from the hip

The international credit crisis is bad news, of course. And bad for a lot of people. Still, there are some amusing things taking place as well. Like the story about the HUGE bank robbery that took place on Monday in the US, in Washington DC. Quite possibly the biggest bank robbery ever!!

When I first read the story of exactly how the US injected 250 billion dollars into the biggest American banks, I was stunned. Then, when I reread the story I started to laugh. I found it hilarious! What a move by the government. From one perspective a much needed infusion of capital, yet from another a highway robbery!

So here is the story, simply to good not to be distributed, courtesy of The New York Times:

Drama Behind a $250 Billion Banking Deal

The chief executives of the nine largest banks in the United States trooped into a gilded conference room at the Treasury Department at 3 p.m. Monday. To their astonishment, they were each handed a one-page document that said they agreed to sell shares to the government, then Treasury Secretary Henry M. Paulson Jr. said they must sign it before they left.

The chairman of JPMorgan Chase, Jamie Dimon, was receptive, saying he thought the deal looked pretty good once he ran the numbers through his head. The chairman of Wells Fargo, Richard M. Kovacevich, protested strongly that, unlike his New York rivals, his bank was not in trouble because of investments in exotic mortgages, and did not need a bailout, according to people briefed on the meeting.

But by 6:30, all nine chief executives had signed — setting in motion the largest government intervention in the American banking system since the Depression and retreating from the rescue plan Mr. Paulson had fought so hard to get through Congress only two weeks earlier.

What happened during those three and a half hours is a story of high drama and brief conflict, followed by acquiescence by the bankers, who felt they had little choice but to go along with the Treasury plan to inject $250 billion of capital into thousands of banks — starting with theirs.

What a story! Has anything like this ever happened before? This must be the biggest tale in the modern history of banking!

The international financial crisis has lead to a spur of initiatives world wide. And now we have had the US rescue plan, with 700 billion USD. In an unprecedented move, the German government has unveiled a €500 billion ($679 billion) rescue plan to shore up the banking system after Sunday’s emergency summit of euro zones nations, where leaders agreed to guarantee new bank debt and inject capital to unfreeze money markets and restore confidence in the financial system. Der Spiegel reports:

The German Finance Ministry said Berlin’s plan includes a €400 billion financial market stabilization fund to guarantee loans and €80 billion to recapitalize the banking sector through the government taking stakes in banks.

An additional sum of €20 billion is also being set aside as a provision to cover losses, according to a statement from the Finance Ministry.

“We’re taking rigorous action to ensure that what we have experienced doesn’t get repeated,” Chancellor Angela Merkel told a news conference.

This is, of course, great news. The German packet is alone almost as large as the US packet. And that begs the question: Is the US packet big enough?

See also:

• New York Times: U.S. Investing $250 Billion in Banks
• Times: President Bush poised to follow UK with $250bn seizure of bank stakes
• New York Times: Stock Slump Imperils Putin’s Effort to Pump Up Russian Wealth, and His Legacy

I started writing about the credit crisis in the US and the possible international consequences of that crisis a long time ago. But writing about it gave me a strange feeling. Obviously I was writing about something that interested just a very few. And, equally clear was the feeling that I was writing about something nobody really wanted to hear about. Also, I strongly felt back then, something which major actors in the financial world as well as governments and central banks were more or less in denial about.

I am not happy to have been right. I am not happy that this crisis so far has turned out to be every bit as serious as I and a relatively small number of other people wrote back then. On the contrary, it is sad. Of course.

Today I feel that perhaps it is that unwillingness to see, to listen, to take the right measures at the right time, that has turned what was once a credit crisis in the US, originating in flawed valuation of the so called sub-prime mortgages, into the wild international beast we today speak of as the international financial crisis. Today governments all over the world fight against this crisis. And we have seen, I should think, that the crisis is not due to the price of oil, and that it cannot be solved by interest rate cuts. And a large number of financial institutions, from Lehmann to the Royal Bank of Scotland, have fallen victim to the crisis. At first there was no response. Then there was too little too late, as the Dainish Bank, for instance, noted. And now it is pure panic.

But now the fight is very much an uphill battle. Much time has been lost. And in this case lost time translates into lost confidence. That confidence must, of course, be restored. But it will take time. And even when the confidence in the international financial system has been restored, the battle will not have been won. There will also be serious shake outs in many sectors of the economy, will large companies failing and new winners emerging. And the global recession we are facing will not be over until consumers start increasing their spending again.

I fear they will not do so for quite some time.

See also:

• Financial Times: The week that panic stalked the markets
• Wall Street Journal: EU Writes Menu of Options
• Financial Times: UK to inject £39bn into banks
• Politiken: IMF frygter finansiel nedsmeltning
• Politiken: Eurolande klar med finansiel redningsplan
• Times: Royal Bank of Scotland under state control
• Guardian: Europe follows Brown plan for survival as EU bank bail-out plan is agreed
• Dagbladet: Europeiske land vil samkjøre krisepakker

While the economic downswing is still making itself felt in the US, it is now also hitting several European countries hard. And inflation is soaring, and hit a record high of 4.1 percent last month.

“There’s no obvious trigger for strong economic growth in Europe until the end of 2009,” says David Owen, chief European economist at Dresdner Kleinwort in London. “Massive [financial] imbalances need to be worked out, and the corporate sectors in many countries remain in a substantial deficit.”

Consumer confidence for the euro area has fallen to negative 29.7, the lowest it has been since 1993. And the news about the plunge in factory orders in Germany, led to the following comment, reported in the New York Times:

“It now looks likely that the euro zone will be the first major economy to fall into recession,” Jonathan Loynes, the chief European economist for Capital Economics, wrote after the report of sagging orders in Germany.

Great Britain

Royal Bank of Scotland, Britain’s second-largest bank, recently posted its first loss in 40 years after taking a £5.9bn hit from the credit crunch. And Barclays, the third-biggest bank, took a fresh £2.8bn write-down. Also, the price of houses are dropping rapidly, according to Guardian

the Halifax said house prices last month were 11% down on a year earlier – the first double-digit decline since its monthly healthcheck of the market was first published 25 years ago.

House prices back to 2006 and still falling, says Times. And new housing orders are down 33%. And, of course, home repossessions surge.

Business groups and City analysts warned that deep and rapid cuts in the cost of borrowing would be needed next year to pull Britain out of its first recession in more than 15 years. House prices are falling more rapidly than they were in the property crash of the late 1980s and early 1990s

It would seem a possible recovery in Britain will not be aided by increased consumer spending in the short term!

Recession in Germany?

Spiegel online writes that the German economy may have shrunk in the second quarter, according to early reports, and that the outlook for industrial production isn’t lively. Germany could slide into recession, and the German economy may have shrunk by around one percent. They also note that:

German factory orders were down by 2.9 percent in June from May, and orders from abroad for German goods plunged by 5.1 percent. Production at German factories rose by 0.2 percent in June — less than expected

Spain in deep trouble

Portugal, Italy, Greece, and Spain all face severe challenges. In Spain, the imploding domestic housing market has pushed the unemployment rate to 10.7 percent. The number of bankruptcies in the building sector is exploding, and one third of the job losses stems from the construction sector. As well, the housing market is stalling. The inflation is about 5 per cent.

The US

The credit cruch is still being felt, and so is the reversal of the wealth effect and high oil prices. In addition to bad news from the banking sector, Fannie Mae, Freddie Mac, Indy Mac, and so, in the latest sign of the deepening troubles, G.M. recently reported a second-quarter loss of $15.5 billionfollowing a loss of $8.7 billion reported earlier by Ford. Car sales are dropping, especially sales of American cars.

Guardian notes that:

The US mortgage finance empire Freddie Mac yesterday predicted the worst housing slump since the Great Depression as it set aside $2.5bn (£1.28bn) to cover credit liabilities caused by delinquent loans and foreclosures.

And in New York Times, Peter S. Goodman recently wrote (August 1) that “More Arrows Seen Pointing to a Recession”.

Overall

Pretty gloomy still. The most positive piece of news is the slight drop in oil prices. But still serious signals of a slowdown of growth and possibly recession both in Europe and the US.

A new study from Harvard University lends considerable support to what I have previously written here about the crisis in the US housing market. The study predicts that

housing woes will continue as the economy wavers from the sharp drop in home building, credit and stock market turmoil, and a slowdown in consumer spending.

The study also adresses the negative wealth effects of the current situation in the housing market:

“Further price declines will not only increase the probability that mortgage defaults end in foreclosure, but also put a tighter squeeze on consumer spending,” the report stated.

As well, the report states that if the economy plunges into a severe recession, housing demand could fall even further. Many factors seem to still point in this direction. There are a number of negative indicators:

American Express experiences late card payments increasing

House prices dropping

Consumer confidence still dropping

The oil price is still rising

And so on and so forth. At the same time, inflation is on the rise, and while the Fed now is expressing strong concerns about this, they have still not really adressed it. My sense is that they will soon have to.

The American airline industry is in trouble. They were already in it, when the oil prices started to rise. And then the rising costs of fuel just made it worse. And since increasing fuel prices coincided with the economic downswing in the US – which in itself meant less demand for travel – things got a lot worse.

But all the principal actors – all the airlines – still work on the assumption that they all have a future in the skies. I doubt if that is the case, but still, that is – naturally – their working assumption.

So now they seem to be in a state of panic. Most of them, at least. And so they are looking for ways to save money, big and small, as well as ways of increasing revenue. Of course.

Panic sometimes results in great ideas. There is nothing like need to make people think and organizations act. However, it is rarely the case that all ideas born of need are great ideas. And this is definitely not the case for the new fees for checking luggage that several of the hardest hit airlines are now introducing.

That, to me, is a ridiculous idea. The reason the airlines introduce it, is that not a single one of them have the guts to raise prices enough to make their operations profitable. And the reason they feel they can’t, of course, is that there is excess capacity. Which means that they fear they will lose passengers if they increase prices. Then the rational, and perhaps also the only viable long-term strategy, is to reduce capacity.

But the airlines are afraid to do that too, because they’re not sure how long the price of fuel is going to stay high, nor are they sure how long the economic downturn in the US is going to last. So they tell themselves that they are in for the long haul, and that it is important to position the companies for the next boom.

However, doing stupid things and making customers even angrier is rarely a great positioning strategy. And regardless of 15 bucks here and there for suitcases (which it will cost the airlines 10 bucks to organize, administer, and collect), as well as create chaos inside the planes, the fact remains that the US airline industry has far too many companies and far too much capacity. And, of course, most customers are quite capable of adding 15 bucks times two to the price of a round trip ticket!

The US airline industry is going to crash. And 15 dollars will not cushion the fall. Rather the opposite.

Every week I receive several offers for American credit cards. And the offers are basically so wild they are completely silly. Mostly I am pre-approved, whatever that means. Now, I am lucky – since I am not an American I don’t have to use any of them. And I don’t.

All of them, of course, have zero interest on something or other and/or have no annual fee. So far all is well. But then the craziness starts.

Wild terms

Stuff like cash-APR 20.9%-26.9%. What? And 3% of the US dollar amount on transactions that are made abroad. Why? Are they nuts? I buy for 2000, they want 60 bucks for doing exactly what?

And then, of course, a so called “finance charge”, up and above the interest rate charged, of 3-5% – depending on the offer – for cash advances. WHAT? So, I take out 1000 dollars in cash, and the buggers want 50 for doing exactly what? Having a machine count bills? Come on!

What to do?

So, on one level my conclusion is: American credit cards are all scams – don’t use them! On another level – for Christ’s sake don’t use them abroad – use cash or travelers cheques!

Efficiency in the credit industry

But then – and this is far more serious: How can the US and Americans tolerate this? An efficient banking and credit industry reduces transaction costs across the board – improves the efficiency for every sector in the economy!

My thinking is that electronic payments are much more efficient than other types. So America must want 99.99% of payments to be electronic. But how can you persuade people to go electronic when the banks and the credit card industry make a scam out it? Well, I don’t think you can.

But other countries have achieved that. And those countries are competitors of the US in the world market. So as long as the US doesn’t sharpen it’s act and get efficient, the competitors have a competitive edge.

Regulation needed

And as far as making consumers and businesses go electronic is concerned: It’s easy to achieve! Just takes some federal regulation. Since the costs of electronic payments, ATM cash advances, and so on, are very close to 0, all the regulators need to do it to impose some low maximum rates.

Say 1 US $ max for cash advances, 2 max if abroad, max interest rate 10% above the Fed’s rate, no charges for over-limit (they can be almost eliminated with modern online technology), but instead allow credit providers to terminate the contract in cases of over the limit. All transfers to the credit card account to be debited within 12 hours.

Does this sound outlandish? Well, it is. I have terms like this on my cards. I can’t thank my bank for it – it’s not because they have chosen to give me terms like this. I have these terms because they have been forced to. But they have no problem complying to them. And they still make excellent money.

See also: Plastic Card Tricks (NYT)
               The World’s Worst Credit Card (it is American, of course!)
               FTC Crack down

The high oil prices may well be with us for a long time to come, if senior analyst Gioavanni Serio in Goldman Sachs is right. In an energy seminar in Oslo he told participants that the oil industry moves in 20-year cycles.

The world is now in a period of sky-high oil prices that will last a long time—probably until 2020, according to the world’s largest investment bank.

The price for American raw oil rose to a record-high USD 112 per barrel this week after new figures revealed a surprising decrease in storage the week before. Brent oil from the North Sea also rose to new highs, selling for USD 109 per barrel.

“In the long-term, oil prices reflect marginal costs to the oil industry,” said Serio at a yearly energy seminar held by Wilhelmsen at Lysaker outside of Oslo. “The oil price and marginal costs stayed low in the 1990s. Now that it has become far more expensive for the oil producers to retrieve oil, the price is going to rise correspondingly,” he predicted.

The Goldman analyst does not think oil demand will increase significantly but he pointed to “bottlenecks everywhere”. He said: “Oil companies are lacking professionals and rig rates have exploded from around USD 100,000 per day in 2002 to USD 500,000 per day this year.”

However, not everyone shares Goldman Sachs’ bullish predictions. Italian oil giant ENI’s CEO Paolo Scaroni said last week he believes oil prices will fall as a result of increased production.

“We expect the oil price to fall to USD 50-60 per barrel, a price that will provide for global growth,” said Scaroni in an interview on Italian TV.

I am frequently surprised by the ability of American media to explain away or minimize the role of domestic factors in the current recession in the US. Washington Post provide the most recent example of this kind of foolishness. Today it featured the following headline:

Exports Not Hurt by Euro’s Strength, Official Says

BRUSSELS, April 15 — Most European exporters are not yet feeling the pain of the strong euro, a European Union official said Tuesday — even as aircraft maker Airbus, which sells its planes in U.S. dollars, called the level “unbearable.”

Now, if the euro was strong, this would be ok. However, if it is the dollar that is weak, then businesses in the EU don’t really have any big problems. Then it is only sales in the US that are affected.

From a business point of view it matters a lot whether it is the dollar that is weak or the euro that is strong – it is only for trade between those two areas that it does not matter which is what. But for all other trade – and an increasing proportion of world trade falls in that category – it matters.

And really, the Euro has strengthened somewhat versus a number of currencies, but the US dollar has weakened by 30-40% against virtually all currencies that count. Therefore it is much more appropriate and correct to speak of a weak dollar than a strong euro!

Competitively speaking, that means raw materials and goods that are imported have become comparatively cheaper for the EU and other countries, while they have become comparatively more expensive for the US.

Thus, the low interest rates in the US and the recession feeds back on the competitive situation of the US in the world economy.

American media continue to focus on the rising price of oil, and how they drive inflation and increase energy costs.

While this is true, it is only true in an indirect sense. It’s not the oil that is extremely expensive – it was much more expensive in 1980, if measured in other currencies – it is the dollar that is weak.

Here’s that chart for the USD versus the Euro for the last 12 months:

Here is the Brent spot price for the same period:

Adjust oil prices for the dollar slip, and there is still a price increase, but it is actually not all that huge.

The dollar is weak because the US interest rate is low – actually negative when adjusted for inflation – and because the US banking system and credit markets are shaky. And the stock marked is in for a rough ride, whether Americans want to believe it or not. So investors, both inside and outside the US, go into oil and commodities.

This, of course, means the causes for the high oil price to a large extent is found in policy failures within the US. There really isn’t all that much cause to blame the Arabs or the rest of the world, certainly not for the current recession in the US, and only to a limited extent for the current oil prices.