential political and commercial backlash, Chinese oil and commodity companies often select their targets carefully," says Luke Parker, head of the M&A Service at Edinburgh energy consultants Wood Mackenzie. "The Chinese have tended to favor acquisitions where they are not competing head to head with the majors." Buying Switzerland's Addax Petroleum, for example, gave Sinopec access to Nigerian and Kurdish oil but ruffled few feathers. When the Chinese do stumble, the results are spectacular. The latest example is the planned $19 billion-plus investment by Aluminum Corp. of China (Chinalco) (ACH) in Anglo- Australian miner Rio Tinto (RTP). Rio Tinto needed the cash, but its shareholders questioned the wisdom of selling an 18% stake to Chinalco, one of Rio Tinto's biggest customers. Most politicians openly condemned the transaction. "[China's] state-owned entities are nothing more than an arm of the Communist Party," says Australian Senator Barnaby Joyce. Stung, Rio backed off, opting instead for a $15.2 billion rights issue and a joint venture with BHP Billiton (BHP). Beijing Times was scathing: "Rio Tinto is just like an unfaithful woman. Once she loved the money in Chinalco's pocket, but she actually didn't love the man himself." In July, Beijing authorities arrested a Rio Tinto employee in China on accusations of industrial espionage, leading many to speculate China was retaliating. Some observers wonder how long it will take for the Chinese to get their dealmaking right. "The finance skills at the top of Chinese companies are not likely to be as developed as [at] U.S. or European or even Indian companies," says Anil Gupta, a professor of strategy and organization at the University of Maryland's Smith School of Business. The result, he says, is that the Chinese often overpay or fail to grasp the challenges involved in a takeover.

244 Skills and Knowhow The Chinese can also scare potential targets. Take the investments by Chinese manufacturers and retailers. "A number of these transactions are about getting skills and knowhow to use in China," says Matthew Phillips, a partner at the Shanghai office of PricewaterhouseCoopers. That was part of the logic behind Haier's stake in Fisher & Paykel Appliances of New Zealand: The Kiwis can teach the Chinese about design. This logic can backfire, as in the case of Beijing Auto and Germany's Opel. "Beijing Auto looks at Opel and sees this as a game-changer," says Mike Dunne, managing director of J.D. Power & Associates in China (like BusinessWeek, a division of The McGraw-Hill Companies). Opel's skills would give Beijing Auto a critical edge in China's car wars. But the Germans fear the Chinese are interested in Opel only as a technology resource, not as a brand to revive. That's limiting Beijing Auto's chances in the bidding, sources say. Other Chinese missteps include Shanghai Auto's 51% purchase in 2004 of Korea's Ssangyong Motors (which is now bankrupt) and television maker TCL's acquisition of RCA Thomson (generally seen as a failure). The jury is still out on the acquisition of IBM's (IBM) PC business by China's Lenovo. But the Chinese are learning. Analysts think Chinese authorities probably froze a deal for GM's Hummer by construction equipment company Sichuan Tengzhong out of fear the Chinese outfit lacks the expertise to run a U.S. company (the other reason for examining the deal is fear of the Hummer's environmental impact). PwC's Phillips says energy companies "have moved up the learning curve very quickly." Bain's Leung describes how executives from a Chinese consumer-products marketer recently traveled to the U.S. to meet with suppliers, customers, and executives of a target company. The thorough due diligence convinced the Chinese to back out. One area where the Chinese tread softly is in the U.S. They recall the abortive 2005 bid for Unocal by China National Offshore Oil (CEO), which ignited a firestorm in the U.S. Congress. "The Chinese perception is that they are trying to acquire companies using market mechanisms, yet they get caught up with political controversies," says Evan Feigenbaum, an ex-Deputy Assistant Secretary of State under George W. Bush. Still, U.S. concern hasn't held back the Chinese elsewhere. Acquisitions have gone ahead in Australia, including a $1.4 billion takeover bid by China Minmetals for Oz Minerals and a $770 million investment in Fortescue Metals by Hunan Valin Iron & Steel. "It is natural for companies when they grow up to find new opportunities outside," says finance professor Zhou. "There will be more Chinese acquisitions abroad. And the world will get used to it." Business Exchange: Read, save, and add content on BW's new Web 2.0 topic network Features-In Depth There is no shortage of Asia boosters these days. Minxin Pei is not one of them. In an essay titled "sia' Rise," appearing in the July/August issue of Foreign Policy, the scholar cautions readers not to believe the hype. Pei debunks an assortment of widely parlayed myths, such as that Asia will lead the world in innovation, that its brand of capitalism is more dynamic than the West's, and that the U.S. is losing its influence in the region. With Stanley Reed and Mark Scott in London, Steve LeVine in Washington, D.C., and Jack Ewing in Frankfurt. Roberts is BusinessWeek's Asia News Editor and China bureau chief. Balfour is Asia Correspondent for BusinessWeek based in Hong Kong. http://www.businessweek.com/print/magazine/content/09_30/b4140042991451.htm

245 SPIEGEL ONLINE 07/15/2009 04:24 PM TURNAROUND, WHAT TURNAROUND? Germany's Export Champions Slammed by Economic Crisis By Alexander Jung The recession is supposedly bottoming out, but where is the upswing? The crisis is hitting southern Germany particularly hard as engineering companies and auto parts manufacturers lose orders at a faster pace than ever before. Ironically, their strength as exporters is the cause of their current troubles. Karl Schlecht is standing on the roof terrace of his company headquarters, looking down at his life's work. He moves carefully toward the railing. Schlecht is 77, his bones ache and his new hip is causing problems. But his ailments are minor when compared with the worries of Putzmeister, the company he founded 51 years ago in Aichtal, a town in Germany's southwestern Swabia region. "It makes my heart ache," says Schlecht, as he stares out at an area devoid of human activity. There is no one to be seen on the factory grounds -- no metal workers, no mechanics, no engineers. Most of the employees have been on short time since January, and the concrete pumps and mortar machines the company produces are beginning to accumulate throughout the plant -- inventory for which there are no longer any buyers. In other words, dead capital. Only last year, Arab and Asian buyers were clamoring for Schlecht's products. Putzmeister had erected a separate building for making large pieces of equipment designed to convey concrete and mortar hundreds of meters into the sky on high-rise building construction sites in Dubai, Beijing and Shanghai. "It was like a beehive," says Schlecht, referring to the amount of activity in the new building. But nothing is humming on those sites anymore. Order volume has declined by more than half, and Putzmeister is already losing €5-10 million ($7-14 million) a month. Management consultants have analyzed the company's operations and recommended sharp cutbacks. "Well," says Schlecht, "we'll have to cut the company in half." And this at a time when others are already hoping for a turnaround in the economy? Putzmeister, with its 3,600 employees, was until recently still being celebrated as one of those typical mid-sized, virtually unknown German companies that is a world leader in its niche market. Many of these companies are mechanical engineering companies and auto parts suppliers, produce first-class products, have exceptional expertise and export a large share of what they make. Putzmeister, for example, exports about 90 percent of its products. The German economy is famous for such "hidden champions." These closet global market leaders have served as both an engine for growth and a job-creating machine for Germany. Their concentration is particularly high in southwestern Germany, in small cities and towns along a corridor stretching from Pforzheim to Stuttgart to Ulm. Their benchmark was the world, and now their world is falling apart. Orders have plunged by anywhere from 30 to 50 percent, in some cases even more. This, in turn, has created massive excess capacity. Temporary workers have long been let go, and fixed-term contracts have expired. Most of the remaining workers are now on state-supported short-time working schemes, where the government helps to make up their lost income.

246 A company that has lost half of its business needs to grow by about 10 percent a year for at least seven years to return to former levels. More realistically, management should consider itself lucky if there is any growth at all in the near future. The direct consequences include mass layoffs, plant closures and bankruptcies. Is there any glimmer of hope? "I don't think so," says Peter Zimmermann, the CEO of Mink, a company based in the town of Göppingen near Stuttgart. A family business in its sixth generation, Mink is the world market leader in specialized industrial brushes. Zimmermann is incensed when he hears people say that the worst is over. "This isn't a crisis," he says. "It's a catastrophe." Zimmermann estimates that the company has been set back by a decade. Orders have declined by 40 percent, and he is now forced to reduce staff, letting people go he would like to have kept on. The priority, says Zimmermann, is to make sure the company survives, "as horrible as it sounds." Even the boldest of optimists are slowly realizing what a break with the past the global economic crisis represents for Germany, particularly for the southwestern state of Baden- Württemberg. More than in most other regions, the population here depends heavily on exports of its products: machinery, industrial equipment and automobiles. The region was one of the main beneficiaries of globalization, making its current plunge all the more precipitous. This regional slump is relatively unaffected by the most recent figures from Berlin, which indicate that German industry experienced a rise in orders and exports in May. The general euphoria over such figures is difficult to comprehend, especially when one considers that the number of new orders, when compared with May of last year -- the key benchmark -- has declined by almost 30 percent, while exports are down about 25 percent. Perhaps the economy is indeed bottoming out, as it reaches what Frank Mattern, the head of management consulting firm McKinsey's German operations, refers to as the "new normal" of business activity. Nevertheless, old sales figures remain unattainable for now. Even if the crisis ends soon, Germany, as a manufacturing economy, will have changed after the crisis. The question is: What will it look like? Companies will become more cautious, taking less risk and investing less, even though nothing is more important now than to develop the products of tomorrow. But companies lack the confidence to do that. This lack of confidence, in turn, has been most detrimental to the dynamics of the economy. "In the coming years," says McKinsey's Frank Mattern, "we will have to get used to lower growth rates." Nowhere has the impact of economic decline been as harsh as in the region that has come to be known as Germany's Musterländle (loosely translated as "model state"). "Things are getting grim here," says Putzmeister CEO Karl Schlecht. An economic network with roots dating back to the early 19th century is beginning to crumble. Back then, young businesses located along the Ulm-Stuttgart railroad line, including press maker Schuler in Göppingen (founded 1839), exhaust specialist Eberspächer in Esslingen (1865), auto parts maker Bosch (1886) and carmaker Daimler (1890) in Stuttgart. Companies were founded then that still shape the region's industrial landscape today. They have survived two world wars and several monetary reforms, but now they face their toughest test yet. Sieghard Bender, the head of the local branch of the IG Metall metalworkers' union, considers 90 of the roughly 100 larger companies in his district to be

247 problem cases. When asked how many of those companies are still doing relatively well, the union leader pauses to think for a moment. Five, he answers. 'People Are Suffering' Bender, an easygoing man in his mid-50s, is sitting on a wooden bench in the garden behind the union's offices. The regional chapter is having a summer party, and Bender is getting himself a serving of pasta salad. He is one of the few people here who has already lived through a severe crisis. In 1991, then IG Metall Chairman Franz Steinkühler sent him to Chemnitz, a traditional location for engineering companies, to save what could be saved after the demise of East Germany. That experience helps him today, says Bender. For months, he has been rushing from one employee meeting to the next. He senses the discontent brewing among workers, who face growing problems and expectations that are essentially unrealizable. On the bright side, he says, the regional chapter is gaining new members again, at a rate of about 50 a month. The summer party has given Bender an evening of respite, with the exception of the music booming from the building. The union officials have taken refuge in the garden, where they are discussing the depressing nature of short-time work. "The people are suffering, the way a dog suffers when it has nothing to do," says Bender, slapping a colleague on the back. The man, Roland Weber, is 38 and can easily spend a quarter of an hour giving an impromptu lecture on how a piece of metal achieves the desired strength through a process of heating and cooling. This is his field, and he clearly knows it inside and out. Weber, a metal hardener by trade, has worked for Index, an Esslingen company that manufactures machine tools, for the past 15 years. He was working six days a week until last fall, but now he works only three days a month. Short-time work has turned his life upside down. Nowadays, Weber handles many of the household responsibilities, driving his children to sports practice or shopping for groceries. He runs into other Index employees at the supermarket, where he sometimes has a cup of coffee with them. Weber has quit smoking, saving €200 ($280) a month as a result. The family has been forced to cut corners, no longer going out to steakhouses in Stuttgart and canceling its beach vacation in Italy. Nevertheless, Weber estimates that they are still short by about €600 ($840) a month. "There's too much month left at the end of the money," he says. Weber prefers not to think about how much longer the short-time work will last, what happens after the company's annual summer shutdown, and whether his profession as a metal hardener has a future. "If I did, I would drive myself crazy." Hundreds of thousands of skilled workers like Weber are now idle, people the center-left Social Democrats 10 years ago were touting as the new "center" of society. They are people who were convinced that happiness is granted to those who work hard, and that success is based on performance. The sociologist Heinz Bude calls them the "core social classes of the German model." Recently they have been feeling that they are trapped in a downward spiral, and their self- confidence has been undermined. "Fear is rampant in the places where value is created in Germany," says Bude. In Göppingen, a traditional Swabian industrial town, the numbers reflect this fear. A year ago, the unemployment rate in the district was 3.5 percent, lower than almost anywhere else in Germany. It has since risen by at least a third. In June, 19,913 people were registered as unemployed. But this number only tells half the story.

248 Another 20,000 workers are on short time. Göppingen has become the capital of short-time work and, as a result, the town's reputation is changing. Schuler, the world's largest manufacturer of presses, is in the red and has cut 600 jobs. The slump in the luxury vehicle market has sharply affected automobile parts supplier Bader, which specializes in leather trim. The well- known model railroad manufacturer Märklin has declared bankruptcy. Hard times are ahead for Göppingen. Mayor Guido Till, a member of the Social Democrats, clings defiantly to every sign of hope. Graphic: German exports Only recently, says Till, a producer of construction machinery held a topping-out ceremony to dedicate a new building, in the midst of the recession. And he estimates that the town's commercial tax revenues this year will be almost as high as they were last year. In fact, Till insists, the crisis has not really made itself felt in his town, and it is "not even an issue" for the city council. A few blocks from the town hall, on the first floor of the municipal employment agency, there is a meeting of a group of people with a completely different take on the crisis. They are employers from the region who have come to the agency to learn more about short-time work. "Feel free to ask me anything you like," says Ralf Schneider, an expert from the Göppingen labor agency. Schneider knows that it takes some business owners a long time to overcome their misgivings about asking for help. One of the attendees speaks up. He wants to know whether workers have to use up all of their accumulated vacation days from previous years before they can go onto short-time work. "Yes, the leftover vacation must be used up first," Schneider responds. But what if some have accumulated more than 100 days, going as far back as 2006? "Oh my goodness," says Schneider. Another attendee asks whether apprentices can be put onto short time. Yes, in principle, says Schneider, but if apprentices fail their final examination later on, they can claim that they weren't properly trained. The employers nod their heads, as it dawns on them that they will have to do more than simply fill out an application form. "Your personnel department won't have to go on short time, I can promise you that," says Schneider. Until recently, the biggest challenge for the employment advisers in Göppingen was to provide companies with enough skilled workers. Now they are struggling with a completely different set of problems. For instance, apprentices who have not been offered full-time work after completing their training programs are increasingly claiming unemployment benefits. The number of unemployed workers under 25 has grown by 82 percent within a year. And, says agency director Martin Scheel, those who are coming to the agency to look for work are, for the first time, mainly people who have completed a vocational training program. "This time, we can't say that it's only affecting unskilled workers." Many people have come to the bitter realization that even the kind of specialized expertise which was always prized in Germany is no guarantee against losing one's job. This is a consequence of global competition, which is becoming considerably more cutthroat now that the prosperous boom years are over.

249 Today, engineering companies and auto parts makers from Asia are penetrating deeply into markets for high-quality goods, markets once dominated by German specialists. The Chinese competitors are making products "of a quality that would leave you speechless," says Putzmeister founder Karl Schlecht. Schlecht has a certain amount of admiration for his Asian competitors, for their discipline, their business acumen and their thriftiness -- all traditional Swabian virtues. "They will soon be making the things we make here just as well as we do, but for a much lower price." For industry veterans, this raises fundamental questions, questions which are on the minds of everyone in the export industry today. Would it have been possible to prevent this sharp downturn? What should companies do now? How can they bring down labor costs even further? Daimler has led the way in this regard. Roughly 60,000 Daimler employees now earn and work almost 9 percent less than they did before. But is this enough? Or will companies have to shift even more of their production away from Germany? Moving production abroad was in decline until recently, but now corporate strategists are rethinking their calculations. Or could the solution be for export-focused companies to abandon their niches and expand their range of customers and products? Some companies have already taken this approach. Auto-parts maker Bosch, for example, is expanding its renewable energy business. But this is only effective to a certain extent, because Bosch's customers in the wind and solar power industries are also struggling and are often unable to secure the financing they need. The options are unsatisfactory. "We did everything right," insists Mink CEO Zimmermann. He says that he consistently emphasized quality, delivered his products on a just-in-time basis, and maintained a broad base of 20,000 customers and 300,000 products. Even more importantly, his company produces brushes, a product which wears out and needs to be replaced. "We thought that was our life insurance policy," says Zimmermann. Zimmermann and his son Daniel, who belongs to the seventh generation of Mink owners, walk through a building that smells of fresh paint. State-of-the-art hole-punching machines are lined up on the floor, virtually untouched, precisely placed behind yellow marker lines. Zimmermann constructed the building specifically for Trumpf, an engineering company based in Ditzingen near Stuttgart, at a cost of €3.5 million ($4.9 million). Trumpf needed plastic panels with embedded brushes, which it uses to prevent pieces of sheet metal from being scratched during shipping. But then demand also slumped at the Ditzingen company. The Mink/Trumpf relationship is indicative of how interdependent companies are in Swabia. When the auto industry is ailing, it no longer needs hole-punching machines from Trumpf. And when Trumpf loses orders, the demand for Mink's brushes declines. The challenge now is to ride out the recession, says Zimmermann. But there is one thing he refuses to do: sell the company. He points to his son and says: "The two of us will be the last to go." Alexander Jung TURNAROUND, WHAT TURNAROUND? 07/15/2009Translated from the German by Christopher Sultan URL:http://www.spiegel.de/international/business/0,1518,636341,00.html

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Viewpoint July 15, 2009, 9:00PM EST Recovery: Where Will the Jobs Come From? Health care and education will keep adding jobs. Manufacturing employment will rebound as the global economy revives, but a big cut in the jobless rate will take years By Chris Farrell The good news is that the downward momentum of the Great Recession is subsiding. The financial panic that seized the global capital markets has eased. CEOs are no longer acting as if depression looms. That said, the consensus forecast is for the economy to emerge slowly out of the downturn. The recovery won't feel much like one, and that's bad news for a labor market where 6.5 million jobs have been lost since the recession began. With the unemployment rate climbing toward double digits, it isn't only Republican lawmakers who are wondering "where are the jobs?" "It's always the case that in the depths of the recession it's hard to say where the jobs will come from," says Barry Bosworth, economist at the Brookings Institution. So, where will the jobs come from? The White House Council of Economic Advisers recently asked just that question. (You can read the report at www.whitehouse.gov/administration/eop/cea/Jobs-of-the-Future.) To come up with an answer, the economists updated the Bureau of Labor Statistics' job projection numbers that were last published in 2007. The CEA's projections run from 2008 through 2016. Sharp Rebound in Manufacturing Jobs? To some extent, the CEA's answer to the trillion-dollar question is: where they're coming from now. (See the accompanying chart.) Health care and education are two sectors of the economy that have expanded throughout the downturn, and both are expected to account for a major share of job growth over the next several years. Employers in all industries will favor workers with skill and education ranging from certificates earned at community colleges to higher degrees. On the other hand, retailing is likely to continue shrinking. Cyclically, export-oriented industries should get a boost as the global economy revives. American-made goods are increasingly competitive, with the dollar relatively weak compared with other major foreign currencies. Indeed, Bosworth expects a sharp rebound in manufacturing employment, especially in the manufacturing-heavy Midwest. It wouldn't take much of a pickup in orders for manufacturing management to recall laid-off workers. "The long-term trend is bad," he says. "But the cyclical trend will be positive because it got clobbered so badly." Economists believe there will be job growth over the next several years. The Great American Job Machine is grinding away slowly at the moment. But job creation is something the U.S. eventually does well. Problem is, it could take years to work down a 10%-plus unemployment rate to more acceptable levels, say, in the 5% range. Wages are likely to be anemic, too, considering how tough the competition will be among laid-off workers for jobs. Income inequality could worsen. "I'm reasonably confident about the state of employment," says Joshua L. Rosenbaum, economist at the University of Kansas. "I worry more about the income level we will have."

251 Wild Card: Innovation The wild card in all this is that job forecasts are notoriously unreliable. The reason is technological innovation and the discovery of new ways of doing business. Innovations can generate jobs—if they materialize. For instance, in 2003 a quarter of American workers were in jobs that weren't listed in the Census Bureau's occupation codes in 1967. You sure won't find words like "Web designer" or "mobile-phone salesperson" in the LBJ-era list. "What's unpredictable are the physical gizmos that will trigger a multiplier effect with employment," says Amar Bhide, visiting professor of economics at the Kennedy School of Government at Harvard University. Daniel Boorstin, the late historian, captured the dynamic this way in a 1987 essay: "Who, for example, could have predicted that the internal- combustion engine and the automobile would breed a new world of installment buying, credit cards, franchises, and annual models—that they would revise the meaning of cities, and even transform notions of crime and morality with no-fault insurance." Problem is, no one can say whether such innovations will appear. Until they do, the prospect is for higher unemployment in the short run and a slow climb into mostly knowledge-based jobs somewhere down the road. The jobs machine may have to wait for a new power source to kick it back into high gear. http://www.businessweek.com/print/investor/content/jul2009/pi20090715_353248.htm

News July 15, 2009, 8:21PM EST The Time Bomb in Corporate Debt Company defaults on the heels of record borrowing will hamper the recovery. Going straight into bankruptcy may be a healthier option By David Henry No surprise here: As the recession grinds on, more companies are falling behind on their debt payments. The default rate tops 11%, up from 2.4% last year—and could peak at 12.8% by the end of the year, the highest ever, according to credit rating agency Moody's Investors Service (MCO). But what's worrying economists more is that the rate could remain stubbornly high for quite a while. "Be prepared for a multi-year period of high defaults," says Louise Purtle, a senior analyst at CreditSights. "We're going to see peaks like a mountain range." That's a departure from the usual pattern in recessions, even severe ones. Historically corporate defaults spike as downturns ease, then fall back to more normal levels. But the recovery may be delayed this time around. Companies aren't cleaning up their balance sheets that much, and current debt levels are unsustainable. The debt overhang could hamper the economy for years to come. The problem, of course, is that corporate borrowers binged on credit during the boom years. Now U.S. companies carry some $1.4 trillion in high-yield bonds and loans, a burden that's nearly triple the amount in 2001, according to Standard & Poor's Leveraged Commentary & Data (MHP), a research group. More than half of the debt comes due in the next five years. Already the pile of debt is forcing companies to make painful choices that will reverberate through the economy. Consider newspaper publisher Gannett (GCI), which has $3.5 billion in

252 debt and reported $1.1 billion of cash flow in the past 12 months. Amid slipping sales, the company is slashing payroll and cutting its dividend. While Gannett has the money to meet interest payments, it has sharply reduced investments for growth. Says a Gannett spokeswoman: "In the first quarter we paid down debt." It's proving more difficult to unwind debt today than in previous downturns. Distressed companies can't easily sell assets to pay off debt amid the harsh dealmaking environment. And many owe more than their underlying assets are worth—not unlike homeowners who owe more on their mortgages than their homes would fetch on the market. Meanwhile, big banks and other financial firms, still battered and bruised from the financial crisis, don't have the strength or the will to refinance all that debt. Without many options, more borrowers will find it tough to meet their financial obligations. So far this year, 128 companies have defaulted, including General Motors, clothier Eddie Bauer (EBHIQ), aerospace company Fairchild, and paper maker Bowater. Those four companies have filed for bankruptcy. S&P figures an additional 207 are "vulnerable" to default. Among the distressed: auto suppliers Accuride (AURD) and American Axle & Manufacturing (AXL), retailers Claire's Stores and Saks (SKS), as well as real estate franchiser Realogy, the owner of the Century 21 and Coldwell Banker brands. Companies are doing everything they can to avoid default. Some have worked out "amend and extend" deals, which postpone the due dates on their loans. For example, video rental chain Blockbuster (BBI) was able get an extra 13 months to pay off a bank loan. In exchange, the company agreed to pay an additional 8% in interest. Lenders are being cautious. Accuride, which makes chassis for trucks, got a mere 45 days to meet financial tests that are a requirement of its loans. Accuride declined to comment. "Band-Aid" Relief Other companies have stays of execution built into their bonds already. During the boom years, more than 60 companies issued bonds that allowed them to put off interest payments for the life of the bond. In a sign of distress, at least 23 companies are using that option today, including casino giant Harrah's Entertainment, chipmaker Freescale Semiconductor, and retailer Neiman Marcus. Neiman Marcus declined to comment. Harrah's and Freescale didn't return calls. But such moves provide only temporary relief. The arrangements "are like Band-Aids," says M. Christopher Garman, editor and publisher of Leverage World. They "don't solve the basic problem" of too much debt. Instead, companies are postponing the inevitable, which weighs down their balance sheets and drags down the broader economy. Look at the recent spate of debt modifications. In the first six months of 2009, nearly 40 companies made special deals with creditors to trim their debt. Generally, only a handful of companies make such arrangements each year. And they're often unsuccessful, according to a recent study by Edward I. Altman, a professor at New York University's Stern School of Business: About half the companies that got these sorts of concessions end up filing for Chapter 11 anyway. "It's a disturbing statistic, because it implies either that their problems were more than debt or that the reduction in debt wasn't enough," says Altman. Chapter 22 The trend persists today. In May 2008 amusement park operator Six Flags (SIXFQ) persuaded a group of creditors to reduce its debt by 5%, or $130 million. The move gave Six Flags some breathing room for its busy summer season and a chance to improve its fortunes. But the company's problems proved insurmountable. Six Flags filed for bankruptcy in June 2009.

253 Media conglomerate Charter Communications filed for bankruptcy in April after lenders modified its debt several times. "Most of the widely used out-of-court restructuring options, such as debt exchanges or refinancing, do not solve the ultimate problem" of excessive leverage, says Bradley Rogoff, a bond strategist at Barclays Capital (BCS). Six Flags declined to comment. The economy may be better off if companies filed for bankruptcy at the outset. Sure, Chapter 11 isn't a cure-all. Many companies that get out of bankruptcy return to court in what experts sarcastically refer to as Chapter 22. But the proceedings do a better job of cleaning up the books and reducing debt loads. Spectrum Brands, the maker of Rayovac batteries, Tetra fish food, and other consumer products, is set to emerge from bankruptcy in August with one-third less debt than when it filed in February. That's twice the relief that companies typically get from creditors out of court. Bankruptcy "often yields better results than just tinkering with the debt and keeping the same management," says Garman of Leverage World. "The only way to really repair a balance sheet thoroughly is Chapter 11." And the more debt that's wrung out of the system, the stronger the overall recovery. Default Despair While much of the corporate sector is suffering, the pain varies greatly by industry, according to a July report from credit rating agency Standard & Poor's (MHP) (which, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP)). Homebuilders and media companies, whose default rates top 10%, are in the worst shape. Surprisingly, financials are among the strongest, with a rate of 2.17%. Only two industries have default rates below their historical averages: telecommunications and utilities. http://www.businessweek.com/print/magazine/content/09_30/b4140022152923.htm

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Goldman defector draws attention to electronic trading firms When Sergey Aleynikov was busted, he was headed to work for Teza Technologies. By William D. Cohan, contributor Last Updated: July 15, 2009: 10:35 AM ET NEW YORK (Fortune) -- After the arrest earlier this month of Sergey Aleynikov, the former Goldman Sachs IT executive, the blogosphere was briefly abuzz with the notion that Aleynikov's new employer would be the Chicago-based, Global Electronic Trading Company, known as GETCO. GETCO is far from a household name, and so the rumor and Aleynikov's arrest drew attention to the highly secretive corner of Wall Street firms, such as GETCO, that are big players in the world of electronic trading. As it turned out, Aleynikov actually had accepted an offer to work for a GETCO competitor, Teza Technologies. That was before he was arrested at Liberty International Airport in Newark, N.J. on July 3. Federal prosecutors subsequently charged Aleynikov with allegedly stealing some proprietary technology that allows Goldman Sachs to execute high-speed and high-volume trades. At a July 4 court appearance, Sabrina Shroff, a lawyer for Aleynikov, said that the government's allegations were "preposterous." She claimed her client was downloading programs to his personal computer to work at home and hasn't disseminated the code. Why software matters to traders The reason that trade secrets are so highly coveted in this world is that firms like Teza and GETCO use their own money to exploit tiny discrepancies in the price of securities from one millisecond to the next. When it comes to computer-driven mega trades, milliseconds count. For instance, a typical trading strategy for GETCO and its ilk would be to exploit the momentary pricing differences between a stock index -- say the S&P 500 (SPX) -- and the stocks that comprise that index. It's a new form of arbitrage that relies primarily on proprietary computer programs, high-speed computers in huge data centers and proximity to various exchanges to be able to get the proprietary information before competitors via high- speed fiber optics cables. "Electronic routing and execution has become the mechanism by which our capital markets operate," according to a recent report by Robert Iati, a partner at TABB Group. "Algorithms account for more than 25% of all shares traded by the buy side today -- a number steadily rising for several years now." Iati said that the "incredible capabilities" offered by technology have given meteoric rise to a relatively few high frequency proprietary trading firms, and that familiar names like "Merrill [Lynch] are being replaced by less familiar ones like Wolverine, IMC and Getco." In an interview with Fortune, Iati recounted how these proprietary trading companies are vying to locate as close to the New York Stock Exchange's new multi-million-dollar data center -- being built in Mahwah, N.J. and set to open in 2010 -- as they can to get the information about trading activity as quickly as possible. "Proximity is everything now," he said, since the data travels over fiber-optic cables at light speed and the less distance it travels, the more quickly it arrives, and the more quickly the price discrepancies can be exploited.

255 GETCO keeps a low profile as it prints money GETCO was founded in 1999 by former traders Daniel Tierney and Stephen Schuler, and Schuler's wife, Mary Jo Schuler, in Chicago -- where many of the new breed of millisecond trading operations are based so as to be close to the Chicago options and trading exchanges. Sophie Sohn, a spokeswoman for GETCO, declined to make additional information about the company available, such as the founders' background, where they used to trade, or the firm's revenues and profits. Sohn said Schuler was out of the country on vacation and would not be available to comment about his firm's business. What is known is that the Schulers, who have two children, are prominent philanthropists in Chicago, having started the Good Heart Work Smart Foundation, which donated some $200,000 to the Park District of Oak Park to renovate a Chicago park. And according to Iati, at the TABB Group, GETCO is making "hundreds of millions of dollars" in annual profits these days and employs "several hundred people," 200 to be exact, according to Sohn, who work in Chicago, New York, London and Singapore. Iati said firms such as GETCO are "very prominent now and wield a lot of influence" in part because they are providing badly needed trading liquidity to the market at a time when the traditional sources of that liquidity -- the big investment banks -- are extinct or highly regulated. In April 2007, General Atlantic Partners, which refers to itself as a "global growth equity" investor, bought a minority investment in GETCO that, according to The Wall Street Journal, was between $200 million and $300 million, and that valued the firm at between $1 billion and $1.5 billion. General Atlantic CEO Bill Ford, and his partner Rene Kern joined the GETCO board, although no other information about the company or General Atlantic's investment in it is available on the General Atlantic website. A spokeswoman for General Atlantic said both Ford and Kern were traveling and not available to comment. She also declined to confirm the amount of General Atlantic's original investment in GETCO. "We are partnering with General Atlantic because of our shared vision for the evolution of capital markets, the firm's understanding of the impact of technology on financial services, its experience supporting growth companies in our industry and its extensive global network," Schuler said at the time. Iati said he believes General Atlantic has "made a mint" on its GETCO investment. A spokeswoman for General Atlantic said it would not be unusual for GETCO to at some point consider a public offering although no such IPO was currently in the works. GETCO's dark pool business GETCO also has a separate business from its proprietary speed-of-light arbitrage business that provides customers, such as money managers and hedge funds, with fast-trade execution often with an "immediate or cancel" feature that insure that the trades cannot be traced. These hidden stock-trading venues, also known as "dark pools" -- in part because the trading takes place away from any exchange and therefore without any reports being filed -- have captured an increasingly large share of U.S. equity volume in recent years. The leading "dark pool" is Goldman Sachs' "Sigma X," which executed about 162 million external orders in April 2008 followed by CrossFinder (owned by Credit Suisse), Knight Link (owned by Knight Capital Group) and then by GETCO, which started its GETCO Execution Services dark pool in March 2008, also according to TABB Group.

256 The fate of the Goldman defector As for Aleynikov, his new firm, Teza placed him on leave after his arrest. And the Goldman Sachs (GS, Fortune 500) defector is not Teza's first brush with controversy. Teza is an "offshoot" of Citadel (the Chicago-based mega hedge-fund). However, following Aleynikov's arrest, Citadel sued several Teza employees including former Citadel trader Misha Malyshev and two other former Citadel employees, alleging that their formation of a new trading firm violated a non-compete agreement they had with the hedge fund. The complaint, filed July 9 in the Chancery Division of Cook County Circuit Court, named Teza, Malyshev and his colleagues Jace Kohlmeier and Matthew Hinerfeld, who both left Citadel along with Malyshev earlier this year. It asks the court for an expedited hearing in the case, saying that Teza could cause "irreparable" harm to Citadel. It also mentions the Aleynikov affair, saying, "Teza's decision to hire Aleynikov, an accused software thief, creates a substantial risk that they have stolen, or may be planning to steal, Citadel's proprietary code." So while these firms are making money hand over fist while trading at the speed-of-light, the ongoing civil and criminal litigation will make it much harder for them to keep out of the limelight. First Published: July 15, 2009: 6:02 AM ET http://money.cnn.com/2009/07/14/news/companies/sergey_aleynikov_getco_goldman.fort une/index.htm?postversion=2009071510

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From the Runways of Austria ...

Mises Daily by Pia Varma | Posted on 7/16/2009 12:00:00 AM It's Economics Week here in Austria and I am reporting on the hottest brands burning up the runways of political thought. All the big names have come out for this star-studded event: the always confused Friedrich Nietzsche, the minimalist and objective Ayn Rand, and the German bohemian-hippie Karl Marx have all graced us with their presence. However, the two haute couture lines creating the most buzz are "Laissez-Faire," by Ludwig von Mises, and "Après Moi le Déluge" by British export, John Keynes. For years these two competing brands have been catfighting it out for dominance in the fiercely competitive international scene. Although both lines will turn heads, they couldn't be less alike. Mises's Laissez-Faire has, as usual, turned out beautifully — it is classic, simple, elegant, and understated. No contradictions. No delusions. No trying-too-hard-to-make-this- work, Betsey Johnson–style market manipulations. Just clean lines and universal truths. With Laissez-Faire, less is always more. Keynes, on the other hand, puts his loud, garish mark on everything he touches. In typical razzle-dazzle style, Déluge will be the talk of the town all season, only to be regretted, discarded, and replaced with the newer, hotter, and edgier trends of next season. With every line overcompensating for the mistakes of the past, the prima donna is shameless in his denial of failure. When Keynes was asked recently about Mises's "Laissez-Faire" line, the diva quipped, "It is better to be roughly right than precisely wrong." Young, naive, overly intellectual, and cocky, Keynes has, over the years, managed to produce nothing but overly complicated intellectual litter that is ripe for racks of sample sales; Déluge is fodder for the herds of wannabes desperate to fit in. The standard fair for Keynes is akin to stripes, patterns, and polka dots, leaving the wearer in a position similar to the titular character in "The Emperor's New Clothes" — perhaps not à poil, but similarly risible! In contrast, Mises has always been a realist, maintaining discipline and control, giving his styles a timeless touch. Mises sets a high standard. He doesn't just see this season or next season: the ideas in Laissez-Faire are not tied to any short-term trend or fad — they are meant to be worn for decades to come. Unlike Keynes, Mises will never force an unflattering — although popular — style into his line. He knows and sticks with what works. When it comes to a label's reputation, these designers have taken wildly different tacks. While Mises has maintained his label's currency by backing it with strong brand assets, using quality fabrics, and controlling supply, Keynes has chosen an alternate plan. He has insisted on making sure every young Hollywood starlet is clad in his styles. He doesn't care that his Chinese manufacturers are sweat shops using the cheapest fabric available. And he has no idea that they are diluting the value by throwing even cheaper knockoffs to the black market. Let's not even start with the gray market! The man doesn't understand business at all. Just who are these two men designing for? Let me sketch you an outline. John Keynes designs for those who want what's trendy and want it now — whether it works for their body type or not. Inappropriate for almost every occasion? They'll take it! Keynes doesn't care, so why should they? After all, the man did arrogantly state in a post-show press conference that "in

258 the long run, we're all dead!" Keynes's designs are based entirely around the instant gratification, quick-fix culture that is currently in vogue. His frequent centerpiece is a psychedelic mini-skirt of a feel-good program, which will be lauded by the sycophantic press as being ahead of its time. His overly inflated ego fed once more, Keynes will continue to put out more disastrous, clashing choices. And Laissez-Faire? Mises designs with longevity in mind. He approaches his line with maturity and responsibility. Despite the recent assertions by French critic Nicolas Sarkozy that "Laissez-Faire is finished," it has continued to remain a firebrand, reserved for the strong and the self-assured. Mises's designs are for those who know what they want, and what works and what doesn't. You can do business in Laissez-Faire. You can be successful in Laissez- Faire. You can prosper in Laissez-Faire. Not so with Keynes. Keynes is popular with the crowd who plays at life. His styles are immature and perfectly suited for socialites who gossip, fight, envy, get jealous, and steal each other's boyfriends. The ones who stir up drama and entangle themselves in things that aren't any of their business. His line exudes a certain lack of responsibility or concern for consequences. He designs for the spoiled beauty queens who walk around on a moral high horse wanting to save the world but spend their days shopping and maxing out their credit cards — and then calling their parents to bail them out. I can't look at his cheap easy-evening looks without picturing partying till dawn, breaking windows à la Britney Spears (as Bastiat rolls in his grave!), collapsing, and waking up in a state of depression with no money and a heck of a lot of debt. I cringe at the image of evenings spent taking advantage of well-meaning, hard-working businessmen who buy the drinks because it's the chivalrous thing to do — and of evenings spent being taken advantage of by not-so-nice men who are looking for some quick favors. Morality … thats all relative! It is always painful for me to sit through a Keynes show. The Iron Lady of high economics herself, Margaret Thatcher, sat next to me concurring that "nothing is more obstinate than a fashionable consensus." The designs are great in theory on a 5'10"-size-2 model, but I cannot help but think of the countless women who will spend entire evenings sucking in the stomach of market realities, constantly tugging and pulling at the skirt of human nature, and trying desperately to walk in the broken heel of a failed government policy. It all adds up to one giant, unfashionable moral hazard that is certain to land anyone on People Magazine's Worst Economics List!

$90 $60 Austrian Economists T-Shirts: The Full Collection

259 I apologize if I have hurt Mr. Keynes's feelings. I know I have been a tad bit harsh, but someone had to rip his metaphorical clothing to shreds. Darling, this is the cutthroat world of economics where you must leave your emotions at the door. I applaud Ludwig von Mises for a wonderfully inspiring show. For me, he has been the highlight of the week. His designs are not about himself or even about the outfit, but rather are meant to emphasize the unique personality of the person wearing it. Mises designs for the individual, not the masses. He knows that simplicity, conservatism, restraint, and freedom within parameters are what make his brand so consistent, so powerful. Mises understands that these are pearls of wisdom and gems of truth: the large, high-waisted, oversized belt of tight fiscal and monetary policy. Mises is also acutely aware that it is only within the strict laws of good economic style that a person's free spirit and brilliance may truly shine through. Pia Varma is a businesswoman turned freedom fighter. She received her B.A. in international business and marketing from the George Washington University. She is currently pursuing a masters in communications from Columbia University. See her website: www.PiaVarma.com. http://mises.org/story/3571

260 THURSDAY, JULY 16, 2009 Housing: Sticky Prices by CalculatedRisk on 7/16/2009 09:41:00 PM Earlier today, DataQuick reported that home sales increased in the California Bay Area. The report mentioned "a perception among potential buyers that prices have bottomed out."

First, a little history: When the housing bubble was inflating, the demand for housing surged with the widespread use of non-traditional mortgage products. Looking at a supply-demand diagram, this surge in demand pushed the curve to the right. At the same time speculators were buying up properties, reducing the supply with the intention of selling later at a higher price. This activity shifted the supply curve to the left (this activity was classic storage). So with the surge in demand, combined with speculators removing supply from the market, prices skyrocketed. This is exactly what I described in April 2005: Housing: Speculation is the Key Of course, once the bubble burst, the supply curve shifted back to the right with speculators unloading properties and all the distressed sales. At the same time, demand declined sharply as speculators disappeared and lenders tightened standards. If housing was a perfect market, prices would have fallen rapidly to the market clearing price. However housing prices are sticky downward - as I described in 2005 post: "[R]eal estate prices display strong persistence and are sticky downward. Sellers tend to want a price close to recent sales in their neighborhood, and buyers, sensing prices are declining, will wait for even lower prices. This means real estate markets do not clear immediately, and what we usually observe is a drop in transaction volumes." This doesn't mean prices are stuck - just sticky. Prices have been falling in most areas for three years, and will probably fall further. And this brings us back to the DataQuick article. Just because demand is picking up a little, doesn't mean prices have bottomed. Note: Ignore the median price in the article - that is rising because of the change in mix. Assume the following diagram shows the current housing market supply and demand. With the current supply and demand curves, and a perfect market, prices would be at P0 and quantity Q0. However prices were actually at P1. Note that demand doesn't fall to zero just because the price is above the market clearing price.

Now prices have fallen from P1 to P2.

This has increased the demand from Q1 to Q2.

I've drawn the diagram to show P2 is still above P0 (typo fixed). Naturally the current buyers think "prices have bottomed out", but they haven't for the market shown. There are clues in the DataQuick report that prices are still too high. The volume of sales is still below normal, foreclosure resales are 37.3 percent of the resale market (a very high

261 percentage) - and foreclosure activity "remains near record levels". And the foreclosure resale statistic don't include short sales, and the recent data from Sacramento suggest short sale activity is fairly strong. There are other reasons to believe prices will fall further, but I just want to point out that the small pickup in demand doesn't suggest a price bottom.

http://www.calculatedriskblog.com/2009/07/housing-sticky-prices.html

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16.07.2009 Blair and Barroso

Those whom the Gods wish to destroy, they first make mad. After the Americans elected Barrack Obama, the Europeans seem to be preparing to appoint/reconfirm that Iraq War “dream ticket” of Jose Manuel Barroso at the Commission and Tony Blair as president of the European Council. Do not dismiss the idea too quickly. After receiving the backing of Gordon Brown, Tony Blair is now (almost) an official candidate for the job, and since Nicholas Sarkozy also favours Blair (he once proposed the idea himself), and so would Berlusconi and Zapatero. If Barroso remains at the Commission (which is very likely), Merkel would find it hard to block a Socialist of the standing of Blair. The Belgians might oppose him, but remember this vote will be taken under qualified majority, and Blair has a lot of support in central and eastern Europe. The conservative Nordics would probably also not oppose him. Glenys Kinnock proposed the idea yesterday, according to the Financial Times, and Downing Street said immediately it would support Blair if he was a candidate. Blair’s aides said there is no job yet to apply for, since it would depend on the ratification of the Lisbon Treaty. (We thought at first that a Blair candidacy would give the Irish a good reason to vote against the Treaty, but we are told that this is not so, since Blair is actually popular in Ireland, as he brokered the Irish peace agreement). For the euro area this means, that there is no job for Jean-Claude Juncker to go to, so that we are stuck with him at the eurogroup for another term (which we think would be another bad (re)appointment. With Barroso/Blair/Juncker in charge, we shudder to think whom they appoint as foreign minister. See also Gideon Rachman, who speculates in his blog on why Brown might support Blair. France faces 7% structural deficit In Les Echos Jacques Delpla makes the point that the financial crisis reduces potential output, thus implying that the cyclical deficit will effectively be structural. The basic point here is that the financial crisis reduced potential output thus if France is to get back to its former growth trend it needs extraordinary growth, while if it were to realise to usual 2% growth from 2011 onwards it still would be 5% below its former trajectory. The worst scenario would be if France would even lose its capacity to generate 2% growth. In the second scenario (lower

263 level but same growth rate from 2010), it implies a 4pp increase in the structural deficit to GDP ratio mainly though the fall in revenues on top of the 3% already projected deficit, implying a 7% structural deficit if there is no radical change in politics. The euro area’s fall of potential output explained Declan Costello, Alexandr Hobza, Gert Jan Koopman, Kieran Mc Morrow , Gilles Mourre, István P. Székely write in Vox that the crisis may reduce the EU’s potential output by 5% of GDP or more. This column warns that the crisis may permanently reduce the EU’s supply- side capacity unless policymakers respond with reforms. It outlines measures to address the crisis and address long-run concerns about demographic shifts, public finances, and climate change. Barroso on the Constitutional Court EU Observer reports on Jose Manual Barroso’s comments on the German Constitutional Court’s judgement, saying it raises serious issue for the future of European integration, and requires further political discussions. Barroso did not provide many details, except saying that the ruling raised “very important and sensitive issues in terms of the competence of the European Union and other competences, namely on the understanding of the principle of subsidiarity.” Klau on Germany’s constitutional court Thomas Klau, in his FT Deutschland column, is aghast at the ruling by Germany’s Constitutional Court, especially its antediluvian views about the European Parliament, and its extreme narrow-minded views of the nature of parliamentary representation. He draws parallels with the US, where supreme court justices are much more public figures and where they undergo public scrutiny before their appointments, unlike in Germany where they are effectively anonymous. He concludes it would be good both for the future of European integration and the health of German democracy to start a campaign against the court and its xenophobic ruling. Inflation is now official negative This is more an event for headline writers than for economists. Euro area inflation was negative in June on an annual basis, to the tune of 0.1%, due entirely to oil prices, which were very high last June. Core inflation, excluding energy and food, was 1.2%. The FT writes that there is no likelihood of a persistent deflation, so that the ECB tolerates this temporary deviation from its inflation target. Cost cutting time in Ireland Two cost-cuttings reports for Ireland will be published today. The Irish Independent has details on the long awaited 300pages report from an expert group, who recommend savings of more than €1.5bn in the social welfare and the axing of 20,000 public-service jobs as well as merging several departments. The articles argues that it would be politically explosive to cut back social welfare as it would convey the impression that the Government is going after the most vulnerable to shore up the hole in the public finances. The second report is from the government itself, which decided to go ahead with the publication amid concerns about repercussions for the Lisbon Treaty referendum, scheduled for October 2, and tensions in the coalition. Ireland is expecting a deficit of 12.2% this year and 11.4% next year.

264

China’s reserves are exploding China’s foreign currency reserves rose by some $180bn ($140bn if adjusted for valuation effect) to $2130bn during the second quarter, Bloomberg reports. Rachel Ziemba writes that this is much larger than the country’s combined trade surplus, FDI and interest income so that there is a lot of hot money flowing into China at the moment, which may suggest that the stimulus is working perhaps too well. She also notes that China seems to have difficulty diversifying out of US dollars. The FT’s Lex column has noted the notion of unwinding of global imbalances sits right up their with the tooth fairy.

265 vox Research-based policy analysis and commentary from leading economists

The negative impact of the financial crisis on potential output necessitates an EU-led policy response Declan Costello, Alexandr Hobza, Gert Jan Koopman, Kieran Mc Morrow, Gilles Mourre, István P. Székely 15 July 2009

The crisis may reduce the EU’s potential output by 5% of GDP or more. This column warns that the crisis may permanently reduce the EU’s supply-side capacity unless policymakers respond with reforms. It outlines measures to address the crisis and address long-run concerns about demographic shifts, public finances, and climate change. The IMF’s most recent forecasts project that the EU’s GDP will fall 4.7% this year and continue to shrink (-0.1%) in 2010 (IMF, 2009). Financial market turbulence, credit shortages/deleveraging, higher unemployment, and steep reductions in activity in certain industries as resources reallocate will inevitably lead to a non-negligible short-run (i.e. 2009/2010) loss in the supply-side capacity of EU economies. However, the repercussions for potential output over the medium and long run are much less certain and depend on an assessment of the various channels through which the crisis could impact labour market developments, investment, and the rate of technological progress (TFP growth). For labour markets, the key determinants are the time needed to reallocate the newly unemployed into alternative employment posts in expanding industries and whether countries can avoid "hysteresis effects" whereby a severe loss in human capital endowments, induced by long spells of unemployment, leads to long-lasting exclusion from the labour market. Investment has already fallen dramatically in the crisis, resulting in a slowdown in the rate of accumulation of productive capital. This, when combined with higher rates of capital obsolescence, is lowering potential growth in the short to medium run. In addition, these adverse effects could persist in the long run if the cost of capital is permanently increased due to changes in attitudes towards risk amongst investors. These developments can also affect the rate of technological progress in the long run, if, for example, they reduce the incentive to engage in innovative activities. It is useful to distinguish the impact of the crisis on the level of potential output in the long run from the impact on long-term potential growth rates (ECFIN 2009). If potential growth rates eventually return to their pre-crisis path, the only permanent effect will be on the level of potential output – the magnitude of this level effect will depend on the amount of growth "lost" in the immediate crisis period and the time needed for activity to recover towards its long-term path. This is illustrated in Figure 1 as a "permanent level loss" scenario (i.e. case 2), and is the broad outcome observed for Korea since 19971. A more optimistic "full recovery" scenario is also feasible if "lost" growth is fully recouped in future years: examples include Mexico (1994), Sweden (1991), and, to lesser extent, Finland (1991). However, there is also a risk that the long-term path of potential growth in the post-crisis era will be permanently lower, either as a direct consequence of the crisis (e.g. shift in risk aversion, insufficient R&D and innovation) or due to inappropriate policy responses. This

266 is shown as a "continuous widening loss" scenario (case 3), as was the case in Japan (1991) and Thailand (1997). Figure 1. Financial crisis and potential output: Three possible cases Case 1. Full recovery

Case 2. Permanent loss in potential output level, no change in long-run potential growth

Case 3. Continuous widening loss due to lower long-run potential growth

267 Expect significant losses in potential output over the long run According to ECFIN estimates of the short-term impact, the severe economic crisis will lead to a sharp downward revision in potential growth rates. These estimates indicate that the potential growth rate of the EU in 2009/10 will be cut in half compared with 2008 (i.e. from around 1.5% to 0.75%) due to increased structural unemployment, a substantially reduced contribution from capital accumulation, and moderate growth in technological progress (total factor productivity). The effects in the medium to long term are more uncertain. Nevertheless, simulations with the Commission's QUEST III DSGE model based on "realistic" assumptions (i.e. a quasi- permanent deterioration in financing conditions, with borrowing costs staying on average 1- 1.25 percentage points higher over the next 20 years compared with the pre-crisis period) point to the possibility of a slow recovery in the EU's medium-term potential growth rate (a point of view shared by recent OECD & IMF analyses), as well as highlighting the risk of a long-run, cumulated, loss in potential output of around 4.5% of GDP. In addition, the simulations suggest that permanent losses in the potential growth rate could materialise due to the negative impact of the higher borrowing costs on intangible investments (R&D, innovation, and ICT capital) and consequently the rate of technological progress. EU economic policies in the years to come should therefore assume a permanent loss in potential output of the order of 5% of GDP as a result of the crisis. What can we learn from past crises? Past episodes of financial distress point to several useful insights on the possible impact of the present crisis on potential growth: • First, crises due to financial distress are characterised by losses in output and employment that are twice as large as those from "classical" downturns, and moreover they can weigh on long-term growth rates. The prompt resolution of problems in the banking sector is fundamental to minimising the effects of the crisis on potential output over the long run; • Second, the impact of crises on long-term potential growth has been very mixed. TFP growth rather than labour market performance explains the different outcomes across countries; • Finally, and most importantly, policy responses matter greatly. For example, Sweden and Finland reversed their economic fortunes and benefited from accelerated potential growth rates, due in large part to the TFP-enhancing restructuring and innovation policies pursued by both governments. Overall, both ECFIN estimates of the impact of the present crisis and the analysis of past crises point to the strong likelihood of a large negative impact on potential output in the short run, followed by a prolonged period of slow growth as economies adjust to their post- crisis growth paths. Whilst it is too soon to draw definitive conclusions, a "permanent level loss" (case 2) in potential output seems plausible, i.e. the economy eventually returns to its pre-crisis potential growth rate but fails to recoup all of the "lost" output. In addition, the risk that the crisis will have a negative impact on long-run potential growth rates (case 3) cannot be excluded, especially if financial conditions remain more restrictive in the long run, thereby negatively impacting R&D investments, TFP growth, and incentives to reform. Five priority areas to boost potential output, prepare for ageing, ensure public finance

268 sustainability, and address climate change The central lesson from the Great Depression and from Japan in the 1990s is that the first policy priority must be to ensure that the financial sector is reformed and recapitalised so that it can resume performing its vital intermediation function. Absent that, years of slow growth are practically unavoidable as "zombie banks" struggle to survive without contributing to growth. Beyond this, however, the lessons from past experiences and economic analysis indicate that a convincing policy agenda aimed at strengthening the supply side of the economy ought to be drawn up and implemented rapidly. Failure to do so would further aggravate the situation and make it even more difficult to "exit" at a later stage. Developing such a structural reform agenda will also require coherence, with the need to simultaneously address the other key long run challenges facing the European economy: demographic ageing, the need to ensure sustainable public finances, and the fight against climate change (Koopman and Székely, 2009). 1. Avoid the damaging policy mistakes of past crises The pressures to mitigate the short-run effects of the crisis increase the risk that governments might repeat the policy mistakes of past crises. Governments should resist these pressures, especially with respect to measures that can severely harm potential output over the medium to long term. Governments should avoid protectionism, any measures that lower labour market participation rates (such as early retirement schemes), and any short- term policy responses to the crisis that prevent essential restructuring from taking place or undermine the commitment to sustainable fiscal policies. Similarly, they should resist pressures to defer current reform efforts aimed at stimulating productivity, labour market participation, or promoting sound public finances. 2. Improve the EU's labour market Past crises have shown that labour markets can significantly affect potential growth by negatively impacting human capital. Reforms to reverse such a trend are currently essential due to the imminent shrinkage of the labour force as a result of demographic ageing and, to a lesser extent, the present recession. The following reforms are vital in this regard: • Firstly, segmented labour markets, with high protection for insiders and limited protection for workers on fixed-term contracts, have led to low structural employment rates, skyrocketing unemployment in the present crisis, and the marginalisation of certain groups. Such structures need to be reformed in line with the "flexicurity" approach that shifts the emphasis to equipping workers to operate in more flexible labour markets. • Secondly, tax and benefit system reforms are crucial to reducing benefit dependency by making work economically attractive. A reduction in the disincentives to work and to hire and a greater link with targeted active labour market policies will contribute to an improvement in the functioning of labour markets. In addition, by establishing a better link between the duration and, possibly, the generosity of unemployment systems on the one hand and the business cycle on the other, unemployment systems could also provide a stronger macro-economic "stabilisation function". • Finally, reforming disability and early retirement schemes and increasing the effective retirement age remain priorities for increasing the labour supply of older workers and contributing to sustainable economic growth in the face of

269 adverse demographic developments. 3. Use Europe's Single Market as an engine for restructuring in Europe Crises tend to lead to a significant restructuring of economic activities – both between and within industries – which turns out to be of crucial importance in boosting productivity. Therefore, once economic growth resumes, short-term measures aimed at preventing viable companies from failing during the crisis should be removed quickly. In the European context, the efficient functioning of the Single Market will be essential in ensuring that industries can restructure on a European scale, thereby benefiting from economies of scale and scope. Following good progress in facilitating market "entry" during recent years, the emphasis must now be placed on facilitating "exits" and "churn". The vigorous implementation of competition policy and the removal of the remaining obstacles to competition will be very important in this respect. Consequently, key EU industries need a careful, evidence-based assessment of obstacles (based on market-monitoring tools) coupled with a strong determination to remove such obstacles. Also, the implementation of the services directive by the end of 2009 will be fundamental in opening up a large and hitherto somewhat-shielded chunk of the EU's economy. 4. Reform Europe's knowledge triangle (education, R&D and innovation) and healthcare systems Reforms aimed at ensuring a modernisation of the framework conditions underpinning the EU's knowledge economy are essential in boosting (total factor) productivity. This will be particularly important since the crisis could permanently impair R&D due to changes in the financial system. Policies to stimulate Europe's R&D and innovation systems need to be pursued, especially since there remains significant potential for further improvement in many Member States. Making the European Research Area a success will, therefore, be an essential pre-requisite. Also, a high level of educational attainment, associated with a productive, skilled, adaptable workforce, is a precondition for lifelong learning (and for higher labour market participation rates). Finally, there is considerable scope for making healthcare and long-term care systems more efficient and thereby raising productivity. Given that these industries represent some 8% of EU GDP and are highly dependent on public operating frameworks, effective policies could have significant macroeconomic effects. Increasing the long-run productive capacity of an economy does not come for free – it requires considerable investments in infrastructure, human capital, R&D, and innovation. In the presence of constrained public finances, some of the constraints may be relaxed by raising the efficiency and effectiveness of public spending and strengthening the role of the private sector in areas such as health, long term care, education, R&D, and innovation. 5. Develop and deploy “green” technologies to address climate change One of the biggest challenges for the world economy is to fight climate change, which in the long run means "decarbonising" our economies. The European Union has set ambitious targets for reducing greenhouse gas emissions by 2020. It is clear from extensive analysis and modelling work that technology will have to play a major role in reaching such objectives. In addition, well-designed and targeted innovation policies in the area of "green technologies" could play an important role in stimulating TFP growth and boosting investment coming out of the present, deep economic crisis. Furthermore, many of the existing environmental technologies are beginning to mature,

270 with a significant additional efficiency potential being available due to economies of scale and learning curve effects. A decisive push for the development of such technologies and their deployment through market mechanisms (in the industries covered by the EU's emission's trading system), in combination with standards and incentives (for households, buildings, and transport), would lead to significant capital formation by businesses and households and would provide a boost to TFP. Developing such a strategy would require careful design – notably with regard to its institutional structure and the need to find the right balance between targeting specific technologies and avoiding a strategy aimed solely at picking "technological winners". Concluding remarks The present crisis will reduce EU potential output by about 5% of GDP. Such a decline will manifestly have major implications for citizens and companies. These losses could be significantly larger if the underlying financial market problems are not speedily resolved or policymakers repeat the mistakes of the past. This assessment highlights the urgent need to develop a EU-level policy agenda aimed at boosting potential output. Furthermore, it is the considered view of the authors that a determined effort to simultaneously address, in a coherent manner, the EU's main medium- to long-run policy challenges could yield rich dividends – not just in terms of potential growth but also in rallying public support behind the priorities for reforms which we have set out in this column. The authors are grateful to Marco Buti and many other colleagues in DG ECFIN for their useful comments. References EC Directorate-General for Economic and Financial Affairs (ECFIN) (2009), "Impact of the current economic and financial crisis on potential output," European Economy Occasional Papers 49, June. Gert Jan Koopman and Istvàn P. Székely (2009), "The financial crisis and potential growth: Policy challenges for Europe," ECFIN Economic Brief Issue 3, June. IMF (2009), “World Economic Outlook Update: Contractionary Forces Receding But Weak Recovery Ahead” 8 July 2009.

1 Examples of different post-crisis scenarios for potential growth were made by the IMF's chief economist, Olivier Blanchard, in a presentation to a conference on long-term investment in Paris on 22 June 2009.

http://www.voxeu.org/index.php?q=node/3771

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China’s $2,000bn foreign reserves Published: July 15 2009 08:46 | Last updated: July 15 2009 18:15

It appears the great unwinding of global imbalances and the dollar’s ensuing demise are notions that belong up there with the tooth fairy. China added $178bn to its foreign reserves in the second quarter, taking its total booty past $2,000bn, the equivalent of twice the annual economic output of New York state. Although there are no official statistics on how China has apportioned these new reserves, US data supports the thesis that China is not yet jettisoning the dollar, however antsy Beijing gets about the greenback’s global dominance. Even so, the pattern of China’s reserve accumulation is changing. While China is still buying more US debt, it is not necessarily doing so with cash recycled from American consumers. The sum of China’s trade surplus and foreign direct investment, the usual driver of reserve accumulation, was the lowest in three years. At about $60bn, it was also about half last year’s quarterly average of $100bn, according to Royal Bank of Scotland. Rather, China’s hoarding is being driven by speculative funds. After all, China, the world’s favourite green shoot, is back in bubble land; its reserve growth is just one indication of this. Poor data mean estimates vary widely, but some $30bn to $70bn of hot money flowed into China in the second quarter. Much of that is flowing into real assets such as property or the stock market, where trading volumes are three times last year’s levels.

272 Hong Kong residents, after grinding down renminbi deposits last year, added more funds in May. Such inflows are also adding pressure on the renminbi to revalue. To mop up this liquidity, Beijing has started selling one-year sterilisation bills again (so far this year, the central bank has injected net cash into the system). Roaring reserves, a bubbly stock market and the tentative start of monetary tightening: all these recall the glory days of 2007-08. Still, do not expect everything to return full cycle. Exports, for one, are weak. While that remains the case, renminbi appreciation is off the cards.

BACKGROUND NEWS

China’s foreign exchange reserves surged through the $2,000bn mark at the end of June after a sharp accumulation of funds in the second quarter, as money poured into the country to take advantage of faster economic growth and a possible future revaluation of the Chinese currency. The People’s Bank of China, the central bank, announced on Wednesday that foreign exchange reserves reached $2,132bn after rising $177.9bn in April to June, including a record monthly build-up of $80.6bn in May. The latest figures represent an abrupt reversal of an emerging trend of the previous two quarters.

http://www.ft.com/cms/s/2/845cb5fa-7113-11de-877c-00144feabdc0,dwp_uuid=e8477cc4- c820-11db-b0dc-000b5df10621.html

273 Press Release

Release Date: July 15, 2009 For immediate release The Federal Reserve Board on Wednesday approved an interim final rule amending Regulation Z (Truth in Lending) to require creditors to increase the amount of notice consumers receive before the rate on a credit card account is increased or a significant change is made to the account's terms. The amendments also allow consumers to reject such increases and changes by informing the creditor before the increase or change goes into effect. These revisions are the first stage in the Federal Reserve Board's implementation of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit Card Act). In May 2009, the Credit Card Act amended the Truth in Lending Act (TILA) and other statutes to establish fair and transparent practices for open-end consumer credit plans, including credit cards. The Credit Card Act's amendments to TILA go into effect in three stages. This interim final rule implements the provisions of the Credit Card Act that go into effect on August 20, 2009. The remaining provisions go into effect on February 22 or August 22, 2010 and will be implemented by the Federal Reserve Board at a later date. The interim final rule implements the requirements in the Credit Card Act as follows: • Creditors must provide written notice to consumers 45 days before the creditor increases an annual percentage rate on a credit card account or makes a significant change to the terms of a credit card account. • Creditors must inform consumers in the same notice of their right to cancel the credit card account before the increase or change goes into effect. If a consumer does so, the creditor is generally prohibited from applying the increase or change to the account. • Creditors generally must mail or deliver periodic statements for credit cards and other open-end consumer credit accounts at least 21 days before payment is due. The notice that will be published in the Federal Register is attached. Comments on the interim final rule must be submitted within 60 days after publication in the Federal Register, which is expected shortly. Attachment (247 KB PDF)

274 Jul 15, 2009 Chinese Reserve Growth Surges: Hot Money Inflows Resume? o After two quarters with limited reserve growth, Chinese reserve accumulation reaccelerated in Q2, indicating a resumption of capital inflows. The Chinese central bank manages the exchange rate to maintain stability against the US dollar. The expectation that China will recover before the rest of the global economy or perform better seems to have contributed to a revival of capital into China despite investment restrictions. With the renminbi having returned to a quasi-peg, more inflows are likely. o Chinese foreign exchange reserves rose to US$ 2.132 trillion at the end of Q2 2009 from $1.9537 trillion at the end of Q1 2009. The headline reserve increase, the highest on record, implies that China is again receiving hot money inflows. Despite worries about the value of its US assets, which make up about 2/3 of reserves, has likely added dollar assets o Economists often add the trade surplus and FDI and add an estimate for income on China's holdings. What is unexplained by these inflows is often deemed to be hot money - short-term capital inflows. In Q2 the trade surplus was about $35 billion and FDI about $21 billion, a total of $55 billion. Adding for income on holdings and remittances suggests hot money inflows of around $60 billion (RGE Monitor). Economists estimates of the hot money flows range from $30-70 billion (FT Lex) Hot Money Back? o According to RGE Monitor calculations, adjusting for valuation changes in the the value of non-dollar assets, Chinese reserves rose about $140 billion in Q2 2009 after rising only about $35 billion in Q1. The sharp increases of over $35-50 billion in reserves per month contrasts with the sluggish growth in Q1. China faced capital outflows of around $100 billion in Q1, now there are small inflows o Inflows were among the highest in May, when inflows to emerging economies surged. o Guan Tao (department of international payments at the State Administration of Foreign Exchange) in June 2009: net inflows are recovering but it is hard to say that hot money is back again. SAFE will try to balance capital flows by broadening the channels for money to leave China. (via BNY) o Despite some regulations allowing companies to hold on to cash outside of China, for the purpose of funding subsidiaries etc, capital inflows continue. While there are restrictions on equity inflows, the improvement in China's equity and property markets may be driving some inflows. Some of the funds may be from Chinese businesses and those resident in Hong Kong. o In Q1: Adjusting for Valuation, the steepest reserve decline still occurred in January but reserve growth was still more sluggish in March than the headline number indicates. Chinese trade surplus and FDI were much higher though, implying significant capital

275 outflows of about $50 billion in Q1. The end of RMB revaluation expectations likely accounted for reversal of capital flows. In Q4 valuation-adjusted reserve growth was about $50 billion, lower than inflows from the trade surplus/FDI(Ziemba) o As well as valuation losses, China is also receiving lower interest on it US debt holdings. Although the Chinese central bank may have suffered losses on its equity portfolio (Setser, FT) it is thought that its equity portfolio is not marked to market which means losses might not be reflected in the headline reserves figure o Wang: residual approach to measuring ‘hot money’ (ie subtracting out FDI/trade balance) may over state short-term capital inflows by excluding remittances and income, for which high-frequency data are not available Past Trends o Rate of growth of Chinese foreign exchange reserves stalled in Q4 2008 when reserves grew only $40 billion from the end of September. The pace of Chinese reserve growth peaked in Q2 2008 when China faced high levels of so-called hot money betting on a currency revaluation. The nation’s reserves rose by US$356.2 billion in 2008, US$461.9 billion in 2007 and US$247.3 billion in 2006. o Setser: Outflows may have been very large in December 2008. "Given a $40 billion trade surplus and another $10 billion from FDI and interest income, the small increases in reserves implies $70 billion plus in monthly hot money outflows … in excess of 10% of China’s GDP annualized." o Hot money inflows started to ebb in Q3, when Chinese reserves rose to $1.906T by the end of September, an increase of less than $100 billion in Q3 2008, a slower pace than in the first two quarters despite the substantial trade surplus and FDI inflows. Yet valuation losses on Euro and pound holdings suggest reserve accumulation might have been higher (perhaps $150 billion - RGE estimate) o Reserves increased $377 billion from January to September 2008 but the pace of accumulation began slowing in May. Monthly increase in H1 2008 exceeded the already fast pace of accumulation in H1 2007 (~40b/month), and is much higher than H2 2007 ($32 billion/month) or 2006 (~$20 billion/month) o Pettis: In 2008, RMB appreciation caused massive hot money inflows (exacerbated by the sub-prime crisis). As much as $40 billion of Q1 reserves were unexplained by trade surplus, FDI, valuation and interest gains. Banks may have been asked to hold recent increase in RRR in dollars ($40b for each 50bp hike), meaning domestic monetary impact of reserve growth is even higher than headline indicates.. o Explanations for reserve growth in 2008 include repatriation of fx that flowed to HK in 2007 or onshore dollar lending (Green), Anderson: Falling dollar increased the value of Chinese reserves in dollar terms (Anderson) Onshore fx lending (Zhao)

Chinese Reserve Growth Surges: Hot Money Inflows Resume? Jul 15, 2009 http://www.rgemonitor.com/26/China?cluster_id=5113

276 Jul 15, 2009 Systemic Risk Levy, Doubling Capital Charges On Trading Books: Regulators Tackle Size And Complexity

Overview: July 14 Bloomberg: Sheila Bair at the FDIC is considering a systemic risk levy for large players that engage in trading activities beyond traditional banking. "The fees would go to a reserve fund for rescues of bank holding companies, modeled on the FDIC’s deposit- insurance fund. They would target risky assets, such as structured products, over-the-counter derivatives and assets kept off of balance sheets." Bair: "We have suggested disincentives for size and complexity." o Systemic risk levy follows approach recommended among others by Nouriel Roubini and Lasse Pedersen (NYU Stern). see Reshaping the Future of the Global Financial System: An Overview Of Proposals o July 14 Bloomberg: Ben Bernanke: "Restricting size is a legitimate option." o Basel Committee on Banking Supervision final paper advocates "incremental risk capital charge" for assets held on trading book thus reducing the incentive for regulatory arbitrage between the banking and trading books. o July 14 FT: New EU capital directive aims to require banks to "roughly double current trading book capital requirements". "The toughest clampdown would come for banks' holdings in so-called "resecuritisations", financial products that are derived from existing securitisations." Moreover, the directive aims at risk-adjusted remuneration feature. o John Plender: "The future shape of banking is becoming clear after the announcement this week of the European Union's proposed revisions to its rules on bank capital and the Basel Committee's revisions to the capital framework. Far from delivering a more utility- like banking system, the regulatory response to the financial crisis is designed broadly to preserve the big bank business model, but with tougher capital penalties on banks' own- account punting and less pro-cyclicality." o Hart/Zingales (Harvard/Chicago U.): The authors design a new, implementable capital requirement for large financial institutions (LFIs) that are too big to fail. The inspiration are margin accounts. "To ensure that LFIs do not default on either their deposits or their derivative contracts, we require that they maintain a capital cushion sufficiently great that their own credit default swap price stays below a threshold level. If this level is violated the LFI regulator forces the LFI to issue equity until the CDS price moves back below the threshold. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are solvent with probability one, while preserving the disciplinary effects of debt." o Andrew Haldane (Bank of England): Network theory suggests that hierarchical decomposability is a key feature of network stability. Financial innovation on the other hand creates horizontal interconnectedness that is hard to disentangle and serves as contagion mechanism that is not easily isolated.

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Why the Crisis Hasn't Ended Mises Daily by Joseph Keckeissen | Posted on 7/15/2009 Why hasn't the crisis ended as yet? It should have been all over with and forgotten by the first of last February. If so, the whole troubled world would have already issued a huge sigh of relief. There would be no more impatient dilly-dallying on the part of investors, waiting for the government to decide who are going to be the recipients of the new trillion in handouts, and causing daily upsurges and downfalls in the unsettled Dow. Assets would have fallen to their normal worth, the present discounted value of their future returns. No need to wrestle with mark-to-market account. No need for Sarbanes and Company to meddle and make newer and stiffer regulations. No need for new super controls. Mr. Geithner wouldn't be stressed to invent new ways to cajole folks to contribute to the buyout of overvalued securitized junk. Nor would there be the least excuse for more G20s to be needled into bastardizing their overbloated monetary systems. Mr. Bernanke would have stopped acting the role of Santa Claus, distributing the government-invented moonshine to the denuded former greats of Wall Street. The corpses of the erstwhile automobile empires would have breathed their last, their good assets now transferred to the hands of newer more responsible entrepreneurs. The prior executives would be moving over to Cheapside and brushing off their overalls, perhaps in line to join a new remodeled UAW, in search for some job where they couldn't mess things up any more. The bankruptcy courts would be finishing up their exequies for the deceased former titans of the packaged debentures. The tombstones of the new economic cemetery would display the once great names of Fannie and Freddie, of Citi, of AIG, of Merrill Lynch, along with the hapless Lehman Brothers, interred several months before. And so many more financial cadavers would have been laid to rest, their memory duly to be forgotten, as perpetrators of a fake capitalism now buried and forgotten. Perhaps the cemetery could be economically located in an enlarged churchyard at Trinity Church at the head of Wall Street, to occupy the now excess real estate in the area and be a perpetual reminder that treason in the capitalist world will always be avenged. Washington would finally be silenced, even if the Fed were not yet duly junked in the process, and the Treasury's overbearance would be bridled as the rest of the uneconomic trash was being flushed out of the system. The Case Shiller indices would have completed their downfall to a level that future homeowners could devote the traditional 30 percent of their money incomes towards purchasing their long-wanted love nests. New families would be rushing in to fill the vacant home sites. True capitalism would be alive again; employment would be rising up to normal. The waiting lines would no longer be for unemployment checks, but rather to be first to enroll in the new jobs daily being created. The new savings of the American people, shocked by the

278 catastrophe, would now offset the strangling of the market rate of interest on the part of the monetary gymnasts, and would reflect the new flow of healthy capital ready to be invested in solid new ventures. The Dow would be healthily aglow with daily increments. All the bubbles would have burst away. Happy days would be here again! We'd once again be rolling in prosperity! But why hasn't this happened? Why is the world still in acute misery, even expecting the worst yet to come? All that would have been necessary to halt the continuation of the present freefall would have been that on January 20th last, precisely at noon, the newly inaugurated president would have announced to the American people (even before the triumphant parade and the orgies that followed) that his program was NO, but NO. If he had said, The inflationary monster TARP is out. No more bloating up the money supply and the budget with inflationary inanities. No more bailouts. No more rescues. No more trillions. Those who have received any bit of largesse will promptly return their ill- gotten loot to the Treasury. The bankruptcy courts are now authorized to get on with their interments at once. Nobody is too big not to be interred. With this no-but-no on the part of the new president, the market would have immediately stood up to perform its traditional job. All bloated prices would have immediately crash-dived down to some normal sustainable level. All talk of newer regulatory agencies would end. Instead of a great inaugural parade, we would have witnessed the opening of a new capitalist cemetery, the funeral cortege bearing the titles of the fallen titans of yesteryear. By the first of February, at the latest, everything would have been again on the upsurge. The second spring of capitalism would be in bloom all over the landscape and President Obama would proudly be presiding over the greatest boom ever in American economic history. But, unfortunately, sad to state, the new president never understood the warnings of Ludwig Von Mises, who told us again and again that the market is the only institution that makes and rectifies prices, that money must not be multiplied, and that the interest rate is naturally and untouchably sacred. On that fateful inauguration day, Obama said YES but YES to all the imbecilities being proposed, by President Bush before him, by the Reids and Pelosis in the Congress, by Paulson, Bernanke, and Geithner, by the great Nobels and the government-adulating economists. Long live Maynard Keynes and the national economic medical corps that will monetize and fiscalize us to perdition. It was the market that was laid to rest in favor of all the new boondoggling experiments that have all but brought America to ruin. We have to bemoan the fact that the new exponential influx of fake money will make prices surge to an unprecedented infinitum. They will soar; perhaps by year's end, an ordinary egg will cost one hundred or so debased dollars. We should rue that day, the 20th of January, when the switch to prosperity could have been turned on, the light of freedom would have again begun to shine, and the economy rerouted upwards. But instead, we applauded the death knell of both liberty and prosperity and issued in a new chaos, far greater than that of the Roosevelt era, one that might last for untold years and years to come. We have rejected the enrichments of a healthy capitalism in favor of an impoverishing government-run fascism. We have resurrected another great depression - and made America the crisis leader of the world, instead of, what it once was, the beacon for world prosperity.

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15.07.2009 Insurers aghast at new accounting rules

FT Deutschland has a story on yesterday’s proposal by the International Accounting Standards Board (IASB) for new accounting rules, and the mostly negative reaction by the German and French insurance industry. The IASB published a proposal to change IAS 39, which deals with the valuation of securities held by financial institutions. Under the proposals, bonds and other fixed income securities with fixed maturities should be valued at cost, while stocks and structured products should be valued under the principle of fair-value accounting (or mark-to-marked accounting). The German insurers say this rule change means that they would dump shares, as any losses would have affect their capital. The finance ministers of Germany and France support the industry, and call for more flexible rules. The industry wants softer rules, while IASB wants simplification. The European Commission supports the IASB.

Spain introduces new accounting rules El Pais leads its economic section with the story that the Bank of Spain approved an important accounting rule change, as a result of which banks can relax their bad loan write-offs. At present, when a loan is bad for two years, it has to be written off completely. Under the new rules, a mortgage or other credit up to 80% of the value of the collateral will not have to be written off completely, but only partially. The underlying accounting assumption is that the value of collateral cannot fall to below 70% of purchase price (which in the case of Spanish property is exceedingly optimistic in our view, as we are looking at 40-50% falls in house price in the US, where the market was not nearly as crazy as in Spain).

Italy’s budget foresees 5.2% deficit in 2010 As other European countries raise their debt levels towards 80/100% of GDP, Italy’s which started out from a level of 106% is raising its debt-to-GDP much more slowly as it has foregone almost any economic stimulus. Yesterday, Giulio Trementi presented his government’s 2010 finance plan, which foresees a deficit-to-GDP ratio of 5%,down from a forecast 5.3% this year, which is relatively modest compared with other industrialised countries. The debt-to-GDP ratio is forecast to rise to 115%. The Italian government (rather

280 optimistically in our view) forecasts 2010 economic growth at 0.5% after a forecast decline of 5.2% this year. La Repubblica has the story.

Pact to support Barroso Le Monde front page has the story that the conservatives, socialists and liberals of the European Parliament agreed a tripartite pact to assure Jose Manuel Barroso a second mandate. Conservatives, who lack an absolute majority in parliament, need this deal while socialists and liberals will push in the coming weeks their ideas and candidates for the next Commission. Socialists call for a new stimulus programme, a pact for European employment and social progress and more financial market regulation. Liberals call for a European bond and (according to a draft declaration) more European governance in economic and social matters. Despite the agreement, there are some MEPs who vote against Barroso in September irrespective of the engagements of the coming weeks. One part of the deal is that MEPs supported former conservative Polish prime minister Jerzy Buzek as new EU Parliament president yesterday, who will be followed by the German Socialist Martin Schulz after 2.5 years.

Andrew Duff on Barroso Writing in FT.com, liberal MEP Andrew Duff defends the EP’s decision to delay Barroso’s investiture until September. There would have been a danger of a no vote in July as Barroso has to negotiate support from both the Socialists and the Liberals. But he said a delay beyond September would be dangerous as it could negatively affect the Irish referendum and the Czech parliament elections, where a victory of Vaclav Klaus’ Europhobic party could still endanger the Lisbon Treaty. (To us it looks as though Barroso will get through in the end. The EP never had the guts to stand up to the Council on the appointment of the Commission president)

No free lunch Two weeks after the VAT tax effectively dropped for French restaurants from 19.6% to 5.5%, the first controls show that this massive reduction was only marginally passed through to the consumers, reports Les Echos. The independents claim higher charges and higher raw material costs as a reason.

Irish taxpayers to pay the price for restoring financial stability The Irish central bank governor John Hurley warned that taxpayer will have to take a hit in purchasing development loans from the banks in order to help restore them to financial stability, reports the Irish Independent. He said a "balance had to be struck" between value for the taxpayer and restoring the function of the banking system in the economy.” The Irish economy is forecasted to shrink by another 8% this year and 3% next year. With respect to monetary policy Hurley was unusually clear: "We are looking at a very gradual economic recovery and it is necessary that this is supported by monetary policy for the present".

Green shoots watch: more mixed signals Euro area industrial output rose by less than expected in May, the FT reports. It was up 0.5% during May, but still 17% down from May 2008. National data revealed that the recovery had gained pace in Germany, France and Italy, but bad news from Spain level the euro area average. A further reminder how fragile the recovery is at the moment came from the

281 (admittedly extremely volatile) ZEW index, an indicator which is based on financial analyst’s assessments. It surprisingly went down from 44 to 39 points, which gives weight to the theory that the brief economic uptick during April was probably little more than an inventory correction, as companies are producing once more to fill depleted inventories. (Note, however, that BMW said it expects demand and production to increase by the end of the year.)

Munchau on Steinbruck In his FT Deutschland column, Wolfgang Munchau says Peer Steinbruck, the German finance ministers, suffers two fundamental weaknesses. The first, and often noted weakness, is an intellectual laziness. The second, perhaps less known problem, is a poor political judgement. His recent criticism of his own party’s pension policies, two months before the election, are reminiscent of the disastrous election campaign he led in North-Rhine Westphalia in 2005, a state in which he was premier, when we was outsted in one of the worst SPD election campaigns ever. Munchau says that Steinbruck is a lose canon, and could be very dangerous for the SPD during the upcoming elections.

Wolf’s pessimistic outlook Martin Wolf writes in his FT column that the recovery will be slow and painful. But his most important judgement is about the failure of global policy makers to learn the lesson from this crisis. The financial sector has more moral hazard now than it did before it entered the crisis. The issue of global imbalances is not being addressed, including the problem of the dollar- based monetary system. The same goes for the inherent vulnerability of emerging markets. http://www.eurointelligence.com/article.581+M5ffb8bb8d32.0.html#

282 Jul 14, 2009 How To Fix the OTC Derivatives Market? Overview: July 14: The U.S. Justice Department is investigating the CDS market. In particular, "The antitrust division sent civil investigative notices this month to banks that own London-based Markit to determine if they have unfair access to price information, according to three people familiar with the matter." (Bloomberg) Meanwhile, members of Congress say that it is poised to pass a bill in 2009. o July 9 Lynn Stout (UCLA): "OTC derivatives have worked for centuries until the Commodity Futures Modernization Act (CFMA) of 2000 among others deregulated the old "rule against difference contracts". To do: Reinstate a simple, elegant legal sieve that separated useful hedging contracts from purely speculative wagers, protecting the first and declining to legally enforce the second. The market takes care of the rest without a penny of taxpayer money." o July 10: Geithner testimony: “To force clearing of all derivatives would ban customized products and we don’t believe that’s necessary. Credit-default swaps “provide an important economic function in helping companies and businesses across the country better hedge against their risk. I think our responsibility is to make sure those benefits come with protections." See Economic Risks and Benefits of Credit Derivatives o On May 13, the U.S. Treasury announced comprehensive OTC derivatives trading reform. In particular, the OTC derivatives markets must be moved “onto regulated exchanges and regulated transparent electronic trade execution systems" ($684 trillion OTC derivatives market). Four main gaps are to be closed: 1) systemic risk (see GAO report); 2) price and counterparty transparency: aggregate data must be made available to the public and detailed positions to regulators. 3) regulators need authority to limit market abuse e.g. naked shorts; 4) need implement stronger consumer and investor protection. Emerging consensus: If a clearinghouse accepts to clear a derivative, it is standardized and must trade through a central counter party. o June 26: Gary Gensler, the new CFTC chairman, in a speech proposes higher capital requirements for customized products in order to incentivize standardization and on- exchange trading. He also singles out hedge funds as causing a run on liquidity. o June 23 Senate Hearing results (via WSJ): SEC Chairman Mary Schapiro proposed that her agency oversee derivatives linked to stocks, bonds (including corporate CDS) and securities ,and that the Commodity Futures Trading Commission (CFTC) oversee all other derivatives including derivatives related to interest rates, foreign exchange, commodities, energy and metals. At the hearing, Gary Gensler pushed for more aggressive regulation than the Obama administration had requested: He wants to require that standardized derivatives be traded on electronic exchanges which includes a central counterparty as well as price and volume transparency.

283 o May 14 Bloomberg: Regulators at the SEC are considering price reporting standards similar to TRACE for the OTC derivatives market. Mind that the switch to TRACE reduced bank profits by almost half seven years ago. o Cass (breakingviews): Focus on standardized OTC products dangerous unless the truly toxic bespoke products are not addressed as well in new regulations. o Sen. Tom Harkin, D-Iowa, introduced in November 08 the Derivatives Trading Integrity Act to eliminate the distinction between derivatives traded over the counter and on an exchange, and thus bring the massive over-the-counter (OTC) derivatives market under federal regulation. Sen. Peterson circulates draft bill that would require all CDS trades to be processed by a clearing house. More significantly, it would ban “naked” CDS trading - i.e. any trades in which protection buyers did not own the underlying bond referenced by the contract. Naked CDS trades account for about 80 per cent of the market. (FT Alphaville) o Industry, academia (via FTAlphaville): Outright ban of naked CDS naked shorts is too extreme. To the extent the committee is concerned about speculation in CDS, they should consider giving the CFTC or the Fed Board the right to establish margin requirements for CDS exchange trades that are not ‘bona fide hedges’ or the like, similar to the rules governing futures contracts. As a result, the bill has no chance to pass in this form. (Reuters) o SIFMA and ISDA industry groups agree to central counterparty but don't want to lose flexibility and fees from OTC trading. Moreover, on and off-exchange trading are not perfect substitutes. Win-Win: Investors appreciate customized products that allow more complete hedges in terms of maturity and exact exposure. On the other hand, banks earn fees and have the advantage of back-office infrastructure vis-a-vis securities exchanges o Jan 30 Bloomberg: Faced with tougher regulation dealers overhaul CDS trading by March 2009 with 'Big Bang' reform: 1) For the first time, the market will have a committee of dealers and investors making binding decisions about the event of default and potential recovery value; 2) In one of the most noticeable changes for traders, those who buy protection will pay an upfront fee depending on current market prices, and then a fixed $100,000 or $500,000 annual payment for every $10 million of protection purchased. (Now, upfront payments are only required for riskier companies whose spread exceed 10%.) o May 6 Bloomberg: The New York Fed is concerned that credit-default swap clearinghouses lack a common feature of their counterparts for futures, allowing customers to segregate their trading from bank accounts: in the run-up to Bear Stearns and Lehman troubles, there were large outflows due to investors that feared for their posted collateral (with good reason as the case of Lehman showed.) o Stephen Cecchetti: Amaranth and LTCM impact comparison shows that regulated exchange trading should be the norm. Advantages: smaller counterparty risk with centralized clearing house and margin calls; asset valuation certainty; standardized products. o see BIS H2 2008 OTC Derivatives Survey http://www.rgemonitor.com/691/Securitization,_Structured_Finance,_and_Derivatives?cluste r_id=12971

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July 15, 2009 Derivatives Are Focus of Antitrust Investigators By ERIC DASH The Justice Department is investigating the role of several major companies in the credit markets, in another indication that the government is intensifying its scrutiny of derivatives, Markit Group Holdings, a data warehouse controlled by several big banks, said Tuesday that it had been notified by antitrust officials at the Justice Department of an inquiry into the “credit derivatives markets and related markets” and that it would “provide any information requested.” The department is conducting a similar inquiry at several banks to determine if they had unfair access to pricing information, according to a person briefed on the situation. The investigation is a sign of the increased attention the derivatives business is getting in Washington. Derivatives are sophisticated and profitable instruments that were intended to limit risk but instead were at the center of the financial crisis last year. The derivatives market now represents transactions with a face value of $600 trillion. They were blamed for the near collapse of the American International Group, the insurance company that was a crucial trading partner with Wall Street firms in one widely used form of derivatives. Over the last several months, lawmakers and regulators have stepped up their efforts to get a handle on these complex instruments. Some watchdog groups say the regulatory proposals do not go far enough. At the same time, the financial industry is waging an aggressive campaign against more stringent regulation of derivatives. The Justice Department inquiry, however, may reflect an effort to rein in the products without legislation. It is unclear exactly what the investigators are looking for, but it appears they are examining whether Markit’s bank shareholders received an advantage as owners and providers of trading data for one type of derivatives known as credit-default swaps. Some market participants also believe that federal officials may also be requesting information from Markit to gather evidence of possible dealer involvement in manipulating prices. Markit is the dominant provider of pricing information in the derivatives industry, providing the data to more than 300 financial firms that use it to determine the prices of similar contracts on their own books. The data provider is majority-owned by several Wall Street firms, including JPMorgan Chase, Bank of America and the Royal Bank of Scotland. Representatives of JPMorgan and Bank of America declined to comment. In a statement released Tuesday, Markit said that it was working “to enhance transparency and efficiency in the credit derivatives market.” The investigation may also fit into the changing political environment in Washington. The Obama administration has made bolstering oversight of derivatives a central part of its plan to reform the financial industry and rein in

285 excessive risk-taking, and has called for requiring certain kinds of credit-default swaps to be traded through a central clearinghouse and possibly one or more exchanges. Wall Street banks are extremely worried about the impact of additional government scrutiny, and have proposed their own set of voluntary rules. Even so, most Wall Street executives expect that regulators will more aggressively police the market in the future. http://www.nytimes.com/2009/07/15/business/15cds.html?_r=1&th=&emc=th&pagewanted= print

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July 15, 2009 Mortgages Are Now a Bank’s Best Friend By ERIC DASH For the last two years, housing has been at the center of the banking industry’s troubles. But for at least one quarter, it will help lift its results. Even as banks remain cautious about lending and millions of borrowers still risk losing their homes, the mortgage business is returning as one of the most lucrative corners of the financial industry. The clearest evidence is emerging this week, as the nation’s biggest banks report their second-quarter numbers. As independent mortgage companies and brokers shut their doors last fall, and major players like Bank of America, JPMorgan Chase and Wells Fargo swallowed up troubled rivals, lending profit margins widened, doubling at big banks amid a refinancing wave during the first half of the year, analysts said. Mortgage securities prices have rallied, allowing banks to book hefty gains on their investment portfolios. And accounting tactics — like new rules that let banks book lower losses on troubled assets and reductions in reserves for future losses because of mortgage modifications — may further burnish their results. “It’s the mother of all mortgage quarters,” said Meredith Whitney, a prominent banking analyst. But whether or not those profits are sustainable remains an open question. “You might believe that the environment has stabilized, but looks are sometimes misleading,” she added. Over all, analysts say that second-quarter bank earnings are likely to be good, if not quite as strong as the first quarter’s. Bank stocks have rallied over the last four months in anticipation of brighter news. The KBW Bank Index, a popular measure of the financial sector, has nearly doubled from its low in early March. Goldman Sachs reported strong profits from trading on Tuesday. But the resurgence of the mortgage business should help most of the big commercial banks, from small regional lenders to national players like Bank of America, Citigroup, JPMorgan Chase and Well Fargo, which report this week. Banks still face a number of threats. Credit card and commercial real estate loan losses continue to climb. And for many, the quarter will be rife with unusual accounting charges. Even so, the refinancing rebound is providing a lift. As the Federal Reserve cut interest rates to record lows, hundreds of thousands of borrowers were able to take out cheaper loans. Lenders issued an estimated $1 trillion worth of mortgages during the first half of 2009, according to Inside Mortgage Finance. Meanwhile, mortgage lending margins are at least two to three times higher than a year ago, analysts said, making it an increasingly important force at the biggest banks. Since 2000, mortgage banking has represented about 3 percent of revenue for Bank of America,

287 JPMorgan and Wells Fargo, Ms. Whitney says. In the first quarter, it more than doubled to about a 6.4 percent share. Banks also stand to book large gains on mortgage bonds as well more obscure instruments called mortgage servicing rights, which rose late in the quarter in anticipation of more borrowers holding onto their existing loans. That extends the number of payments that lenders can collect. The values of those rights fell sharply in the first quarter and through most of the second quarter, when interest rates were low. But as interest rates climbed toward the end of June, banks got the best of both worlds: a several-week flurry of refinancings and an increase in the value of the servicing rights. Frederick Cannon, a banking analyst at Keefe Bruyette Woods, estimated that the value of Wells Fargo’s servicing rights could rise by nearly $8 billion, or more than 60 percent, to as much as $20.2 billion. Other big banks could experience similarly large gains, although some might be reduced by interest-rate hedging. Aggressive accounting could also pump up the lenders’ results. Most of the big banks took advantage of an 11th-hour rule accounting rule change in the first quarter to book smaller losses on troubled securities. Jack T. Ciesielski of The Analyst’s Accounting Observer estimated that without the change, earnings for the biggest banks in the Standard & Poor’s financial index would have been almost cut in half. In the second quarter, the impact could be even greater. In addition, the banks may book some early benefits from a subsidy the government gives them for modifying mortgages — gains that are likely to proliferate in coming quarters if the Obama administration’s Making Home Affordable program takes off. So far, the government has agreed to funnel $18 billion of taxpayer money to lenders, investors and borrowers to keep Americans in their homes. Under the program, Bank of America could receive as much as $6 billion to offset part of the losses it incurs from lowering monthly loan payments and to defray its costs, according Treasury Department data. JPMorgan Chase is eligible for $3.5 billion. Wells Fargo could get as much as $2.9 billion. Citigroup and GMAC stand to collect more than $1 billion each. The first checks start arriving this month — although over the long term, industry insiders project that the banks will retain only around one-third of those funds, with the rest going to subsidize borrowers and investors. While banks are expected to make loan modifications because it is sound business, Treasury officials say they believe the subsidies will encourage lenders to make even more modifications than they otherwise would. So far, more than 270,000 borrowers have received offers since the program was introduced this spring. The administration hopes to see that number rise to around four million. http://www.nytimes.com/2009/07/15/business/15bank.html?th&emc=th

288 Greetings from RGE Monitor! RGE Monitor's Newsletter

As we did last week with our U.S. economic outlook, this week we present a preview of our outlook for the Chinese economy in 2009 and 2010. The following is excerpted from the RGE’s global outlook, which will be released to RGE clients later this month.

The full version of the China outlook will include the following sections • Stimulus Boosting Investment: Pressing on the Same Levers • Property Investment Stabilizing? • Consumption Holding Up, But Can it Grow? • Inflation and Monetary Policy: Leaning on the Banks • Fiscal Policy and Effectiveness of the Stimulus • Banks and Credit Market Vulnerabilities • The Chinese Yuan and Equity Markets • Chinese Reserve Accumulation and Diversification

The RGE Monitor Global Economic Outlook presents analysis quarterly on over 70 countries and several global crucial issues. Specifically, in this update, our analysts cover trade and protectionism, risks of rising fiscal deficits around the world, global imbalances and climate change, among other issues. The complete RGE Monitor Global Economic Outlook will be available to Tier 1 Advisory Clients at the end of this week in advance of next week’s posting on the site for RGE Premium subscribers. And now for our China outlook. Prompted by aggressive government investment, Chinese growth has been improving from the near stall experienced at the end of 2008. When GDP statistics are released this week, Chinese growth is expected to have accelerated from the 6.1% y/y reported in Q1 2009. Manufacturing surveys indicate expansion, residential property shows signs of stabilization, fixed investment is surging and, prompted by incentives, consumption has held up. Despite this acceleration, which stems from Beijing’s aggressive policy response to the economic crisis, RGE still believes that China will grow well below trend in both 2009 and 2010, given the sluggishness of the global economy and the risks posed by China’s fiscal and monetary s timulus itself. RGE expects growth of only about 7.0% in 2009 and 7.7-8.0% in 2010. Moreover, China may have only limited ability to boost other countries’ economies. Exports, which may have stabilized at a low level, will continue to be a drag on growth well into 2010. Imports also continue to be weak, suggesting that domestic demand has yet to pick up significantly. The reduced trade surplus will contribute to a smaller current account surplus than in 2008. Commodities have dominated Chinese imports in H1 2009, as China took advantage of cheaper prices. With commodity prices now climbing and stockpiles filled, China may slow its purchases in H2 2009, a time when purchases tend to be lower in any case. Chinese support of

289 exports, through increased export rebates and limitations on imports, will likely have limited effect given weak G3 demand and could also contribute to trade protectionism globally. Government investment has driven China’s growth acceleration while domestic private demand has weakened. With most private capital expenditure financed by retained earnings, weaker corporate profits may restrain private capital expenditure into 2010. So far Chinese electrical demand has yet to match the surge in investment an d industrial production. Yet industrial production will likely see further improvement from current levels (8% in May 2009), despite remaining lower than the 2008 pace. In an effort to limit unemployment, the government has purchased excess output including metals and grain and goods to refined fuels to processed metals. Should China be unable to absorb this new capacity domestically, it might seek to increase exports, increasing a global supply glut. Chinese consumption has held up, but from a low base (only 36% of GDP), and China is not able to take up the global slack stemming from increased savings by the U.S. consumer. The strong performance of retail and auto sales, prompted in part by incentives does illustrate the ability of the government to influence public and private consumption, however, and raises the possibility that China may have had a stronger underlying domestic demand dynamic than many credited. Yet in 2009, the Chinese consumption basket still faces disinflationary pressure and may face several more months of negative growth. In the longer term, today’s policies will pose inflationary pressures. With its domestic savings, deeper domestic supply chain and low (domestic) debt burden, China may be better placed than many countries to stimulate demand. Yet the weakness of imports, despite price-induced commodity demand, suggests that so f ar this year domestic demand remains weak. A reallocation of capital domestically to extend China’s fragmented social safety net, possible only in the longer term, might be required for sustainable consumption driven growth. Greater spending on health, education and retirement, as well as an effort to boost purchasing power through exchange rate appreciation, could reduce Chinese structural incentives to save and stimulate sustainable domestic and global growth. Chinese bank lending, for the first half of 2009, has been particularly aggressive, reaching a value equivalent to 25% of China’s 2008 GDP. But this lending, whose pace reaccelerated in June 2009, might contribute to asset bubbles--especially in property--and could increase non- performing loans in the future. Small and medium sized enterprises, however, still have challenges finding funds, exacerbating a longer-term corporate finance challenge. Meanwhile, Chinese officials have begun mopping up some of the liquidity through the issuance of bills. In the near term, risks to the growth outloo k may be tilted to the upside, but in the longer term, vulnerabilities could lead to weaker growth. These risks include an even weaker global growth recovery; deterioration of China’s fiscal position, delays of more consumption-oriented policies; and the costs of monetary and credit easing. China has been relatively effective, now and in the past, at ramping up government investment and encouraging state-owned enterprises to spend and banks to lend, but if the rebound in domestic or external growth is weaker, this new production could exacerbate overcapacities and increase the government’s contin gent liabilities. As such, the revival in Chinese asset markets, especially the equity markets, may be somewhat premature. Given the still speculative nature of the Chinese markets and the influence of government policies, the equity market could be vulnerable for a correction. It is worth remembering, however, that Chinese markets are somewhat buffered from foreign portfolio flows, given investment restrictions, and that the Chinese government is carefully restarting the

290 IPO pipeline. Given Beijing’s determination to ensure currency stability, the renminbi is likely to retain its quasi peg to the U.S. dollar. Given China’s reluctance to allow currency appreciation when external demand remains weak, RGE expects China to continue accumulating reserves, including U.S. debt--albeit at a much slower pace than in H1 2008. In the longer term, the renminbi is likely to appreciate, given Chinese growth and productivity dynamics and the slow but steady steps Beijing is taking to allow the currency to be used beyond Chinese borders. Despite China’s concerns about the value of its large stock of U.S. assets, reserve diversification will continue to be difficult, th ough the purchase of $50 billion in SDR-denominated bonds from the IMF will be only a small share of its $2 trillion in reserves. As a group, Chinese investors such as the Chinese Investment Corporation (CIC) will cautiously become more active investors, resuming their equity purchases. Investment in resources and loans to resource rich countries should continue to be a major part of China’s asset allocation, and should boost production of the Chinese national oil companies by clustering operations in countries like Iraq. Slower than trend growth in China could negatively affect emerging market economies in Asia, Africa and Latin America. So far commodity exporters have benefited most from the surge in Chinese commodity demand. This demand may slow as prices climb and stockpiles overfill. Even if demand slips in Q3 2009, as seasonal trends would dictate, commodity exporters may benefit more from Chinese consumption than suppliers of capital goods and export inputs such as the Asian Tigers and Japan. Despite the demands from Chinese infrastructure heavy stimulus, a sluggish economic recovery suggests energy and metal demand growth might be more subdued in H2 2009 and in 2010 once it has filled stockpiles.

291 Jul 8, 2009 RGE Monitor – U.S. Economic Outlook: Q2 2009 Update Christian Menegatti Greetings from RGE Monitor! The first half of 2009 has ended and we at RGE Monitor are in the process of updating our quarterly Global Economic Outlook. Below you will find a preview of our views on the short-to-medium term prospects for the U.S. economy. The full version of the RGE U.S. economic outlook (available for RGE Premium subscribers) will include analysis on: • U.S. Consumer Comeback? • Is the U.S. Housing Sector Stabilizing? • U.S. Commercial Real Estate the Next Shoe to Drop? • U.S. Industrial Production and Investment in a Severe Downturn • U.S. Exports Under Pressure • U.S. Labor Market Pain Continues • Fiscal Stimulus Provides Inadequate Stimulus • Ballooning U.S. Fiscal Deficit Raises Concerns • Fed Too Soon to Exit Easing Mode, but Time to Talk About It • Inflation Pressures Not in Sight Quite Yet • U.S. Treasuries • U.S. Dollar • Structural Weaknesses Will Constrain the U.S. Economic Recovery The RGE Monitor Global Economic Outlook presents analysis on over 70 countries and several global crucial issues. Specifically, in this Q2 update, our analysts cover trade and protectionism, risks of rising fiscal deficits around the world, global imbalances and climate change, among other issues. The RGE Monitor Global Economic Outlook will be available soon to RGE Premium subscribers. Now back to our U.S. preview. The United States is in the 20th month of a recession that has been by far the longest and most severe of the post-war period. While comparisons with the Great Depression are frequent and appropriate (especially if we look at the pace of contraction in industrial production), the aggressiveness of policy measures has significantly reduced the probability of a near- depression. Economic activity fell off a cliff in Q4 2008 and Q1 2009, with two consecutive quarters of sharp contraction – by 6.3% and 5.5% respectively – in line with our previous forecasts. The general consensus is that this recession will end sometime in the second half of 2009. While RGE Monitor expects more quarters of negative real GDP growth in 2009, we also expect the pace of contraction of economic activity to slow significantly. We forecast negative real GDP growth in Q2 2009 and Q3 2009, and for real GDP to remain flat in Q4.

292 After the sharp contraction in economic activity in 2009, growth will reenter positive territory only in 2010, and then at a very sluggish rate, well below potential. Even if economic activity stops contracting by the end of 2009, that might not mark the official end of this recession. Recessions are not measured exclusively by GDP contractions. Unemployment, industrial production, real manufacturing, wholesale retail trade sales and real personal income (less transfer) are all considered when it is time for the National Bureau of Economic Research (NBER) to put dates around recession periods. As reported by the NBER, this recession started in December 2007, and all the above indicators peaked between November 2007 and June 2008. U.S. real GDP will stop contracting at the end of 2009, but it is likely that many of the above indicators will not bottom out (or peak, in the case of unemployment) before mid-2010. Improvements in real economic activity are present and visible in the reduction of the pace of job losses, in the improvement in indicators of manufacturing activity, in the stabilization of housing starts and in the improvement of financial conditions. However, RGE Monitor does not yet see signs of a strong and sustainable recovery. Lingering Concerns: Labor market conditions are still quite dire, more than 3.4 million jobs have been lost in 2009 and about 6.5 million have been lost since the beginning of the recession. Compare this with the 2.5 million jobs lost in the recession of 2001; 1.5 million lost in the recession of the early 1990s; 3 million in the one of the early 1980s; 2.2 million in the one of the 1970s. The pace of job losses has fallen from the 600K plus per month registered between December and March 2009 to about 350K in May and 467K in June; the average monthly job losses in this recession is now at about 360K. While the recent slowing of losses is a positive development, we have to put this in perspective: in previous post-war recessions, average monthly job losses have ranged between 150 thousand and 260 thousand. Moreover, average weekly hours in private nonfarm payrolls are at the lowest since 1964, as employers have cut employees’ hours. Job openings and turnover openings continue to fall and are at the lowest levels since 2000, indicating continued weakness in the economy. The U.S. consumer is still the engine of U.S. growth, and contributes to over 70% of aggregate demand. While saving rates are headed for the high single digits and high oil prices together with long-term rates keep putting a dent in personal consumption, the over-leveraged consumer is finding some support in the tax breaks of the fiscal stimulus package. Yet the over-indebted U.S. consumer – whose deleveraging process yet has to start – will likely continue to put the brakes on consumption, while the savings rate continues to creep up. While this will encourage a rebalancing in the U.S. and global economy, in the medium-term it isn’t likely to support strong U.S. and global growth. Housing starts appear to have stabilized and will likely move sideways for quite some time. However, housing demand is not yet improving at a pace that can guarantee that the lingering inventory overhang will dissipate. This implies that home prices will continue to fall. RGE Monitor expects home prices to continue to fall through mid-2010. U.S. industrial production has been contracting for 17 months in a row – with a short break in October 2008. Industrial production usually finds a bottom shortly after the ISM manufacturing index does. While the index probably found its bottom back in December 2008--at depression levels of 32.9--industrial production remains in a mode of contraction that started in January 2008. Financial conditions are showing some improvement. Banks are borrowing at zero interest rates and higher net interest margin can definitely help rebuild capital. Regulatory

293 forbearance, changes in FASB (Financial Accounting Standards Board) rules and under- provisioning might enable banks to post better than expected results for a few quarters. However, relaxation of mark-to-market rules reduces the banks’ incentives to participate in the Public-Private Investment Program (PPIP) and therefore reduces the likelihood that the program will succeed in clearing toxic assets from banks’ balance sheets. The muddle- through approach might be successful in a scenario in which the U.S. and global economy recover soon and go back to potential growth during 2010, but according to RGE’s forecasts, this is highly unlikely. While we might have positive surprises coming from the banking system in the next couple of quarters, the situation could turn around again after that, jarring confidence in financial markets in a way that would spill into the real economy. Increases in the unemployment rate, well beyond the rates envisioned by the adverse scenario of the recent bank stress tests, imply that recapitalization needs are larger than what the too-lenient stress test prescribed. The U.S financial system – in spite of the massive policy backstop – thus remains severely damaged, and the credit crunch remains unlikely to ease very fast. A sharp rise in public debt burden – the U.S. Congressional Budget Office estimates that the public-debt-to-GDP ratio will rise from 40% to 80% (in the next decade), or about $9 trillion – will also put a dent on growth. If long-term rates were to increase to 5%, the resulting increase in the interest rate bill alone would be about $450 billion, or 3% of GDP. The implication is that the fiscal primary surplus will have to be permanently increased by 3% of GDP, which could constitute further pressure on the disposable income of the U.S. consumer. Not only does the U.S. economy face downward risks to growth in the medium-term, but potential growth might fall as well. The U.S. population is aging. With employment still falling – and another jobless recovery on the horizon – the rate of human capital accumulation will fall. Moreover, workers who remain unemployed for a long period of time lose skills, while young workers that enter the workforce, but don’t find a job, don’t acquire on-the-job skills. Reduced investments in worker training and education, coupled with lower capital expenditure, are a recipe for lower productivity ahead. Deflationary pressures are still present in the U.S. economy. Demand is falling relative to supply and excess capacity is still promoting slack in the goods markets. Moreover, the rising slack in labor markets, which is pushing down wages and labor costs, implies that deflationary pressures are going to be dominant this year and next year. This implies that the Fed will keep monetary policy loose for a while longer. However, discussion of an exit strategy has to start now as investors’ concerns about the Fed’s ballooning balance sheet and expectations of inflation both mount. There are also signs that a double-dip recession could materialize toward the second half of next year, or in 2011. If oil prices rise too much, too fast, too soon, that’s going to have a negative effect in terms of trade and real disposable income in oil-importing countries. Also, concerns about unsustainable budget deficits are high and are pushing long-term interest rates higher. If these budget deficits are going to continue to be monetized, eventually, toward the end of next year, there is a risk of a sharp increase in expected inflation that could push interest rates even higher. Together with higher oil prices, driven up in part by this wall of liquidity rather than fundamentals alone, this could be a double whammy that would push the economy into a double-dip or W-shaped recession by late 2010 or 2011. In conclusion, the outlook for the U.S. economy remains very weak. The recent rally in global equities, commodities and credit may soon fizzle out as worse-than-expected earnings and financial news take their toll on this rally, which has gotten ahead of improvements in actual macroeconomic data. http://www.rgemonitor.com/economonitor- monitor/257243/rge_monitor__us_economic_outlook_q2_2009_update

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El Banco de España alivia al sector al reducir las provisiones obligatorias Se reducen un 50% las dotaciones de la morosidad de las hipotecas de buena calidad - Por contra, se gravan más los créditos al consumo fallidos ÍÑIGO DE BARRÓN - Madrid - 15/07/2009 La contabilidad se puede graduar y permite dar o quitar tiempo de vida a las entidades. En este caso, el Banco de España ha decidido rebajar la presión sobre bancos y cajas ante la dureza de la crisis y las malas perspectivas de futuro. La contabilidad se puede graduar y permite dar o quitar tiempo de vida a las entidades. En este caso, el Banco de España ha decidido rebajar la presión sobre bancos y cajas ante la dureza de la crisis y las malas perspectivas de futuro. En una carta enviada el lunes a las patronales del sector, el organismo dirigido por Miguel Ángel Fernández Ordóñez comunicó las nuevas reglas sobre provisiones que serán un 50% más bajas de media que las actuales, en el caso de las buenas hipotecas. No era todo lo que ha pedido el sector durante meses (sobre todo las cajas), pero sí supone aflojar una cuerda que empezaba a ahogar a muchas entidades. En cambio, en un gesto salomónico muy típico del supervisor español, ha decidido incrementar las dotaciones por la morosidad de los créditos al consumo. Es decir, el Banco de España considera que pueden crecer los impagos en los préstamos para muebles, electrodomésticos, viajes y coches y pide más refuerzos a las entidades que entren en este negocio más arriesgado porque la garantía se deprecia con rapidez. Técnicamente, el Banco de España permitirá, a partir de ahora, que cuando un crédito, concedido por debajo del 80% del valor de tasación, sea moroso por más de dos años, no se deberá provisionar el 100% de lo que falta por pagar, como ocurría hasta ahora. Es decir, se entendía que el valor residual del piso era cero, algo exagerado, como ha reconocido el propio supervisor. Con la nueva normativa, se reconocerá que, pese a las crisis, la vivienda siempre conserva el 70% de su valor residual (la diferencia entre el precio de compra y las cantidades abonadas al banco) por lo que se reducen las exigencias de provisiones ante los morosos. Las entidades han enviado series históricas de las distintas crisis que ha vivido España, en las que según ellas, se demostraba que la vivienda no ha bajado nunca de ese 70%. Fuentes del mercado apuntan que se corta el "efecto arrastre" de la morosidad, que ahora cumple dos años. Tras los cambios, el Banco de España considera que queda un sistema de provisiones adecuado que mantiene los altos niveles de exigencia y de garantías. La normativa que se suaviza ahora proviene de 2004 y fue un intento baldío de frenar la locura inmobiliaria en la que se habían metido bancos y cajas. Hasta ahora el sector ha dotado 26.000 millones en provisiones genéricas (que son el colchón para la morosidad futura) y 19.000 millones en específicas (las que responden a créditos fallidos). Bancos y cajas se han quejado en muchas ocasiones de tener que provisionar más que sus competidores europeos por los créditos morosos. Sin embargo, este cambio regulatorio no afectará a lo que se considera crédito dudoso, que tiene un calendario creciente a partir de los tres meses de impago. La tasa de morosidad está situada en el 4,5% del total, aunque las cajas esperan cerrar el ejercicio en el 6%. Por otro lado, el Banco de España nombró ayer director general del Fondo de Reestructuración Ordenada Bancaria (FROB) a Julián Atienza, en la primera reunión de la

295 Comisión Rectora. El Banco de España ha propuesto a cinco de los ocho integrantes del FROB, y el resto son de los Fondos de Garantía de Depósitos de cajas, bancos y cooperativas. Roberto Higuera, ex consejero delegado del Popular, representa a los bancos. Además, Luis Ángel Rojo, ideólogo de la norma que obliga a los bancos a acumular reservas en épocas de bonanza para cubrir pérdidas futuras (provisiones anticíclicas), advirtió ayer a los reguladores extranjeros de que aunque adopten el modelo, no acabarán con los excesos de los banqueros. "Los bancos españoles hicieron todo tipo de disparates, aun con este modelo", dijo a Bloomberg en una entrevista. Rojo fue gobernador del Banco de España entre 1992 y 2000 y consejero del Santander desde 2005. Roja lamenta que Europa no les escuchara cuando les contaron las bondades de este sistema, que ahora quieren imponer.

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La termosolar puede cubrir la cuarta parte de la electricidad mundial en 2050 La energía termosolar podría cubrir más de la cuarta parte de la demanda eléctrica mundial en 2050 y gracias a ella se podría ahorrar ese año el 20 por ciento de todas las emisiones de CO2 que hay que reducir en el sector energético para salvar el clima. EFE MADRID 14 · 07 · 2009 Así se recoge en el informe "Energía Solar Térmica de Concentración: perspectiva mundial 2009", elaborado por Greenpeace junto con la Asociación Europea de la Energía Solar Termoeléctrica (ESTELA) y el Programa Solar PACES de la Agencia Internacional de la Energía. A más corto plazo, el estudio señala que este tipo de energía -que produce calor o electricidad mediante el uso de cientos de espejos que concentran los rayos del sol- podría abastecer el 7 por ciento de la electricidad mundial en el año 2030. Durante la presentación del estudio, el responsable de cambio climático y energía de Greenpeace, José Luis García, ha destacado que con una superficie algo menor a la de la Comunidad Valenciana se puede generar toda la demanda eléctrica actual de la Unión Europea. Asimismo, con una superficie similar a la de Andalucía y Cataluña juntas o al 0,5 por ciento de todos los desiertos mundiales se podría producir toda la electricidad consumida en el mundo. García ha subrayado que se trata de una energía viable desde el punto de vista técnico y comercial, no contribuye al cambio climático y su fuente (el sol) no se agotará nunca. Además, las centrales solares termoeléctricas tienen la ventaja de que pueden seguir funcionando aunque no haya sol, ya que pueden almacenar la energía en forma de calor o bien operar en combinación con otras energías renovables, como el biogás. El informe muestra que las inversiones en esta nueva tecnología superarán este año los 2.000 millones de euros y podrían generar unos ingresos de 20.800 millones, además de crear 90.000 empleos en el mundo en el año 2015. Actualmente, ya hay 564 megavatios operativos a escala mundial, de los cuales España produce 132, tiene otros 1.417 en construcción y 12.682 propuestos, lo que le sitúa a la cabeza en la expansión de esta energía renovable. A este respecto, Valeriano Ruiz, presidente de Protermosolar (la patronal del sector) y vicepresidente de ESTELA, ha asegurado que la razón fundamental del liderazgo de España es la existencia de primas, por lo que ha asegurado que el punto de partida para el desarrollo de esta tecnología es la voluntad política, "razonablemente mantenida" en España por todos los gobiernos. Precisamente el mantenimiento de un sistema de primas fiables, aunque en una senda decreciente, la eliminación del límite actual de potencia por planta (50 megavatios) y la no

297 imposición de cupo de potencia total como se ha hecho con la energía fotovoltaica, son algunas de las recomendaciones de Greenpeace para España. Ruiz ha situado entre el año 2015 y el 2020 el momento en que la energía termosolar será competitiva, un plazo que, según Greenpeace, dependerá de la nueva regulación energética que haga el Gobierno. Según este catedrático de Termodinámica de la Universidad de Sevilla, la termosolar va a dar estabilidad al sistema eléctrico y ha subrayado que su expansión "no se puede ya parar de ninguna manera". http://www.energiadiario.com/publicacion/spip.php?article11202

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14.07.2009 The political consequences of Germany's constitutional court By: Wolfgang Munchau

There was a collective sigh of relief in Brussels this month when Germany’s constitutional court ruled that the Lisbon treaty was consistent with German law. This means Germany will be able ratify the treaty before the end of the year. But not so fast. If you read the entire 147-page ruling, you realise that the court has given a damning verdict on future European integration. For example, it declared a hypothetical fiscal policy co-ordination or the establishment of a single European Union military command as unconstitutional. The ruling is not only relevant for Germany’s future position on further European integration but also has important implications for anyone who has yet to make up their minds about the Lisbon treaty. The Irish electorate, for example, which will hold a second referendum on the treaty in October, might wish to look closely at the judgment. Those who vote Yes in the referendum will have do so in the knowledge that because of this verdict there will not be another treaty for a very long time. It may be our generation’s last shot. I want to focus on three aspects of this complex ruling: the separation of powers between member states and the EU; the court’s view of the European parliament; and its view on European integration. First, Germany’s constitutional court takes a clear stance on sovereignty. Ultimate authority always has to rest in a single place – and that is the member state for now. If you wanted to transfer sovereignty to the EU, you would have to dump your national constitution and adopt a European version in its place. As this is not going to happen, the court, in effect, ruled that all sovereignty in the EU is national. Power may be shared, but sovereignty may not. Second, the court does not recognise the European parliament as a genuine legislature, representing the will of a single European people, but as a representative body of member states. A particular criticism made by the court is that the European parliament does not behave like a true parliament. There is no formal opposition. There is no grouping that supports a government. While the Lisbon treaty increases the powers of the European parliament, it does not, in the court’s view, fix its ultimate short-coming: that the parliament

299 does not constitute an effective control of EU executive power. Arguing purely from the narrow perspective of German constitutional law, it is partly for that reason that the court decided to strengthen the relative position of the German parliament. As a result, Germany will be able to ratify the Lisbon treaty only after a change in a domestic power-sharing law. Third, and perhaps most important, the court has given an explicit opinion on the question of European integration. Where does it end? The answer is: right here. The court said member states must have sovereignty in the following areas: criminal law, police, military operations, fiscal policy, social policy, education, culture, media, and relations with religious groups. In other words, European integration ends with the Lisbon treaty. It is difficult to conceive of another European treaty in the future that could be both material and in line with this ruling. You might have noted the reference to fiscal policy in the list of policy areas reserved for member states. This is interesting in view of the debate about the policy response to the financial crisis, and the introduction of a constitutional balanced budget law in Germany. I have some sympathy with the court’s view that macroeconomic policy has to be anchored in a firm decision-making structure. In other words, macroeconomic policy cannot be run on the basis of loose inter-governmental co-operation as it is now. In a crisis, somebody needs to be in charge. But I fear that the court jumped to the wrong conclusion by anchoring the responsibility for fiscal policy exclusively at the national level, once and for all, thus ignoring the economic and geopolitical issues that may arise from the existence of a monetary union. Consider, for example, the combination of this judgment and the recently-passed balanced budget law, and ask what this will do to the coherence of the eurozone? Some commentators hope the balanced budget law will not be rigorously applied, as it contains several loopholes, such as the Bundestag’s prerogative to suspend the rules in an emergency. But remember, this is not ordinary law; it is enshrined in the constitution. I have no doubt that this hard-headed court will enforce the balanced budget principle like a religious dogma. In terms of economic policy, the court’s view may have been consistent with the realities that prevailed before the Maastricht treaty in the early 1990s. But a decision that essentially rules out effective economic crisis management in a monetary union, by anchoring all relevant political decisions at the national level, is hardly consistent with a sustainable single currency. Something will have to give, and I would not be prepared to predict what will happen if an actual conflict were to arise. The court’s judgment reflects the nationalistic, post-Bismarck era political mood in Berlin at the moment. At the very least, anyone locked in a monetary union with Germany should be very worried. http://www.eurointelligence.com/article.581+M54200903327.0.html#

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La solidez bancaria amortigua la crisis en Latinoamérica Un seminario analiza los desafíos a los que se enfrenta la región DENISSE CEPEDA - Madrid - 14/07/2009 Los sistemas financieros latinoamericanos han gozado de mejor salud que los de los países desarrollados. Cuatro factores han favorecido a la región: sus flexibles tasas de cambio y la acumulación de reservas internacionales, la creación y el fortalecimiento de los mercados locales de bonos, las estrictas normas sobre el sector financiero en materia de riesgo y de liquidez, y el decrecimiento de la posición de deuda exterior de los bancos latinoamericanos en los últimos seis años. América Latina no escapa, sin embargo, a la crisis global. Afronta varios desafíos en el futuro inmediato: la fuerte regresión en el flujo de capitales, la caída de los precios de los commodities y la desaceleración económica global. Este panorama fue expuesto por el presidente de la Federación Latinoamericana de Bancos (Felaban), Ricardo Marino; el secretario de Economía del Gobierno español, José Manuel Campa, y el secretario general iberoamericano, Enrique Iglesias, en el Encuentro Iberoamericano que se celebra en Madrid, donde se analiza el papel de la banca en la recuperación de las economías iberoamericanas. En su intervención, Campa afirmó que la normalización de la actividad crediticia en el sistema bancario es "un requisito para que la recuperación económica sea vigorosa y sostenible". Pero todavía quedan algunos obstáculos por superar. El secretario de Economía advirtió de que, durante varios meses, el aumento de la morosidad presionará a la baja la cuenta de resultados de las entidades financieras. Por esta razón, defendió el Fondo de Reestructuración Ordenada bancaria (FROB), dijo "es un instrumento importante pero no urgente", y recomendó que "el sector público apoye determinados flujos de financiación durante algún tiempo, mientras los bancos recuperan su capacidad y puedan asumir riesgos". Para Campa, la solución reside en la transparencia sobre las pérdidas y, donde sea necesario, el saneamiento, la reestructuración e inyección de capitales. "Las entidades financieras deben competir en igualdad de condiciones, pero sometidas a un marco de regulación y supervisión riguroso que exija un nivel de capital suficiente, que cuide con especial celo la calidad de las cuentas y que se preocupe también de que la relación con los clientes se base en la transparencia", concluyó. Ricardo Marino, presidente de Felaban, comentó que para recuperarse la caída en la producción y el aumento del desempleo se debe revitalizar primero al sector financiero. En el caso de América Latina, Marino indicó que las economías dolarizadas o de países dependientes de Estados Unidos, como México, serán las más afectadas. Aunque aseguró que se han observado mínimos signos de recuperación en otras, como las de Brasil, Perú y Chile, esto debido al restablecimiento del crédito y el impulso de las inversiones. "En América Latina la banca es parte activa de la solución, no del problema. En la región no hubo quiebras de bancos importantes, ni pánicos financieros, ni paquetes ruinosos de hipotecas de alto riesgo. Nuestras instituciones se encuentran fuertemente capitalizadas y las reservas están a niveles considerablemente más elevados que en el resto del mundo; [Latinoamérica] es pionera en aplicar las normas de riesgo con extremo rigor, cosa que no ocurrió en los países desarrollados", destacó el representante de la banca.

301 Marino añadió que Felaban trabaja en el perfeccionamiento de los marcos regulatorios, que incluyan esquemas que garanticen el acceso a los servicios financieros de las poblaciones vulnerables, la elaboración de un código de mejores prácticas, el fortalecimiento de los modelos de gestión y que impulse la educación financiera para mejorar la imagen de la banca. El organismo hizo una llamada a las instituciones financieras para que reconozcan la necesidad de aplicar medidas de protección más rigurosas. Los riesgos seguirán latentes mientras no se conozca la evolución y el comportamiento de la economía internacional, apuntó Enrique Iglesias. Uno de los riesgos, añadió el secretario general iberoamericano, es la ralentización de la economía causada por la reducción del crédito, las medidas proteccionistas en el comercio y la falta de estímulos para incrementar la demanda. Pese a todo, Iglesias aseguró que esta coyuntura brinda una enorme oportunidad a América Latina para aprovechar su posición geográfica y su capacidad productiva e invertir en la educación para impulsar su desarrollo.

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ANÁLISIS: EL ACENTO Con la ayuda de Calvino 14/07/2009 El primer ministro de Holanda, el democristiano Jan Peter Balkenende, ha aprovechado que se cumplen 500 años del nacimiento de Calvino para sugerirles a los suyos que ha llegado la hora de volver sobre sus enseñanzas. "Pensamiento a largo plazo, ahorrar para futuras generaciones, sobriedad y ética profesional": todas estas lecciones, ha dicho, las ha aprendido del gran reformista protestante y las considera indispensables para salir de la actual crisis económica. Para el político holandés, esta crisis "es también de carácter moral y ha sido creada por la avaricia, la preocupación por el dinero y el egoísmo". Llama la atención que el mensaje haya sido dirigido a una población que poco tiene que ver (aparentemente) con Calvino: el 40% de los holandeses se declara no religioso y el 28% se considera católico. Balkenende pertenece al 19% de los que se declaran protestantes. Afinando más, él es calvinista, como calvinistas son el ministro de Finanzas y el de Familia y Juventud. Tres espadas que unirán así su voz en esta llamada a esas recomendaciones que hiciera en su día Jean Cauvin (1509-1564), Calvino, el teólogo francés que se enfrentó a la Iglesia de Roma por la facilidad con la que se apartaba de las lecciones del Evangelio para caer en las más variadas corruptelas. Calvinistas fueron muchos de los rasgos que hicieron de Holanda una de las avanzadillas del capitalismo. El gran país de los comerciantes y de los manufactureros, el lugar donde reinaron la austeridad y el culto al trabajo, la capacidad de ahorro y las buenas artes para reinvertir las ganancias. Todos esos valores que, como en su día analizó Max Weber, sirvieron de combustible espiritual con el que levantar la maquinaria capitalista. Se trata pues de volver al mismo lugar desde el que se partió: al rigor de Calvino frente a todos esos capitalistas de pacotilla, amigos del derroche y la avaricia. No tanto egoísmo como austeridad y ascetismo. Ésa es la ayuda que Calvino puede ofrecerle al capitalismo de hoy. Si Balkenende consigue convencer a los holandeses de hoy de que ése es el camino, habrá que estar muy atentos a los nuevos signos que adopta el viejo puritanismo. http://www.elpais.com/articulo/opinion/ayuda/Calvino/elpepiopi/20090714elpepiopi_3/Tes?p rint=1

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Oil's Puzzling Spring Surge Reignites Debate About Speculators July 14, 2009 By Steven Mufson Washington Post Staff Writer Tuesday, July 14, 2009 The run-up in oil prices that began earlier this year was not as steep as last summer's record climb, but it was almost as mystifying. Demand was low, the global economy was sagging, and the world's oil consumers and producers were brimming with excess supply. Those factors ought to keep prices down, but the monthly average price of crude oil jumped $10 a barrel from February to April, another $10 in May and again in June. Gasoline prices in the United States rose 54 days in a row, and AAA called the increases through May "the largest five-month retail advance this century." Then over the past 10 days, oil prices tumbled back, falling to $59.69 a barrel, to the lowest level in eight years, summoning memories of last year, when prices hit a record $147 on July 11 before falling back down. Renewed pessimism about the economy was one reason for the 10-day swoon, but the abrupt shift has been dizzying. And not entirely reassuring. Many regulators, oil analysts and oil executives say that the lurches in price this year -- even more than last year's -- must be attributable primarily to one factor: Speculators. "Here we go again," Bart Chilton, a commissioner at the Commodity Futures Trading Commission, said late last month. "Crude oil prices are up 60 percent on the year. Supplies are at a 10-year high, and demand is at a 10-year low. You do the math. Why should prices be over $70?" Last week, the CFTC said it would consider new measures to curb speculation and increase transparency in energy markets, where the agency's data suggest that a substantial amount of oil trading was concentrated in the hands of just a few investment banks and trading firms. Also last week, the leaders of Britain and France urged measures to counter "damaging speculation." Regulators worry that even a small bubble in oil prices could stifle economic recovery by draining money from savings or other purchases, undercutting the government stimulus program and reigniting inflation. "It's almost as if these current prices are in an alternative universe," hedge-fund manager Mike Masters, a fixture at congressional hearings on commodities oversight, said in an interview with the trade publication Mastering Derivatives. "You've got the speculative price of oil, and you've got what the actual price of oil would be." Speculation, many analysts note, is a loaded term. It conjures images of unprincipled middlemen who manipulate and bet on prices. In reality, "speculators" are simply investors who have no commercial use for oil and never plan to take delivery. They can include state pension funds and college endowments, as well as investment banks and hedge funds seeking to use oil futures the same way they use other financial instruments. " 'Speculation' isn't a dirty word," Chilton wrote in an e-mail. "Speculators are a necessary part of futures markets, and they play a critical and important role in the price discovery

304 process. If, however, a group of entities is affecting the price of a critically important commodity in an uneconomic fashion, the CFTC has a responsibility to investigate and address it." Some oil experts, economists and analysts said supply and demand have, in fact, been bigger factors than speculation in driving oil prices. And those experts expect costs to keep going up. "We continue to gain confidence that the trough in the oil cycle has passed and a new up-turn is underway," Goldman Sachs oil analyst Arjun Murti wrote in a report last month. He cited stagnant world oil supplies -- and declining production outside the Organization of the Petroleum Exporting Countries -- along with a gradual revival of demand. Goldman Sachs boosted its price forecasts by $10 a barrel, saying the cost would surpass $100 over the next couple of years. Adam Sieminski, chief energy economist for Deutsche Bank, asked, "How long can a commodity stay below its replacement cost?" He estimated that the cost of finding a new barrel of oil is "at least $60 and might be $80." Chilton -- like others who see a bubble in oil prices -- points to the wave of money coming into oil markets from investors. Last year, the CFTC estimates, about $200 billion flowed into regulated oil markets. Chilton said billions of dollars more probably flowed into unregulated, or "dark," markets, where it is impossible to identify players or track trade volumes. Investment banks say money has been flowing into oil funds. Many of these investors are seeking to diversify their holdings or protect themselves against inflation that governments and central banks might foment while jolting the global economy. "It's like a barbecue that is not catching fire," said Jan Loeys, J.P. Morgan Chase's London- based head of market strategy. "You put all kinds of lighter fluid on it, and it's not taking. Then at some point, it takes, and then you don't have a lot of time before it blows up in your face." Loeys has been telling clients that oil has been a better inflation hedge than gold, a traditional haven in times of instability or inflation. While he accurately predicted in late June that oil prices could drop $10 with falling stock markets, he added, "I think there's a high chance that in the next six months, the oil price will be higher, and a large part of that will be fear of the upside risk of inflation." James C. May, head of the Air Transport Association, said the opacity of oil markets distorts prices. "People are playing the same expectations game as a year ago," he said. "We've got an average consumption somewhere in the 80- to 84 million-barrel-a-day range in physical trades out there, and at the same time well over a billion barrels being traded on the speculative side." Does all that trading change the price? Most economists say no. They say speculators are essentially placing side bets while supply and demand dictate prices. "They matter for a little while, but they can't fight gravity," said Kevin Book, an energy expert at ClearView Energy Partners, pointing to last week's price decline. CFTC statistics show that physical and speculative traders have different views of the market. In May, for example, noncommercial traders increased their bets on rising prices, while commercial traders adjusted their positions in anticipation of falling prices. Therefore, some analysts say, noncommercial traders can skew markets. (In the week ended July 7, the CFTC reported that noncommercial traders sharply reduced their bets on rising prices, one reason prices dipped.)

305 Economists say that a sign of a speculative bubble is a buildup in inventories because people will hoard supplies in anticipation of ever higher prices. Last year, there were few signs of that. This year, however, worldwide inventories have been at or near record levels. Additional oil has been floating offshore in tankers. Last week, the Energy Information Administration reported that U.S. commercial stocks are high enough to cover 60.6 days of demand, several more than usual. Roger Diwan, an oil expert at the Washington consulting firm PFC Energy, argues that there can be a bubble even without excess physical stockpiles. He says paper contracts for oil futures on the New York Mercantile Exchange -- which requires physical delivery -- are an easier way for people to lay aside supplies without having to lease ships or storage tanks. Wei Xiong, an economist at Princeton University, has studied financial bubbles and has been looking at last year's oil shock. He said CFTC data show that when prices started soaring in 2007, the "long positions," or bets on rising prices by noncommercial traders -- those trading for investment and not for delivery -- were 4.5 times the average of the previous decade. "This evidence does suggest that many investors are speculating on the appreciation of oil prices," he said. Moreover, he said, OPEC members can curtail output instead of adding to inventories. "Since the cost of storing oil is much higher than many other commodities, the best way for producers to build up inventory is to keep the oil underground," he said. "The latest surge in oil prices defies fundamental logic," Edward Morse, oil expert at Louis Capital Markets Research, wrote in late June. "But in a disturbing echo of the 2007-08 commodity bubble, markets are again shrugging off the fundamental picture in favor of financial positioning and return-chasing." Steven Mufson Oil's Puzzling Spring Surge Reignites Debate About Speculators July 14, 2009 http://www.washingtonpost.com/wp- dyn/content/article/2009/07/13/AR2009071303324_pf.html

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Congress Mulls Trading Curbs for Its Own Financial Workload Brings Concerns By Zachary A. Goldfarb Washington Post Staff Writer Tuesday, July 14, 2009 A congressional committee yesterday pushed for stronger curbs to prevent financial trading based on confidential information by lawmakers, their staff or other government officials. Lawmakers and market experts said stronger limits are needed now that the government is playing a much bigger role in the private sector as a result of the financial crisis. They said it is much more likely that policymakers will know market-sensitive information about public companies. "Congress and the federal government are now so enmeshed in the operations of our financial markets that the potential for abuse by members of Congress, congressional staff and federal employees is staggering," Rep. Louise Slaughter (D-N.Y.) said at a hearing of the oversight and investigations subcommittee of the House Committee on Financial Services. Slaughter and Rep. Brian Baird (D-Wash.) have introduced legislation that would prohibit lawmakers and their staffs from trading stocks or engaging in other financial transactions based on information they learn in their jobs that is not also available to the public. Currently, there is no prohibition. Under the proposal, lawmakers and their staff would have to disclose any stock, bond or commodity trades exceeding $1,000 within 90 days. They also would not be able to pass confidential information to outsiders. A vote on the legislation has not been scheduled. There has been no specific evidence of insider trading by lawmakers or their aides. But suspicions surface from time to time. A 2004 study by a Georgia State University professor said senators got returns on investments 25 percent higher than ordinary investors. And recent disclosures showed that many lawmakers have sizeable investments in the financial firms that have been bailed out over the past year. Executive-branch employees are supposed to follow government ethics rules that prohibit trading based on nonpublic information. However, the conduct of two Securities and Exchange Commission employees came into question recently in an inspector general's report raising concerns about the timing and appropriateness of trades by the employees. Inspector General David Kotz said this was indicative of a broken system at the SEC for ensuring that workers don't abuse their positions. "The SEC had essentially no compliance system in place to ensure that its own employees, with tremendous amounts of nonpublic information at their disposal, did not engage in insider trading themselves," Kotz said yesterday. The SEC issued a statement describing what it is doing to try to improve internal safeguards. "The employees at the SEC have a well-deserved reputation for integrity and professionalism," the statement says. "When fully implemented, these measures will further bolster our standing by helping to prevent not only an actual impropriety, but the appearance of one as well." Kotz said the steps the SEC outlined would meet or exceed his recommendations. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/13/AR2009071303123_pf.html

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U.S. Considers Rescue of Major Small-Business Lender CIT Group's Plight Poses Difficult Choices for Administration By Binyamin Appelbaum Washington Post Staff Writer Tuesday, July 14, 2009 The deteriorating health of CIT Group, a major small-business lender, is shaping up as a gut check for the Obama administration, which may be forced to choose between allowing a painful failure and conducting a rescue that would underscore just how fragile the economy remains. While CIT has about $75 billion in assets, it was not included in the government's stress tests of major financial firms, and most analysts agree that its failure would have relatively modest consequences for the financial system. But it has grabbed the administration's attention because of its focus on small-business lending, an area of outsize political importance. The New York company is mounting an increasingly public case that its failure would crumple thousands of fragile firms. Administration officials met yesterday afternoon to review CIT's problems and to consider possible responses, according to a person familiar with the matter. Some officials would like to leave CIT alone, to show that the economy is strong and that the government will not rescue every faltering firm. But at a time when the administration already is working on ways to increase lending to small businesses, other officials see rescuing CIT as a necessary and obvious step. Treasury Secretary Timothy F. Geithner, traveling in London, said yesterday that the situation is being watched closely. "I'm actually pretty confident in that context we have the authority and the ability to make sensible choices," Geithner said. CIT is one of the dying breed of lenders that relied on Wall Street for funding. Many have collapsed since investors stopped buying their loans almost two years ago. CIT was too big to go quickly, but it is facing a crisis as billions of dollars in long-term debts are starting to come due, and its vital signs are flagging. Stock in CIT has lost 94 percent of its value since the beginning of 2008. It fell 11.76 percent yesterday to close at $1.35 amid media reports that it is considering a bankruptcy filing. Its bonds plunged on the news. Its credit ratings have been slashed by all three firms that evaluate the likelihood that a company will repay its debts. Moody's cut its rating by four notches yesterday, citing "growing concern with CIT's liquidity position and prospects for survival of the franchise." The company's plight is putting a spotlight on the Federal Deposit Insurance Corp. The independent agency so far has not allowed CIT to participate in a program that helps companies sell debt to investors, something CIT desperately wants to do. The agency guarantees to repay investors if the companies default, and officials are concerned about CIT's viability, sources said. In a parallel case, the administration pressured the FDIC to guarantee debt issued by GMAC, another lender long dependent on Wall Street. Senior officials argued that the FDIC was placing its own interests above the needs of the economy. They prevailed after agreeing to a

308 broader aid package designed to ensure the company's survival, including a direct investment from the Treasury Department and an agreement from the Federal Reserve to waive standard restrictions on the company's lending activities. Government officials have discussed a similar approach to CIT's problems, but the talks remain preliminary, sources said. Spokesmen for the FDIC and the Treasury declined to comment. CIT said in a statement that it "remains in active discussions with its principal regulators on a series of measures to improve the company's near-term liquidity position." CIT's struggles highlight the difficulty of the administration's efforts to make loans available to small businesses. Banks traditionally make loans to the cream of small-business applicants, and standards have only grown more restrictive as banks struggle with rising defaults. The Fed's quarterly survey of bank lending officers showed that banks in the first quarter generally reduced the availability of small-business loans, increased scrutiny of applicants, and charged higher interest rates and fees. CIT and other independent lenders offered small businesses an alternative to bank loans, restraining prices and allowing many marginal companies to find funding. The non-banks got their money from Wall Street, bundling their loans into securities snapped up by investors, who returned money for a new round of loans. The collapse of the subprime mortgage market froze the securitization business almost two years ago, however, and only a small number of investors have returned. Another small-business lender, the credit-card company Advanta, suspended all lending to its 1 million customers at the end of May. A month later, regulators ordered the company to wind down its banking operations. CIT has managed to continue making loans, in part by drawing on emergency credit lines obtained from banks before the crisis. The firm also holds billions of dollars in debt that initially offered a financial reserve. But the company now faces an acute problem: About $1 billion of that debt is coming due in August. With time running out, CIT has hired Skadden Arps Slate Meagher & Flom, a firm that often helps companies file for bankruptcy. CIT already has received considerable support from the government. The Fed in December granted CIT expedited approval to become a bank-holding company, making it eligible for various forms of federal aid including direct investments from the Treasury. At the time, the Fed said the company was well-capitalized, with an adequate buffer against likely losses, thanks to its success in raising capital. One week later, the Treasury invested $2.3 billion. As a result, if CIT fails, the government could rank among the largest losers. http://www.washingtonpost.com/wp- dyn/content/article/2009/07/13/AR2009071302957_pf.html

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14.07.2009 Socialists for Barroso

Jean Quatremer has a good story this morning, according to which the Socialists in the European Parliament are ready to support Barroso’s reelection in September so that Socialist leader Martin Schulz can become president of the European Parliament in return. In September, Barroso would only need a simple majority, while he would require an absolute majority if the vote were held under the rules of the Lisbon Treaty – which may have been the case after a yes vote in the Irish referendum on Oct. 2. The article discusses the electoral dangers of this strategy – both in view of the Irish referendum and the German elections end- September. Daniel Cohn Bendit is quoted as saying that this could lose the SPD additional votes at the national elections, while Social Democrats pointed out that it would have no effect at all. (Unfortunately, we concur with the latter statement, unless the Greens were able and willing to turn their domestic campaign more aggressively against the SPD) Trichet says time to think about exit strategies Les Echos quotes Jean Claude Trichet effectively saying that it is time to think about exit strategies. At a seminar at the University of Munich he warned against the idea that it is too early or even completely inopportune to envisage early exit strategies. He said that these positions are completely wrong. Trichet also said that it will take time for extra liquidity to translate into credits, urging banks to remember their responsibilities to lend to firms and households (see Reuters). Ireland’s unemployment on the rise Ireland has moved from having the second lowest unemployment rate among the EU-15 countries two years ago to the second highest, the Irish Independent reports. With 8.3% it is still much less than Spain, with an unemployment rate of 18.5% the highest in the OECD, but joblessness has risen faster in Ireland than anywhere else. Recession over FT Deutschland has an article according to which the recession may have ended in the second quarter, according to some estimates – a few weeks ahead of expectations. German

310 economists are now expecting growth close to zero during the second quarter, maybe even a small increase in GDP. Previous estimates had suggested that the economy would only start to reach break-even growth in the third quarter. The article interviews a number of economists who tend to express optimism especially in view of the recently published strong data for industrial orders and output. Recession not over Writing in the FT, Tim Lee says in an environment with no inflation and no bubbles, there will be more deleveraging. The consequence will be a weak global recovery with “falling stock markets and commodity prices, falling government bond yields and widening credit spreads, weak carry trade recipient currencies (for example, the Australian dollar) and strong funding currencies (mainly the yen and US dollar) – in short, a troubling return to the markets that we suffered for most of last year.” Sovereign CDS market rises The FT has the story that the market for sovereign CDS, in which investors can protect their sovereign bonds against default (or speculate on sovereign default) has risen five-fold since the collapse of Lehman Brothers in September. The rise in this asset class underlines that investors no longer believe in the notion of a risk-free asset, as some are even speculating on the default of US and UK government bonds. The article also says that providers are launching a new indexes, through which, for example, you can protect against (or more likely speculate on), the default of euro area sovereign bonds. Taleb and Spitznagel on debt Writing in FT, Nassim Tabel and Marc Spitznagel argue that the only way for the world to get out of this crisis is to swap debt for equity. They warn not to repeat the mistakes of the past, through excessively lose monetary and credit policies, and over-reliance on financial models that do not work. They say excessive debt causes financial fragility, while equity is robust. This is also why the bursting of the dotcom bubble had comparatively mild macroeconomic effects. Delong on economic policy at the zero bound Brad Delong has a very good discussion of two contrasting conclusions by two prominent teams of economists about the effectiveness of fiscal policy at the zero bound. Eichenbaum, Christiano and Rebelo have produced a DSGE model with a large fiscal multiplier, while Cogan, Cwik, Taylor and Wieland have a similar model which produces no such effects. The difference lies in the assumptions of what happens at the zero bound. In the latter nothing special happens, except that inflation expectations are rising, long-term interest rates go up, while the first paper assumes that a zero interest rate policy implies an extreme fall in output, leading to deflationary expectations. Delong likes the model, but says the multipliers are probably too large. http://www.eurointelligence.com/article.581+M5cf4a269718.0.html#

311 Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two- Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; [email protected].

July 13, 2009 Cracking Christiano, Eichenbaum, and Rebelo's Big Multipliers without Coffee... July 13, 2009 Greg Mankiw asks a question: Greg Mankiw's Blog: Modern macro even Paul Krugman will love: Lately, Paul Krugman has been dissing modern macroeconomics, mainly because many macroeconomists do not agree with his conclusions about fiscal policy. This new paper by Marty Eichenbaum, Larry Christiano, and Sergio Rebelo should, however, make Paul happy. They report large fiscal policy multipliers in a new Keynesian DSGE model when the economy is at the zero interest lower bound. An open question: How can the results in this paper be reconciled with results by John Cogan, Tobias Cwik, John Taylor, and Volker Wieland, who seem to perform a similar policy simulation in a similar model but reach a very different conclusion? Are there subtle differences in the models? Or subtle differences in the policy experiments? Or did one team simply make a mistake of some sort? Figuring out why these two prominent teams of researchers come to opposite conclusions about fiscal policy multipliers, and which conclusion is more applicable to actual policy, would be a good paper topic for an ambitious grad student. As I understand it, the big problem with Cogan, Cwik, Taylor, and Wieland is that there is nothing special going on at the zero nominal interest rate bound. In their model, a fiscal expansion (a) raises expected future inflation, which (b) creates expectations of future interest rate rises by the Federal Reserve to cool off that inflation, which (c) damps present spending, and so (d) shrinks the multiplier. Their model is a model of a small multiplier in an economy away from the zero nominal interest rate bound when central banks are targeting inflation. Christiano, Eichenbaum, and Rebelo, (CER) by contrast, have a model in which: a shock increases desired savings.... When the shock is small enough, the real interest rate falls and there is a modest decline in output. However, when the shock is large enough, the zero bound becomes binding.... The only force that can induce the fall in saving required to re-establish equilibrium is a large transitory fall in output. The fall in output must be very large because hitting the zero bound creates an economic meltdown. A fall in output lowers marginal cost and generates expected deflation which leads to a rise in the real interest rate. This increase in the real interest rate leads to a rise in desired savings which partially undoes the effect of the fall in output. As a consequence, the total fall in output required to reduce savings

312 to zero is very large. This scenario captures the paradox of thrift originally emphasized by Keynes (1936).... The government spending multiplier is large when the zero bound is binding because an increase in government spending lowers desired national savings and shortcuts the meltdown created by the paradox of thrift... That said, I think that the CER multipliers are much too large to be applicable to our world today. If I understand CER completely (which I may not: the coffee has not yet hit the brain this morning), their Calvo pricing assumption creates a direct link between output Y and inflation π. Recall the flow -of-funds balance equation: S(Y, 0-π) = D + I(0-π) Savings S as an increasing function of income Y and of the real interest rate, which is the nominal interest rate 0 (we are at the lower bound) minus the inflation rate π, is equal to the government deficit D plus investment I which is a decreasing function of the real interest rate, which is the nominal interest rate 0 minus the inflation rate π. An increase in the deficit thus (a) directly increases saving S necessary to finance the deficit which requires a direct increase in Y. But this direct increase in Y then increases inflation π--there is less deflation. And less deflation means both less savings and more investment. So the direct effect increase in Y does not generate enough savings to close the gap in the flow-of-funds market: savings must increase by more--which requires that Y increase by even more. The government deficit thus genuinely "primes the pump" and the multiplier is very large. This channel is, I think, the channel pointed to by those who think that the New Deal had an enormous impact, as Roosevelt's deficits in combination with the increase in price rigidity produced by the NIRA and the breaking of deflationary expectations created by the abandonment of the gold standard diminished desired S. But I don't think we have big expectations of deflation right now. And I don't think fiscal policy moves right now are having a great deal of effect in reducing expected deflation. So I don't think the interaction of output gaps and deflation is playing a big role in boosting the multiplier right now... I may well, however, assign CER next March when I hit the Great Depression week in Econ 210a as an argument for why Cary Brown's estimates of the fiscal policy effect of the New Deal are too low... And it is nice to see a model in which J. Bradford DeLong and Lawrence H. Summers (1986), "In Increased Price Flexibility Destabilizing?" American Economic Review makes a reappearence... http://delong.typepad.com/sdj/2009/07/cracking-chistiano-eichenbaum-and-rebelos-big- multipliers-without-coffee.html

313

"Another Bubble" in Housing? It Could Happen, Says Yale's Robert Shiller Posted Jul 13, 2009 08:30am EDT by Aaron Task Related: The slowing rate of decline in home prices is likely to continue but the housing market is "still in an abysmal situation," says Robert Shiller, a professor of economics at Yale. The co-creator of the S&P Case-Shiller Index, which tracks national housing prices, says the housing market could "languish for many years," due to the "huge inventory" of unsold holds, "shadow inventory" of homes kept off the market by banks and other potential sellers, and "a lot of financial problems." But incredibly, the author of Animal Spirits (with George Akerlof), The Subprime Solution and Irrational Exuberance believes "there could be another bubble" in housing, once the excess inventory is worked off. "This is not my more probable scenario [but] people have gotten very speculative in their attitudes toward housing," he says. Shiller cites Boston as one area for a potential echo-bubble in housing, noting its typically volatile market did not fall in the past two years as dramatically as "more bubbly" cities like Phoenix. The professor and bubble expert isn't predicting it, but the fact he's even mulling the possibility is eye-opening, to say the least. Whether you think the housing bubble is going to collapse further or reinflate, Shiller's firm MacroMarkets recently listed two indexes on the NYSE Arca that allow investors to place their bets (or hedge their own housing exposure): The bullish Major Metro Up (NYSE: UMM) and the bearish Major Metro Down (NYSE: DMM). Going forward, Shiller hopes to offer similar securities for specific cities and geographic areas.

314 U.S. Trade Deficit Narrows as Exports Rebound: Sustainable? Jul 10, 2009

o o Trade deficit narrowed by 9.7% to $25.9 billion in May 2009 (lowest since November 1999) from $28.8 billion in April 2009, led by an increase in exports and a decline in imports. Real trade deficit fell from from $40.1 billion in April to $36.2 billion in May. o The goods deficit fell to $37.3 billion and services surplus rose to $11.4 billion. Non-oil deficit fell to $22.7 billion. o Oil deficit fell to $13.3 billion in May from $14.3 billion in April, reflecting a decline in demand for oil due to higher prices. The import price index for oil showed a 9.3% gain in May 2009. o Imports fell 0.4% in May 2009 to $149.3 billion (lowest since September 2004) led by a fall in industrial supplies, automotive parts and consumer goods imports. Exports rose 1.6% in May 2009 to $121.8 billion led by industrial supplies, foods, feeds and beverages and consumer goods. ISM index for export orders and imports has started improving since April 2009. o Trade gap with China in May 2009 increased to $17.4 billion from $16.7 billion led by a rise in imports. Trade gap with EU, Japan and Mexico declined in May. o U.S. Import price indexes rose 3.2% in June 2009, led by a sharp 20.3% increase in the index for petroleum imports. The export price index rose 1.1% in June o Q1 2009: exports fell 28.7% but imports fell at a much faster pace at 34.1%. This led to a positive GDP contribution of net exports of 2.18%. Trade contribution to GDP growth turned negative in Q4 2008 (-0.5%) compared to Q2 (1.05%) and Q3 2008 (2.93%). Net exports had contributed positively to GDP growth since Q1 2007 o Risks: Both imports and exports peaked in July 2008 and the decline in imports has largely exceeded decline in exports, leading to a positive contribution of net exports to GDP. But the risk ahead is that export growth may continue to decline through 2009 at a much faster pace on global slump while imports may stabilize as consumer spending and industrial production contract at a much slower pace (due to inventory adjustment), and as oil prices pick up. Lower U.S. imports will also hit the export-oriented economies which in turn will reduce demand for U.S. exports. Also, global recovery might lag U.S. recovery so that imports recover faster than exports. These factors may raise the trade deficit and keep the trade contribution to GDP negative or a small positive number in the coming quarters. Implementation of fiscal stimulus packages around the world and U.S. might boost exports and imports temporarily o Via WSJ: The moderation in import decline suggests the pace at which domestic demand is plunging has eased . Weak global recovery and USD strength will limit boost to exports though the largest decline in exports may have passed (Nomura). Rising U.S. savings rate and and decline in consumer spending as a percentage of GDP back towards more sustainable share will imply a narrower trade deficit (MFR). As firms de-stock and trade flows stabilize, the real trade balance will be relatively steady in the next few quarters and will likely widen after recovery in 2010 (RBS)

315 o Though Japan, EU a/c for small share of U.S. exports but slowing demand, manufacturing activity in largest export growth contributors (E. Asia ex-Japan and Latam) pose risk (JP Morgan, not online) o Trade contribution to GDP growth is largely due to lower imports (led by recession in domestic demand and inventory liquidation by firms) (Merrill Lynch, not online) http://www.rgemonitor.com/166/United_States?cluster_id=5003

316 Germany's 'Bad Bank'-Scheme: How Good Is It? Jul 10, 2009

Overview: On July 10, the German upper house voted in favor of adopting the current "bad bank" bill which is aimed at stabilizing the financial sector. The scheme allows for the creation of a Special Purpose Vehicle (SPV) to which banks can transfer their "toxic assets" which are currently estimated at EUR 230 billion. The government hopes that this will result in increasing fresh lending activity which in turn is necessary in order to support the future economic recovery. The Most Important Features of the Bill: o Participation in the program is on a voluntary basis. o There are three different models, one for commercial banks and one for state- owned regional banks. In addition, the state-owned banks can now also found their own "bad bank" on a regional level, instead of at the national level. o Banks can transfer illiquid assets to the SPV for a maturity of up to 20 years. In exchange participating banks receive government bonds from Germany's Financial Market Stabilization Fund agency (S0FFin) with the aim of increasing liquidity in the market. o The Landesbanken can transfer not only illiquid assets but also whole non- strategic business operations. o The toxic assets of each bank will be assigned a market price or a “fair value” assessed by a third party. o Banks have to immediately write down 10% of the book value as a loss when making use of the "bad bank" as long as this action does not push core capital below 7%. In addition banks have to pay an annual fee for using the "bad bank" facility. o The scheme does not transfer responsibility for the toxic assets which the intent of putting less financial stress on the government. Each bank creates its own SPV so that the ownership of the toxic assets can be determined easily. o Potential losses - the difference between the book value and the "fair value" have to be carried by the owners of the banks and will be paid from profits or dividends. In the case of the regional "bad bank" for Landesbanken, the state is liable for any losses if a state-owned regional bank decides to create its own "bad bank". o The valuation date for such risk positions was moved from March 31, 2009 to June 30, 2008 (pre-Lehman) days before the bill was adopted in order to encourage the banks' participation. o Participating banks have to agree to certain conditions such as limiting annual executive pay to EUR 500,000 and mandatory "stress tests", the results of which will not be made public.

317 Opinions: o Since the program is voluntary, banks that are announcing their participation are automatically stigmatized. As a result the scheme is not attractive for banks and the vast majority of them has not shown any interest so far. o In the adopted bill, state-owned banks were able to avoid mandatory consolidation as proposed during an earlier draft. As a result the long overdue reform of the German banking sector will again not materialize which could jeopardize the economic recovery due to their history of low profitability and excessive risk-taking. (See also Germany's Landesbanken: World Champions In Risky Banking Transactions) o The schemes avoids a drastic sector clean-up. Wolfgang Munchau in his column in the Financial Times said that "the plan is a giant accounting trick". One could "compare the scheme to a deep freezer. The banks are trying to buy time. When the crisis is over, they hope that the structured securities can be sold at reasonable prices. Until that happens nothing is resolved." o Changing the balance sheet date to June 30, 2009 made the deal a lot more attractive for banks. The result will be that banks will be able to prop up their balance sheets for the future due to this favorable valuations. o The German plan avoids upfront outlays by the government and keeps banks responsible for their lending decisions rather than dumping losses immediately on the taxpayer. o The Wall Street Journal wrote on May 15: "The bad bank does not cost the government any money upfront which is convenient with regards to general elections in fall 2009. In the long-run though zombie banks can curb credit flows, hold back economic growth and lack transparency. Capital injections are preferable." o Credit Suisse economist Sofia Rehman said the scheme is unattractive to commercial banks. "The important point about the German bad bank scheme is that it does not provide for any genuine risk transfer," (via WSJ) o On May 14 an article in Financial Times Deutschland quotes banking experts as saying that this scheme will be counter-productive as it effectively prevents banks from raising new capital. Investors do not know how large the future losses will be, and the banks will not be able to pay dividends for long periods.(Via Eurointelligence) http://www.rgemonitor.com/385/Germany?cluster_id=13702

318 Chinese Exports Contracted by 21% in June: Could Exports Be Close to a Bottom? Jul 10, 2009 Overview: Chinese exports have been contracting on a y/y basis for eight months but may now be showing signs of stabilization, growing on a seasonally adjusted monthly basis in June 2009. Imports have begun to increase also on a monthly basis perhaps reflecting the increase in commodity prices since the beginning of 2009 but also the increase in production and possibly domestic demand. Yet the export weakness and weak trade surplus will be a drag on growth, likely keeping China below potential. o Chinese exports contracted by 21.4% y/y in June from 26.4% y/y in May. June's decline, the eight consecutive monthly decline matches the longest string of declines in 1995-6 . Imports fell by 13% ( less than expected and much lower than the over 20% so far in 2009) leaving a trade surplus of $8.54 billion ( from $13.4 billion in May and the lowest in 2 years if one excludes the months disrupted by the Chinese new year ) (via Bloomberg) o Exports rose 4.5% on a seasonally adjusted basis m/m from May and imports climbed 2.2% (Customs Bureau, via Bloomberg) o While some analysts feel that exports may be near their weakest given that export orders in the PMI are starting to climb, recovery could drag and be sluggish given weak external demand. o Peng (Citi): The sharp increase in imports (+$11.8 billion or 15.7% m/m) could reflect new demand from production and investment,. Deals for purchasing foreign capital equipment and materials may keep imports strong yet the 'pitiful surplus' will weaken growth. The weak export demand may indicate a slow start in global restocking o Sandbu: Although the y/y figures look depressing, Chinese exports have remained relatively flat or increasing in m/m terms after falling sharply in January. In normal times, y/y figures paint a more accurate picture, but in a fast-changing environment y/y figures obscure what is happening o Imports have lagged the investment rebound. The government extended export incentives again in June the seventh export tax rebate increase in less than a year o In May exports to Taiwan dropped 40.5% y/y 38.7% to S. Korea 38.7%, 29.2% to the EU, 26% to Japan and 21.2% to the U.S.. Commodity imports continue to surge on demand associated with the fiscal stimulus measures, especially notable in the YoY YTD growth in aluminum (156.8%) and copper (53%). o Nielsen (Danske): According to seasonally adjusted data, exports have stabilized. The rebound in China’s exports has been weaker than in most other Asian countries, suggesting that the Chinese recovery has been a major driver in Asian recovery as well as supporting Latin America and Australia. China’s exports appear to have bottomed out as its domestic demand picks up. China’s trade surplus is likely to decline substantially and China’s accumulation of FX reserves should ease significantly. o China was taking the opportunity to purchase commodities at cheaper prices. commodity imports amid lower price

319 o Processing trade has been losing weight in the total foreign trade, accounting for about 40% of total trade in Q1 compared to 42.1% in Q408. Policymakers have been under pressure to reverse the earlier policies discouraging processing trade. o UOB: Total container throughput of China's top 8 ports dropped 16.7% in Feb, the steepest decline in 17 years. Pearl River Delta has been hardest hit. Bohai Rim still had modest growth thanks to low exposure. o ChinaStakes: The total trade volume and in the latest Canton Fair in early May totaled $26.23bn , down 16.9% from the fair in fall 2008, a leading indicator that Chinese trade will continue to be weak. Trading in machinery products totaled $11.26 billion, down 19.5%. Trading volume of light industrial and textile products fell 15.3% and 11.7%, while that of food and shoes had much smaller volumes but rose slightly. At the 104th Canton Fair last fall, numbers of buyers and trading volume dropped 9.1% and 17.5%, respectively o The collapse in demand from Chinese key export destinations U.S. and EU (which absorb over 50% of total exports) can not be offset by exports to emerging economies as those in Asia count on final demand in the G3, and emerging economies are also reducing consumption especially those that export commodities. Intra-Asia trade trade has plunged since October. Import slump reflects a reduction in price and volume of commodities as well as lower demand for processing trade inputs - it may also reflect slowing domestic demand. o Contraction now driven by slowdown of higher valued exports such as electronic goods, containers and steel products. Exports of textiles, clothing and footwear, which fell sharply early in 2008 have stabilized. o Green: Machinery imports continue to be weak indicating a real downturn in domestic investment and manufacturing and evidence of a sharp deceleration of economic growth in the fourth quarter and poor growth momentum in the first quarter (via WSJ) o L+F :processing trade has been losing weight in total foreign trade, total exports and total imports. In 1-3Q08, processing trade accounted for only 40.8% of the total trade value, compared with 45.4% in 2007. This trend was in line with the government’s policy direction to discourage processing trade and the exports of products that are energy- and resource-intensive, highly polluting, labor-intensive and low value- added. http://www.rgemonitor.com/26/China?cluster_id=4517

320

13.07.2009 Bavaria’s CSU wants co-decision rights with government on EU policy

The judgement of Germany’s constitutional court has prompted the CSU, Angela Merkel’s Bavarian allies, to insist that the Bundestag should in future make binding recommendations which the government has to adopt. This is a populist negotiating stance, which is not likely to prevail in the end, but which is likely to make co-decision legislation a touch tougher than previously thought. The constitutional court demand to change a domestic by-law to implement the Lisbon Treaty in Germany, to ensure a material strengthening of the parliament’s position. The ruling, however, does not require total codetermination, which is effectively now what Horst Seehofer, chairman of the CSU, insists on. He appears to calculate that euroscepticism may be a vote-winner in a federal election, as will any decision that will clip the German government’s freedom of manoeuvre. See FT Deutschland and others for coverage of that story. Munchau on the German Constitutional Court Wolfgang Munchau gave a detailed assessment of the Constitutional Court’s ruling in his FT column this morning. He writes that the Court may have cleared Germany’s way to sign the Lisbon Treaty, but has otherwise given a very restrictive verdict for the future of European integration. In particular it has defined a number of areas – including fiscal policy- which it reserves for the domestic realm, thus making effective policy co-ordination in the EU unconstitutional. The Court has also given a damning verdict on the European Parliament, which it defines not as a parliament but as an assembly representing nations. Munchau concludes it is difficult to conceive of another treaty that is both material and in line with this ruling. Furthermore, this verdict is really bad news for the euro area, whose very existence the court did not seem to have taken into account. Oivier Costa on the EP For a different and much more positive perspective of the European Parliament than that given by the German constitutional court, see the comments by Olivier Costa, a French academic, whose has published extensively on the EP. Jean Quatremer has interviewed him. In particular, Costa refutes the criticism that the parliament is not a real parliament because it has no government-parties and opposition.

321 De Villepin criticises Sarkozy In an interview with the FT Dominique de Villepin says that Nicolas Sarkozy is wasting an opportunity to overhaul the French economy by pursuing too many “half-baked” and “badly timed” reforms. In particular he criticised France’s stimulus package for favouring yet more infrastructure improvements over measures to support jobs and boost research. De Villepin describes Sarkozy’s distinction between a “good” deficit arising from investment and a “bad” deficit arising from decades of excessive spending as “absurd”. He said: “When you are obese, you cannot say there is good fat and bad fat. All fat is dangerous and endangers the life of the patient.” OECD sees end of crisis for France and Italy France and Italy could be the first countries to emerge from a crisis, according to the OECD’s leading indicator, according to La Repubblica. The indicator suggests that the recession may have reached the nadir, but the overall level is still way behind compared with last year, except in the two countries. Germany has the worst relative performance in the euro area with minus 11.7% compared to the previous year. While in Germany the index was at least mildly up on a month-to-month basis in May, it was still falling in Japan. ECB warns that Spain will be slow to recover ECB board member Gonzales Paramo warned that Spain‘s recovery will take longer than expected, reports the Irish Independent. "Recovery will be slower due to the amount of debt, weight of construction, the level of education of the unemployed and deficiencies in the labour market which needs to be made much more flexible” he said. The unemployment rate has doubled in less than two years. The workforce enjoys some of the highest firing costs in the world, but a quarter is on temporary contracts and were the first to lose their jobs in the crisis. Spain’s dependency on construction Spain remains the EU country with the largest dependence on the construction industry, according to El Pais. Citing from the latest Eurostat figures, construction still makes up some 10.3% of GDP, down from 10.9% the year before, against a euro area average of 5.8%. The reason for the relatively small fall in the GDP shares, according to the paper, is the Spanish government’s large injections of cash for public construction (which suggests that an end of the stimulus would have significantly negative consequences for economic growth.) France contemplates about end of car wreckage premium In an interview with Les Echos, industry minister Christian Estrosi said that the French government is working on phasing out the car wreckage premium, a scenario brought into the discussion last week by Carlo Ghosn, head of Renault. Estrosi said that the premium cannot be maintained indefinitely (who would have thought..) . Unemployment support for part timers The Dutch part time unemployment scheme, launched three months ago as part of the Dutch stimulus package, is to be topped up by €1bn since its initial endowment of €375m is already spent, reports Nisnews. The government also announces that it will introduce

322 restrictions on its accessibility. First plans suggest that only firms with less than 30% of part time staff can benefit from the full 15 month period of unemployment support, while others will only have access to maximum one year. Ask the people, and you get a very confusing response So what do you make of that poll? The latest FT/Harris poll shows that Europeans start to blame their governments for the crisis (we always thought that this will ultimately go down as a policy crisis more than a financial crisis, so we would concur with that judgement), while the Americans have a much better view of the Obama administration’s crisis handling. While the Europeans blame politicians, they tend to like the central bankers a lot better. Okay, but then comes this: “About half of respondents believe interest rate cuts and government spending will stoke inflation in the near future.” So it seems to be that the biggest problem of this crisis is not the actual fall in GDP, not the actual increase in unemployment, not even the very likely strong increase in future unemployment, but the possible, though not certain, increase in future inflation. Economists unhappy about G20 FT Deutschland has a story in which it asked a number of economists from the US and Germany about their assessment of the financial reform agenda of the G20. The assessment was mostly negative. If there is no deal at the next G20 in Pittsburgh, they said, there will be no significant reform – the kind of which could prevent a future crisis. The economists were particularly concerned about the lack of agenda to tackle global imbalances. Europe needs reforms not a Kenyesian stimulus Kenneth Rogoff writes in Les Echos that the real question for Europe is not whether its stimulus package is sufficiently aggressive but whether Europe can push through necessary economic reforms despite the crisis. Keynesian stimulus packages are no answer to the long term growth challenges that Europe is facing. A flexible labour market, pan European financial market reforms and trade openness would instead lift European growth potential towards the end of the crisis defying current forecasts of a prolonged European stagnation. But if Germany continues to encourage its citizens to buy only German cars and if the French oblige its industries to keep its factories in France, Europe could remain paralysed for decades.

http://www.eurointelligence.com/article.581+ M51d1ffddb31.0.html

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KENNETH ROGOFF L'Europe a besoin de réformes, pas d'une relance keynésienne

[ 13/07/09]

KENNETH ROGOFF, ANCIEN CHEF ECONOMISTE AU FMI, EST PROFESSEUR D'ECONOMIE ET D'ADMINISTRATION PUBLIQUE À L'UNIVERSITE HARVARD. A quoi ressemblera la courbe de croissance de l'Europe après la crise ? Pour les Européens, toujours inquiets d'un effondrement économique, c'est un peu comme si l'on demandait à un passager du « Titanic » ce qu'il allait faire à son arrivée à New York. C'est pourtant une question cruciale à l'heure où l'Europe doit faire face à une pression constante des Etats-Unis et du Fonds monétaire international, entre autres, qui insistent sur la nécessité de mettre en oeuvre rapidement des politiques de relance keynésienne. Il est vrai que la situation est sombre en ce moment. Le revenu en Europe pourrait chuter de 4 % cette année, le taux de chômage s'établir autour de 10 % dans la plupart des pays, frôlant même les 20 % en Espagne et en Lettonie. Le système bancaire va mal, même si des gouvernements ont tenté de masquer les déboires de leurs banques. Mais, aussi mauvaise que soit la situation actuelle, la récession finira un jour. Oui, le risque de percuter un iceberg est toujours bien réel. Cela pourrait commencer par un défaut de paiement des pays baltiques, déclenchant une panique en Autriche et dans les pays nordiques. Mais, pour l'instant, un effondrement généralisé semble moins probable qu'un retour progressif à la stabilité. Un retour suivi d'une croissance faible accompagnée par des niveaux records d'endettement et un chômage élevé. Voici un bien triste tableau. Certains observateurs ont très vivement critiqué les économistes européens pour ne pas avoir appliqué une politique monétaire et budgétaire aussi agressive que celle choisie par leurs homologues américains. Pour quelle autre raison l'Europe souffre-t- elle plus de la récession que les Etats-Unis, se lamentent-ils, alors que tous s'accordent à dire que les Etats-Unis sont à l'origine de cet effondrement économique mondial ? Ces critiques estiment que l'Europe sortira de la crise dans un état bien pire que celui des Etats-Unis, mais il est trop tôt pour émettre un tel jugement. Une récession d'une telle ampleur résultant d'une crise financière telle que celle que nous traversons est loin d'être un événement mineur qui peut se résoudre en un an. Par conséquent, les réponses des économistes ne peuvent donc pas être évaluées sur des mesures à court terme. Il faut aussi se poser la question de ce qui va se passer dans les cinq prochaines années que de se la poser pour les six prochains mois. Peu nombreux sont ceux qui se posent les vraies questions. La réponse extrêmement agressive de l'Amérique va provoquer une augmentation plus rapide de sa dette alors que sa politique de la planche à billets signifie qu'il lui sera difficile de mettre en oeuvre une stratégie lui permettant d'essuyer les surplus de liquidités. Les dépenses de l'Etat américain sont passées en peu de temps de 18 % à 28 % du PIB et, dans le même temps, la Réserve fédérale américaine a triplé ses liquidités. L'approche plus tempérée de l'Europe, tout en augmentant les risques à court terme, pourrait bien payer à plus long terme, surtout si les taux d'intérêt augmentent, rendant beaucoup plus difficile à supporter le poids d'une dette trop importante.

324 La vraie question n'est pas de savoir si l'Europe fait appel à des plans de relance keynésiens suffisamment agressifs, mais bien de savoir si elle parviendra à réaliser une réforme profonde de son économie alors que s'atténuera la crise. Si l'Europe maintient un marché de l'emploi plus flexible, si ses marchés financiers sont régulés de manière plus paneuropéenne, en restant ouverts aux échanges, la courbe de croissance pourrait bien reprendre à la hausse dès la fin de la crise. Si les pays européens adoptent une politique protectionniste, avec une Allemagne qui encourage ces citoyens à préférer les voitures allemandes ou un gouvernement français obligeant son industrie automobile à maintenir en fonctionnement des usines qui ne sont plus productives, etc., on peut en effet s'attendre à ce que la paralysie perdure encore pendant une dizaine d'années. Bien sûr, l'année qui vient de s'écouler n'offre pas les circonstances idéales pour une réforme économique en Europe. Il n'a jamais été aisé pour les leaders européens d'encourager de profondes réformes en périodes de récession. Et les choses se sont compliquées lorsque le gouvernement tchèque n'a pas obtenu le vote de confiance à mi-parcours des six mois de sa présidence de l'Union européenne, laissant la Commission telle un canard boiteux. L'approche des prochaines élections en Allemagne, associée aux inquiétudes liées au résultat du référendum irlandais sur le traité de Lisbonne (qui accorderait - enfin - une nouvelle Constitution dont l'Europe a grand besoin), n'a pas permis une vraie réforme. Pourtant, les nombreux points forts de l'Europe, dont les moindres ne sont pas la force démocratique de ses gouvernements et ses solides institutions, sont souvent sous-évalués en tant que valeurs de compétitivité à long terme dans l'économie globalisée d'aujourd'hui. La récente récession présente de nombreux challenges, mais les leaders européens ont eu raison d'éviter de s'empoisonner avec des mesures expéditives d'inspiration keynésienne, surtout là où elles ne peuvent pas répondre aux challenges à long terme auxquels l'Europe est confrontée. Si l'Europe entreprend enfin les réformes profondes dont elle a besoin, il n'y a aucune raison pour qu'elle ne profite pas d'une croissance du revenu par habitant durant les dix prochaines années au moins aussi importante que celle des Etats-Unis. De plus, l'euro a une incroyable opportunité pour jouer un rôle significatif en tant que monnaie de réserve, compte tenu des inquiétudes sur la viabilité de la politique budgétaire américaine. On n'ose pas imaginer ce qui pourrait arriver si l'Europe ne parvient pas à sortir de cette ornière. Elle perdrait probablement son rôle, pourtant si nécessaire, de contrepoids face aux Etats-Unis. Ce n'est peut-être pas la première de leurs préoccupations actuelles (on voit plus de T-shirts Obama en Europe qu'aux Etats-Unis), mais les Européens ne verraient peut-être pas d'un si bon oeil l'avènement d'un George Bush III. Fort heureusement, il est à prévoir que les Européens ne tarderont pas à agir.

Cet article est publié en collaboration avec Project Syndicate, 2009. http://www.lesechos.fr/imprimer.php

325

Opinion

July 13, 2009 OP-ED COLUMNIST Boiling the Frog

By PAUL KRUGMAN Is America on its way to becoming a boiled frog? I’m referring, of course, to the proverbial frog that, placed in a pot of cold water that is gradually heated, never realizes the danger it’s in and is boiled alive. Real frogs will, in fact, jump out of the pot — but never mind. The hypothetical boiled frog is a useful metaphor for a very real problem: the difficulty of responding to disasters that creep up on you a bit at a time. And creeping disasters are what we mostly face these days. I started thinking about boiled frogs recently as I watched the depressing state of debate over both economic and environmental policy. These are both areas in which there is a substantial lag before policy actions have their full effect — a year or more in the case of the economy, decades in the case of the planet — yet in which it’s very hard to get people to do what it takes to head off a catastrophe foretold. And right now, both the economic and the environmental frogs are sitting still while the water gets hotter. Start with economics: last winter the economy was in acute crisis, with a replay of the Great Depression seeming all too possible. And there was a fairly strong policy response in the form of the Obama stimulus plan, even if that plan wasn’t as strong as some of us thought it should have been. At this point, however, the acute crisis has given way to a much more insidious threat. Most economic forecasters now expect gross domestic product to start growing soon, if it hasn’t already. But all the signs point to a “jobless recovery”: on average, forecasters surveyed by The Wall Street Journal believe that the unemployment rate will keep rising into next year, and that it will be as high at the end of 2010 as it is now. Now, it’s bad enough to be jobless for a few weeks; it’s much worse being unemployed for months or years. Yet that’s exactly what will happen to millions of Americans if the average forecast is right — which means that many of the unemployed will lose their savings, their homes and more. To head off this outcome — and remember, this isn’t what economic Cassandras are saying; it’s the forecasting consensus — we’d need to get another round of fiscal stimulus under way very soon. But neither Congress nor, alas, the Obama administration is showing any inclination to act. Now that the free fall is over, all sense of urgency seems to have vanished. This will probably change once the reality of the jobless recovery becomes all too apparent. But by then it will be too late to avoid a slow-motion human and social disaster.

326 Still, the boiled-frog problem on the economy is nothing compared with the problem of getting action on climate change. Put it this way: if the consensus of the economic experts is grim, the consensus of the climate experts is utterly terrifying. At this point, the central forecast of leading climate models — not the worst-case scenario but the most likely outcome — is utter catastrophe, a rise in temperatures that will totally disrupt life as we know it, if we continue along our present path. How to head off that catastrophe should be the dominant policy issue of our time. But it isn’t, because climate change is a creeping threat rather than an attention-grabbing crisis. The full dimensions of the catastrophe won’t be apparent for decades, perhaps generations. In fact, it will probably be many years before the upward trend in temperatures is so obvious to casual observers that it silences the skeptics. Unfortunately, if we wait to act until the climate crisis is that obvious, catastrophe will already have become inevitable. And while a major environmental bill has passed the House, which was an amazing and inspiring political achievement, the bill fell well short of what the planet really needs — and despite this faces steep odds in the Senate. What makes the apparent paralysis of policy especially alarming is that so little is happening when the political situation seems, on the surface, to be so favorable to action. After all, supply-siders and climate-change-deniers no longer control the White House and key Congressional committees. Democrats have a popular president to lead them, a large majority in the House of Representatives and 60 votes in the Senate. And this isn’t the old Democratic majority, which was an awkward coalition between Northern liberals and Southern conservatives; this is, by historical standards, a relatively solid progressive bloc. And let’s be clear: both the president and the party’s Congressional leadership understand the economic and environmental issues perfectly well. So if we can’t get action to head off disaster now, what would it take? I don’t know the answer. And that’s why I keep thinking about boiling frogs.

327 Opinion

July 11, 2009 OP-ED COLUMNIST The Human Equation

By BOB HERBERT Vice President Joe Biden told us this week that the Obama administration “misread how bad the economy was” in the immediate aftermath of the inauguration. Puh-leeze. Mr. Biden and President Obama won the election because the economy was cratering so badly there were fears we might be entering another depression. No one understood that better than the two of them. Mr. Obama tried to clean up the vice president’s remarks by saying his team hadn’t misread what was happening, but rather “we had incomplete information.” That doesn’t hold water, either. The president has got the second coming of the best and the brightest working for him down there in Washington (think of Larry Summers as the latter- day Robert McNamara), and they’re crunching numbers every which way they can. They’ve got more than enough data. They understand the theories and the formulas as well as anyone. But they’re not coming up with the right answers because they’re missing the same thing that McNamara and his fellow technocrats were missing back in the 1960s: the human equation. The crisis staring America in its face and threatening to bring it to its knees is unemployment. Joblessness. Why it is taking so long — seemingly forever — for our government officials to recognize the scope of this crisis and confront it directly is beyond me. There are now five unemployed workers for every job opening in the U.S. The official unemployment rate is 9.5 percent, but that doesn’t begin to tell the true story of the economic suffering. The roof is caving in on struggling American families that have already seen the value of their homes and retirement accounts put to the torch. At the present rate, upwards of seven million homes can be expected to fall into foreclosure this year and next. Welfare rolls are rising, according to a survey by The Wall Street Journal. The National Employment Law Project has pointed out that hundreds of thousands of unemployed workers will begin losing their jobless benefits, just about the only thing keeping them above water, by the end of the summer. Virtually all of the job growth since the start of the 21st century (which was nothing to crow about) has vanished. If you include the men and women who are now working part time but would like to work full time, and those who have become so discouraged that they’ve stopped actively searching for work, you’ll find that 16.5 percent of Americans are jobless or underemployed. Nearly everyone who is fortunate enough to have a job has a spouse or a parent or an in-law or a close friend who is desperate for employment. Anyone who believes that the Obama stimulus package will turn this jobs crisis around is deluded. It was too small, too weakened by tax cuts and not nearly focused enough on creating jobs. It’s like trying to turn a battleship around with a canoe. Even if it were

328 working perfectly, the stimulus would not come close to stemming the cascade of joblessness unleashed by this megarecession. I’d like to see the president go on television and, in a dramatic demonstration of real leadership, announce a plan geared toward increasing employment that is both big and visionary — something on the scale of the Manhattan Project, or the interstate highway program or the Apollo spaceflight initiative. My choice would be a “Rebuild America” campaign that would put men and women to work repairing, maintaining, designing and rebuilding the nation’s infrastructure in the broadest sense — everything from roads and schools and the electrical power grid to innovative environmental initiatives and a sparkling new mass transportation network, including high- speed rail systems. One of the ways of financing such an effort would be through the creation of a national infrastructure bank, which would provide federal investment capital for approved projects and use that money to leverage additional private investment. There was a time when Americans could think on such a scale and get it done. We used to be better than any other nation on the planet at getting things done. It would be tragic if the 21st century turns out to be the time when that extraordinary can-do spirit disappears and we’re left with nothing more meaningful and exciting than lusting after tax cuts and trying to pay off credit card debt. The joblessness the nation is experiencing is crushing any hope of a real economic recovery. With so many Americans maxed out on their credit cards and with the value of their homes deep in the tank, the only money available to spend in most cases is from paychecks. The best and the brightest in Washington may have a theory about how to get the economy booming without dealing with the employment crisis, but I’d like to see that theory work in the real world. http://www.nytimes.com/2009/07/11/opinion/11herbert.html?th&emc=th

329 Opinion

July 10, 2009 OP-ED COLUMNIST The Stimulus Trap

By PAUL KRUGMAN As soon as the Obama administration-in-waiting announced its stimulus plan — this was before Inauguration Day — some of us worried that the plan would prove inadequate. And we also worried that it might be hard, as a political matter, to come back for another round. Unfortunately, those worries have proved justified. The bad employment report for June made it clear that the stimulus was, indeed, too small. But it also damaged the credibility of the administration’s economic stewardship. There’s now a real risk that President Obama will find himself caught in a political-economic trap. I’ll talk about that trap, and how he can escape it, in a moment. First, however, let me step back and ask how concerned citizens should be reacting to the disappointing economic news. Should we be patient and give the Obama plan time to work? Should we call for bigger, bolder actions? Or should we declare the plan a failure and demand that the administration call the whole thing off? Before you answer, consider what happens in normal times. When there’s an ordinary, garden-variety recession, the job of fighting that recession is assigned to the Federal Reserve. The Fed responds by cutting interest rates in an incremental fashion. Reducing rates a bit at a time, it keeps cutting until the economy turns around. At times it pauses to assess the effects of its work; if the economy is still weak, the cutting resumes. During the last recession, the Fed repeatedly cut rates as the slump deepened — 11 times over the course of 2001. Then, amid early signs of recovery, it paused, giving the rate cuts time to work. When it became clear that the economy still wasn’t growing fast enough to create jobs, more rate cuts followed. Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve. They should give existing policies time to work, but they should also consider making those policies stronger. And that’s what the Obama administration should be doing right now with its fiscal stimulus. (It’s important to remember that the stimulus was necessary because the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump.) That is, policy makers should stay calm in the face of disappointing early results, recognizing that the plan will take time to deliver its full benefit. But they should also be prepared to add to the stimulus now that it’s clear that the first round wasn’t big enough. Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of

330 government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger. Hence the danger that the Obama administration will find itself caught in a political- economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively. As I said, I was afraid this would happen. But that’s water under the bridge. The question is what the president and his economic team should do now. It’s perfectly O.K. for the administration to defend what it’s done so far. It’s fine to have Vice President Joseph Biden touring the country, highlighting the many good things the stimulus money is doing. It’s also reasonable for administration economists to call for patience, and point out, correctly, that the stimulus was never expected to have its full impact this summer, or even this year. But there’s a difference between defending what you’ve done so far and being defensive. It was disturbing when President Obama walked back Mr. Biden’s admission that the administration “misread” the economy, declaring that “there’s nothing we would have done differently.” There was a whiff of the Bush infallibility complex in that remark, a hint that the current administration might share some of its predecessor’s inability to admit mistakes. And that’s an attitude neither Mr. Obama nor the country can afford. What Mr. Obama needs to do is level with the American people. He needs to admit that he may not have done enough on the first try. He needs to remind the country that he’s trying to steer the country through a severe economic storm, and that some course adjustments — including, quite possibly, another round of stimulus — may be necessary. What he needs, in short, is to do for economic policy what he’s already done for race relations and foreign policy — talk to Americans like adults. http://www.nytimes.com/2009/07/10/opinion/10krugman.html?th&emc=th

331

10.07.2009 Global investors dump euro assets

The Bank of New York Mellon, one of the world’s largest custodian banks, said concerns about the European banking sector had risen to their highest level since March and could put increased pressure on the euro, the FT reports. The bank, which holds funds of some of the world largest investors, like central banks, and funds of funds, said its own flow data showed net outflows from German bonds for the first time since mid-March. BoNY Mellon said it also tracked outflows from Italian, Spanish, Portuguese, Belgian and Greek bonds. Countries most at risk were Austria, Italy, France, Belgium, Germany and Sweden, which together accounted for 84 per cent of the exposure to a slowdown in emerging Europe. The paper quoted Simon Derrick, head of currency research of the bank, as saying that the euro area has lost its safe haven status, and is increasingly seen as a high-risk region among international investors. ECB bulletin emphasises exit strategy

68 ECB Monthly Bulletin July 2009, Table 2, p. 68 La Repubblica reports on the ECB’s latest monthly bulletin, according to which economic growth will continue to be weak in 2009, stabilise by the middle of 2010, and start growing more strongly in 2011. The central bank also called on the government to think about exit strategies as the recovery takes hold. According to the ECB, loose monetary policies will

332 eventually transmit to the real economy. The news story also notes that Italy is among the countries where the efforts to save the banks and the financial system have had exactly zero cost. Here is the ECB table on the impact of bank rescues on government’s fiscal position. It is strongest in the Netherland, Belgium and Ireland. For the euro area as a whole the direct impact is a meagre 3.3% of GDP, plus 7.5% in contingent liabilities. China wants a replacement of the dollar China is getting increasingly concerned about its dollar trap, and the issue of a search for an alternative global currency is becoming more urgent. The FT has the story that Dai Bingguo, China’s state council, told the G8 the following: ”We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system.” China’s central bank raised the issue a few months ago, but this comment suggests that this is now becoming the official Chinese position. Irish public sector prices rising despite historic CPI fall Irish Independent picks up Fine Gael’s accusation that the government of ripping off consumers as the cost of public services – e.g. transport and health - continue to rise while overall cost of living are falling by 5.4%, faster than anywhere else in Europe and the sharpest drop since 1933. Government prices such as waste, hospital services, bus and rail transport, and education, increased by 5.1% while prices set by government regulators such as energy, telecoms, and health insurance, rose by 9%. By contrast, the consumer price index fell for the sixth month in a row and is back to a level in early 2007. But experts warn that the danger of deflation is higher, which would raise the real value of existing debts and increase bad loans in banks. Bad news for the Irish economy with an outstanding private debt level of 175% of GDP. Warning of a Japan scenario Gustav Horn, one of Germany’s best known economic forecasters, who is now the head of the IMK Institute, has warned not to misinterpret the first signs of economic stabilisation. According to FT Deutschland, he said one should remember the Japanese plight in the early 1990s, when the government cut the fiscal stimulus after the first signs of recovery. There is a now a danger that Germany would go Japan’s way into a multi-year stagnation. His forecast is for a fall in growth of 6.5% for 2009, and 0.4% in 2010. Thomas Fricke on Steinbruck In his FT Deutschland column, Thomas Fricke wonders why finance minister Peer Steinbruck is so concerned about rising inflation, but not about the very likely increase in unemployment to 5m. He writes the problem is that unemployment hits only a small minority, and through their employment contracts most people are totally protected against dismissal. To them, inflation is far more serious, given the low wage increases. So Fricke concludes the solution to the problem is liberalisation of dismissal laws, rising wages – and a new finance minister. http://www.eurointelligence.com/article.581+M56f8f62d61b.0.html#

333 10.07.2009 The G8’s Too Easy German-American Consensus By: Adam Posen

This week’s G8 Summit in earthquake shattered L’Aquila, Italy, is likely to produce more consensus but fewer concrete results than the two prior meetings. On a number of issues – climate change, Iran and Afghanistan, aid to Africa – the Obama administration has moved the US position closer to that of its G8 partners and international norms. That narrowing of the transatlantic gap is true on the financial crisis issues as well. It could be hard to see this, sitting in Germany. Both German Chancellor Angela Merkel and Finance Minister Peer Steinbrück have pumped up their rhetoric for the home market ahead of the September elections. To listen to them, boom-bust cycles and Anglo-Saxon finance, lax regulation and securities market vultures, American consumerism and rising deficits all are terrible things that must be dealt with to prevent another crisis. I have no doubt that these public figures believe much of what they are saying, which is kind of scary. There are even a few valid points of economic truth underlying what they say (particularly their call for greater regulation of financial institutions) amidst the populist wishful thinking. As opposed to the rhetoric, the actual policy difference between the US and Germany, and thus within the G8, as on economic matters, however, is pretty small. On financial regulations, both the US and German governments are committed to increasing capital and liquidity requirements for financial institutions, bringing as many non-banks under supervision as possible, moving most derivatives on to open exchanges and through clearing houses, reducing the role and conflicts of interests of credit rating agencies, and tightening tax loopholes for financial transactions. The German (and French) proposals are one notch stricter than the US proposals, and that is the right direction to head. But both sides of the Atlantic, and the German and American governments in particular, are still not being tough enough on the fragile banks in their national systems, and are still refusing to confront head on the problem of ‘too big to fail’ institutions. The BIS is fully justified to have announced the insufficient measures taken by western governments regarding the banking system, and to call for greater action. On fiscal stimulus, the rhetorical divide overstates the actual distance between

334 Germany and the US as well. By the time the March G20 summit was over, Germany had joined China, Japan, the UK, and the US in mounting significant fiscal stimulus to counter the crisis. All the back and forth about automatic stabilizers was beside the point – what matters is that everyone was moving in the same direction and how much government deficits rose in response to the downturn, and in both Germany and the US they rose a lot. I think the criticism of the German Grand Coalition’s lecturing other European governments about fiscal discipline is justified, but that has more to do with the future of eastern Europe and the euro area, not so much the crisis response per se. Merkel’s criticism of US fiscal laxity was directed at the wrong target. It is the Obama administration trying to expand health insurance coverage without fully paying for it which will be the real fiscal risk for the US, not the temporary stimulus measures. Trade is another area where the rhetorical gap is much wider than the actual practice and proposed changes. The Obama administration and US Congress have put in place domestic content restrictions on public works spending by state and local governments, which are protectionist. They have also given a lot of state subsidies to the troubled US- headquartered auto companies GM and Chrysler. The CDU-SPD Coalition government, however, has also been giving out state-aid, particularly but not only to the auto sector. Germany has been better than some of its EU neighbors in terms of putting up outright protectionist barriers, and certainly better than the US on that score. Germany has also, however, been unwilling to consider being less export-oriented in its sources of economic growth. If Merkel and Steinbrück believe that global imbalances driven by US over- consumption led to the boom-bust crisis, then they must accept that Germany must be less of a net trade surplus country in years ahead to limit those imbalances. From the G8 perspective, there will be no real conflict since mutual non-aggression will prevail, meaning Germany will not directly attack the US for its trade barriers so long as the US does not directly attack Germany for its export dependence. Japan worked out a similar implicit deal with the US after the trade conflicts of the 1980s. So the upcoming G8 Summit in Italy will not fail in terms of showing sharp divisions between the advanced democracies. If anything, in finance, fiscal policy, and trade, the reality of convergence will undercut the rhetoric that Merkel and Steinbrück are selling at home about their criticisms of US policies and financial capitalism. Unfortunately, this too easy agreement leaves the G8 member governments far short of what they all need to do for all of our sakes, particularly in terms of creating sustainable recoveries in the banking sector and in global trade.

Adam Posen is Deputy Director of the Peterson Institute for International Economics in Washington, DC.

335 MARKETS China attacks dollar’s dominance

By George Parker and Guy Dinmore in L’Aquila, Krishna Guha in Washington and Justine Lau in Hong Kong Published: July 9 2009 19:03 | Last updated: July 9 2009 19:03 China has launched its highest-profile criticism of the dominant role of the US dollar as a global reserve currency at a meeting of the world’s biggest economies. Dai Bingguo, Chinese state councillor, raised the issue on Thursday when he joined the leaders of four other emerging economies for talks with the leaders of the Group of Eight industrialised nations – including US President Barack Obama – in the earthquake-damaged Italian town of L’Aquila. The remarks, in front of Mr Obama, caused concern among western leaders, some of whom fear that even discussion of long-term currency issues could unsettle markets and undercut economic recovery. Gordon Brown, Britain’s prime minister, said he did not remember Mr Dai making the remarks. But he said the focus should be on moving the world out of recession. “We don’t want to give the impression that big change is around the corner and the present arrangements will be destabilised,” said Mr Brown. ”We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates and promote a diversified and rational international reserve currency system,” said Mr Dai, according to the Chinese foreign ministry. While he did not name the dollar, Mr Dai was unequivocal in calling for the world to diversify the reserve currency system and aim at relatively stable exchange rates among leading currencies. The dollar weakened in subsequent trading, although it was difficult to tell whether this was due to the Chinese remarks or cross-currents in risk appetite and economic data. Analysts said Mr Dai’s comments – which follow earlier statements by the People’s Bank of China in March – appeared mostly political in nature. While China desires in the long run to move to a more multipolar global financial system, Chinese officials understand that there is no alternative to the dollar in the short term and may not be for many years. By faulting the dollar Beijing can express its displeasure at US policy and exert leverage over the US in general, including in the broad debate over the future governance of the international financial system. The challenge also serves as a shot across the bows for the US at a time when China is concerned about giant US government deficits and the Federal Reserve’s unorthodox monetary policy. Beijing wants the US to take seriously its obligation to sustain the value of China’s nearly $2,000bn in US Treasuries.

336 Separately, Joseph Yam, chief executive of the Hong Kong Monetary Authority, said Hong Kong might consider diversifying more of its US$200bn reserves away from the US dollar. Mr Yam said he had an “open mind” as to whether the territory would invest its reserves in renminbi-denominated assets. “There may come a time in the future when we think that a small, modest exposure to the renminbi - notwithstanding it being a non-convertible currency still - may be something that we may pursue. But we don’t have any plans at this moment, any concrete plans,” said Mr Yam. “A bit of diversification won’t hurt us,” he added. HK seeks to boost renminbi business By Justine Lau in Hong Kong Published: July 9 2009 18:25 | Last updated: July 9 2009 18:25 oseph Yam, chief executive of the Hong Kong Monetary Authority, believes the wider use of the renminbi will create an opening for the territory. Hong Kong issues a currency of its own pegged to the dollar, as it seeks to solidify its position as a regional financial centre. But the global economic slowdown has generated growing debate, fuelled in part by the Chinese central bank, about the dollar’s role as the dominant world reserve currency, compounded by worries that mounting US debt could weaken the dollar. On the back of this, China has signed bilateral agreements with other governments to settle trade in each other’s currencies and establish credit swap lines. “If the renminbi becomes an international currency and a currency that is used in all sorts of transactions, then we will be able to handle those transactions. We have the platform to do so,” Mr Yam told the FT in an interview. “It is as though you build a six-lane highway, initially without traffic. But you will be able to generate traffic. ” Mr Yam said the territory had been building the capacity for renminbi business since 2001 and boasted the world’s most sophisticated system to support those transactions. Hong Kong became the first place outside the mainland to allow its banks to take deposits, handle remittances and issue debit and credit cards in renminbi in 2003. It has since introduced renminbi cheques. This week, Hong Kong lenders began to help companies to settle transactions in the Chinese currency. This would allow the development of trade finance in renminbi and an interbank market, Mr Yam said. “The renminbi is likely to become a rather more significant currency in the fullness of time, an international currency and possibly even a reserve currency,” said Mr Yam. He had an “open mind” as to whether Hong Kong’s $226bn (€161bn, £139bn) exchange fund, which holds most of its foreign currency reserves, would invest in renminbi-denominated assets. “There may come a time in the future when we think that a small, modest exposure to the renminbi – notwithstanding it being a non-convertible currency still – may be something that we may pursue. But we don’t have any plans at this moment,” said Mr Yam. The exchange fund holds about 86 per cent of its assets in US dollars. Mr Yam, who will retire on October 1 after heading the HKMA since 1993, on Thursday warned that the world economy remained unsettled. “There is a high degree of uncertainty associated with it, and I have an uncomfortable feeling that the factors underlying that uncertainty have not been adequately reflected in the performance of financial markets. The global financial crisis is, of course, continuing,” he said in a weekly column.

337

Value of Bank Repayments Draws Scrutiny By Amit R. Paley Washington Post Staff Writer Friday, July 10, 2009 The banks participating in the federal bailout program could end up repaying the government as much as $2.1 billion less than taxpayers are entitled to under a plan being implementing by the Obama administration, according to a new congressional oversight report. The report, scheduled to be released today, addresses the financial instruments, known as warrants, that the banks sold to the federal government as part of the $700 billion bailout effort launched last fall. The Treasury Department is allowing banks, including 10 of the nation's largest, to exit the program, which would require them to buy back the warrants from the government. The five-member Congressional Oversight Panel, which oversees the bailout initiative, looked at 11 small banks that have repurchased their warrants from the Treasury for $18.7 million. The panel's study found that the warrants were sold for only 66 percent of their estimated value, meaning that taxpayers would have recovered $10 million more if the securities had been sold at their market value. If the full group of warrants is valued that way, taxpayers could be shortchanged by as much as $2.1 billion, the study concludes. But the report notes that the sales to small banks are likely to be affected by market forces that do not apply to bigger financial institutions, which could reduce the overall shortfall to taxpayers. Warrants are essentially the right to buy shares of a company at a fixed price in the future. For example, a warrant could allow the government to purchase shares of a financial institution for $100 over the next decade. If the shares rise above $100, the government could buy them for less than their market value and then turn around and sell them for a profit. The panel, chaired by Harvard Law School professor Elizabeth Warren, noted that the Treasury may be choosing not to maximize returns to taxpayers in order to allow banks to exit the program as quickly as possible. They also pointed out that the program is in its very early stages, and the prices paid so far may not be representative of valuations in the future. The oversight group says in the report that the best option may be to sell the warrants in an open public market in order to increase transparency and boost returns for the government. Andrew Williams, a Treasury spokesman, said that the department "has laid out a consistent and clear process for valuing warrants in a manner that protects taxpayers." He added: "Treasury is using a more comprehensive approach to valuing the warrants that includes obtaining quotes from multiple market participants who regularly participate in buying and selling similar securities." Amit R. Paley Value of Bank Repayments Draws Scrutiny http://www.washingtonpost.com/wp- dyn/content/article/2009/07/09/AR2009070903004_pf.html

338 Energy & Environment

July 10, 2009 Oil Weakens as Recovery Hopes Dim

By JAD MOUAWAD Oil prices briefly fell under $60 a barrel on Thursday after nearly two weeks of uninterrupted declines, as traders and investors acknowledged that a global economic recovery would take longer than hoped. At the end of a volatile trading session, crude oil futures pared their losses, settling at $60.41 a barrel, up 27 cents, after falling as low as $59.25 a barrel during the day in New York. The price of oil has fallen by about $10 a barrel in the last six trading days, or nearly 17 percent. Oil rose to $72.68 a barrel in June, its highest trading close this year on optimism about a fast recovery. Thursday’s session followed the release of a weekly report from the Energy Department showing a substantial increase in gasoline inventories in the United States, with total oil inventories reaching their highest level since 1990. The report, widely viewed as bearish for oil markets, also signaled weaker-than-expected consumption. “The bottom line is that it’s all about demand and the lesson here is that the recovery is going to be a long and bumpy road, and not a smooth and straight line,” said Michael Wittner, the global head of oil research at Société Générale, in London. He expects prices could fall as low as $50 a barrel in the short term. Oil prices have shown striking volatility in recent years, as energy markets attracted investors like hedge funds and pension funds. Strong demand for oil, coupled with weak growth in supplies over the last decade, propelled oil to a record of $145.29 a barrel last year. The price bubble burst when the global economy plunged into a recession and industrial activity worldwide slowed sharply last year. That shaved the global demand for oil and pushed prices down to a low of $33 a barrel in December. But in their latest display of volatility, oil prices have rebounded this year, more than doubling since their year-end lows as many investors bet on a quick recovery. Commodities are also seen as an attractive way to hedge against a weakening dollar and potentially higher inflation. The economic outlook remains murky at best. This week, the International Monetary Fund said the global economy would shrink 1.4 percent this year, a bigger decline than its April forecast of 1.3 percent. At the same time, the monetary fund also predicted stronger growth than it had initially forecast for 2010. “The market basically overshot because it was overly optimistic about the economy,” said Antoine Halff, the head of commodities research at Newedge, a brokerage firm. “Expectations are being scaled down.” The recent volatility in commodity markets is also having political ramifications. On Tuesday, the Commodity Futures Trading Commission, the top federal commodity regulator, said it was considering clamping down on speculation in energy markets. The

339 move would be politically popular, especially as gasoline prices have risen to an average of $2.58 a gallon. But some energy experts warned that such a move could backfire by making energy markets less liquid, and therefore even more volatile. “Trading limits is potentially a big one,” Mr. Wittner said. “One of the danger of position limits is that if you reduce volumes, you can actually increase volatility.” In the meantime, even as demand remains weak, many analysts do not expect oil prices to fall substantially. One reason is the strong discipline shown by producers within the Organization of the Petroleum Exporting Countries. OPEC, which has set a target price of around $75 a barrel, has managed to reduce production in recent months to match the drop in demand. The secretary general of OPEC, Abdullah al-Badri, told reporters on Wednesday that oil prices were at a “comfortable” level, though still lower than the target set by the group last May. Oil consumption is expected to fall this year, for the second year in a row. PFC Energy, a consulting firm, expects a drop to 1.1 million barrels a day in oil demand this year, followed by a modest recovery in 2010 led by developing nations. But the analysts caution that the growth in demand is unlikely to return to the annual average levels seen in 2003-7, of 1.6 million barrels a day. “The striking drop off in crude prices over the last two weeks is a stark reminder of the hard reality of current global economic conditions: While the pace of contraction has slowed, stabilization should not be mistaken for recovery,” PFC said in a report. “The worst period of the global economic and financial crisis is likely now in the past, but there remain few actual signs of a real and durable improvement in global final demand or trade prospects.” http://www.nytimes.com/2009/07/10/business/energy-environment/10oil.html?th&emc=th

340

09.07.2009 G8 fails to agree economic strategy

The big headline is the long overdue deal to limit the increase in the earth’s temperature by 2 degree Celsius, but there was no economic agreement. Angela Merkel predictably wanted the world to focus on exit strategies. Gordon Brown, Nicholas Sarkozy and Barack Obama think that she is hopping mad, or rather as the FT put it, they believe “that such talk was premature when the world still faced economic dangers.” (see also the IMF story below). So they ended up agreeing in the final communiqué that exit strategies will vary from country to country. (Of course, that’s what you would have had without a G8.) Brown is quoted as saying that the three big threats to the global economy are a rising oil price, protectionism and high unemployment. IMF sees end to recession – but not in euro area The IMF came out with revised forecasts yesterday, according to which global economic growth for 2009 was revised downward – from minus 1.3% to minus 1.4% – and revised upwards for 2010, from 1.9% to 2.5%. The optimism for 2010 reflects stronger growth in emerging markets, the US, China and Japan. For the US, the 2010 forecasts are up from 0 to 0.8%, for Japan from 0.5% to 1.7%, but for the euro area only from minus 0.4% to minus 0.3%. Unemployment will rise throughout 2010 on a global level, as the growth is insufficient to stabilise employment. FT Deutschland quotes Olivier Blanchard as warning that governments and central banks not to embark on premature exit strategies. While the risk of a global financial meltdown is now lower, the banking sector remained at risk. The IMF said the stabilisation occurred only as a result of direct government intervention. Blanchard also said the big challenge for the post-2010 era is to find a replacement of the US consumer as a source for global demand growth. ECB worried about creeping euroisation In its annual report The International Role of the Euro, the ECB expressed concerned about creeping euroisation in eastern Europe, and the macroeconomic risks that are associated with it. (for a summary see this report in the FT.) Last December, €95.4bn in euro banknotes were in circulation outside the euro area – a rise by almost a third. 13% of all euro banknotes are now circulating outside the euro area. Almost all deposits in Montenegro were in euros, and slightly more than half in Croatia. More than half of loans in Latvia, Bulgaria and Lithuania were denominated in euros. Draghi warns on credit crunch in Italy

341 Now, it is the really the central bankers who are most pessimistic. La Repubblica reports that Mario Draghi warned of deteriorating credit conditions, according to Il Sole 24 ore. He said the latest bank statistics already showed negative credit growth rates, while previously bank credit had grown at levels of close to 10%. The only type of credit that is still growing, albeit more moderately, is consumer credit. He also noted that the large banking groups in particular are cutting down on credit more aggressively. Tremonti ready to give Italian banks tax concessions Giulio Tremonti is not known to be a particular friend of Italian banks. But the expected losses on credit could become so stifling to the Italian banking sector that Mr Tremonti is now ready to consider fiscal relief, Il sole 24 ore reports. This could include tax exemptions on bad loans, for example. The article also noticed that the minister had used far more conciliatory tones in his latest speech compared to his earlier remarks. He also said that Italy would play a constructive role in the debate to modify Basle II and IAS 39. Bowles to head Economic and Monetary Affairs in EP The successor to Pervanche Beres as chair of the economic and monetary affairs committee of the European Parliament will be the British liberal MEP Sharon Bowles (an extraordinary to choice in our view to nominate a politician from a non-euro area country to the committee to which the president of the European Central Bank legally has to answer). Jean Quatremer reports that Beres may head up a new temporary committee that focuses on all aspects of the financial crisis. (The EP – quite optimistically in our view – lime-limited the duration of that committee to one year according to FT Deutschland. ) EU Observer reports that the British liberal Graham Watson, the group’s former president, would chair that committee (which is even odder. That would leave two Brits, from the same minority party, as the only people who can mount a parliamentary challenge to all aspects of euro area economic policy.) Hermann Van Rompuy says don’t worry about Belgium Belgium PM Hermann Van Rompuy has an extensive interview in Le Monde, in which he said that the country was struggling with distorted perceptions abroad, amplified by the hundreds of foreign journalists based in Brussels. He said the financial crisis had trumped the domestic debate on institutional reform, but said the majority of Flemish parties only wanted a shift of certain powers from the centre to the region, not an eclipse of the Belgian state. He said foreign observers should recall that in Belgium debate on constitutional change is complicated and time-consuming. O’Rourke on what can go wrong Writing in the Irish Times (hat tip Irish Economy blog), Kevin O’Rourke says much can still go wrong in the global economy. O’Rourke has done some research with Barry Eichengreen showing that we are still on the same trajectory for global industrial output and trade (and share prices) as in the early phase of the Great Depression. He expressed some confidence that the world economy will be able to decouple from the 1929-1932 path because of a different economic policy response. But he says dangers are still lurking ahead. First, there are still accidents waiting to happen, for example Lativa. Second, there is a possibility of a credit crunch. Third, rising oil prices pose a threat, and, fourth, so would a premature exit, as some politicians in the euro area are demanding. http://www.eurointelligence.com/article.581+M568340a3f9c.0.html#

342

Treasury Dials Back Plan to Aid Banks Less Help to Investors Buying Toxic Assets By David Cho and Binyamin Appelbaum Washington Post Staff Writers Thursday, July 9, 2009 The Obama administration's program to help relieve banks of their toxic securities, once touted by officials as critical to reviving the financial system, was instead unveiled yesterday as a modest safety net aimed at preventing the banking sector from suffering a relapse. Treasury officials made the decision to scale back the program because they determined that banks no longer need such dramatic government involvement, officials said. But the initiative also ran up against considerable resistance from financial firms worried about the stigma of participating in a government bailout and the prospect that politicians could impose tough conditions. Even Pimco, the massive bond fund that helped devise the original idea, said yesterday in a statement that it had decided not to participate "as a result of uncertainties regarding the design and implementation of the program." The long-delayed program will launch with a government investment of up to $30 billion to finance the purchase of as much as $180 billion in toxic securities, though government officials said a smaller total was likely. When Treasury Secretary Timothy F. Geithner unveiled the department's troubled asset program four months ago, he said the Treasury could contribute up to $100 billion to two initiatives for buying up to $500 billion in toxic assets. The other initiative has been delayed indefinitely. Banks hold vast quantities of toxic assets -- distressed residential and commercial mortgages and securities derived from those mortgages -- that they are reluctant to sell because investors are demanding fire-sale prices. But holding these toxic assets limits the ability of banks to make new loans. The Treasury program detailed yesterday offers investors billions of dollars in cheap financing to buy toxic securities, which should allow these investors to offer banks higher prices for some toxic assets. The program will not be big enough to clear away most of the toxic assets weighing down the books of banks. But with many firms recovering, officials now envision the initiative in part as a backstop. The program also is designed to foster an initial market for these assets and establish prices that can then be used as a reference by private investors. "We're not trying to be the market. We're trying to jump-start the market," a Treasury official said. Nine private firms have been selected to partner with the government and run the investment funds that will purchase toxic assets. These include a subsidiary of General Electric, one of the largest recipients of federal aid, and BlackRock, which the government already has tapped for several other roles.

343 The fund managers have to put in $20 million of their own money and each raise at least $500 million over the next 12 weeks. At that point, the program can finally begin. The other firms selected by the Treasury are AllianceBernstein, Invesco, Marathon Asset Management, Oaktree Capital Management, RLJ Western Asset Management, TCW Group and Wellington Management. GE Capital Real Estate will participate as a joint venture with Angelo, Gordon & Co. These firms will partner with 10 small minority-owned and woman- owned financial services business, Treasury officials said. Buying toxic assets was of paramount importance to government officials last fall when Congress approved the $700 billion bailout, dubbed the Troubled Assets Relief Program. But weeks after the measure became law, the Treasury decided to use most of the first installment of those funds to inject capital directly into banks. Once President Obama was sworn into office, Treasury officials again urged that buying toxic assets remained critical. Separate from the securities derived from troubled loans, there are trillions of dollars in distressed residential and commercial mortgages on the balance sheets of banks, industry analysts said. But an effort led by the Federal Deposit Insurance Corp. to buy these loans was shelved last month because of a lack of interest from buyers and sellers.

David Cho and Binyamin Appelbaum Treasury Dials Back Plan to Aid Banks, 9, julio, 2009 http://www.washingtonpost.com/wp-dyn/content/article/2009/07/08/AR2009070803012.html

Press Releases

Updated: July 8, 2009 FOR IMMEDIATE RELEASE: July 8, 2009 CONTACT: Treasury Public Affairs (202) 622-2960

JOINT STATEMENT BY SECRETARY OF THE TREASURY TIMOTHY F. GEITHNER, CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM BEN S. BERNANKE, AND CHAIRMAN OF THE FEDERAL DEPOSIT INSURANCE CORPORATION SHEILA BAIR Legacy Asset Program

The Financial Stability Plan, announced in February, outlined a framework to bring capital into the financial system and address the problem of legacy real estate-related assets. On March 23, 2009, the Treasury Department, the Federal Reserve, and the FDIC announced the detailed designs for the Legacy Loan and Legacy Securities Programs. Since that announcement, we have been working jointly to put in place the operational structure for these programs, including setting guidelines to ensure that the taxpayer is adequately protected, addressing compensation matters, setting program participation limits, and establishing stringent conflict of interest rules and procedures. Recently released rules are detailed separately in the Summary of Conflicts of Interest Rules and Ethical Guidelines . Today, the Treasury Department, the Federal Reserve, and the FDIC are pleased to describe the continued progress on implementing these programs including Treasury’s launch of the Legacy Securities Public-Private Investment Program. Financial market conditions have improved since the early part of this year, and many financial institutions have raised substantial amounts of capital as a buffer against weaker than expected

344 economic conditions. While utilization of legacy asset programs will depend on how actual economic and financial market conditions evolve, the programs are capable of being quickly expanded if these conditions deteriorate. Thus, while the programs will initially be modest in size, we are prepared to expand the amount of resources committed to these programs. Legacy Securities Program The Legacy Securities program is designed to support market functioning and facilitate price discovery in the asset-backed securities markets, allowing banks and other financial institutions to re- deploy capital and extend new credit to households and businesses. Improved market function and increased price discovery should serve to reinforce the progress made by U.S. financial institutions in raising private capital in the wake of the Supervisory Capital Assessment Program (SCAP) completed in May 2009. The Legacy Securities Program consists of two related parts, each of which is designed to draw private capital into these markets. Legacy Securities Public-Private Investment Program (“PPIP”) Under this program, Treasury will invest up to $30 billion of equity and debt in PPIFs established with private sector fund managers and private investors for the purpose of purchasing legacy securities. Thus, Legacy Securities PPIP allows the Treasury to partner with leading investment management firms in a way that increases the flow of private capital into these markets while maintaining equity “upside” for US taxpayers. Initially, the Legacy Securities PPIP will participate in the market for commercial mortgage-backed securities and non-agency residential mortgage-backed securities. To qualify, for purchase by a Legacy Securities PPIP, these securities must have been issued prior to 2009 and have originally been rated AAA -- or an equivalent rating by two or more nationally recognized statistical rating organizations -- without ratings enhancement and must be secured directly by the actual mortgage loans, leases, or other assets (“Eligible Assets”). Following a comprehensive two-month application evaluation and selection process, during which over 100 unique applications to participate in Legacy Securities PPIP were received, Treasury has pre-qualified the following firms (in alphabetical order) to participate as fund managers in the initial round of the program:

• AllianceBernstein, LP and its sub-advisors Greenfield Partners, LLC and Rialto Capital Management, LLC; • Angelo, Gordon & Co., L.P. and GE Capital Real Estate; • BlackRock, Inc.; • Invesco Ltd.; • Marathon Asset Management, L.P.; • Oaktree Capital Management, L.P.; • RLJ Western Asset Management, LP.; • The TCW Group, Inc.; and • Wellington Management Company, LLP.

Treasury evaluated these applications according to established criteria, including: (i) demonstrated capacity to raise at least $500 million of private capital; (ii) demonstrated experience investing in Eligible Assets, including through performance track records; (iii) a minimum of $10 billion (market value) of Eligible Assets under management; (iv) demonstrated operational capacity to manage the Legacy Securities PPIP funds in a manner consistent with Treasury’s stated Investment Objective while also protecting taxpayers; and (iv) headquartered in the United States. To ensure robust

345 participation by both small and large firms, these criteria were evaluated on a holistic basis and failure to meet any one criterion did not necessarily disqualify an application. Each Legacy Securities PPIP fund manager will receive an equal allocation of capital from Treasury. These Legacy Securities PPIP fund managers have also established meaningful partnership roles for small-, veteran-, minority-, and women-owned businesses. These roles include, among others, asset management, capital raising, broker-dealer, investment sourcing, research, advisory, cash management and fund administration services. Collectively, the nine pre-qualified PPIP fund managers have established 10 unique relationships with leading small-, veteran-, minority-, and women-owned financial services businesses, located in five different states, pursuant to the Legacy Securities PPIP. Moreover, as Treasury previously announced, small-, veteran-, minority-, and women-owned businesses will continue to have the opportunity to partner with selected fund managers following pre- qualification. Set forth below is a list (in alphabetical order) of the established small-, veteran-, minority-, and women-owned businesses partnerships:

• Advent Capital Management, LLC; • Altura Capital Group LLC; • Arctic Slope Regional Corporation; • Atlanta Life Financial Group, through its subsidiary Jackson Securities LLC; • Blaylock Robert Van, L.L.C.; • CastleOak Securities, LP; • Muriel Siebert & Co., Inc.; • Park Madison Partners LLC; • The Williams Capital Group, L.P.; and • Utendahl Capital Management.

In addition to the evaluation of applications, Treasury has conducted legal, compliance and business due diligence on each pre-qualified Legacy Securities PPIP fund manager. The due diligence process encompassed, among other things, in-person management presentations and limited partner reference calls. Treasury has negotiated equity and debt term sheets (see attached link for the terms of Treasury’s equity and debt investments in the Legacy Securities PPIP funds) for each pre-qualified Legacy Securities PPIP fund manager. Treasury will continue to negotiate final documentation with each pre-qualified fund manager with the expectation of announcing a first closing of a PPIF in early August. Each pre-qualified Legacy Securities PPIP fund manager will have up to 12 weeks to raise at least $500 million of capital from private investors for the PPIF. The equity capital raised from private investors will be matched by Treasury. Each pre-qualified Legacy Securities PPIP fund manager will also invest a minimum of $20 million of firm capital into the PPIF. Upon raising this private capital, pre-qualified Legacy Securities PPIP fund managers can begin purchasing Eligible Assets. Treasury will also provide debt financing up to 100% of the total equity of the PPIF. In addition, PPIFs will be able to obtain debt financing raised from private sources, and leverage through the Federal Reserve’s and Treasury’s Term Asset-Backed Securities Loan Facility (TALF), for those assets eligible for that program, subject to total leverage limits and covenants.

Legacy Securities and the Term Asset-Backed Securities Loan Facility On May 19, 2009, the Federal Reserve Board announced that, starting in July 2009, certain high- quality commercial mortgage-backed securities issued before January 1, 2009 (“legacy CMBS”) would become eligible collateral under the TALF. The Federal Reserve and the Treasury also continue

346 to assess whether to expand TALF to include legacy residential mortgage-backed securities as an eligible asset class. The CMBS market, which has financed approximately 20 percent of outstanding commercial mortgages, including mortgages on offices and multi-family residential, retail and industrial properties, came to a standstill in mid-2008. The extension of eligible TALF collateral to include legacy CMBS is intended to promote price discovery and liquidity for legacy CMBS. The announcements about the acceptance of CMBS as TALF collateral are already having a notable impact on markets for eligible securities. Legacy Loan Program In order to help cleanse bank balance sheets of troubled legacy loans and reduce the overhang of uncertainty associated with these assets, the FDIC and Treasury designed the Legacy Loan Program alongside the Legacy Securities PPIP. The Legacy Loan Program is intended to boost private demand for distressed assets and facilitate market-priced sales of troubled assets. The FDIC would provide oversight for the formation, funding, and operation of a number of vehicles that will purchase these assets from banks or directly from the FDIC. Private investors would invest equity capital and the FDIC will provide a guarantee for debt financing issued by these vehicles to fund asset purchases. The FDIC’s guarantee would be collateralized by the purchased assets. The FDIC would receive a fee in return for its guarantee. On March 26, 2009, the FDIC announced a comment period for the Legacy Loan Program, and has now incorporated this feedback into the design of the program. The FDIC has announced that it will test the funding mechanism contemplated by the LLP in a sale of receivership assets this summer. This funding mechanism draws upon concepts successfully employed by the Resolution Trust Corporation in the 1990s, which routinely assisted in the financing of asset sales through responsible use of leverage. The FDIC expects to solicit bids for this sale of receivership assets in July. The FDIC remains committed to building a successful Legacy Loan Program for open banks and will be prepared to offer it in the future as needed to cleanse bank balance sheets and bolster their ability to support the credit needs of the economy. In addition, the FDIC will continue to work on ways to increase the utilization of this program by open banks and investors. ### REPORTS

• Conflict of Interest Rules • Legacy Securities FAQ • Letter of Intent and Term Sheet

http://www.financialstability.gov/latest/tg_07082009.html

347 Business

July 9, 2009 U.S. Unveils More Frugal Bank Plan

By GRAHAM BOWLEY and MICHAEL J. de la MERCED For nearly a year, the question has vexed Washington and Wall Street: What do we do with all these impaired mortgage investments? The answer still, it seems, is wait and hope. After months of back-and-forth with the banking industry, the Obama administration on Wednesday unveiled a scaled-down version of its plan to buy troubled mortgage-related securities. The decision represents a huge gamble that banks have recovered sufficiently to help pull the economy out of recession. In the program, the Treasury, Federal Reserve and the Federal Deposit Insurance Corporation said they would commit up to up to $30 billion of public money to buy bad mortgage-related securities from banks. They named nine fund managers who together would commit up to an additional $30 billion more and oversee the funds to purchase the assets. The total of $60 billion to go toward purchasing the assets from banks was significantly less than was originally foreseen as being necessary to tackle the ailing financial sector in March. The Treasury conceded that the program was “modest” but that it could be expanded if the economy or financial markets deteriorated. It also insisted that it was only one of several programs under way to help the economy and that others like the Term Asset-Backed Securities Loan Facility, or TALF, were working well. The plan was initially started nearly four months ago, as a way to purge banks of trillions of dollars of souring loans and securities built up during the subprime era. The authorities feared these bad assets would weigh down banks and discourage them from making the loans needed to revive the economy. The decision to scale back the program rests on an assumption that the stabilization of financial markets since then and the return to profitability among some of the banks are sustainable. The risk, some experts warn, is that the worst may not yet be over. Many banks may still face big losses this year and next, particularly if unemployment remains high or, as many economists predict, home foreclosures mount and commercial real estate continues to founder. “It’s clear that there are a ton of losses still to come,” said Douglas J. Elliott, a fellow of the Brookings Institution. “How prepared are the banks to handle those? There is a great deal of uncertainty here.” In part, the administration had little choice but to scale back the program. Many banks refused to participate, believing that the assets they hold are worth far more than investors were willing to pay for them. Banks argue that they are in a much better stronger financial position than they were in the spring. Last month, the administration was forced to postpone indefinitely another central plank of its bank rescue plan — the program to rid the banks of their bad home loans — because it could not persuade enough banks to take part.

348 Some analysts question whether banks are strong enough to weather further losses. Although the economy is not deteriorating as fast as it was, unemployment is still rising and banks are still only lending cautiously. The stock market, which reacted ecstatically after the program was announced in the spring, has fallen back in recent weeks, in part because of worries about the sclerotic pace of the recovery. The Bank for International Settlements warned in its annual report last month that governments worldwide had not done enough to address the issue of weak assets and that this was holding back global lending. “We will not get out of the recession until we stabilize housing,” said Wilbur L. Ross, one of the fund managers selected. “This is a big step in that direction.” Some analysts said the authorities were wise to begin with a scaled down version of the program which could be ramped up once it got going and proved to be successful. “I personally think it makes sense to not use all your tools at once,” said Moshe Orenbuch, a bank analyst at Credit Suisse. Mr. Ohrenbuch said it was not necessarily having troubled assets on their books that was preventing banks from lending again. He cited a range of other factors, including the weakness of demand among businesses and consumers for new loans. Andrew Rabinowitz, the chief operating officer of Marathon Asset Management, a $9 billion investment firm selected as one of the managers, said that although some of the bigger banks might be reluctant to participate by offloading their assets, there were many other financial institutions that still needed to move bad assets off their books in order to make new loans. “There’s no question in my mind that there’s a purpose,” Mr. Rabinowitz said. The prices of impaired assets, which plummeted when the crisis was at its most intense, rallied during the spring, in part because some banks were beginning to hoard the securities in anticipation of the government’s initiatives to help the banks. But prices had fallen back in recent weeks over uncertainty about the scale of the funds and which classes of assets would be included in the program. Jack Healy contributed reporting. http://www.nytimes.com/2009/07/09/business/09bank.html?th=&emc=th&pagewanted=print

349 BoE Unorthodox Monetary Policy: No Change Again Jul 9, 2009

Overview: July 9, BoE kept Bank Rate on hold at 0.5% and will maintain £125bn asset purchase program as planned despite many expecting a small increase in the amount to £150bn, the maximum allowed. BoE has the broadest form of unconventional monetary policy among the major central banks as it seeks to boost broad as well as narrow money, private credit, and to reduce bond yields for both the public and private sector. However, the scale of its program was small: BoE began with GBP75bn (5% of GDP) in March 2009, with access to another GBP75bn later (BNP). Compared to the BoJ and Fed though, the BoE's program is the largest as a percentage of nominal GDP (21.4%). Policy Effectiveness o The BoE's March Meeting Minutes revealed that CP and corporate bond purchases have reduced spreads and aided price discovery; Equity markets have firmed; PMI surveys improved; consumption seems to be forming a bottom o Mortgage approvals, house prices and new buyer inquiries have increased o BNP: The recovery in the CIPS surveys in recent months has been spectacular. Both surprised on the upside (again) in May, with the services sector survey surging 3 points to 51.7 – above the crucial boom-bust threshold o MS: An increase in the money supply may not necessarily translate to an increase in credit though. Non-bank financial institutions (NBFIs) hold a large chunk of the gilts that BoE is looking to buy. NBFIs may just park their cash in banks, while banks park their cash at the BoE o UniCredit: The Fed and BoE QE programs have so far proved unable to significantly affect long-term yields Alternative Monetary Policy: Quantitative Easing in the UK o Quantitative Easing: BoE authorized Mar 5 to 'print money' by swapping cash for gilts. Mar 11, BoE begins purchasing government bonds. Mar 25, BoE begins purchasing corporate bonds. The aim of the program is to reduce the liquidity premium on corporate bonds of high grade. o Scale: GBP150bn total allowed, GBP125bn total planned. The amount purchased represents half of the issuance in the DMO remit from the latest pre-budget report. BoE expects to complete purchases in August o Funding: Issuance of central bank reserves o Purchases: The majority of the first GBP75bn will be used to purchase gilts through reverse auction, the first of which will be on 11th March. The Bank doesn't intend to buy index-linked or rump stocks while the maximum maturity will be 25 years and minimum residual maturity will be 5 years. Part of the sum will be used to purchase private sector assets as part of the Asset Purchase Facility (APF). Deposits will pay zero rate and the rate charged for the lending facility will be 75bp. Corporate bonds purchased will be BBB or higher and issued in GBP by companies that make 'a material contribution to activity in the UK'.

350 o Exit Strategy: BoE will sell off its asset holdings once the recovery comes. However, there is a risk that removing the stimulus will choke off the tentative signs of recovery. On the other hand, a delayed rollback of QE may produce an inflation overshoot Alternative Monetary Policy: Qualitative Easing via APF o Qualitative Easing: BoE started buying commercial paper, corporate bonds, ABS and other private-label securities on a sterilized basis through the Asset Purchase Facility (APF) in February after Chancellor Darling authorized BoE on Jan 29 o APF Purchases: Chancellor Darling emphasizes that the Bank's purchase of assets via APF should be guided by "an assessment of which transactions would be most likely to restore the flow of finance to corporate borrowers". Central bank governor Mervyn King says that the Bank will "focus initially on purchases of corporate bonds, commercial paper, and paper issued under the Credit Guarantee Scheme". However, it will also consult on plans to purchase syndicated loans and ABS o APF Funding: Initially, at least, APF was not funded by printing money. The Government indemnified the Bank, which created a GBP50bn fund financed by the issue of Treasury bills and DMOs cash management operations. The government provided the funds - essentially the corporate/private sector was borrowing from the government via the Bank of England while the government was borrowing from other parts of the private sector. In other words, the government became an intermediary. After Mar 11 though, APF will be expanded thru QE o APF to become an agent of Quantitative Easing too: At GBP50bn, the fund for APF was small in relation to bank lending (about 2.0%), which raised questions about its effectiveness. Then on Mar 5, BoE was authorized to print money by purchasing gilts Interest Rate Policy: Will BoE Head to ZIRP? o With the onset of QE, the Bank Rate will remain at 0.5% for the foreseeable future o BNP: Recession is now a given and in our view the data point to it being pretty nasty. It's doubtful that the weaker GBP will boost export growth any time soon, not least given plunging import demand in the eurozone o BoE: Inflation is expected to fall further as retail energy and food prices fall and the Value Added Tax reduction takes effect. Measures of inflation expectations have come down also leading to a risk that inflation will undershoot the 2% target in the face of a synchronized downturn despite past fiscal and monetary easing. MPC's forecasts annual CPI inflation a bit below 1% at the two-year horizon o Buiter: The jump upwards in the stock of base money has been driven by an increase in liquidity preference by banks. As long as fear, risk aversion, and partly irrational despondency among banks persist, the increase in M0 since September 2008 will not be inflationary. It reflects the BoE leveraging up to counteract the otherwise excessively rapid, sudden and destructive deleveraging of the commercial banks http://www.rgemonitor.com/475/United_Kingdom?cluster_id=3696

351

75 Years of Housing Fascism

Mises Daily by Dale Steinreich | Posted on 7/9/2009 12:00:00 AM

On June 28, 1934, Franklin Delano Roosevelt signed into law the National Housing Act (NHA) of 1934. Hugh Potter, president of the National Association of Real Estate Boards (NAREB) called it "the most fundamental legislation … ever enacted affecting real estate and home ownership." While federal intervention in housing had begun in 1932 under the supposedly laissez-faire Hoover, Potter's assessment was correct in the sense that the act broke new ground in terms of the range of public-private collaboration — and the unintended destructive consequences of such. Let's get the boring housekeeping facts out of the way first: NHA 1934 created the Federal Housing Administration (FHA), which insured private lenders against losses on loans; made loans to lenders; "insured" lender mortgages meeting certain criteria (including much longer loans up to 20 years in length, periodic payments by a borrower "not in excess of his reasonable ability to pay," and interest ceilings); established national mortgage associations that purchased and sold mortgages and issued securities funding such activity; and created the Federal Savings and Loan Insurance Corporation (FSLIC), which insured savings and loan (S&L) deposits. (Recall that FSLIC — pronounced Fizz'-lick in the industry — after repeated bailouts, fizzled into insolvency for the last time before being abolished in 1989.) The insuring of much longer mortgage loans is key here. In 1930, about 33% of American households owned their own homes and by 1990 that figure had risen to about 67%.[1] The typical mortgage was 5 years in length ending in a balloon payment (principal plus interest). Even though these loans were usually renewed for another 5-year term and were a better reflection of natural scarcity, the system still drew accusations of favoring the upper middle class and the wealthy.[2] The government solution, beginning with NHA 1934, was 20- and 30-year fixed-interest-rate mortgages repaid in small amounts over time to greatly boost house affordability. This writer, who studied the private-interest dynamics of the time in graduate work, found little evidence, to his surprise, that the class-based criticism of the old mortgage system came predominately from progressives. All the evidence examined clearly revealed progressives desiring more state intervention in terms of housing for the poor, but none asserting that the

352 only suitable dwellings for the poor and lower middle classes were detached houses and some sort of government-given right of affordability to such. (Of course today's progressives in the Obama administration and the Heather Booths of groups such as ACORN are a different matter. Some of them certainly do assert beliefs bearing some resemblance to the latter.) The most powerful interests pushing the bill were the usual selectively free-market Republican-leaning bankers, realtors, builders, building-materials manufacturers, and even some architects. One of the most powerful interests at the time was the National Association of Real Estate Boards (NAREB). Leonard Freedman wrote that these antigovernmental crusades [waged by NAREB against public housing] were hypocritical. No industry has received more help from government than the business of housing. NAREB had advocated a federally chartered mortgage discount bank in the 1920s and early 1930s and was strongly supportive of the Federal Housing Administration and other agencies which employed the resources of the federal government to underwrite the credit structure of the housing industry. To the Home Builders, FHA was indispensable. They were also firm believers in the Federal National Mortgage Administration and the VA mortgage program. While the savings and loan leagues had no use for most of these programs, they had promoted and supported the Home Loan Bank in the 1930s, and it became one of their main props.[3] While the S&L leagues may not have had much use for some federal programs, the S&L industry would eventually come to be destroyed by the replacement of the 5-year mortgage with the artificial 20-year amortized mortgage, plus regulatory and tax incentives that encouraged S&Ls to load over 80% of their asset portfolios with the new longer-term mortgages. It is amazing how long the system remained stable before calamity struck. In legend at least, from the end of World War II to about the mid-1960s, the sleepy and idyllic world of the S&L executive conformed to the rule of 3-6-3: pay your depositors 3%, earn 6% on their home loans, and be on the golf course by 3:00 p.m. Even though it was released early during this period, the 1946 movie It's a Wonderful Life and its beloved protagonist George Bailey (Jimmy Stewart), who operated an S&L in the fictional Bedford Falls, propagates this wholesome apple-pie, church-steeple, red-white-and-blue small-town narrative. While there could have been at least a little more than a grain of truth to this story, Martin Mayer reveals the part that resembles Shirley Jackson's "The Lottery": [d]espite its lovely reputation … the old fashioned S&L was a nest of conflicting interests that squawked for sustenance from the customers' deals. On its board were the builder, the appraiser, the real estate broker, the lawyer, the title insurance company, and the casualty insurance company. (Also the accountant: One mutual S&L in Ohio that lost virtually all of its depositors' money was audited by an accountant who sat on the board, and nobody thought there was anything wrong with that.) Plus there was somebody from the dominant political party and from one of the churches. Many little mouths to feed. It is not unfair to say that nobody controlled what this board did.[4] The beginning of the end came in about 1965. The rise in interest rates in the two decades after World War II posed little threat to S&Ls. The interest rate on 10-year T-bonds was 2.8% in 1953 and 4% by 1963. The yield curve remained normal throughout this period (i.e., short- term rates were lower than long-term rates). The years between 1965 and 1982 were a different story. By 1982, the rate on 10-year T-bonds was 13.9% and, even worse for S&Ls, the rate on 1-year T-bills was 14%.[5] Not only had rates risen dramatically; the yield curve

353 had inverted as well. The Fed had struck again. For S&Ls, the rule of 3-6-3 had turned into 8- 6-0, quickly sinking them into heavier and heavier losses.[6] To bring a quick end to a long story, the Fed used Regulation Q (its authority to set maximum rates on time deposits given to it by the Banking Act of 1933) for the first time to lower (instead of raise) deposit rates in 1967. FDIC and FSLIC extended the rate ceiling over every institution they had jurisdiction over. Along came Henry Brown and Bruce Bent in 1971 with an innovation known as the money market fund (MMF) that was not subject to Regulation Q. Fidelity, Dreyfus, and Merrill Lynch quickly followed their example.[7] Funds poured out of banks and thrifts into MMFs. The "deregulation" wave in the 1970s began under Gerald Ford (not Jimmy Carter, as is commonly asserted) with the railroad industry in 1976. Carter was involved in enacting the first financial "deregulation," the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980. The Garn-St. Germain Act was enacted in 1982 during the Reagan administration. Neither was truly deregulatory. DIDMCA raised the deposit-insurance ceiling to a whopping (at least in 1980) $100,000, increasing the moral-hazard problem. Both allowed thrifts only limited diversification of their asset portfolios. Both completely failed and in 1989 the industry was bailed out with hundreds of billions of dollars. Parallels to Today Back to NHA 1934. In terms of the unforeseeable and destructive effects of government regulation, it's difficult to find a better example of a time bomb: it was set in 1934 to explode in $147 billion (about $239 billion in 2008 dollars) of damage 55 years later.[8] Then, to top it all off, the free market received the blame! Alan Blinder (kind of the Paul Krugman of the late 1980s) would write in his Keynesian College economics textbook that [t]he rash of bankruptcies in the savings and loan industry in the 1980s seemed to support those who claimed that deregulation had gone too far … [as the] industry began to be populated by financial cowboys … [so that] much imprudent risk-taking and mismanagement was tolerated, and the industry was beset by an outrageous amount of fraud.[9] It's a hilarious assessment, as only about 4% of the cost of the debacle resulted from private fraud (and this because state regulators left the S&Ls' vault doors open). The largest portion (29%) consisted of the state fraud of $43 billion in interest costs accrued because zombie S&Ls were kept on life support by regulators hiding their balance-sheet deficiencies with accounting gimmicks.[10] On the current economy and housing debacle, Paul Krugman, writing just last May, blames everything on Garn-St. Germain, pretending as if DIDMCA and all the problems of the previous decades leading up to it never happened. This is not to defend the Republicans, who created havoc as well as the Democrats did, but to point out the holes in Krugman's "salvation through regulation" demagoguery. His portrayal of the "responsible" New Deal is laughable. For NHA 1934 didn't just help create the S&L crater; it helped — every bit as much as the Fed and other factors — to pave the way for today's acre upon acre of half-cleared land and half-finished subdivisions, and street upon unlit street of vacant homes with for-sale signs in front of them with few prospective buyers in sight. (Environmentalists would seem to be natural enemies of the true cause of miles upon miles of ugly suburban sprawl, yet they overwhelmingly fix the blame on the "greed of the free market.") Rethinking Robert Taft

354 While the establishment Left is certainly horrible on the issue of housing, the Right has its own shameful legacy as well. In 1943, the National Resources Planning Board had already been anticipating the end of the war and drawing up extensive plans that were so ambitious for socializing US housing markets that they were practically communist. So alarming were the board's plans that the House of Representatives ended its funding for fiscal year 1944. Little better over the long run was the board's de facto successor, the Senate Subcommittee on Housing and Urban Redevelopment, led by Senator Robert Taft of Ohio.

Taft declared that housing was an exception to laissez-faire and that restoration of urban areas was impossible without federal intervention. This represented a huge victory for advocates of government intervention since it blurred ideological differences on the issue of government involvement in housing markets. Out of Taft's committee came many ideas that were eventually implemented in the Housing Act of 1949.[11] (Bewilderingly, Taft still seems to be included in the history of notable free-market politicians. Yet it would seem unthinkable for Ron Paul to participate in anything close to what Taft did.) The current housing debacle wasn't caused by "eight years of cowboy capitalism ushered in by George W. Bush" and there was never any real deregulation of any sort at any time. It was a project created over three-quarters of a century by fascists from both parties. Dale Steinreich is an adjunct scholar of the Mises Institute. Send him mail. See his article archives. Comment on the blog. You can subscribe to future articles by this author via this RSS feed.

Notes [1] Mayer, Thomas, James S. Duesenberry, and Robert Z. Aliber. Money, Banking, and the Economy. 4th ed. New York: Norton, 1990. See p. 94. [2] Ibid. [3] Freedman, Leonard. Public Housing: The Politics of Poverty. New York: Holt, 1969. See pp. 163–64.

355 [4] Mayer, Martin. The Greatest-Ever Bank Robbery: The Collapse of the Savings and Loan Industry. New York: Scribners, 1990. See p. 29. [5] Mayer, Duesenberry, and Aliber 1990, p. 94. [6] Actual figures from 1981 reveal that S&Ls on average were paying 10.92% on deposits and earning 10.11% on assets (see Mayer, p. 94), and this despite a Herculean effort by government and the thrift industry to eliminate the negative spread. The real villain, the Fed, was right in front of their face, yet they never acknowledged it! [7] Markham, Jerry W. A Financial History of the United States: From the Age of Derivatives into the New Millennium (1970–2001). Vol. 3. Armonk, N.Y.: M.E. Sharpe, 2001. See p. 6. [8] Ely, Bert. "Savings and Loan Crisis." Fortune Encyclopedia of Economics. Ed. David R. Henderson. New York: Time Warner, 1993. $147 billion was the September 1990 present- value cost of the crisis. [9] Baumol, William J., and Blinder, Alan S. Economics: Principles and Policy. 5th ed. New York: HBJ, 1991. pp. 223, 232. [10] Ely. [11] Ewalt, Josephine H. A Business Reborn: The Savings and Loan Story 1930–1960. Chicago: American Savings and Loan Institute Press, 1962. See p. 236. http://mises.org/story/3544#note8

356

07/08/2009 03:02 PM

ECONOMIC RECOVERY IN GERMANY 'The End of the World Has Been Cancelled' German analysts are greeting an unexpected rise in manufacturing orders with delight, with some going so far as to say the worst is over. Still, plenty of realists are warning that cautious optimism remains the order of the day.

DDP The German government's scrapping premium is partially credited with driving a gain in national manufacturing. There was a very pleasant surprise in store for the German economy with the release of national manufacturing statistics for May: Orders were 4.4 percent higher than in April. The figures, released by Germany's Economics Ministry on Tuesday, surprised analysts who had only predicted a gain of 0.5 percent. They also made May the third successive month in which orders rose. Additionally business confidence was up and there were also positive signals coming out of the steel industry and from medium-sized businesses. The German stockmarket reacted to the positive news and the DAX went up, although it gave up some of those gains later in the day. And all of this was considered the first solid indicator of an ongoing change for the largest economy in the euro zone, where Europe's common currency is used. It led to optimism in some German quarters, with Commerzbank analyst Dr Ralph Solveen, going so far as to say, "the end of the world has been cancelled, businesses are beginning to re-stock." Solveen and other analysts suggested that the German economy had now survived the recession's mid-year, low point and that the latter part of 2009 should continue to see slow but steady growth. "Over the past two months we have seen small but significant gains," agreed the Federal Statistical Office. Most of the orders that contributed to sector gains came from outside of the European Union, with Asian markets particularly helpful; domestic orders were up 3.9 percent while orders from other EU nations rose 1.2 percent. But other analysts also warned against too much optimism. "This third rise in a row is a nice surprise," said Heinrich Bauer, an economist with Postbank. " But I would be careful about talking about an upswing quite yet." And Norbert Irsch, chief economist of the German state development bank KfW, warned of the danger of an over-optimistic "speculative bubble." A Scrapping Premium Bubble? A closer examination of the manufacturing sector gains indicated that a good portion of the rise is due to the German automobile industry. Orders there rose by almost 10 percent, which made industries that had not seen quite as much growth -- such as the makers of heavy machinery and manufacturing equipment, where gains came in at around 5.9 percent -- look better than they actually were.

357 Although export orders for German cars had risen, some naysayers pointed out that the auto industry's gains could have a lot to do with the German government's scrapping premium. Berlin is paying €2,500 out to car owners who scrap a vehicle that's at least nine years old, and the premium has kept the German carmakers busier than many of their counterparts overseas. But news reports this week indicate the wrecking rebate can't go on for too much longer -- the €5 billion budget funding the rebate is almost used up and it can only pay for another estimated 280,000 old cars. Some German politicians are already calling for the auto industry to "wean itself off the drugs." Additionally, statisticians pointed out that the Easter holidays in April could have made May's figures look better while economists noted that, though manufacturing might be doing better, the Germany economy would still have to grapple with the ongoing effects of unemployment and public spending in the future. And although the steel industry has seen a small gain, it continues to languish in the worst downturn seen in decades. Many blast furnaces are still closed and "in the coming months, prospects ... still look dim," said Hans Jürgen Kerkhoff, president of the German Steel Federation recently. Meanwhile in a reflection of what politicians had been saying earlier in the week, when they warned German banks to loosen up credit facilities, Volker Treier, the chief economist for the German Chamber of Commerce and Industry, said that this "delicate flower" that was the economy shouldn't be hindered by lack of credit. So despite improvements in business morale and what looks to be some genuine light at the end of a long, dark tunnel, one thing that no one in German business is forgetting -- or can change -- is this: Manufacturing orders are still down 29 percent compared to last year and the country's gross domestic product is still expected to shrink by 6 percent this year. cis

URL:

• http://www.spiegel.de/international/business/0,1518,635055,00.html

358 Jul 8, 2009 Global Economic Outlook: Is a Recovery In Sight? Analysts are now revising upward their growth estimates, suggesting that the contraction of growth will be slightly less severe than was expected in February and March. However, they remain divided about whether the recovery will begin in the latter half of 2009 or be delayed until 2010. Consensus now suggests that the U.S. economy might bottom in H2 2009 and that Chinese acceleration in H2 2009 could be more pronounced. The outlook remains weak for Europe and Japan. However growth may be well below potential in 2010. o IMF (July) The global economy is beginning to emerge from the recession "but stabilization is uneven and the recovery is expected to be sluggish." Economic growth may be 0.5 percentage points higher than projected in April 2009 or a 1.4% contraction in 2009 and 2.5% growth in 2010. Advanced economies will contract by 3.8% in 2009 - the U.S. by 2.4% (slightly less than in April), eurozone by 4.8%, Japan by 6%, UK by 4.3%, Canada by 2.3%. Eurozone will continue to contract in 2010 (0.3) while U.S. (0.6%) Canada (1.4), Japan (1.7%) and UK (0.2%) have below potential growth o IMF: Emerging markets will slow sharply, growing by only 1.5% in 2009 before rebounding to 4.7% in 2010 (lower than the 6% in 2008). China to grow 7.5% in 2009 (8.5% in 2010) India 5.4% (6.5%). Asean to contract by 0.3% in 2009 before growing 3.7%) Latin America (-2.6), Eastern Europe (-5) and CIS (-5.8) to all face contractions in 2009 and sluggish growth in 2010 while the Middle east grows only 2% o OECD (June) now expects a 4.1% contraction in the OECD area for 2009 (from the 4.3% expected in March) followed by a 0.7% growth in 2010. Thanks to a strong economic policy effort, OECD activity now looks to be approaching its nadir but the ensuing recovery is likely to be both weak and fragile. Recovery will take hold in a staggered manner across countries, reflecting differential policy stimulus and the force of headwinds from balance sheet vulnerabilities. A recovery appears to be in motion in most large non-OECD countries. The U.S. may bottom in H2 2009 and show marginally positive growth (as will Japan). Signs of impending recovery in the euro area are not yet as clearly visible and recovery may be sluggish. o World Bank (June): Global GDP, after falling by a record 2.9% in 2009, is expected to recover by a modest 2.0% 2010 and by 3.2% in 2011 as banking sector consolidation, continuing negative wealth effects, elevated unemployment rates, and risk aversion are expected to weigh on demand throughout the forecast period. Despite higher growth rates in developing countries (given stronger underlying productivity and population growth), output will remain subdued. Given output losses to date—and because GDP will reach its potential growth rate only by 2011—the output gap (the gap between actual GDP and its potential), unemployment, and disinflationary pressures are projected to build over 2009 to 2011. o UN (May): The world economy (World Global Product) is expected to shrink by 2.6% in 2009 after a nearly 4% annual increase in 2004-2007. Despite an expected recovery (1.2% growth) in 2010, risks are on the downside in 2010. World income per capita is expected to decline by 3.7% in 2009. In a more optimistic scenario, in which the financial and credit markets are healed in 2009, world GDP could rise 2.3% in 2010. o In April's World Economic Outlook, the IMF forecasts that real global economic activity will contract by 1.3% in 2009 (1.8ppts lower than January's 0.5% growth prediction and

359 3ppts lower than in November 2008) before staging a modest recovery in 2010. In June (Reuters) it reportedly raised its forecast, suggesting global growth of 2.4% (up from 1.9% in 2010). o Citigroup: Recessions — in terms of declining GDP — are ending, or soon should, in many countries, and our growth forecasts have edged up in recent months in many regions. with low inflation, most major countries can afford to keep low interest rates and extensive unconventional stimulus in place for an extended period with the RBA being among the first to hike rates. Global growth is likely to contract by 2% in 2009 before increasing by 2.9% in 2010 (based on PPP weights) o Dadush (Carnegie): Signs of stabilization―though scattered and sometimes contradictory―have begun to emerge. However, it is still too early to say that a sustained recovery is imminent. Global industrial production is currently down about 13% over last year, and while it may rise in the coming months due to inventory correction, the future remains murky. GDP forecasts for 2009 are still being marked down to reflect a weaker-than-expected start to the year. o BNP: A deeper and sharper inventory reduction, stabilization of financial confidence and policy actions may have helped bring about green shoots earlier than expected, but they may be transitory given that the countries that have had a mercantilist growth strategy have not sufficiently stimulated domestic demand to offset the hurt from falling exports. o RGE Monitor (April): Global economic activity is expected to contract by 1.9% in 2009. Advanced economies are expected to contract 4% in 2009. Japan and the eurozone will suffer the sharpest downturns. U.S. GDP will continue to contract, albeit at a slower pace throughout 2009, with negative growth in every quarter. Emerging markets will slow down sharply from the stellar growth rates of the past few years, with the BRIC economies growing less than half their 2008 pace of 7.5%. o Morgan Stanley: Massive global policy action has moved us further away from a Great Depression-type scenario, and the risks of contracting output and structural deflation have waned. Global output will probably start growing in 3Q09, with G10 output growth turning positive in 4Q. Growth for 2009 as a whole will stay firmly in negative territory for all regions except Asia excluding Japan (AXJ) (where China and India will keep growth in positive territory). o Baseline: The global economy remains weak across the board, with no significant signs of improvement. Moreover, growth in 2010 is not a foregone conclusion. o Goldman: Growth in the emerging world may likely keep the global economy from contracting in 2009, but risks are tilted to the downside. The global economy may expand by about 1% y/y in 2009, down from about 3.2% in 2008. Most of that growth will come from Brazil, Russia, India and China as domestic demand growth will offset declining exports. China alone may contribute more than 60% to global growth in 2009 o Citi: The nadir for growth in most regions remains late this year with 1.7% global growth expected, with shallow recoveries expected in 2010. The deepening global recession is creating greater challenges to policy making. Markets will face more challenges to growth after the recession due to a rise in the cost of financial intermediation and the potential to draw the wrong lessons from the crisis. o Merrill: The global financial crisis is bringing an end to the vendor financing model, whereby excess consumption in the US was financed by a savings glut in the emerging world. The market will ensure this adjustment finally happens. http://www.rgemonitor.com/10002/Global_Macroeconomic_Issues?cluster_id=6171

360

07/08/2009 03:42 PM THE MAN NOBODY WANTED TO HEAR Global Banking Economist Warned of Coming Crisis By Beat Balzli and Michaela Schiessl William White predicted the approaching financial crisis years before 2007's subprime meltdown. But central bankers preferred to listen to his great rival Alan Greenspan instead, with devastating consequences for the global economy. William White had a pretty clear idea of what he wanted to do with his life after shedding his pinstriped suit and entering retirement. White, a Canadian, worked for various central banks for 39 years, most recently serving as chief economist for the central bank for all central bankers, the Bank for International Settlements (BIS), headquartered in Basel, Switzerland. Then, after 15 years in the world's most secretive gentlemen's club, White decided it was time to step down. The 66-year-old approached retirement in his adopted country the way a true Swiss national would. He took his money to the local bank, bought a piece of property in the Bernese Highlands and began building a chalet. There, in the mountains between cow pastures and ski resorts, he and his wife planned to relax and enjoy their retirement, and to live a peaceful existence punctuated only by the occasional vacation trip. That was the plan in June 2008. And now this. White is wearing his pinstriped suits again. He has just returned from California, where he gave a talk at a large mutual fund company. Then he packed his bags again and jetted to London, where he consulted with the Treasury. After that, he returned to Switzerland to speak at the University of Basel, and then went on to Frankfurt to present a paper at the Center for Financial Studies. From there, White traveled to Paris to attend a meeting at the Organization for Economic Cooperation and Development (OECD). Finally, he flew back across the Atlantic to Canada. White is clearly in demand, including in North America. Since the economy went up in flames, the wiry retiree has been jetting around the globe like a paramedic for the world of high finance. He shows no signs of exhaustion, despite his rigorous schedule. In fact, White, with his gray head of hair, is literally beaming with energy, so much so that he seems to glow. Perhaps it is because someone, finally, is listening to him. Listening to him, that is, and not to his rival of many years, the once-powerful former chairman of the US Federal Reserve Bank, Alan Greenspan. Greenspan, who was reverentially known as "The Maestro," was celebrated as the greatest central banker of all time -- until the US real estate bubble burst and the crash began. Before then, no one in the world of central banks would have dared to openly criticize Greenspan's successful policy of cheap money. No one except White, that is.

361 'A Disorderly Unwinding of Current Excesses' White recognized the brewing disaster. The analysis department at the BIS has a collection of data from every bank around the globe, considered the most impressive in the world. It enabled the economists working in this nerve center of high finance to look on, practically in real time, as a poisonous concoction began to brew in the international financial system. White and his team of experts observed the real estate bubble developing in the United States. They criticized the increasingly impenetrable securitization business, vehemently pointed out the perils of risky loans and provided evidence of the lack of credibility of the rating agencies. In their view, the reason for the lack of restraint in the financial markets was that there was simply too much cheap money available on the market. To give all this money somewhere to go, investment bankers invented new financial products that were increasingly sophisticated, imaginative -- and hazardous. DER SPIEGEL

DER SPIEGEL Graphic: The curse of cheap money As far back as 2003, White implored central bankers to rethink their strategies, noting that instability in the financial markets had triggered inflation, the "villain" in the global economy. "One hopes that it will not require a disorderly unwinding of current excesses to prove convincingly that we have indeed been on a dangerous path," White wrote in 2006. In the restrained world of central bankers, it would have been difficult for White to express himself more clearly. Now White has been proved right -- to an almost apocalyptical degree. And yet gloating is the last thing on his mind. He, the chief economist at the central bank for central banks, predicted the disaster, and yet not even his own clientele was willing to believe him. It was probably the biggest failure of the world's central bankers since the founding of the BIS in 1930. They knew everything and did nothing. Their gigantic machinery of analysis kept spitting out new scenarios of doom, but they might as well have been transmitted directly into space. For years, the regulators of the global money supply ignored the advice of their top experts, probably because it would require them to do something unheard of, namely embark on a fundamental change in direction. The prevailing model was banal: no inflation, no problem. But White wanted central bankers to take things a step further by preventing the development of bubbles and taking corrective action. He believed that interest rates ought to be raised in good times, even when there is no risk of inflation. This, he argued, counteracts bubbles and makes it possible to lower interest

362 rates in bad times. He also advised the banks to beef up their reserves during a recovery so that they would be in a position to lend money in a downturn. If White's model had been applied, it might have been possible to avoid the collapse of the financial system -- or at least soften the fall. But there was simply no support for his ideas in the singular, and highly secretive, world of central bankers. Prima Donnas of the Banking World The BIS is a closed organization owned by the 55 central banks. The heads of these central banks travel to the Basel headquarters once every two months, and the General Meeting, the BIS's supreme executive body, takes place once a year. The central bankers -- from Alan Greenspan and his successor Ben Bernanke, to German Bundesbank President Axel Weber and Jean-Claude Trichet, the head of the European Central Bank (ECB) -- are fond of the Basel meetings. When they arrive, the BIS's dark office building at Centralbahnhof 2 in Basel suddenly comes alive. Secretaries inhabit the otherwise deserted offices of the governors, stenographers and chauffeurs stand at the ready and dark limousines wait outside. The penthouse at the top of the building, with its magnificent view of Basel, is decorated for the annual dinner, the nuclear shelter in the basement is swept out and the wine cellar is restocked with the best wines. At the BIS's private country club, gardeners prepare the tennis courts as if a Grand Slam tournament were about to be held there. The losers of matches can find comfort in the clubhouse, where the Indonesian guest chef serves up Asian delicacies à la carte. "Central bankers can sometimes be prima donnas," says former BIS Secretary General Gunter Baer. He remembers the commotion that erupted at one of the annual events when it became known that a certain vintage of Mouton Rothschild was unavailable. The corridors of the BIS headquarters buildings are lined with retro white leather chairs and sofas from the 1970s. The round table where the delegates address the problems of the global economy is polished to a high gloss. But the most impressive space of all is the auditorium, with its modern armchairs in white leather and chrome, the thousands of tiny LED lights, the booths in the back where the interpreters sit behind one-way glass, and the console where the financial masters of the world do their work, centrally positioned at the front of the room. The room is evocative of the control room in "Star Trek." It was supposed to be the hub from which the financial world was to be guided through every possible hazard. Naturally, the building is largely bugproof, the goal being to prevent anything from leaking to the outside and any unauthorized individuals from penetrating into its interior. There are no public minutes of the meetings. Everything that is discussed there is confidential. The word transparency is unknown at the BIS, where nothing is considered more despicable than an indiscreet central banker. Central bankers, proud of their independence, are intent on holding themselves above all partisan influences while taking all necessary measures to keep the global economy healthy. These traits make the BIS one of the world's most exclusive and influential clubs, a sort of Vatican of high finance. Formally registered as a stock corporation, it is recognized as an international organization and, therefore, is not subject to any jurisdiction other than international law. It does not need to pay tax, and its members and employees enjoy extensive immunity. No other institution regulates the BIS, despite the fact that it manages about 4 percent of the world's total currency reserves, or €217 trillion ($304 trillion), as well as 120 tons of gold.

363 "Our strength is that we have no power," says BIS Secretary General Peter Dittus. "Our meetings are generally not oriented toward decision-making. Instead, their value consists in the exchange of views." There are no across-the-board agreements on the order of: "Let's raise the prime rate by a point." Opinions take shape in a much more subtle fashion, through something resembling osmosis. Central bankers are not elected by the people but are appointed by their governments. Nevertheless, they wield power that exceeds that of many political leaders. Their decisions affect entire economies, and a single word from their lips is capable of moving financial markets. They set interest rates, thereby determining the cost of borrowing and the speed of global financial currents. Their greatest responsibility is to prevent a bank or market crash from jeopardizing the viability of the financial system and, with it, the real economy. It is no accident that central bankers are also in charge of bank supervision in most countries. But this time they failed miserably. How could this community of central bankers, despite its access to insider information, have so seriously underestimated the dangers? And why on earth did it not intervene? "Somehow everybody was hoping that it won't go down as long as you don't look at the downside," William White told SPIEGEL. "Similar to the comic figure Wile E. Coyote, who rushes over a cliff, keeps running and only falls when he looks into the depth. Of course, this is nonsense. One falls, because there is an abyss." But why did they all refuse to recognize the abyss? Why did the central bankers, of all people -- those whose actions are above profit expectations, shareholder pressure and the need to please voters -- keep their eyes tightly shut? Did they too succumb to the general herd instinct? "As long as everything goes well, there is a great reluctance to (make) any kind of change," says White. "This behavior is deeply rooted in the human mind." White calls it the human factor. And that factor had a name: Alan Greenspan. The Killjoy Vs. the Party Animal Greenspan was long a member of the BIS board of directors and was effectively White's superior. As a fervent champion of the free market, he advocated the model of minimal intervention. In his view, the role of central banks was to control inflation and price stability, as well as to clean up after burst bubbles. Because no one can know when bubbles are about to burst, he argued, it would be impossible to intervene at the right moment. In his eyes, the instrument of sharply raising interest rates to counteract market excesses routinely failed. Leaning "into the wind," he argued, was pointless. He could even cite historical proof for his thesis. Between the beginning of 1988 and the spring of 1989, the Fed raised the prime rate by three percentage points, the goal being to curtail lending by raising the cost of borrowing. The textbook conclusion was that this would be toxic to the markets, but precisely the opposite occurred: Prices continued to rise. This supposed paradox repeated itself five years later. Once again, the Fed raised interest rates and, again, the market shot up. These experiences only strengthened Greenspan's conviction that raising interest rates was an ineffective tool to counteract bubbles. However he never tried raising interest rates to a significantly greater degree than had previously been done, to see what would happen.

364 The question of who was right, Greenspan or White, didn't exactly lead to a power struggle in Basel. The forces were too unevenly distributed for that. On the one side was the admonishing chief economist, with his seemingly antiquated model that advocated the establishment of reserves, and on the other side was the glamorous central banker, under whose aegis the economy was booming -- the killjoy vs. the party animal. The central bankers certainly discussed the competing models. But most of them were behind Greenspan, because his system was what they had studied at their elite universities. They refused to accept White's objections that the economy is not a science. There was no way of verifying his model, they said. Besides, who was about to question success? Greenspan was their superstar, the inviolable master, a living legend. "Greenspan always demanded respect," White recalls, referring to the Maestro's appearances. Hardly anyone dared to contradict the oracular grand master. And why should they have contradicted Greenspan? "When you are inside the bubble, everybody feels fine. Nobody wants to believe that it can burst," says White. "Nobody is asking the right questions." He even defends his erstwhile rival. "Greenspan is not the only one to blame. We all played the same game. Japan as well as Europe followed the low interest policy, almost everybody did." Meanwhile, White noted with concern what the central bankers were triggering as a result. Their policy of cheap money led to the Asian financial crisis in 1997. When the debt that banks had accumulated went into default, the International Monetary Fund (IMF) and other donors had to inject more than $100 billion (€71 billion) to rescue the world economy. In describing the failure of the markets as far back as 1998, White wrote that it is naïve to assume that markets behave in a disciplined way. But Greenspan, the champion of free markets, remained impassive. A few weeks later, the market demonstrated its destructive power once again, when Russia plunged into a financial crisis, bringing down the New York hedge fund Long Term Capital Management (LTCM) along with it. The New York Fed hurriedly convened a meeting of the heads of international banks, initiating a bailout that remains unprecedented to this day. The global economy was saved from a systemic crisis -- at a cost of $3.6 billion (€2.6 billion). And what did Greenspan do? He lowered interest rates. Then the next bubble, the so-called New Economy, began to grow in Silicon Valley. It burst in the spring of 2000. What did Greenspan do? He lowered interest rates. This time the reduction was massive, with the benchmark rate dropping from 6 percent to 1 percent within three years. This, according to White, was the cardinal error. "After the 2001 crash, interest rates were lowered very aggressively and left too low for too long," he says. While the economy was recovering from the demise of the dotcom sector and from the terrorist attacks of Sept. 11, 2001, cheap money was already on its way to triggering the next excess. This time it took place in the housing market, and this time it would be far more devastating. White was losing his patience. Was there no other option than to regularly allow the economy to collapse? Didn't the policy of operating without a safety net border on stupidity? And wasn't it written, in both the Bible and the Koran, that it was important to provide for seven years of famine during seven good years?

365 This time, White didn't just want to discuss his views behind closed doors. This time, he decided to seek a broader audience. One Villain Replaced by Another His destination was Jackson Hole in Wyoming, a kind of Mecca for financial experts. It was August 2003. Once a year, the Federal Reserve Bank of Kansas City invites leading economists and central bankers to a symposium in Jackson Hole. Against the magnificent backdrop of the Grand Teton National Park, the world's financial elite spends its time unwinding on hiking trails and in canoes, before retreating into conference rooms to discuss the state of the global economy. Only those who can hold their own in front of this audience are considered important in the industry. "This is an opportunity we can't afford to miss," BIS economist Claudio Borio told his boss, White, as he wrote himself a few last-minute notes in his room at the Jackson Lake Lodge in preparation for his speech to the symposium. Greenspan was in the audience when Borio and White presented their theories -- theories that had absolutely nothing in common with the powerful Fed chairman's worldview, or that of most of his colleagues. White and Borio described the dramatic changes that had taken place since deregulation of the financial markets in the 1980s. Price stability was no longer the problem, they argued, but rather the development of imbalances in the financial markets, which were increasingly causing earthquake-like tremors. "It is as if one villain had gradually left the stage only to be replaced by another," White and Borio wrote in the paper they presented at Jackson Hole. As it turned out, it was a villain with the ability to unleash devastatingly destructive forces. It was created by what the two BIS economists called the "inherently procyclical" nature of the financial system. What they meant is that perceptions of value and risk develop in parallel. People suffer from a blindness to future dangers that is intrinsic to the system. The better the economy is doing, the higher the ratings issued by the rating agencies, the laxer the guidelines for approving credit, the easier it becomes to borrow money and the greater the willingness to assume risk. A bubble develops. When it bursts, the results can be devastating. "In extreme cases, broader financial crises can arise and exacerbate the downturn further," White wrote in his analysis. The consequences, according to White, are high costs to the real economy: unemployment, a credit crunch and bankruptcies. All it takes to predict such imbalances, White argued, is to monitor "excessive credit expansion and asset price increases," and to take corrective action early on, even without a pending threat of inflation. This task, the authors concluded, must be performed by monetary policy, among other things. The central banks, according to White and Borio, could limit credit expansion and thus avoid adverse effects on the global economy. The Jackson Hole paper was an assault on everything Greenspan had preached and, as everyone knew, he was not fond of being contradicted. Other members of the audience glanced surreptitiously at the Maestro to gauge his reaction. Greenspan remained impassive, his face expressionless behind his large spectacles, as he listened to White. Later, during a more relaxed get-together, he refused to even look at White. White suspected he had failed to convince his audience.

366 "You can lead a horse to water, but you can't make it drink," he says. 'All We Could Do Was to Present our Expertise' Now that the US prime rate is bobbing up and down between zero and 0.25 percent, and the Fed is pumping hundreds of billions of dollars into the market, White's words at the 2003 conference have undoubtedly come back to haunt many a central banker. In that speech, White had prophesied that if the "worst scenario materializes, central banks may need to push policy rates to zero and resort to less conventional measures, whose efficacy is less certain." He warned that the money supply could dry up. Markets, he wrote, "can freeze under stress, as liquidity evaporates." He also identified -- a full four years before the bursting of the real estate bubble -- the disturbing developments in the US real estate market as a consequence of lax monetary policy. "Further stimulus has not come free of charge and has raised questions about the sustainability of the recovery," he warned. From today's perspective, White's predictions are almost frightening in their accuracy. But when push came to shove, he was unable to overturn the prevailing ideology. "We were staff," he says. "All we could do was to present our expertise. It was not within our power how it was used." Despite the disappointment at Jackson Hole, White didn't give up on supplying data, facts and analyses. Perhaps, he reasoned, this constant flow of information could help to break through mental barriers. He would repeatedly refer to the "Credit Risk Transfer" report published by the BIS's Committee on the Global Financial System in 2003. The publication describes how loans were packaged into tranches using so-called collateralized debt obligations and then marketed worldwide. For banks, the experts wrote, "CRT instruments may reduce banks' incentives to monitor their borrowers and alter their treatment of distressed borrowers." That, in a nutshell, was the underlying problem that would eventually trigger the mother of all crises. Many US bankers lowered their guard when it came to issuing subprime mortgages, because they could be repackaged and quickly resold, for example to unsophisticated bankers at German state-owned Landesbanken in places like Dresden, Hamburg and Munich. The central bankers were also not exactly taken by surprise by the failure of the rating agencies. In their report, the BIS experts derisively described the techniques of rating agencies like Moody's and Standard & Poor's as "relatively crude" and noted that "some caution is in order in relation to the reliability of the results." But nothing happened. A Greek Tragedy in the Making In the 2004 BIS annual report, White was unusually frank in criticizing the Fed's lax monetary policy. Although Greenspan sat on the bank's board of directors at the time, the board never sought to influence the analyses of its experts. But neither did it take them seriously. In January 2005, the BIS's Committee on the Global Financial System sounded the alarm once again, noting that the risks associated with structured financial products were not being "fully appreciated by market participants." Extreme market events, the experts argued, could "have unanticipated systemic consequences."

367 They also cautioned against putting too much faith in the rating agencies, which suffered from a fatal flaw. Because the rating agencies were being paid by the companies they rated, the committee argued, there was a risk that they might rate some companies too highly and be reluctant to lower the ratings of others that should have been downgraded. These comments show that the central bankers knew exactly what was going on, a full two- and-a-half years before the big bang. All the ingredients of the looming disaster had been neatly laid out on the table in front of them: defective rating agencies, loans repackaged to the point of being unrecognizable, dubious practices of American mortgage lenders, the risks of low-interest policies. But no action was taken. Meanwhile, the Fed continued to raise interest rates in nothing more than tiny increments. "You can see all the ingredients of a Greek tragedy," says White. The downfall was in sight, and yet no one dared disrupt the party, no one except White, the lone BIS economist, who says: "If returns are too good to be true, then it's too good to be true." And yet the economy was humming along, and billions in bonuses were being handed out like candy on Wall Street. Who would be willing to put an end to the orgy? Clearly not Greenspan. 'I Asked Myself: Is This the Big One?' The Fed chairman was not even impressed by a letter the Mortgage Insurance Companies of America (MICA), a trade association of US mortgage providers, sent to the Fed on Sept. 23, 2005. In the letter, MICA warned that it was "very concerned" about some of the risky lending practices being applied in the US real estate market. The experts even speculated that the Fed might be operating on the basis of incorrect data. Despite a sharp increase in mortgages being approved for low-income borrowers, most banks were reporting to the Fed that they had not lowered their lending standards. According to a study MICA cited entitled "This Powder Keg Is Going to Blow," there was no secondary market for these "nuclear mortgages." Three days later, Greenspan addressed the annual meeting of the American Bankers Association in Palm Desert, California, via satellite. He conceded that there had been "local excesses" in real estate prices, but assured his audience that "the vast majority of homeowners have a sizable equity cushion with which to absorb a potential decline in house prices." The Maestro had spoken -- and the party could continue. William White and his Basel team were dumbstruck. The central bankers were simply ignoring their warnings. Didn't they understand what they were being told? Or was it that they simply didn't want to understand? In the March 2006 BIS quarterly report, the Basel analysts described, once again, the grave risks of the subprime market. "Foreign investment in these securities has soared," they wrote. They also cautioned that there were "signs that the US housing market is cooling" and warned that investors "may be exposed to losses in excess of what they had anticipated." A short time later, White argued for his model once again in a working paper titled "Is Price Stability Enough?" Low inflation rates are not a sign of normalcy, he warned, and central banks should not allow themselves to be led astray by low rates. Both the LTCM bankruptcy and the collapse of the stock markets in 2001 occurred "in an environment of effective price stability." It was a waste of time and effort. Roger Ferguson, the then-deputy Fed chairman, ironically started to refer to the BIS's Cassandra-like chief economist as "Merry Sunshine."

368 "There are limits to pressing your argument," White says. "If you keep repeating your point over and over again, nobody will listen anymore." A Loss of Confidence Ben Bernanke, who succeeded Greenspan as Fed chief in early 2006, was especially deaf to White's warnings. When he presented his biannual report on the state of the economy to the US Congress on July 19, 2006, he made no mention whatsoever of the subprime risk. A few months later, in December, the BIS reported that the index for securitized US subprime mortgages had fallen sharply in the fourth quarter of the year. A loss of confidence began to take shape. The first casualties began surfacing a few weeks later. On Feb. 8, 2007, HSBC, the world's third-largest bank at the time, issued the first profit warning in its history. On April 2, the US mortgage lender New Century Financial filed for bankruptcy. Bernanke remained unimpressed. "The troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system," he said. It was June 5, 2007. White made one last, desperate attempt to bring the central bankers to their senses. "Virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s, respectively. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived," he wrote in June 2007 in the BIS annual report. But even if Bernanke had listened, it would have been too late by then. On June 22, the US investment bank Bear Stearns announced that it needed $3 billion (€2.1 billion) to bail out two of its hedge funds, which had suffered heavy losses during the course of the US real estate crisis. In Germany, entire banks were soon seeking government bailout funds. Banks increasingly lost trust in one another, and the money markets gradually dried up. It was the beginning of the end. "When the crisis started, I asked myself: Is this the big one?" White recalls. "The answer was: Yes, this is the big one." Just as Predicted Meanwhile, the global economy is on the brink of disaster, as it faces the most devastating and brutal crisis in a century. The only reason the financial system is still intact is that governments are spending billions to support it. Central bankers have been forced to abandon their air of sophisticated aloofness and to try, together with politicians, to save what can be saved. Nowadays no one is talking about the free market's ability to heal itself. And everything happened just the way White predicted it would. This is visibly unpleasant for officials at the BIS. Even though they can pride themselves for having provided the best analyses, they have also been forced to admit that their central bankers failed miserably. "We had the right nose, but we didn't know how to use it," says BIS Secretary General Dittus. "We didn't manage to portray the global and financial imbalances in a convincing fashion." Did White express himself unclearly? No, it was more that he represented a system that only questioned the prevailing view. "Ultimately, an economic model can only be defeated by an opposing model," says BIS Chief Economist Stephen Cecchetti, White's successor. "Unfortunately, we don't have a generally recognized model yet. Perhaps this partly explains why our warnings were less effective than would have been desirable."

369 The group of the 20 most important industrialized and emerging nations, which is now left with the task of cleaning up the wreckage of the crisis, apparently faces less academic problems. At the London G-20 summit in April, the group decided to promote a crisis- prevention model based on White's theories. They want to introduce what might be called his hoarding model, which calls for banks to build up reserves in good times so that they can be more flexible in bad times. The central banks, according to White, must actively counteract bubbles and exert stronger control over the financial industry, including hedge funds and insurance companies. As an adviser to German Chancellor Angela Merkel's group of experts, White helped to shape the basic tenets of the new order. And the 79th annual report of the BIS, published in Basel last week, also reads like pure White. It lists, as the causes of the crisis, extensive global imbalances, a lengthy phase of low real interest rates, distorted incentive systems and underestimated risks. In addition to improved regulation, the BIS argues that "asset prices and credit growth must be more directly integrated into monetary policy frameworks." Simply Part of Life Even though this is what he has been saying for more than 10 years, White, a passionate financial professional, is the last person to show signs of bitterness. During a conversation in his Paris office at the OECD, he has no harsh words for those who had long dismissed him as an alarmist. For White, the BIS will always be the greatest experience for an economist. The errors made by central bankers, politicians and business executives, he says, are simply part of life. "Take the Enron example," he says. "We analyzed the disaster and found that 12 different levels of the government malfunctioned. This is part of human nature." He is familiar with human nature, and he knows how to handle it. White is more concerned about the things he doesn't understand. New Zealand is a case in point. Interest rates were raised early in the crisis there, and yet the central bank was unable to come to grips with the credit bubble. Investors were apparently borrowing cheap money from foreign lenders. This is the sort of thing that worries him. "That's when you have to ask yourself: Who exactly is controlling the whole thing anymore?" Perhaps his model has a flaw in that regard. Could it be possible that central bankers today have far less influence than he assumes? The thought causes him to wrinkle his brow for a moment. Then he smiles, says his goodbyes and quickly disappears into a Paris Metro station. He knows that he is needed.

Translated from the German by Christopher Sultan

URL: http://www.spiegel.de/international/business/0,1518,635051,00.html