Big Risks for U.S. in Trying to Value Bad Bank Assets

By VIKAS BAJAJ and STEPHEN LABATON

Published: February 1, 2009

As the Obama administration prepares its strategy to rescue the nation’s banks by buying or guaranteeing troubled assets on their books, it confronts one central problem: How should they be valued?

Not just billions, but hundreds of billions of taxpayer dollars are at stake.

The Treasury secretary, Timothy F. Geithner, is expected to announce details of the new plan within weeks. Administration and Congressional officials say it will give the government flexibility to buy some bad assets and guarantee others in an effort to have a broad impact but still tailor the aid for different institutions.

But getting this right will not be easy. The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency.

The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.

The bond analyzed by S.& P. is just one of thousands that the government might buy or guarantee should it go forward with setting up a “bad bank” that would acquire $1 trillion or more of toxic assets from banks.

The idea is that, free from the burden of carrying these bad assets, banks would start lending again and bolster the faltering economy. The bad bank set up by the government would, over time, sell the assets and recover some or most of what it had paid.

While the government is considering several approaches to helping the banks, including more capital injections, buying or insuring toxic assets is likely to be a centerpiece. Determining the right price for these assets is crucial to success. Placing too low a value would force institutions selling and others holding similar investments to register crushing losses that could deplete their capital and make it harder for them to increase lending.

But inflated values would bail out the companies, their shareholders and executives at the expense of taxpayers, who would swallow the losses if the government could not recoup what it had paid.

Some critics of the plan warn that the government should not buy the assets, because banks will try to get too high a price and leave taxpayers holding the bag.

“To date, the banks have stuck their heads in the sand,” said Lynn E. Turner, a former chief accountant for the Securities and Exchange Commission, “and demanded that they be paid the price of good apples for bad apples.”

But many believe that, given the depth of the problem and the fact that it keeps getting worse, the government has little choice.

Finance experts from Wall Street and academia are advising the administration on other options. To sidestep the thorny valuation problem, some have suggested that the bad bank acquire only assets that have already been marked down significantly and guarantee other assets, but officials would have just as difficult a task in determining how much to charge for insuring risky assets.

Economists predict that the cost of the program will most likely exceed the $350 billion remaining in the $700 billion Troubled Assets Relief Program that Congress approved in October.

They say the Obama administration may need upwards of $1 trillion in additional aid for banks — on top of the more than $800 billion the administration is seeking in an economic stimulus measure moving through Congress.

Many in Washington question whether the rescue has achieved its goal of stabilizing the financial markets. A report by the Government Accountability Office on Friday concluded that whether the bailout program had been effective might never be known.

“While the package helped avoid a financial collapse, many are frustrated by the results — and rightfully so,” President Obama said in his weekly address on Saturday. “Too often taxpayer dollars have been spent without transparency or accountability. Banks have been extended a hand, but homeowners, students, and small businesses that need loans have been left to fend on their own.”

Mr. Obama and many lawmakers have expressed anger that banks that received the first batch of aid money do not appear to have increased their lending significantly, even as some firms have spent billions on bonuses, corporate jets and other perks. In two weeks the House will hold a hearing to ask chief executives of the eight largest banks about their spending controls.

As early as this week, the Treasury Department may impose new limits on the executive pay of companies receiving financial assistance. The Oversight Panel created by Congress to monitor the program is also expected to publish a report this week looking at whether the government paid too much to the large banks that they have provided with assistance.

A frequent refrain in Washington and on Wall Street is that there are no current market prices for toxic securities. But people who buy and sell these investments say that is a simplistic reading of the problem. They say most kinds of securities can be valued and are being traded, but trading has slowed as sellers and buyers disagree about what that the price should be.

The value of these securities is based on the future cash flow they provide to investors. To determine that, traders have to make assumptions about the housing market and the economy: How high will the unemployment rate go in the coming years? How many borrowers will default? What will homes be worth?

The Standard & Poor’s group, Market, Credit and Risk Strategies, which operates independently from the company’s credit ratings business, has been studying troubled securities for investors and banks. The bond that is trading at 38 cents provides a vivid illustration of the dilemma in valuing these assets.

The bond is backed by 9,000 second mortgages used by borrowers who put down little or no money to buy homes. Nearly a quarter of the loans are delinquent, and losses on defaulted mortgages are averaging 40 percent. The security once had a top rating, triple-A.

Michael G. Thompson, a managing director at the S.& P. group, says his computer models can easily calculate what the bond is worth under different situations. “This is not rocket science, this is straight bond math,” he said. But determining what the future holds is much harder. “We are not masters of the universe who can predict the macroeconomic environment,” he added

Some would-be buyers of these assets fear that a deep recession could drive up default rates and push down home prices much further. They also worry that a cataclysm like the failure of a big bank could send prices tumbling again, just as the collapse of Lehman Brothers did in September. Others see no reason to bid up prices because those who need to sell are desperate.

Big banks and other owners of mortgage investments have argued that the low market prices reflect fire sales. Many have classified such securities as level-three assets, for which accounting rules allow them to determine values using computer models rather than the marketplace. Mr. Thompson estimates that at the end of September financial firms had $600 billion in such hard-to-value assets.

But critics like Mr. Turner say that the banks’ accounting for these assets cannot be trusted because they have an incentive to use optimistic assumptions.

In some instances, the government has guaranteed losses on certain assets for big, systemically important companies like Citigroup and Bank of America.

Policy makers have found such arrangements appealing because they do not require upfront payments and they can be customized for each bank, Douglas J. Elliott, a fellow at the Brookings Institution, wrote in a recent paper.

Still, government guarantees need to be based on sound valuations, Mr. Elliott and others say. If the government underestimates the risks of default, taxpayers could eventually lose tens of billions of dollars. The cost of insuring such assets in the private market is often several times greater than the price the government is charging banks.

Whatever approach the Obama administration takes, investors and policy makers say it should provide more and clearer information about the health of banks and the risks that the government is taking.

Many analysts do not trust what they are told about the quality of the securities and loans held by banks and other financial firms. Most banks provide only a very general description of their holdings, because they consider the information privileged.

But the government, using its power as a big investor, could compel the banks to divulge more specific data, without giving away the names of individual bonds or loans, analysts said. The market could then do its own analysis on what the assets are worth.

“At least it would give the government one objective measure of the value of these assets,” said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. “In the absence of transparency and clarity, investors are going to assume a value that will be conservative and then add a risk premium.”

CalPERS investment chief sees 'no place to hide' in the markets

Joseph Dear prepares to take over as the pension fund seeks to shore up its ability to pay benefits amid losses.

By Marc Lifsher
February 2, 2009

Reporting from Sacramento -- There doesn't appear to be a lot of philosophical or practical daylight between Joseph A. Dear, the new chief investment officer of the country's largest public pension fund, and the labor-oriented board that hired him.

And he doesn't see much daylight in gloomy financial markets, either.

• 

  CalPERS' new investment chief

Dear, 57, is leaving a similar post at the Washington State Investment Board to run the $177-billion portfolio at the much larger, 1.6-million-member California Public Employees' Retirement System, or CalPERS. He'll start at CalPERS' Sacramento high-rise headquarters March 2.

"The job I had here at Washington State is similar to the job at CalPERS, though CalPERS is on a larger scale," Dear said in an interview Friday. He said he believed that his combination of experience in investment management and public administration was "what CalPERS was looking for."

Dear concedes that he faces both "a challenge and an opportunity" in helping the giant pension fund stabilize its value and try to recoup a stunning loss of $62.4 billion, or 26%, since July 1, as financial markets worldwide plummeted.

Not surprisingly, Dear indicated that he's in sync with the fund's 13-member board of directors on the broad issues of protecting healthcare and defined-benefit retirement security for the state, local government, school district and public university employees who participate in the system.

Fixed pensions "are a major tool for securing economic security in retirement," he said. "It's of interest to everyone in the country and the state of California."

But from the viewpoint of non-government workers, the risk is that CalPERS' investments won't be sufficient to cover promised benefits -- leaving taxpayers to pony up, at a time when their own retirement savings have dwindled.

CalPERS already has warned state and local government units that they may have to increase contributions to the fund to preserve promised benefits if the portfolio doesn't recover.

Dear cautioned that "there's no place to hide for any investor in this environment." But he stressed that large institutional investors such as CalPERS must "maintain the courage of convictions [as] long-horizon investors."

Though he declined to address in detail any of CalPERS' investment policies, Dear said he agreed with the fund's program of maintaining an increasingly diverse portfolio of investments, which includes domestic and foreign stocks, corporate bonds, real estate, private equity funds and commodities.

But with markets volatile and asset values still falling in many sectors, it's also important for CalPERS to periodically reevaluate its mix of holdings, he said. That process is at the top of the CalPERS board's to-do list for this spring, the fund announced late last year.

CalPERS has stumbled badly with some of its real estate investments, in particular, over the last year.

Stemming losses and planning for the future are essential tasks during a deep economic recession with no recovery imminent, Dear said.

"What we have to see is a return of more normal functioning of the credit markets and stabilization of housing prices," he said.

But "who knows" when those turnarounds will come, he said.

California holds back payments amid budget crisis

SAN FRANCISCO (Reuters) – Like thousands of other Californians, Marcus Sanders would like a tax refund to help his family as recession tightens its grip on the economy and while he looks for full-time work.

When California's state government will release its refunds, however, is uncertain.

The payments were due to start on Monday but State Controller John Chiang has said he will hold back the refunds for at least 30 days because the state must close a $15 billion shortfall in its current budget and needs its dwindling cash for more pressing payments, including debt service.

Sanders, a 46-year-old lawyer and corporate consultant in Antioch, California, who is getting by on contract work, said he appreciates the state's financial predicament and would be willing to wait on a tax refund to help. But not every household may be able to afford to do the same, he said.

"Every bit of cash you get in a tight time, you'll use it," Sanders said.

Sarah Gilson of San Francisco also is concerned about Chiang's decision. The recent law school graduate does not expect a tax refund but sees withholding them as a blow to the state's already ailing economy and as lowering her odds of landing a job at a law firm.

"I don't see how that stimulates the economy," Gilson said. "People look at my resume and are impressed with what they see but they're just not hiring."

Gilson said she faces cutthroat competition. She said one law firm recently pulled a job notice from her law school's job office within a few hours of posting it. The firm had received 400 applications.

"You're not even getting reply e-mails thanking you for your application because so many people are looking for work that firms can't process them," she said.

STATE BURNS THROUGH CASH

California has fallen on hard times. The housing slump and foreclosure crisis hit it harder than most other states and tumbling consumer spending in recent months has roiled its economy, the world's eighth largest.

California's unemployment rate jumped to 9.3 percent in December, well above its 5.9 percent a year earlier and the month's national average of 7.2 percent. Economists predict the state's rate will soon cross into double-digits, compounding its government's financial troubles, rooted in worse a than expected fall in revenues.

One of the state government's most pressing troubles is that its cash account will be tapped out within weeks unless Gov. Arnold Schwarzenegger and lawmakers close the state's current budget shortfall -- then they must close the next fiscal year's budget gap, projected at $25 billion.

California's financial crisis has unnerved Wall Street -- it has warned of possible downgrades to the state's already low general obligation bond rating -- and is adding to a gloomy outlook in storefronts, government offices, labor halls and corporate boardrooms across the state.

"Everybody is concerned about this. The state is on the edge of going into the abyss," said Bill Hauck, president of the California Business Roundtable, which represents the state's largest employers.

IN LIEU OF PAYMENT

For businesses providing goods and services to the state, its thinning cash account is especially concerning as Chiang, in addition to withholding tax refunds, is planning to issue notes from the state promising payment instead actual payment.

With recession likely to drag on for some time and lenders tightfisted, companies doing business with the state government need reliable revenues, not promises, said Ruben Barrales, chief executive of the San Diego Regional Chamber of Commerce.

"Many of our members are bracing themselves," Barrales said, adding that, "Some are questioning whether to go after state business ... or if they win a job to accept it."

Subcontractors on state projects likewise are anxious because contractors many not be paid, said Andy Berg of the San Diego chapter of the National Electrical Contractors Association: "Contractors always say 'I haven't got the money because I haven't got paid yet.' At least this time they'll be telling the truth."

In anticipation of state IOUs, contractors are cutting hours for subcontractors or idling them, scrapping equipment orders and hoarding cash, Berg said.

For some the measures may be too little too late. "If you've done $5 million worth of work and you're waiting for a paycheck, that'll put some of the biggest contractors out of business," Berg said.

Financial Times: China Faces Spectre of Widespread Civil Unrest, Violence

More than 20m rural migrant workers in China have lost their jobs and

returned home as a result of the global economic crisis according to

government figures, raising the spectre of widespread unrest in the

authoritarian country. By the start of the Chinese New Year Spring Festival

on 25 January, 15.3 per cent of China’s 130m migrant workers had lost

their jobs and returned from manufacturing centres in the south and east

of the country to their home villages or towns, according to Chen Xiwen,

Director of the Office of Central Rural Work Leading Group. Mr Chen said

these job losses were a direct result of the global economic crisis and its

impact on the country’s export-oriented manufacturing sector and he

warned that the mass of unemployed migrants would pose new challenges

to social stability in the countryside. The figure of 20 million unemployed

migrants is double the previous official figure released by the Ministry of

Human Resources and Social Security at the end of December 2008 . . .

Violent unrest rocks China as crisis hits

The collapse of the export trade has left millions without work and set off a wave of social instability, writes

China's new year of the ox portends calm but there is little sign of it as workers in Shezhen protest over unpaid wages as factories shut

Michael Sheridan in Hong Kong

Bankruptcies, unemployment and social unrest are spreading more widely in China than officially reported, according to independent research that paints an ominous picture for the world economy.

The research was conducted for The Sunday Times over the last two months in three provinces vital to Chinese trade – Guangdong, Zhejiang and Jiangsu. It found that the global economic crisis has scythed through exports and set off dozens of protests that are never mentioned by the state media.

While troubling for the Chinese government, this should strengthen the argument of Premier Wen Jiabao, who will say on a visit to London this week that his country faces enormous problems and cannot let its currency rise in response to American demands.

The new US Treasury secretary, Timothy Geithner, has alarmed Beijing and raised fears of a trade war by stating that China manipulates the yuan to promote exports.

However, a growing number of economists say the unrest proves that it is not the exchange rate but years of sweatshop wages and income inequality in China that have distorted global competition and stifled domestic demand. The influential Far Eastern Economic Review headlined its latest issue “The coming crack-up of the China Model”.

Yasheng Huang, a professor at the Massachusetts Institute of Technology, said corruption and a deeply flawed model of economic reform had led to a collapse in personal income growth and a wealth gap that could leave China looking like a Latin American economy.

Richard Duncan, a partner at Blackhorse Asset Management in Singapore, has argued that the only way to create consumers is to raise wages to a legal minimum of $5 (£3.50) a day across Asia – a “trickle up” theory.

The instability may peak when millions of migrant workers flood back from celebrating the Chinese new year to find they no longer have jobs. That spells political trouble and there are already signs that the government’s $585 billion stimulus package will not be enough to achieve its goal of 8% growth this year.

The American economist Nouriel Roubini said growth figures of 6.8% in the fourth quarter of 2008 masked the reality that China was already in recession – a view privately shared by many Chinese financial analysts who dare not say so in public.

Even security guards and teachers have staged protests as disorder sweeps through the industrial zones that were built on cheap manufacturing for multinational companies. Worker dormitory suburbs already resemble ghost towns.

In the southern province of Guangdong, three jobless men detonated a bomb in a business travellers’ hotel in the commercial city of Foshan to extort money from the management.

The Communist party is so concerned to buy off trouble that in one case, confirmed by a local government official in Foshan, armed police forced a factory owner to withdraw cash from the bank to pay his workers.

“Hundreds of workers protested outside the city government so we ordered the boss to settle the back pay and sent police armed with machine-guns to take him to the bank and deliver the money to his workforce that very night,” the official said.

On January 15 there were pitched battles at a textile factory in the nearby city of Dongguan between striking workers and security guards.

On January 16, about 100 auxiliary security officers, known in Chinese as Bao An, staged a street protest after they were sacked by a state-owned firm in Shenzhen, a boom town adjoining Hong Kong.

About 1,000 teachers confronted police on the streets of Yangjiang on January 5, demanding their wages from the local authorities.

In one sample week in late December, 2,000 workers at a Singapore-owned firm in Shanghai held a wage protest and thousands of farmers staged 12 days of mass demonstrations over economic problems outside the city.

All along the coast, angry workers besieged labour offices and government buildings after dozens of factories closed their doors without paying wages and their owners went back to Hong Kong, Taiwan or South Korea.

In southern China, hundreds of workers blocked a highway to protest against pay cuts imposed by managers. At several factories, there were scenes of chaos as police were called to stop creditors breaking in to seize equipment in lieu of debts.

In northern China, television journalists were punished after they prepared a story on the occupation of a textile mill by 6,000 workers. Furious local leaders in the city of Linfen said the news item would “destroy social stability” and banned it.

At textile companies in Suzhou, historic centre of the silk trade, sales managers told of a collapse in export orders. “This time last year our monthly output to Britain and other markets was 60,000 metres of cloth. This month it’s 3,000 metres,” said one.

She said companies dared not accept orders in pounds or euros for fear of wild currency fluctuations. Trade finance has all but ceased. Some 40% of the workforce had been laid off, she added.

Nearby, in the industrial hub of Changshu, all the talk was of Singapore-listed Ferro China, which exported steel products to customers in Britain, Germany, Korea and Japan. Last October its shares were suspended.

The company is reported to have been weighed down by $800m in debts and, according to the specialist business magazine Caijing, has started a court-or-dered restructuring.

A researcher found the gates closed and under tight guard, 2,000 employees out of work and witnesses who told of company vehicles being seized by impatient creditors. Holders of Ferro China debt include Credit Suisse and Citi-group.

Even in the city regarded as the most entrepreneurial in China, Wenzhou, the business community is reeling. “We estimate that foreign companies have defaulted on payments for 20 billion yuan (£20 billion) owed to Wenzhou firms,” said Zhou Dewen, chairman of the city’s association for small and medium-sized businesses.

“British businessmen are better than other customers because even if they owe money they can be contacted and promise to pay their bills if they can raise the cash but many other foreigners just disappear,” he said.

Slumping demand for consumer electronics in Britain has been blamed for the crisis engulfing the southern city of Shunde, in Guangdong, where a cluster of 3,000 electrical firms has grown up around big exporters like Kelon, a white-goods manufacturer.

“The impact on us from the slowdown in the British market will be huge,” said a manager at Kelon, who asked not to be named.

Shunde is one of the amazing one-industry Chinese towns that has come from nothing to generate 20% of China’s export production of domestic electrical appliances, making 60% of its sales to Europe.

Now the whole province is wrestling with sudden, sharp decline. A researcher who watched officials handling complaints at a local labour bureau reported “class hatred” among workers.

“Why did the boss cut your salary? You must be lazy or absent from work,” an official told one group of petitioners.

“What do you mean? Are you an official of the people’s government or a slave of the bosses?” demanded an irate worker.

Their claim dismissed, the group warned onlookers: “We are thinking of taking extreme action.”

A legal advocate for migrant workers, Xiao Qingshan, told a tale of violent intimidation by the state in collusion with unscrupulous businessmen.

On January 9, Xiao said, 14 security officers from the local labour bureau broke into his office, confiscated 600 legal case files, 160 law books, his computer, his photocopier, his television set and 100,000 yuan in cash.

“That evening I was ambushed near the office by five strangers who forced a black bag over my head and then threw me into a shallow polluted canal,” he said. His landlord has since given him notice to quit his rented home.

Xiao said he was defying bribery and threats to speak to the foreign media because he wants international businesses to know what is really happening in “the workshop of the world”.

A Threat to Putin’s Big Plans

James Hill for The New York Times

BARGAIN Russians seemed fine giving Vladimir Putin great power, if they could live well. Enter an economic crisis.

MOSCOW — Over the last eight years, as Vladimir V. Putin has amassed ever more power, Russians have often responded with a collective shrug, as if to say: Go ahead, control everything — as long as we can have our new cars and amply stocked supermarkets, our sturdy ruble and cheap vacations in the Turkish sun.

James Hill for The New York Times

But now the worldwide financial crisis is abruptly ending an oil-driven economic boom here, and the unspoken contract between Mr. Putin and his people is being thrown into doubt. In newspaper articles, among political analysts, even in corners of the Kremlin, questions can be heard. Will Russians admire Mr. Putin as much when oil is at $40 a barrel as they did when it was at $140 a barrel? And if Russia’s economy seriously falters, will his system of hard, personal power prove to be a trap for him? Can it relieve public anger, and can he escape the blame?

“We talk about a lack of democracy in Russia, but I like my own formula for the country, which is authoritarianism with the consent of the governed,” said Dmitri Trenin, director of the Carnegie Moscow Center. “And it can be taken away.”

“The present rulers know that they will not be toppled by Kasparov,” Mr. Trenin said, referring to Garry K. Kasparov, the former chess champion whose political challenges to Mr. Putin can seem quixotic. “But if the working people of Russia decide that they have had enough, that will be the end of it. It happened to Gorbachev, and it almost happened to Yeltsin.”

Few are predicting Mr. Putin’s downfall any time soon, especially considering how methodically he has undermined the opposition. Many Russians believe he rescued them from the misery of the 1990s, and the polls say his popularity remains very high.

But those polls also show his popularity slipping a bit, amid far darker indicators. The unemployment rate is soaring, banks are failing and the ruble has dropped so fast in value that Russians are again hiding their money in dollars in their apartments. Sporadic protests have broken out as some factories close or cut production.

For now, the Kremlin is desperately spending down the hundreds of billions of dollars in reserves that it put away in good times, all the while trying to quell comparisons to Russia’s economic meltdown in 1998, when the government, under Boris Yeltsin, defaulted on its debt. Mr. Putin, the current prime minister and former president, and his protégé, President Dmitri A. Medvedev, try to assure the public that they are addressing its pain. Yet Mr. Putin has created a government so highly centralized and so resistant to criticism that it is unclear whether it can respond adeptly to rising dissatisfaction.

At all levels, government officials are unaccustomed to vying in contested elections, let alone to reaching out for popular support or trying to get a feel for the range of grass-roots sentiment.

The Parliament is essentially an arm of the Kremlin, and Mr. Putin has done away with the election of regional governors, who are now presidential appointees. The structure is known here as Mr. Putin’s vertical system of power — decisions emanate from the very top, then are passed down to regional and finally local officials.

Aleksandr A. Auzan, an economist and board member at a research institute set up by President Medvedev, said that in the Putin system, “there is not a relationship between the authorities and the people through the Parliament or through nonprofit organizations or other structures. The relationship to the people is basically through television. And under the conditions of the crisis, that can no longer work.”

In other words, if people feel their government is not heeding their complaints, they may think their only option is to take to the streets.

One social scientist, Yevgeny S. Gontmakher, created a bit of a sensation in political circles late last year when he explored this theme in an article in a newspaper, Vedomosti, that he titled, “Scenario: Novocherkassk — 2009.”

He described how unrest could occur in industrial cities that depend on a single factory, if the factory closes. (Novocherkassk is such a city; in Soviet times, food shortages set off riots there that the Soviets brutally suppressed.)

In the scenario, local authorities beholden to Moscow would freeze up or panic in the face of spontaneous protests, and the situation would quickly deteriorate.

“The vertical system of power is not flexible,” Mr. Gontmakher said in an interview. “These bureaucrats, they wait for a reaction from Moscow, even in small situations, before making decisions. This is a big threat. It is very dangerous for Putin.”

The government’s response to the article hinted at how the authorities remain unsure whether to address the country’s financial troubles with a thaw or a crackdown. At first, Kremlin officials thanked Mr. Gontmakher. Then, federal media regulators warned Vedomosti that the article might be “an attempt to incite extremist activities.”

Mr. Putin may have also put himself in a political bind by establishing his tandem leadership with Mr. Medvedev. (Barred from running for a third consecutive presidential term, Mr. Putin anointed Mr. Medvedev as his successor and had Mr. Medvedev appoint him prime minister.)

Mr. Putin is still considered Russia’s paramount leader, but by taking the title of prime minister, he may have deprived himself of a fall-guy-in-waiting. That role traditionally has gone to Russia’s prime ministers; President Yeltsin repeatedly dismissed his during the 1998 default.

So far, Mr. Putin has instead made a scapegoat of the United States, saying it was at the heart of Russia’s crisis, rather than Russia’s over-reliance on the export of natural resources.

Last week, as opposition leaders in Russia planned protests over the crisis, Mr. Putin was at the World Economic Forum in Davos, Switzerland.

He began his keynote address by saying, “In the last few months, virtually every speech on this subject has started with criticism of the United States. But I will do nothing of the kind.” And then he went on to do just that.

‘Grimmest’ Davos Ever Brings Anger, Finger-Pointing at Bankers

By James Hertling and Simon Kennedy

Feb. 2 (Bloomberg) -- The theme of the World Economic Forum’s annual meeting was “Shaping the Post-Crisis World.” Unfortunately, the assembled executives, policy makers and do- gooders were stuck in the here and now.

The search for scapegoats and the worst economic prospects since World War II resulted in a gathering marked by fear, anger and bitterness, a far cry from the usual search for consensus.

Turkish Prime Minister Recep Tayyip Erdogan stormed out of a panel discussion and Russian Prime Minister Vladimir Putin hectored the U.S. as the font of the world’s economic woes. Almost everyone blamed the few bankers who showed up for the near-collapse of the financial system.

Attendees were “less reluctant to criticize, and sometimes very vocally criticize, the U.S. and its capitalist system because of the problems we’re having,” said David Rubenstein, co-founder of the Carlyle Group, who first came to Davos a decade ago. “Maybe that’s deserved, but it’s a big change.”

“Everyone I spoke to says it’s the grimmest Davos they’ve ever been to,” said Kenneth Rogoff, professor of economics at Harvard University and a World Economic Forum regular since 2002. “The mood has been very depressed. It’s a low-burn depression.”

Another big change was the virtual absence of Wall Street figures among the 2,500 delegates at the conference, which ended yesterday.

‘Stupid Things’

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon was the only U.S. banking chief who showed up. He made a concession to the mood of this year’s event by accepting some blame for the collapse that has led to more than $1 trillion of writedowns. He deflected the rest at regulators.

“God knows, some really stupid things were done by American banks and by American investment banks,” Dimon said. “To policy makers, I say: ‘Where were they?’”

That attitude was tough for some to swallow. At one session, a call for curbs on bankers’ bonuses was met with applause by sections of the audience.

“We should not trust these bankers,” said Nassim Nicholas Taleb, author of the best-selling book “The Black Swan.” “Look at their track record. The only way to stop the process is for the government to own those banks.”

With the world’s elite nursing a collective hangover after the greatest era of global prosperity came to an end, there was enough bile to go around.

Erdogan’s Walkout

Erdogan stunned a packed house on Jan. 29 by walking out on a debate on last month’s war in the Gaza Strip. He claimed that the session’s moderator didn’t give him equal time with Israeli President Shimon Peres and vowed never to return to Davos. By the time he met the press an hour later, he promised to reconsider.

Anyone who thought Barack Obama’s election as president would temper criticism of U.S. policies would have been disappointed. Economists questioned his $819 billion stimulus plan, urged him to deliver another rescue package for banks and fretted about soaring national debt.

“People are looking for the solution but don’t yet have the question formulated,” Arif Naqvi, chief executive officer of Abraaj Capital Ltd., which manages $7.5 billion, said.

The need for action wasn’t in debate. Away from the slopes, U.S. stocks capped their worst ever January, the International Monetary Fund forecast the weakest global growth in 60 years and companies from Starbucks Corp. to Caterpillar Inc. cut jobs.

Deepening Recession

That led many attendees to predict they’ll still be in a funk when they return in 2010.

“We’re in a multi-multi year problem,” Howard Lutnick, chief executive officer of Cantor Fitzgerald LP., said. “We’ve weathered horrible times before. That’s what lies ahead of us now.”

Delegates also took turns bashing America’s policies and its role in the world.

Chinese Premier Wen Jiabao and Putin cited the U.S. for leading the world into recession in back-to-back speeches on the opening day.

“Just a year ago, American delegates speaking from this rostrum emphasized the U.S. economy’s fundamental stability and its cloudless prospects,” Putin said.

To cap it off, Putin dismissed a query from audience member Michael Dell, head of personal-computer maker Dell Inc., about what the technology community could do to assist Russia.

“We don’t need any help. We are not invalids,” Putin said.

Balanced Tone?

The spats gave this year’s conference a more balanced tone, said Bahraini banker Khalid Abdulla-Janahi, who remembers then- Vice President Dick Cheney “hammering the Russians, the Iranians and many others” during his 2004 visit.

“This time, it was a two-way street,” said the chairman of Ithmaar Bank BSC. “We heard Putin hammering the West and Erdogan standing up to Peres. That’s how it should be.”

Those who made it to the five-day Alpine retreat insisted that they weren’t wasting their time or their money --and they really didn’t mind the muted tone of the event’s party circuit.

“People are conscious about throwing parties or even smiling this year,” said Martin Sorrell, chief executive of WPP Group Plc. “It’s become a little too big, but it’s never been more relevant.”

China falls into budget deficit as spending balloons

China's attempts to spend its way out of economic depression led to a fiscal deficit of 111bn yuan (£12bn) last year.

By Malcolm Moore in Shanghai
Last Updated: 3:03PM GMT 02 Feb 2009

China falls into budget deficit as spending balloons

Despite a near 20pc rise in tax revenues and a record surplus of 1.19 trillion yuan (£128bn) in the first six months of the year, the dramatic scale of government spending in November and December was enough to plunge the entire year into deficit.

The figures are the first indication of how quickly and forcefully China reacted to the economic crisis after it announced a fiscal stimulus package of 4 trillion yuan in November to build new roads, railways, schools and hospitals.

Government spending in December surged to 1.66 trillion yuan, more than triple the previous month's total and 31pc higher compared to the same month last year.

The news came as Wen Jiabao, the Chinese prime minister, said that he was mulling over another fiscal stimulus package. "We may take further new, timely and decisive measures. All these measures have to be taken pre-emptively, before an economic retreat," he told the Financial Times.

Although Mr Wen did not mention any concrete details, it is widely believed that the Chinese government wants to put together a social benefits package, in order to encourage people to up their spending and reduce their saving.

There are already some signs that consumers are reacting positively to government propaganda urging them to open their wallets and "buy Chinese" in order to keep the economy going. Retail sales rose by almost 14pc during the Chinese New Year holidays, compared to last year.

The State Council, China's equivalent of a ministerial cabinet, has also promised to help farmers weather the downturn by increasing subsidies and raising the minimum purchase price for grain. It also said it would boost agricultural loans, and start to stockpile grain, cotton, cooking oils and pork.

Stephen Green, an economist at Standard Chartered bank in Shanghai, said the Chinese government has enough money to keep spending. "The central government has been running a fairly conservative fiscal policy in recent years, and there is money in the bank. Central government debt was 18pc of GDP at the end of 2008, a low level," he said.

He has predicted that this year's fiscal deficit will reach 2.7pc of GDP as China continues to spend its way out of trouble.

Beijing has also already commanded commercial banks to increase their lending and to loosen credit controls. Reports suggest that commercial banks have been ordered to make sure that 1 trillion yuan of credit is available for projects before the end of February. The banks are also likely to be forced to pay for a variety of local government projects, despite the risk of default.

A fall-off in tax revenues during the third quarter also contributed to the budget shortfall, and there are anecdotal reports that Chinese tax offices have been commanded to increase their haul and step up their anti-evasion measures.

More evidence emerged of China's slowdown as manufacturing figures showed a contraction for the sixth month in a row in January. The CLSA China Purchasing Managers Index rose to a seasonally adjusted 42.2 from 41.2 in December. A reading below 50 reflects a contraction.

Veneroso: Japan on the Edge of the Abyss

A reader chided me for not making note of the truly dreadful factory output figures released last Thursday, which showed a fall of 9.6%.

I have to confess that I have fallen into "Japan bad news" syndrome, in that I expect bad news out of Japan and therefore did not focus enough on the details. And while I do not aspire to covering every financial news story (that's what the MSM is for), the latest figures paint a grim picture, even by our new, desensitized standards.

It wasn't simply that December was truly awful, but it came on top of a nearly-as-bad November. From Bloomberg:

Japanese manufacturers cut production an unprecedented 9.6 percent last month, deepening a recession that’s expected to be the worst in the postwar era.

The drop eclipsed the previous record of 8.5 percent decline set in November, the Trade Ministry said today in Tokyo. Economists predicted a month-on-month decrease of 8.9 percent....

The International Monetary Fund said this week that Japan’s gross domestic product will shrink 2.6 percent this year, the bleakest projection for any Group of Seven economy except the U.K. That contraction would be Japan’s worst since World War II.

Yes, the Baltic Dry Index, which some see as a proxy for international trade, picked up a bit from its near-death level in January, but that may be due to Chinese New Year-related spending.

A hedge fund correspondent sent Frank Veneroso"s ;latest piece, "The Yen: Will The Traders Push The Land Of The Rising Sun Off The Face Of The Earth?" which gives a sense of how bad things could get. Some excerpts:

1)The Japanese industrial production data and METI forecast was bad beyond all imagining. Industrial production might fall by 1/3 in the 12 months ending in January. It could fall in a mere four months between November and February by more than half the U.S. Great Depression decline which took almost four years.

2) Nothing like this has ever happened to a major industrial nation to my knowledge – not even during the 1929 – 1933 Great Contraction.

3) The trade weighted yen is by far the strongest currency in the world. Japan is losing competitiveness fast. Given the lags in trade matters will get worse.

4) The insane trader community continues to push the yen up as a safe haven. It is all so detached from reality I suppose they could take it higher.

Yves here. I only get the privilege of reading Veneroso now and again, but I cannot recall him taking a tone remotely like what follows:

I have been writing about an Asian black hole for almost two months now. I have been crying from the rooftops about an emerging depression in Japan. It has been as though a neutron bomb had gone off in the world. There was no one who seemed to notice, no one who seemed to listen.

Every week it gets worse and worse and worse. Today it was Japan....

THERE HAS NEVER BEEN DATA THIS BAD FOR ANY MAJOR ECONOMY – EVEN IN THE GREAT DEPRESSION. December industrial production came in down 9.6%, worse than the METI forecast. It is now down almost 21% year over year. METI forecasts a further 4.7% decline in February. The inventory to production ratio soared again. Maybe METI will be correct.

If it is, Japan industrial production will have fallen 28% (non annualized) in four months. It will have fallen by a third in about a year. Nothing in the history of major nations compares. A 28% decline in four months would be more than half of the entire decline in U.S. industrial production over the 3 years and nine months of the U.S. Great Depression.

It would be a greater decline in four months than in any 12 month period in the Great Depression in the U.S. We are literally looking at the unimaginable. (I am attaching the U.S. industrial production index from the Great Depression for comparison).

IT’S A DEPRESSION IN JAPAN – ALREADY – PURE AND SIMPLE.

Veneroso later turns to how markets are making matters far worse by pushing the yen to an unwarranted high level:

Financial markets have only one rationale in economic theory: to sift through all of the fundamental information that has a bearing on prospective returns to investments and thereby establish the set of “right” prices that will lead to an optimal allocation of real resources. Because of uncertainty and imperfect information, an optimum allocation will never be reached, but a second best allocation can. There is no other “social” rationale for financial markets.

When financial markets become nothing other than a casino, as they had during the bubble period, and market participants flee fundamentals for the witchcraft of technical analysis and other divinings of market dynamics, market participants will send prices flying about in ways that have nothing to do with prospective returns to real investments. The result will be a serious misallocation of real resources.

When bubblized markets go from a mere speculative casino to a casino in which pivotal players are driven only by the pursuit of short-run fee income by hook or by crook, you can get a more willful proliferation of “false” prices and an even worse misallocation of resources.

This is what has happened over the last ten years. The result is what economic theory says it should be: today’s global financial, economic, and social catastrophe. The ruling maxim in such a regime seems to be that market participants will push prices to the point where they do the maximum financial, economic and social damage. I believe that, despite the massive losses to market participants that such behavior has now brought them, their behavior has not changed. Half a generation is enough to breed a cohort among market participants that knows of no other way. This cohort has been hurt and has had its wings clipped, but the markets have become commensurately less liquid. This cohort still runs the show.

Let us now apply this to the Japanese yen. According to the most recent economic data the land of the rising sun apparently risks falling off the face of the earth. Nonetheless, the Japanese yen soars. We hear the ludicrous mantra from all the investment banks and all of their speculator clients that the yen is a safe haven amidst the global chaos.

To my mind the real reason why the yen soars is because it soars. Except for a brief interlude in the mid 1990s the Japanese yen has been bounded on the upside by a ROUND NUMBER – 100 YEN TO THE DOLLAR. It bumped against the ceiling time and again. In recent months the unwinding of massive yen financed carry trades caused a powerful, though transitory, impetus on the part of yen debtors to panic purchase yen. This impetus broke the yen through its magic barrier of 100. Since everyone now ignores fundamentals and only looks at the witchcraft of charts and technical tools they now all have the next technical objective of 79 yen to the dollar on the brain. That was the spike high in the yen in that brief mid 1990s foray above the great ROUND NUMBER of 100. In my judgment it is this chart objective on the brain that explains yen strength today now that most of the panic buying by yen carry traders has abated.

Yves here. Veneroso does omit a couple of factor: first, that Japanese banks, unlike their US, UK, and Euro counterparts, have almost no exposure to the Anglo-Saxon debt binge. But they have their own issues. Japanese banks still have significant holdings of industrial companies. Under Basel rules, they can count 50% of market value as equity. Japanese stocks and the yen tend to move inversely, and the yen at current levels or higher has pushed the Nikkei to levels that make bank capital look less than solid. And now that the industrial side of the economy is falling off a cliff, the Nikkei is unlikely to soon even if the yen were to fall a fair bit.

Second, with Japan at tantamount to zero rates, its currency is not vulnerable to deprecation due to short-term interest rate cuts, which in theory makes it appealing. Back to his piece:

The yen is strengthening massively against currencies all over. On a trade weighted basis, it is by far the strongest currency on the planet. There are long lags between changes in currencies, exchange rates and trade. The recent take off in the yen is not yet fully reflected in Japanese exports. The lags are too long. The weakness we are seeing in Japanese exports today is in large part derived from aggregate demand weakness from its trading partners. It is the result of an earlier appreciation in the yen for perhaps 120 yen to the dollar to 110 to the dollar or 100 to the dollar. And perhaps, most importantly, it is the result of a secular trend in which its lower wage neighbors in Asia are making inroads – big inroads – into the global markets which it has traditionally dominated as an exporter.

When the long lags between the yen exchange rate change and trade and industrial production fully run their course the land of the rising sun may fall off the face of the earth. And with it will fall all the market participants who refuse to look at fundamentals and chase chart witchcraft and ephemeral market dynamics who have been the big bulls engineering that yen exchange rate that will maximally undermine the markets, economy, and social fabric of Japan.

It's a little early in the week for apocalyptic forecasts. One can only hope Veneroso is wrong, but it seems likely that the (considerable) damage of an overly high yen is already done.