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Monday, 3 November 2008
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I like to run a wine bar with performers like her and crowd like this.
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America must lead a rescue of emerging economies
George Soros Oct 28 2008
The global financial system as it is currently constituted is characterised by a pernicious asymmetry. The financial authorities of the developed countries are in charge and they will do whatever it takes to prevent the system from collapsing. They are, however, less concerned with the fate of countries at the periphery. As a result, the system provides less stability and protection for those countries than for the countries at the centre. This asymmetry - which is enshrined in the veto rights the US enjoys in the International Monetary Fund, explains why the US has been able to run up an ever-increasing current account deficit over the past quarter of a century. The so-called Washington consensus imposed strict market discipline on other countries but the US was exempt from it.
The emerging market crisis of 1997 devastated the periphery such as Indonesia, Brazil, Korea and Russia but left America unscathed. Subsequently, many peripheral countries followed sound macroeconomic policies, once again attracting large capital inflows, and in recent years have enjoyed fast economic growth. Then came the financial crisis, which originated in the US. Until recently peripheral countries such as Brazil remained largely unaffected; indeed, they benefited from the commodity boom. But after the bankruptcy of Lehman Brothers (NYSE:LEH) , the financial system suffered a temporary cardiac arrest and the authorities in the US and Europe resorted to desperate measures to resuscitate it. In effect, they resolved that no other big financial institution would be allowed to default and also they guaranteed depositors against losses. This had unintended adverse consequences for the peripheral countries and the authorities have been caught unawares. In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic.
The IMF is discussing a new credit facility for countries at the periphery, in contrast to the conditional credit lines that were never used because the conditions attached to them were too onerous. The new facility would carry no conditions and no stigma for countries following sound macroeconomic policies. In addition, the IMF stands ready to extend conditional credit to countries that are less well qualified. Iceland and Ukraine have already signed and Hungary is next.
The approach is right but it will be too little, too late. The maximum that could be drawn under this facility would be five times a country's quota. In the case of Brazil, for example, this would amount to $15bn, a pittance when compared with Brazil's own foreign currency reserves of more than $200bn. A much larger and more flexible package is needed to reassure markets. The central banks at the centre should open large swap lines with the central banks of qualifying countries at the periphery and countries with large foreign currency reserves, notably China, Japan, Abu Dhabi and Saudi Arabia, ought to put up a supplemental fund that could be dispersed more flexibly. There is also an urgent need for short-term and longer-term credit to enable countries with sound fiscal positions to engage in Keynesian counter-cyclical policies. Only by stimulating domestic demand can the spectre of a world-wide depression be removed.
Unfortunately the authorities are always lagging behind events; that is why the financial crisis is spinning out of control. Already it has enveloped the Gulf countries, and Saudi Arabia and Abu Dhabi may be too concerned with their own region to contribute to a global fund. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.
President George W. Bush has convened a G20 summit for November 15 but there is not much point in holding such a meeting unless the US is serious about supporting a global rescue effort. The US must show the way in protecting the peripheral countries against a storm that has originated in the US, if it does not want to forfeit its claim to the leadership position. Even if Mr Bush does not share this point of view, it is to be hoped the next president will - but by then the damage will be much greater.
The writer is chairman of Soros Fund Management and author of The New Paradigm for Financial Markets
Rio Chief Albanese Says Slowdown in China Is Gathering Pace
By Brett Foley
Nov. 3 (Bloomberg) -- Rio Tinto Group Chief Executive Officer Tom Albanese said the economic slowdown in China, the world's largest user of metals, is quickening and demand won't rebound until 2009.
``It is decelerating more in the fourth quarter than we saw in the third quarter,'' Albanese said yesterday in an interview at the company's ilmenite mine in Madagascar. ``That is going to lead to a deferred pickup in cumulative demand for most of the things we produce during the course of 2009.''
Rio is among mining companies reviewing investment plans after commodity prices plunged amid signs of a global economic slowdown. The London-based company, fending off a $76.8 billion hostile bid from BHP Billiton Ltd., is planning to spend more than $9 billion on new mines and expansions next year.
``We want to tailor our expected delivery of those projects with when we see demand picking up,'' Albanese said. ``We'll prioritize spending towards the most robust projects.''
Projects that are almost complete will start production while those at an ``early stage'' and without financial commitments ``will have to be given some latitude on the timing,'' he said.
Copper, which accounted for 22 percent of Rio's sales in the first half, has fallen 44 percent in the past two months while aluminum has declined 24 percent.
Chinese Contraction
China accounted for 17 percent of Rio's sales in the first half. It's economy grew at the slowest pace in five years in the three months through September, the fifth straight quarter that the expansion has cooled. The country's Purchasing Managers' Index, published Nov. 1 by the China Federation of Logistics and Purchasing, showed a contraction in September.
Sliding aluminum prices have led to about 1.6 million metric tons of global smelting capacity being idled, and another 700,000 tons may follow, Albanese said. ``Prices at these levels are having definitive supply effects,'' he said.
Rio is reviewing the costs of its joint venture with Saudi Arabia's state-owned mining company Ma'aden to build a $10.5 billion aluminum smelter complex.
``We have rapid capital and construction costs escalation,'' Albanese said. ``This is an opportunity to test those assumptions of escalation and see if we can start bringing down the cost of these new projects.''
Aluminum Cuts
Rio, the world's second-largest producer of aluminum and iron-ore, rejected Melbourne-based BHP's sweetened, all-share offer on Feb. 6, saying it undervalued the company and its growth prospects. The offer is awaiting approval from European Union regulators, who last month told lawyers for BHP that the Australian company's bid may break antitrust rules, two people close to the case said.
Rio said Oct. 15 it was reviewing its spending timetable and project costs. The company has already idled sections of its highest-cost aluminum plants. Rio's development plans include the $3 billion Oyu Tolgoi copper and gold mine in Mongolia, the $6 billion Simandou iron ore mine in Guinea and a $1.5 billion nickel project in Sulawesi, Indonesia.
The ilmenite produced at Rio's $1 billion QIT Madagascar Minerals mine in the island's Fort-Dauphin region is used to make paint and toothpaste. The company said in February it may double output at the project from a planned 750,000 tons a year.
WASHINGTON - With defaults on credit card debt spiraling amid a global financial downturn, banks already reeling from the mortgage crisis are losing billions more from unpaid credit card bills.
Big banks have formed an unusual alliance with consumer advocates to urge the government to allow huge portions of credit card debt to be forgiven, a turnabout from recent years when the banking industry lobbied strenuously to make it harder for consumers to erase their credit card debts in bankruptcy.
The new pilot program could involve as many as 50,000 people. On an individual basis, the amount of debt to be forgiven would rise according to the severity of the borrower's financial situation, up to 40 percent.
"There's obviously a financial benefit to the financial institutions to step up to the plate right now," said Susan Keating, president and chief executive of the National Foundation for Credit Counseling, which has 108 member organizations around the country. "We absolutely support the proposal."
Amid rising job losses, consumers - even those with strong credit records - have been defaulting at high levels on their credit cards. Banks already battered by the mortgage and credit crises are bleeding tens of billions from the losses.
The proposal pitched to federal regulators by the Financial Services Roundtable, which represents more than 100 big banks and other financial companies, and the Consumer Federation of America, would allow lenders to reduce by as much as 40 percent the amount of credit card debt owed by deeply indebted consumers in a pilot program.
Nearly all the biggest credit card banks have agreed to such a program, in which lenders would forgive as much as 40 percent of the amount consumers owe, allowing them to pay back the remainder over time.
Current government rules don't allow lenders to offer repayment plans that reduce the amount owed and borrowers to repay the balance over several years.
In cases where the principal can be reduced, borrowers normally are required to pay off the remainder over months.
Leaders tackle economic brush fires around the globe
By David Jolly November 2, 2008
Prime Minister Gordon Brown of Britain on Sunday urged Gulf nations to help bolster the International Monetary Fund's bailout capacity, as leaders around the world spent another weekend trying to extinguish the brush fires of the economic crisis.
Brown has called on China and Middle Eastern countries to take an expanded role in financing the IMF's activities as the crisis has deepened.
"The Saudis, I think, will contribute so we can have a bigger fund worldwide," Reuters quoted Brown as telling reporters in the Saudi capital, Riyadh, after weekend meetings with King Abdullah and Saudi businessmen. "The oil producing countries, who have generated over $1 trillion from higher oil prices in recent years, are in a position to contribute."
The IMF has committed $30 billion in the past few weeks in bailout packages for Hungary, Iceland and Ukraine. It said Wednesday that it would lend as much as $100 billion to economically healthy countries that are having trouble borrowing as a result of the turmoil in the global markets.
The fund, a 185-member organization, has more than $200 billion in resources, and can draw on additional funds from its members.
"We probably will need more resources," Dominique Strauss-Kahn, the fund's managing director, said last week. "There is no way the fund can solve the problem on its own."
Brown's call came on the type of weekend that has become common as the credit crisis intensified, with governments scrambling to bolster growth and backup troubled institutions.
In Berlin, Chancellor Angela Merkel's government was working on an economic stimulus plan for Germany that media reports said would be valued at about €50 billion, or $63.6 billion. In a podcast, Merkel said the cabinet would approve the measures Wednesday.
"We know that the international financial markets crisis will also have an impact on our economy," she said. "However, we want the impact on our economy to be limited."
She also called on banks to make use of the €500 billion fund the government has made available for troubled lenders.
In Lisbon, the authorities said they were setting up a credit line of €4 billion for Portugal's banks, and were moving to nationalize one of the smaller lenders in the country, Banco Português de Negócios.
The Associated Press quoted Portugal's finance minister, Fernando Teixeira dos Santos, as saying the bank had losses of around €700 million. "The government has taken this decision, above all, to ensure that account-holder savings are safe," Teixeira dos Santos said.
In Russia, where the benchmark Micex stock index has fallen nearly 60 percent this year, officials announced new measures to halt capital flight. Igor Shuvalov, a first deputy prime minister, told state television Sunday that the government would move to limit the sale of rubles by banks that receive government aid.
That came a day after the Russian Finance Ministry said it had injected more than $6 billion from a government fund into Vnesheconombank, or VEB, a state-run bank. VEB will use the funds to provide loans to banks and to buy stocks and bonds.
In Beijing, the Chinese prime minister, Wen Jiabao, warned in a Communist Party publication that the economic meltdown was raising the risk of social unrest, and he called for more focus on domestic spending, the China News Service reported.
Wen said the government's need to promote economic growth was beginning to override its mandate to keep inflation in check. The monetary authorities in Beijing cut interest rates Wednesday for the third time in two months, bringing the benchmark rate down to 6.66 percent from 6.93 percent.
Wen's warning followed the release Saturday of a survey of Chinese purchasing managers that showed manufacturing, a linchpin of the economy, contracted in October.
In Mumbai, the Reserve Bank of India, the central bank, said Saturday that it would "employ both conventional and unconventional measures" to respond to the crisis. The bank, which had just cut its benchmark interest rate by a full percentage point on Oct. 20, cut the rate again, by a half point, to 7.5 percent.
Major central banks including the U.S. Federal Reserve and the Bank of Japan last week cut their main interest rate targets, while the European Central Bank and Bank of England are both expected to cut rates at their policy meetings Thursday.
Brown's political fortunes, which had been flagging, have been revived by his decision to inject funds directly into British banks, a move that became a model for global action.
As a result, Brown's standings in the British polls have risen considerably, making it not impossible that he will call an election before he is required to do so in May 2010.
Brown's efforts to drum up support for the IMF during a four-day Mideast tour come less than two weeks before a Nov. 15 meeting of global leaders in Washington, at which officials will explore ways to reorder the global financial system.
Brown, who was traveling in the region with a large entourage of business leaders, was also seeking more Middle Eastern investment for the British economy. On Friday, Barclays, the British bank, said it would raise billions of dollars by selling shares to Abu Dhabi and Qatar, which could leave the two state investors with as much as 32 percent of the bank.
Deutsche Bank rejects aid Deutsche Bank reiterated Sunday that it would not ask for funds from the German government's €500 billion rescue package, a day after Chancellor Angela Merkel urged more institutions to participate, The Associated Press reported from Berlin.
Unlike many financial institutions around the world, Germany's largest bank has remained largely unscathed by the effects of the subprime crisis. On Thursday, the bank surprised analysts by reporting a profit in the third quarter.
"We have a very strong refinancing basis, so that we do not need to use the rescue package," Deutsche Bank's chief executive, Josef Ackermann, told the TV broadcaster ZDF.
Deutsche Bank has also pledged €12 billion to a separate €50 billion package to prop up the embattled commercial property lender Hypo Real Estate.
Malaysia has been affected by the fall in prices of export commodities like petroleum, palm oil and rubber. Many developing countries are hit by the end of the commodity boom resulting from the global economic crisis.
COMMODITY prices have begun to decline sharply in the past few months, at a time when the turmoil in global financial markets intensified, and as recessionary conditions took hold in many developed countries.
Malaysia is one of the countries affected. As a net oil exporter, it has been hit by the dramatic fall in the oil price from a peak of US$140 a barrel just a few months ago to the current price of just above US$60.
Even more significant has been the alarming and quick decline in the price of palm oil. Crude palm oil futures in Malaysia tumbled from a record high of RM4,500 a tonne in early March to about RM1,500 at the end of last week.
This 66% drop is causing incomes to fall correspondingly among the smallholders in Malaysia and Indonesia. According to a Financial Times report, millions of small producers in Indonesia are now struggling to survive.
The price of rubber is also coming under pressure. Last week, officials of Malaysia, Thailand and Indonesia met in Bangkok and agreed to cut rubber output by 215,000 tonnes in 2009 to boost prices, which according to Thai official had fallen from US$2 a kg a year ago to US$1.72.
The output cuts in the three countries will be through the felling of plantations, reduction of tapping and delay in starting the tapping of new trees by a year, according to a Thai official after the meeting.
The fall in commodity prices is not all bad news. Consumers benefit from lower prices, and manufacturers have lower costs. Importing countries also get reduced import bills.
But for developing countries like Malaysia which are commodity exporters, the losses far outweigh the benefits, as export earnings fall and millions of producers suffer reduced incomes.
For the past few years there has been a boom in prices of most commodities. Some analysts even predicted that there had been a structural shift in commodity trends and the boom would last many years, instead of being part of the usual boom-and-bust cycle.
Other analysts saw the super-boom as partly driven by real demand increase (especially in China) but also significantly driven by speculators. This is now proving correct.
There is a slowdown in demand, but more importantly a flight from commodity markets by speculators, due to the global financial crisis and the deepening recession.
Data from the UN Food and Agriculture Organisation show that for many food commodities, export prices peaked around June and have been declining since, with the price falls intensifying in the past two months. However, prices of most food commodities are still higher than a year ago, with some exceptions.
Meanwhile, the prices of many minerals and metals have also fallen significantly in recent weeks.
The “commodity boom” seems to be over and is being replaced by a new general commodity price slump.
The FAO Food Price Index (FFPI) dropped a further 6% in September, falling to a nine-month low of 188 points. The sharp decline in the index reflected the rapid decrease in international prices of all major food and feed commodities.
The fall in food prices overall was reflected in the decline in indices for cereals, oils and fats, meat and sugar.
After reaching a high of 278 points in June 2008, the FAO Cereal Price Index fell to 228 points in September. The FAO Oils/Fats Price Index fell to 209 points in September, or 28% below the June record.
The FAO Meat Price Index fell to 140 points in September, 4% below its peak in August. And the Dairy Price Index fell to 218 points in September, down almost 12% from August.
According to the FAO report, the fall in prices of most cereals continued in September and into the first week of October.
This was largely in response to favourable prospects for 2008 harvests, the influence of falling crude oil prices and financial turmoil in world economies.
The report gave a detailed account of the price situation in three major cereals – wheat, maize and rice.
On rice, the FAO said that expectations of record 2008 padi crops in the northern hemisphere were keeping downward pressure on export prices. The price of Thai white rice 100% B averaged US$764 per tonne in September, about 3% down from August, and fell to US$734 in the first week of October.
The drop in Thai prices over the past few months would likely have been more pronounced had it not been for the country’s official procurement programme launched in June.
Indeed, in other export markets the slide has been deeper, with price quotations over the same period down 35% in Vietnam and Pakistan and 16% in the US.
However, prices are still well above their values of September 2007 (by 130% in Thailand, 92% in the United States, 74% in Vietnam and 53% in Pakistan).
On wheat, international prices continued to decline sharply. The US wheat price averaged US$308 a tonne in September, and fell to US$264 in the first week of October, about 45% below its peak in March, and 25% down from October 2007.
Maize prices fell further towards the end of September and in early October. The US maize price averaged US$229 per tonne in September, and fell to US$184 in the first week of October, 35% below the peak in June, but still 13% above October last year.
According to the FAO, 36 countries are in need of external assistance as a result of crop failures, conflict or insecurity, natural disasters, and high domestic food prices.
FRANKFURT — Shares in Volkswagen fell by nearly half Wednesday after its main shareholder, Porsche, took steps to ease a quadrupling in the stock price that had pushed some of the world’s biggest hedge funds to the wall.
The move came as the German financial supervisor, Bafin, announced a formal investigation into gyrations of VW stock that briefly made it the most valuable company in the world a day earlier. “We need to take a closer look if there was market manipulation,” a Bafin spokeswoman, Anja Engelland, said.
Porsche said it would dump up to 5 percent of its VW shares — presumably at a great profit — “to avoid further market distortions and the resulting consequences for those involved.” Volkswagen stock, which rose to above 1,000 euros, or to about $1,284, at one point on Tuesday, plummeted on Wednesday to close at 517 euros. That is still well above its close Friday of 210 euros.
Porsche, which has engaged in a creeping takeover of Volkswagen over several years, unleashed a punishing market dynamic this week on investors who believed VW stock would lose value if Porsche took majority control.
These short-sellers, who borrow stock in the hope of buying it back later at a lower price, scrambled to buy shares of VW to cover their bets after Porsche revealed Sunday that it controlled a much larger pool of VW shares than previously disclosed, creating scarcity in the number of shares investors could buy.
Many hedge fund managers were relieved on Wednesday when the share price fell. Funds like Greenlight Capital, Glenview Capital and SAC Capital had bet that Volkswagen’s stock was overvalued back when the price was below 200. The spike in the stock put funds with big positions at risk, and some of those funds could face large margin calls from the banks this week if the stock does not continue to fall.
Porsche, whose own shares jumped Wednesday by 37 percent, flatly denied any wrongdoing. “Porsche has not been active in the market during these share price movements,” it said. “Allegations of price manipulation by Porsche are therefore without foundation whatsoever.”
The episode highlights how Porsche, the sports car manufacturer that keeps investment bankers and hedge fund managers moving at high speeds down the world’s highways, beat both at their own game.
Porsche raised its stake in Volkswagen to 42.6 percent from 35 percent, and said Sunday it had taken options that settle in cash for an additional 31.5 percent. By acquiring options to buy VW shares at a certain price, Porsche was in the position Wednesday to exercise them, and then sell at elevated prices for a colossal profit.
“Presumably they are doing this to earn money, and not to help the hedge funds,” said Jens Schattner, an auto analyst at Sal. Oppenheim in Frankfurt.
With big names and big money at stake, the spectacle has riveted Germany, with some unease but a fair dose as well of schadenfreude among many Germans.
“As opposed to previous speculative bubbles that cost a lot of small investors their money in the stock exchange casino, the chaos around VW shares overwhelmingly hits professional gamblers,” Die Tageszeitung, a left-leaning Berlin newspaper, wrote. “Sympathy does not seem appropriate.”
But with its use of financial derivatives, surprise pronouncements and calculated opacity, Porsche did appear to be acting a bit like one of the hedge funds that a German politician once famously called “locusts” that prey on unsuspecting companies. Indeed, in the 2006-7 fiscal year, Porsche engaged in a similar financial strategy that drew in vastly higher profits than the sales of its cars.
The size of Porsche’s profit on this week’s transactions is likely to remain a mystery until next year, analysts said. Stock option transactions earned Porsche 3.6 billion euros in the fiscal year that ended June 30, 2007, or 62 percent of its pretax profit. It has yet to reveal results for the 2007-8 financial year, and the current transactions will not register until its report in late 2009.
German law does not require Porsche to reveal details of the price at which it bought the cash options, or the strike price at which they can be exercised, the two main variables in the profit calculation.
Porsche’s financial strategy of securing control over Volkswagen has been the brainchild of its chief financial officer, Holger P. Härter, who sits on the larger company’s board. The Schaeffler Group, a maker of roller bearings, used a similar approach to seize control of Continental, one of the world’s largest auto parts makers, this summer.
The German Finance Ministry is now examining whether to broaden disclosure rules to include complex financial derivatives that can be used to circumvent normal disclosure rules on shareholdings.
Porsche and Schaeffler are family-controlled companies, a fact that appears to have limited the political fallout from the rough-and-tumble tactics. Porsche is often held up by German critics of American-style capitalism as a company that makes enviable profits while paying its workers a premium wage.
Ulrich Hocker, director of DSW, a German shareholder protection group, said a player like Deutsche Bank, for example, would have run into a thicket of criticism for using such tactics, being widely held and much more American in its outlook.
“If Deutsche had done this, we would have a terrible uproar,” Mr. Hocker said. “But Porsche is a family company that has the reputation of doing well for their people, and they are using that reputation to the fullest.”
By CHARLES DUHIGG and CARTER DOUGHERTY November 1, 2008
“People come up to me in the grocery store and say, ‘How did we get suckered into this?’ ” — Marc Hujik, of the Kenosha, Wis., school board
On a snowy day two years ago, the school board in Whitefish Bay, Wis., gathered to discuss a looming problem: how to plug a gaping hole in the teachers’ retirement plan.
It turned to David W. Noack, a trusted local investment banker, who proposed that the district borrow from overseas and use the money for a complex investment that offered big profits.
“Every three months you’re going to get a payment,” he promised, according to a tape of the meeting. But would it be risky? “There would need to be 15 Enrons” for the district to lose money, he said.
The board and four other nearby districts ultimately invested $200 million in the deal, most of it borrowed from an Irish bank. Without realizing it, the schools were imitating hedge funds.
Half a continent away, New York subway officials were also being wooed by bankers. Officials were told that just as home buyers had embraced adjustable-rate loans, New York could save money by borrowing at lower interest rates that changed every day.
For some of the deals, the officials were encouraged to rely on the same Irish bank as the Wisconsin schools.
During the go-go investing years, school districts, transit agencies and other government entities were quick to jump into the global economy, hoping for fast gains to cover growing pension costs and budgets without raising taxes. Deals were arranged by armies of persuasive financiers who received big paydays.
But now, hundreds of cities and government agencies are facing economic turmoil. Far from being isolated examples, the Wisconsin schools and New York’s transportation system are among the many players in a financial fiasco that has ricocheted globally.
The Wisconsin schools are on the brink of losing their money, confronting educators with possible budget cuts. Interest rates for New York’s subways are skyrocketing and contributing to budget woes that have transportation officials considering higher fares and delaying long-planned track repairs.
And the bank at the center of the saga, named Depfa, is now in trouble, threatening the stability of its parent company in Munich and forcing German officials to intervene with a multibillion-dollar bailout to stop a chain reaction that could freeze Germany’s economic system.
“I am really worried,” said Becky Velvikis, a first-grade teacher at Grewenow Elementary in Kenosha, Wis., one of the districts that invested in Mr. Noack’s deal. “If millions of dollars are gone, what happens to my retirement? Or the construction paper and pencils and supplies we need to teach?”
The trail through Wisconsin, New York and Europe illustrates how this financial crisis has moved around the world so fast, why it is so hard to tame, and why cities, schools and many other institutions will probably struggle for years.
“The local papers and radio shows call us idiots, and now when I go home, my kids ask me, ‘Dad, did you do something wrong?’ ” said Shawn Yde, the director of business services in the Whitefish Bay district. “This is something I’ll regret until the day I die.”
Selling Risk
Whitefish Bay’s school district did not intend to become a hedge fund. It and four nearby districts were just trying to finance retirement obligations that were growing as health care costs rose.
Mr. Noack, the local representative of Stifel, Nicolaus & Company, a St. Louis investment bank, had been advising Wisconsin school boards for two decades, helping them borrow for new gymnasiums and classrooms. His father had taught at an area high school for 47 years. All six of his children attended Milwaukee schools.
Mr. Noack told the Whitefish Bay board that investing in the global economy carried few risks, according to the tape.
“What’s the best investment? It’s called a collateralized debt obligation,” or a C.D.O., Mr. Noack said. He described it as a collection of bonds from 105 of the most reputable companies that would pay the school board a small return every quarter.
“We’re being very conservative,” Mr. Noack told the board, composed of lawyers, salesmen and a homemaker who lived in the affluent Milwaukee suburb.
Soon, Whitefish Bay and the four other districts borrowed $165 million from Depfa and contributed $35 million of their own money to purchase three C.D.O.’s sold by the Royal Bank of Canada, which had a relationship with Mr. Noack’s company.
But Mr. Noack’s explanation of a C.D.O. was very wrong. Mr. Noack, who through his lawyer declined to comment, had attended only a two-hour training session on C.D.O.’s, he told a friend.
The schools’ $200 million was actually used as collateral for a complicated form of insurance guaranteeing about $20 billion of corporate bonds. That investment — known as a synthetic C.D.O. — committed the boards to paying off other bondholders if corporations failed to honor their debts.
If just 6 percent of the bonds insured went bad, the Wisconsin educators could lose all their money. If none of the bonds defaulted, the schools would receive about $1.8 million a year after paying off their own debt. By comparison, the C.D.O.’s offered only a modestly better return than a $35 million investment in ultra-safe Treasury bonds, which would have paid about $1.5 million a year, with virtually no risk.
The boards, as part of their deal, received thick packets of documents.
“I’ve never read the prospectus,” said Marc Hujik, a local financial adviser and a member of the Kenosha school board who spent 13 years on Wall Street. “We had all our questions answered satisfactorily by Dave Noack, so I wasn’t worried.”
Wisconsin schools were not the only ones to jump into such complicated financial products. More than $1.2 trillion of C.D.O.’s have been sold to buyers of all kinds since 2005 — including many cities and government agencies — an increase of 270 percent from the four previous years combined, according to Thomson Reuters.
“Selling these products to municipalities was pretty widespread,” said Janet Tavakoli, a finance industry consultant in Chicago. “They tend to be less sophisticated. So bankers sell them products stuffed with junk.”
From the Wisconsin deal, the Royal Bank of Canada received promises of payments totaling about $11.2 million, according to documents. Stifel Nicolaus made about $1.2 million. Mr. Noack’s total salary was about $300,000 a year, according to someone with knowledge of his finances. And Depfa received interest on its loans.
In separate statements, the Royal Bank of Canada and Stifel Nicolaus said board members signed documents indicating they understood the investments’ risks. Both companies said they were not financial advisers to the boards but merely sold them products or services. Stifel Nicolaus said its relationship with the boards ended in 2007. Mr. Noack now works for a rival firm.
“Everyone knew New York guys were making tons of money on these kinds of deals,” said Mr. Hujik, of the school board. “It wasn’t implausible that we could make money, too.”
A Bank Goes Global
By the time Depfa financed the Wisconsin schools’ investment, it had already become an emblem of the new global economy. It was founded 86 years ago as a sleepy German lender, and for most of its history had focused on its home market.
But in 2002 a new chief executive, Gerhard Bruckermann, moved Depfa to the freewheeling financial center of Dublin to take advantage of low corporate taxes. He soon pushed the company into São Paulo, Mumbai, Warsaw, Hong Kong, Dallas, New York, Tokyo and elsewhere. Depfa became one of Europe’s most profitable banks and was famous for lavish events and large paychecks. In 2006, top executives took home the equivalent of $33 million at today’s exchange rates.
Mr. Bruckermann was a gregarious leader who joked that he hoped to make all employees into millionaires. He divided his time between a London home and a vast farm in Spain, where he grew exotic medicinal plants. And his success fueled an arrogance, former colleagues say.
Mr. Bruckermann once told a trade publication that Depfa, unlike German banks, understood how to benefit from the global economy. “With our efforts, we are like the one-eyed man who becomes king in the land of the blind,” he was quoted as saying.
Mr. Bruckermann, who left the bank earlier this year, did not respond to requests for an interview.
But as Depfa grew, other European banks began competing with the firm. So executives stretched into riskier deals — the sort that would eventually send shockwaves across Europe and the United States.
Some of Mr. Bruckermann’s employees grew concerned about deals like one struck in 2005 with the Metropolitan Transportation Authority of New York, the agency overseeing the city and suburban subways, buses and trains.
For years, municipal agencies like the M.T.A. had raised money by issuing plain-vanilla bonds with fixed interest rates. But then bankers began telling officials that there was a way to get cheaper financing.
Bankers said that cities, like home buyers, could save money with adjustable-rate loans, where the payments started low and changed over time. What they did not emphasize was that such payments could eventually skyrocket. Such borrowing — known as variable-rate bonds — also carried big fees for Wall Street.
The pitches were very successful. Municipalities issued twice as many variable-rate bonds last year as they did a decade earlier.
But variable-rate bonds had a hitch: many investors would purchase them only if a bank like Depfa was hired as a buyer of last resort, ready to acquire bonds from investors who could find no other buyers. Depfa collected fees for serving that role, but expected it would rarely have to honor such pledges.
Mr. Bruckermann’s salespeople traveled the world encouraging officials to sign up for variable-rate loans. And bureaucrats and politicians, including some in New York, jumped in.
By 2006 Depfa was the largest buyer of last resort in the world, standing behind $2.9 billion of bonds issued that year alone. It backed a $200 million bond issued by the M.T.A.
But as Depfa grew, it became more reliant on enormous short-term loans to finance its operations. Those loans cost less, and thus helped the bank achieve higher profits, but only when times were good. Indeed, some employees were worried about that debt.
But Mr. Bruckermann plowed ahead, and it paid off. In 2007, even as the global economy was softening, Mr. Bruckermann persuaded one of Germany’s biggest lenders, Hypo Real Estate, to purchase Depfa for $7.8 billion. Mr. Bruckermann’s cut was more than $150 million. He left the company to grow oranges on his Spanish estate.
The Risks Turn Bad
Last March the delicate web tying Wisconsin, Dublin and Manhattan became an anchor dragging everyone down.
Mr. Yde, the director of business services for the Whitefish Bay district, began receiving troubling messages indicating the district’s investments were declining. Worried, he started coming into his office at dawn, before the hallways of Whitefish Bay High School filled with students.
As the sun rose, Mr. Yde searched for explanations by the light of his computer screen. He Googled “C.D.O.’s.” He called bankers in London and New York. Each person referred him to someone else.
Then notices arrived saying that the bonds insured by Whitefish Bay’s C.D.O.’s were defaulting. It became increasingly likely that the district’s money would be seized to pay off other bondholders. Most, if not all, of the $200 million would probably be lost.
As other districts received similar notices, panic grew. For some boards, interest payments on borrowed money were now larger than revenue from the investments. Officials began quietly warning that they might have to dip into school funds.
“This is going to have a tremendous financial impact,” said Robert F. Kitchen, a member of the West Allis-West Milwaukee school board. Officials say some districts may have to cut courses like art and drama, curtail gym and classroom maintenance, or forgo replacing teachers who retire.
Problems were emerging elsewhere, as well.
Depfa’s executives were realizing that their loans to the Wisconsin schools were unlikely to be repaid. Additionally, bonds all over the world were declining in value, exposing the company to the possibility they would have to make good on their pledges as a buyer of last resort. And Depfa was still borrowing billions each month to cover its short-term loans. By autumn, the short-term debt of the bank and its parent company, Hypo, totaled $81 billion.
Then, in mid-September, the American investment bank Lehman Brothers went bankrupt. Short-term lending markets froze up. Ratings agencies, including Standard & Poor’s, downgraded Depfa, citing the company’s difficulties borrowing at affordable rates.
That set off a crisis in Germany, where officials worried that Depfa’s sudden need for cash would drag down its parent company and set off a chain reaction at other banks. The German government and private banks extended $64 billion in credit to Hypo to stop it from imploding.
“We will not allow the distress of one financial institution to endanger the entire system,” Angela Merkel, the German chancellor, said at the time.
That crisis spread almost immediately to the M.T.A.
The transportation authority, guided by Gary Dellaverson, a rumpled, cigarillo-smoking chief financial officer, had $3.75 billion of variable-rate debt outstanding.
About $200 million of that debt was backed by Depfa. When the bank was downgraded, investors dumped those transportation bonds, because of worries they would get stuck with them if Depfa’s problems worsened. Depfa was forced to buy $150 million of them, and bonds worth billions of dollars issued by other municipalities.
Then came the twist: Depfa’s contracts said that if it bought back bonds, the municipalities had to pay a higher-than-average interest rate. The New York transportation authority’s repayment obligation could eventually balloon by about $12 million a year on the Depfa loans alone.
On its own, that cost could be absorbed by the agency. But, as the economy declined, the M.T.A. had lost hundreds of millions because tax receipts — which finance part of its budget — were falling. And its ability to renew its variable-rate bonds at low interest rates was hurt by the trouble at Depfa and other banks. The transportation authority now faces a $900 million shortfall, according to officials. It is “fairly breathtaking,” Mr. Dellaverson told the M.T.A.’s finance committee. “This is not a tolerable long-term position for us to be in.”
In a recent interview, Mr. Dellaverson defended New York’s use of variable bonds.
“Variable-rate debt has helped M.T.A. save millions of dollars, and we’ve been conservative in issuing it,” he said. “But there are risks, which we work hard to mitigate. Usually it works. But what’s happening today is a total lack of marketplace rationality.”
In a statement, the transportation authority said that it was exploring options to reduce the cost of the Depfa-backed bonds, that its variable-rate bonds had delivered savings even during the current turmoil and that the agency had remained within its budget on debt payments this year.
However, the transportation authority has already announced it will raise subway and train fares next year because of various fiscal problems, and may be forced to shrink the work force and reduce some bus routes. Some analysts say fares will probably rise again in 2010.
The Depfa fallout doesn’t end there. Rating agencies have downgraded the bonds of more than 75 municipal agencies backed by Depfa, including in California, Connecticut, Illinois and South Dakota. Officials in Florida, Massachusetts and Montana have cut budgets because of C.D.O.’s or similar risky bets.
And Hypo, the German company that bought Depfa, last week asked the German government for financial help for the third time. Depfa has frozen much of its business, according to Wall Street bankers, and though it continues to honor its commitments, some wonder for how long.
The Wisconsin school districts have filed suit against the Royal Bank of Canada and Stifel Nicolaus alleging misrepresentations. Board members hope they will prevail and schools and retirement plans will emerge unscathed. The companies dispute the lawsuit’s claims. Mr. Noack is not named as a defendant and is cooperating with the school boards.
In Mrs. Velvikis’s classroom at Grewenow Elementary in Kenosha, students have recently completed a lesson in which each first grader contributed a vegetable to a common vat of “stone soup.” The project — based on a children’s book — teaches the benefits of working together. The schools have learned that when everyone works together, they can also all starve.
“Our funding is already so limited,” Mrs. Velvikis said. “We rely on parent donations for some supplies. You hear about all these millions of dollars that have been lost, and you think, that’s got to come out of somewhere.”
7 comments:
America must lead a rescue of emerging economies
George Soros
Oct 28 2008
The global financial system as it is currently constituted is characterised by a pernicious asymmetry. The financial authorities of the developed countries are in charge and they will do whatever it takes to prevent the system from collapsing. They are, however, less concerned with the fate of countries at the periphery. As a result, the system provides less stability and protection for those countries than for the countries at the centre. This asymmetry - which is enshrined in the veto rights the US enjoys in the International Monetary Fund, explains why the US has been able to run up an ever-increasing current account deficit over the past quarter of a century. The so-called Washington consensus imposed strict market discipline on other countries but the US was exempt from it.
The emerging market crisis of 1997 devastated the periphery such as Indonesia, Brazil, Korea and Russia but left America unscathed. Subsequently, many peripheral countries followed sound macroeconomic policies, once again attracting large capital inflows, and in recent years have enjoyed fast economic growth. Then came the financial crisis, which originated in the US. Until recently peripheral countries such as Brazil remained largely unaffected; indeed, they benefited from the commodity boom. But after the bankruptcy of Lehman Brothers (NYSE:LEH) , the financial system suffered a temporary cardiac arrest and the authorities in the US and Europe resorted to desperate measures to resuscitate it. In effect, they resolved that no other big financial institution would be allowed to default and also they guaranteed depositors against losses. This had unintended adverse consequences for the peripheral countries and the authorities have been caught unawares. In recent days there has been a general flight for safety from the periphery back to the centre. Currencies have dropped against the dollar and the yen, some precipitously. Interest rates and credit default premiums have soared and stock markets crashed. Margin calls have proliferated and spread to stock markets in the US and Europe, raising the spectre of renewed panic.
The IMF is discussing a new credit facility for countries at the periphery, in contrast to the conditional credit lines that were never used because the conditions attached to them were too onerous. The new facility would carry no conditions and no stigma for countries following sound macroeconomic policies. In addition, the IMF stands ready to extend conditional credit to countries that are less well qualified. Iceland and Ukraine have already signed and Hungary is next.
The approach is right but it will be too little, too late. The maximum that could be drawn under this facility would be five times a country's quota. In the case of Brazil, for example, this would amount to $15bn, a pittance when compared with Brazil's own foreign currency reserves of more than $200bn. A much larger and more flexible package is needed to reassure markets. The central banks at the centre should open large swap lines with the central banks of qualifying countries at the periphery and countries with large foreign currency reserves, notably China, Japan, Abu Dhabi and Saudi Arabia, ought to put up a supplemental fund that could be dispersed more flexibly. There is also an urgent need for short-term and longer-term credit to enable countries with sound fiscal positions to engage in Keynesian counter-cyclical policies. Only by stimulating domestic demand can the spectre of a world-wide depression be removed.
Unfortunately the authorities are always lagging behind events; that is why the financial crisis is spinning out of control. Already it has enveloped the Gulf countries, and Saudi Arabia and Abu Dhabi may be too concerned with their own region to contribute to a global fund. It is time to start thinking about creating special drawing rights or some other form of international reserves on a large scale, but that is subject to American veto.
President George W. Bush has convened a G20 summit for November 15 but there is not much point in holding such a meeting unless the US is serious about supporting a global rescue effort. The US must show the way in protecting the peripheral countries against a storm that has originated in the US, if it does not want to forfeit its claim to the leadership position. Even if Mr Bush does not share this point of view, it is to be hoped the next president will - but by then the damage will be much greater.
The writer is chairman of Soros Fund Management and author of The New Paradigm for Financial Markets
Rio Chief Albanese Says Slowdown in China Is Gathering Pace
By Brett Foley
Nov. 3 (Bloomberg) -- Rio Tinto Group Chief Executive Officer Tom Albanese said the economic slowdown in China, the world's largest user of metals, is quickening and demand won't rebound until 2009.
``It is decelerating more in the fourth quarter than we saw in the third quarter,'' Albanese said yesterday in an interview at the company's ilmenite mine in Madagascar. ``That is going to lead to a deferred pickup in cumulative demand for most of the things we produce during the course of 2009.''
Rio is among mining companies reviewing investment plans after commodity prices plunged amid signs of a global economic slowdown. The London-based company, fending off a $76.8 billion hostile bid from BHP Billiton Ltd., is planning to spend more than $9 billion on new mines and expansions next year.
``We want to tailor our expected delivery of those projects with when we see demand picking up,'' Albanese said. ``We'll prioritize spending towards the most robust projects.''
Projects that are almost complete will start production while those at an ``early stage'' and without financial commitments ``will have to be given some latitude on the timing,'' he said.
Copper, which accounted for 22 percent of Rio's sales in the first half, has fallen 44 percent in the past two months while aluminum has declined 24 percent.
Chinese Contraction
China accounted for 17 percent of Rio's sales in the first half. It's economy grew at the slowest pace in five years in the three months through September, the fifth straight quarter that the expansion has cooled. The country's Purchasing Managers' Index, published Nov. 1 by the China Federation of Logistics and Purchasing, showed a contraction in September.
Sliding aluminum prices have led to about 1.6 million metric tons of global smelting capacity being idled, and another 700,000 tons may follow, Albanese said. ``Prices at these levels are having definitive supply effects,'' he said.
Rio is reviewing the costs of its joint venture with Saudi Arabia's state-owned mining company Ma'aden to build a $10.5 billion aluminum smelter complex.
``We have rapid capital and construction costs escalation,'' Albanese said. ``This is an opportunity to test those assumptions of escalation and see if we can start bringing down the cost of these new projects.''
Aluminum Cuts
Rio, the world's second-largest producer of aluminum and iron-ore, rejected Melbourne-based BHP's sweetened, all-share offer on Feb. 6, saying it undervalued the company and its growth prospects. The offer is awaiting approval from European Union regulators, who last month told lawyers for BHP that the Australian company's bid may break antitrust rules, two people close to the case said.
Rio said Oct. 15 it was reviewing its spending timetable and project costs. The company has already idled sections of its highest-cost aluminum plants. Rio's development plans include the $3 billion Oyu Tolgoi copper and gold mine in Mongolia, the $6 billion Simandou iron ore mine in Guinea and a $1.5 billion nickel project in Sulawesi, Indonesia.
The ilmenite produced at Rio's $1 billion QIT Madagascar Minerals mine in the island's Fort-Dauphin region is used to make paint and toothpaste. The company said in February it may double output at the project from a planned 750,000 tons a year.
Banks back credit card relief plan
Program would wipe out up to 40% of total
Associated Press
October 31, 2008
WASHINGTON - With defaults on credit card debt spiraling amid a global financial downturn, banks already reeling from the mortgage crisis are losing billions more from unpaid credit card bills.
Big banks have formed an unusual alliance with consumer advocates to urge the government to allow huge portions of credit card debt to be forgiven, a turnabout from recent years when the banking industry lobbied strenuously to make it harder for consumers to erase their credit card debts in bankruptcy.
The new pilot program could involve as many as 50,000 people. On an individual basis, the amount of debt to be forgiven would rise according to the severity of the borrower's financial situation, up to 40 percent.
"There's obviously a financial benefit to the financial institutions to step up to the plate right now," said Susan Keating, president and chief executive of the National Foundation for Credit Counseling, which has 108 member organizations around the country. "We absolutely support the proposal."
Amid rising job losses, consumers - even those with strong credit records - have been defaulting at high levels on their credit cards. Banks already battered by the mortgage and credit crises are bleeding tens of billions from the losses.
The proposal pitched to federal regulators by the Financial Services Roundtable, which represents more than 100 big banks and other financial companies, and the Consumer Federation of America, would allow lenders to reduce by as much as 40 percent the amount of credit card debt owed by deeply indebted consumers in a pilot program.
Nearly all the biggest credit card banks have agreed to such a program, in which lenders would forgive as much as 40 percent of the amount consumers owe, allowing them to pay back the remainder over time.
Current government rules don't allow lenders to offer repayment plans that reduce the amount owed and borrowers to repay the balance over several years.
In cases where the principal can be reduced, borrowers normally are required to pay off the remainder over months.
Leaders tackle economic brush fires around the globe
By David Jolly
November 2, 2008
Prime Minister Gordon Brown of Britain on Sunday urged Gulf nations to help bolster the International Monetary Fund's bailout capacity, as leaders around the world spent another weekend trying to extinguish the brush fires of the economic crisis.
Brown has called on China and Middle Eastern countries to take an expanded role in financing the IMF's activities as the crisis has deepened.
"The Saudis, I think, will contribute so we can have a bigger fund worldwide," Reuters quoted Brown as telling reporters in the Saudi capital, Riyadh, after weekend meetings with King Abdullah and Saudi businessmen. "The oil producing countries, who have generated over $1 trillion from higher oil prices in recent years, are in a position to contribute."
The IMF has committed $30 billion in the past few weeks in bailout packages for Hungary, Iceland and Ukraine. It said Wednesday that it would lend as much as $100 billion to economically healthy countries that are having trouble borrowing as a result of the turmoil in the global markets.
The fund, a 185-member organization, has more than $200 billion in resources, and can draw on additional funds from its members.
"We probably will need more resources," Dominique Strauss-Kahn, the fund's managing director, said last week. "There is no way the fund can solve the problem on its own."
Brown's call came on the type of weekend that has become common as the credit crisis intensified, with governments scrambling to bolster growth and backup troubled institutions.
In Berlin, Chancellor Angela Merkel's government was working on an economic stimulus plan for Germany that media reports said would be valued at about €50 billion, or $63.6 billion. In a podcast, Merkel said the cabinet would approve the measures Wednesday.
"We know that the international financial markets crisis will also have an impact on our economy," she said. "However, we want the impact on our economy to be limited."
She also called on banks to make use of the €500 billion fund the government has made available for troubled lenders.
In Lisbon, the authorities said they were setting up a credit line of €4 billion for Portugal's banks, and were moving to nationalize one of the smaller lenders in the country, Banco Português de Negócios.
The Associated Press quoted Portugal's finance minister, Fernando Teixeira dos Santos, as saying the bank had losses of around €700 million. "The government has taken this decision, above all, to ensure that account-holder savings are safe," Teixeira dos Santos said.
In Russia, where the benchmark Micex stock index has fallen nearly 60 percent this year, officials announced new measures to halt capital flight. Igor Shuvalov, a first deputy prime minister, told state television Sunday that the government would move to limit the sale of rubles by banks that receive government aid.
That came a day after the Russian Finance Ministry said it had injected more than $6 billion from a government fund into Vnesheconombank, or VEB, a state-run bank. VEB will use the funds to provide loans to banks and to buy stocks and bonds.
In Beijing, the Chinese prime minister, Wen Jiabao, warned in a Communist Party publication that the economic meltdown was raising the risk of social unrest, and he called for more focus on domestic spending, the China News Service reported.
Wen said the government's need to promote economic growth was beginning to override its mandate to keep inflation in check. The monetary authorities in Beijing cut interest rates Wednesday for the third time in two months, bringing the benchmark rate down to 6.66 percent from 6.93 percent.
Wen's warning followed the release Saturday of a survey of Chinese purchasing managers that showed manufacturing, a linchpin of the economy, contracted in October.
In Mumbai, the Reserve Bank of India, the central bank, said Saturday that it would "employ both conventional and unconventional measures" to respond to the crisis. The bank, which had just cut its benchmark interest rate by a full percentage point on Oct. 20, cut the rate again, by a half point, to 7.5 percent.
Major central banks including the U.S. Federal Reserve and the Bank of Japan last week cut their main interest rate targets, while the European Central Bank and Bank of England are both expected to cut rates at their policy meetings Thursday.
Brown's political fortunes, which had been flagging, have been revived by his decision to inject funds directly into British banks, a move that became a model for global action.
As a result, Brown's standings in the British polls have risen considerably, making it not impossible that he will call an election before he is required to do so in May 2010.
Brown's efforts to drum up support for the IMF during a four-day Mideast tour come less than two weeks before a Nov. 15 meeting of global leaders in Washington, at which officials will explore ways to reorder the global financial system.
Brown, who was traveling in the region with a large entourage of business leaders, was also seeking more Middle Eastern investment for the British economy. On Friday, Barclays, the British bank, said it would raise billions of dollars by selling shares to Abu Dhabi and Qatar, which could leave the two state investors with as much as 32 percent of the bank.
Deutsche Bank rejects aid
Deutsche Bank reiterated Sunday that it would not ask for funds from the German government's €500 billion rescue package, a day after Chancellor Angela Merkel urged more institutions to participate, The Associated Press reported from Berlin.
Unlike many financial institutions around the world, Germany's largest bank has remained largely unscathed by the effects of the subprime crisis. On Thursday, the bank surprised analysts by reporting a profit in the third quarter.
"We have a very strong refinancing basis, so that we do not need to use the rescue package," Deutsche Bank's chief executive, Josef Ackermann, told the TV broadcaster ZDF.
Deutsche Bank has also pledged €12 billion to a separate €50 billion package to prop up the embattled commercial property lender Hypo Real Estate.
Countries hit by falling commodity prices
BY MARTIN KHOR
November 3, 2008
Malaysia has been affected by the fall in prices of export commodities like petroleum, palm oil and rubber. Many developing countries are hit by the end of the commodity boom resulting from the global economic crisis.
COMMODITY prices have begun to decline sharply in the past few months, at a time when the turmoil in global financial markets intensified, and as recessionary conditions took hold in many developed countries.
Malaysia is one of the countries affected. As a net oil exporter, it has been hit by the dramatic fall in the oil price from a peak of US$140 a barrel just a few months ago to the current price of just above US$60.
Even more significant has been the alarming and quick decline in the price of palm oil. Crude palm oil futures in Malaysia tumbled from a record high of RM4,500 a tonne in early March to about RM1,500 at the end of last week.
This 66% drop is causing incomes to fall correspondingly among the smallholders in Malaysia and Indonesia. According to a Financial Times report, millions of small producers in Indonesia are now struggling to survive.
The price of rubber is also coming under pressure. Last week, officials of Malaysia, Thailand and Indonesia met in Bangkok and agreed to cut rubber output by 215,000 tonnes in 2009 to boost prices, which according to Thai official had fallen from US$2 a kg a year ago to US$1.72.
The output cuts in the three countries will be through the felling of plantations, reduction of tapping and delay in starting the tapping of new trees by a year, according to a Thai official after the meeting.
The fall in commodity prices is not all bad news. Consumers benefit from lower prices, and manufacturers have lower costs. Importing countries also get reduced import bills.
But for developing countries like Malaysia which are commodity exporters, the losses far outweigh the benefits, as export earnings fall and millions of producers suffer reduced incomes.
For the past few years there has been a boom in prices of most commodities. Some analysts even predicted that there had been a structural shift in commodity trends and the boom would last many years, instead of being part of the usual boom-and-bust cycle.
Other analysts saw the super-boom as partly driven by real demand increase (especially in China) but also significantly driven by speculators. This is now proving correct.
There is a slowdown in demand, but more importantly a flight from commodity markets by speculators, due to the global financial crisis and the deepening recession.
Data from the UN Food and Agriculture Organisation show that for many food commodities, export prices peaked around June and have been declining since, with the price falls intensifying in the past two months. However, prices of most food commodities are still higher than a year ago, with some exceptions.
Meanwhile, the prices of many minerals and metals have also fallen significantly in recent weeks.
The “commodity boom” seems to be over and is being replaced by a new general commodity price slump.
The FAO Food Price Index (FFPI) dropped a further 6% in September, falling to a nine-month low of 188 points. The sharp decline in the index reflected the rapid decrease in international prices of all major food and feed commodities.
The fall in food prices overall was reflected in the decline in indices for cereals, oils and fats, meat and sugar.
After reaching a high of 278 points in June 2008, the FAO Cereal Price Index fell to 228 points in September. The FAO Oils/Fats Price Index fell to 209 points in September, or 28% below the June record.
The FAO Meat Price Index fell to 140 points in September, 4% below its peak in August. And the Dairy Price Index fell to 218 points in September, down almost 12% from August.
According to the FAO report, the fall in prices of most cereals continued in September and into the first week of October.
This was largely in response to favourable prospects for 2008 harvests, the influence of falling crude oil prices and financial turmoil in world economies.
The report gave a detailed account of the price situation in three major cereals – wheat, maize and rice.
On rice, the FAO said that expectations of record 2008 padi crops in the northern hemisphere were keeping downward pressure on export prices. The price of Thai white rice 100% B averaged US$764 per tonne in September, about 3% down from August, and fell to US$734 in the first week of October.
The drop in Thai prices over the past few months would likely have been more pronounced had it not been for the country’s official procurement programme launched in June.
Indeed, in other export markets the slide has been deeper, with price quotations over the same period down 35% in Vietnam and Pakistan and 16% in the US.
However, prices are still well above their values of September 2007 (by 130% in Thailand, 92% in the United States, 74% in Vietnam and 53% in Pakistan).
On wheat, international prices continued to decline sharply. The US wheat price averaged US$308 a tonne in September, and fell to US$264 in the first week of October, about 45% below its peak in March, and 25% down from October 2007.
Maize prices fell further towards the end of September and in early October. The US maize price averaged US$229 per tonne in September, and fell to US$184 in the first week of October, 35% below the peak in June, but still 13% above October last year.
According to the FAO, 36 countries are in need of external assistance as a result of crop failures, conflict or insecurity, natural disasters, and high domestic food prices.
VW Shares Plunge, a Day After Surge
By CARTER DOUGHERTY
October 29, 2008
FRANKFURT — Shares in Volkswagen fell by nearly half Wednesday after its main shareholder, Porsche, took steps to ease a quadrupling in the stock price that had pushed some of the world’s biggest hedge funds to the wall.
The move came as the German financial supervisor, Bafin, announced a formal investigation into gyrations of VW stock that briefly made it the most valuable company in the world a day earlier. “We need to take a closer look if there was market manipulation,” a Bafin spokeswoman, Anja Engelland, said.
Porsche said it would dump up to 5 percent of its VW shares — presumably at a great profit — “to avoid further market distortions and the resulting consequences for those involved.” Volkswagen stock, which rose to above 1,000 euros, or to about $1,284, at one point on Tuesday, plummeted on Wednesday to close at 517 euros. That is still well above its close Friday of 210 euros.
Porsche, which has engaged in a creeping takeover of Volkswagen over several years, unleashed a punishing market dynamic this week on investors who believed VW stock would lose value if Porsche took majority control.
These short-sellers, who borrow stock in the hope of buying it back later at a lower price, scrambled to buy shares of VW to cover their bets after Porsche revealed Sunday that it controlled a much larger pool of VW shares than previously disclosed, creating scarcity in the number of shares investors could buy.
Many hedge fund managers were relieved on Wednesday when the share price fell. Funds like Greenlight Capital, Glenview Capital and SAC Capital had bet that Volkswagen’s stock was overvalued back when the price was below 200. The spike in the stock put funds with big positions at risk, and some of those funds could face large margin calls from the banks this week if the stock does not continue to fall.
Porsche, whose own shares jumped Wednesday by 37 percent, flatly denied any wrongdoing. “Porsche has not been active in the market during these share price movements,” it said. “Allegations of price manipulation by Porsche are therefore without foundation whatsoever.”
The episode highlights how Porsche, the sports car manufacturer that keeps investment bankers and hedge fund managers moving at high speeds down the world’s highways, beat both at their own game.
Porsche raised its stake in Volkswagen to 42.6 percent from 35 percent, and said Sunday it had taken options that settle in cash for an additional 31.5 percent. By acquiring options to buy VW shares at a certain price, Porsche was in the position Wednesday to exercise them, and then sell at elevated prices for a colossal profit.
“Presumably they are doing this to earn money, and not to help the hedge funds,” said Jens Schattner, an auto analyst at Sal. Oppenheim in Frankfurt.
With big names and big money at stake, the spectacle has riveted Germany, with some unease but a fair dose as well of schadenfreude among many Germans.
“As opposed to previous speculative bubbles that cost a lot of small investors their money in the stock exchange casino, the chaos around VW shares overwhelmingly hits professional gamblers,” Die Tageszeitung, a left-leaning Berlin newspaper, wrote. “Sympathy does not seem appropriate.”
But with its use of financial derivatives, surprise pronouncements and calculated opacity, Porsche did appear to be acting a bit like one of the hedge funds that a German politician once famously called “locusts” that prey on unsuspecting companies. Indeed, in the 2006-7 fiscal year, Porsche engaged in a similar financial strategy that drew in vastly higher profits than the sales of its cars.
The size of Porsche’s profit on this week’s transactions is likely to remain a mystery until next year, analysts said. Stock option transactions earned Porsche 3.6 billion euros in the fiscal year that ended June 30, 2007, or 62 percent of its pretax profit. It has yet to reveal results for the 2007-8 financial year, and the current transactions will not register until its report in late 2009.
German law does not require Porsche to reveal details of the price at which it bought the cash options, or the strike price at which they can be exercised, the two main variables in the profit calculation.
Porsche’s financial strategy of securing control over Volkswagen has been the brainchild of its chief financial officer, Holger P. Härter, who sits on the larger company’s board. The Schaeffler Group, a maker of roller bearings, used a similar approach to seize control of Continental, one of the world’s largest auto parts makers, this summer.
The German Finance Ministry is now examining whether to broaden disclosure rules to include complex financial derivatives that can be used to circumvent normal disclosure rules on shareholdings.
Porsche and Schaeffler are family-controlled companies, a fact that appears to have limited the political fallout from the rough-and-tumble tactics. Porsche is often held up by German critics of American-style capitalism as a company that makes enviable profits while paying its workers a premium wage.
Ulrich Hocker, director of DSW, a German shareholder protection group, said a player like Deutsche Bank, for example, would have run into a thicket of criticism for using such tactics, being widely held and much more American in its outlook.
“If Deutsche had done this, we would have a terrible uproar,” Mr. Hocker said. “But Porsche is a family company that has the reputation of doing well for their people, and they are using that reputation to the fullest.”
The Reckoning
From Midwest to M.T.A., Pain From Global Gamble
By CHARLES DUHIGG and CARTER DOUGHERTY
November 1, 2008
“People come up to me in the grocery store and say, ‘How did we get suckered into this?’ ” — Marc Hujik, of the Kenosha, Wis., school board
On a snowy day two years ago, the school board in Whitefish Bay, Wis., gathered to discuss a looming problem: how to plug a gaping hole in the teachers’ retirement plan.
It turned to David W. Noack, a trusted local investment banker, who proposed that the district borrow from overseas and use the money for a complex investment that offered big profits.
“Every three months you’re going to get a payment,” he promised, according to a tape of the meeting. But would it be risky? “There would need to be 15 Enrons” for the district to lose money, he said.
The board and four other nearby districts ultimately invested $200 million in the deal, most of it borrowed from an Irish bank. Without realizing it, the schools were imitating hedge funds.
Half a continent away, New York subway officials were also being wooed by bankers. Officials were told that just as home buyers had embraced adjustable-rate loans, New York could save money by borrowing at lower interest rates that changed every day.
For some of the deals, the officials were encouraged to rely on the same Irish bank as the Wisconsin schools.
During the go-go investing years, school districts, transit agencies and other government entities were quick to jump into the global economy, hoping for fast gains to cover growing pension costs and budgets without raising taxes. Deals were arranged by armies of persuasive financiers who received big paydays.
But now, hundreds of cities and government agencies are facing economic turmoil. Far from being isolated examples, the Wisconsin schools and New York’s transportation system are among the many players in a financial fiasco that has ricocheted globally.
The Wisconsin schools are on the brink of losing their money, confronting educators with possible budget cuts. Interest rates for New York’s subways are skyrocketing and contributing to budget woes that have transportation officials considering higher fares and delaying long-planned track repairs.
And the bank at the center of the saga, named Depfa, is now in trouble, threatening the stability of its parent company in Munich and forcing German officials to intervene with a multibillion-dollar bailout to stop a chain reaction that could freeze Germany’s economic system.
“I am really worried,” said Becky Velvikis, a first-grade teacher at Grewenow Elementary in Kenosha, Wis., one of the districts that invested in Mr. Noack’s deal. “If millions of dollars are gone, what happens to my retirement? Or the construction paper and pencils and supplies we need to teach?”
The trail through Wisconsin, New York and Europe illustrates how this financial crisis has moved around the world so fast, why it is so hard to tame, and why cities, schools and many other institutions will probably struggle for years.
“The local papers and radio shows call us idiots, and now when I go home, my kids ask me, ‘Dad, did you do something wrong?’ ” said Shawn Yde, the director of business services in the Whitefish Bay district. “This is something I’ll regret until the day I die.”
Selling Risk
Whitefish Bay’s school district did not intend to become a hedge fund. It and four nearby districts were just trying to finance retirement obligations that were growing as health care costs rose.
Mr. Noack, the local representative of Stifel, Nicolaus & Company, a St. Louis investment bank, had been advising Wisconsin school boards for two decades, helping them borrow for new gymnasiums and classrooms. His father had taught at an area high school for 47 years. All six of his children attended Milwaukee schools.
Mr. Noack told the Whitefish Bay board that investing in the global economy carried few risks, according to the tape.
“What’s the best investment? It’s called a collateralized debt obligation,” or a C.D.O., Mr. Noack said. He described it as a collection of bonds from 105 of the most reputable companies that would pay the school board a small return every quarter.
“We’re being very conservative,” Mr. Noack told the board, composed of lawyers, salesmen and a homemaker who lived in the affluent Milwaukee suburb.
Soon, Whitefish Bay and the four other districts borrowed $165 million from Depfa and contributed $35 million of their own money to purchase three C.D.O.’s sold by the Royal Bank of Canada, which had a relationship with Mr. Noack’s company.
But Mr. Noack’s explanation of a C.D.O. was very wrong. Mr. Noack, who through his lawyer declined to comment, had attended only a two-hour training session on C.D.O.’s, he told a friend.
The schools’ $200 million was actually used as collateral for a complicated form of insurance guaranteeing about $20 billion of corporate bonds. That investment — known as a synthetic C.D.O. — committed the boards to paying off other bondholders if corporations failed to honor their debts.
If just 6 percent of the bonds insured went bad, the Wisconsin educators could lose all their money. If none of the bonds defaulted, the schools would receive about $1.8 million a year after paying off their own debt. By comparison, the C.D.O.’s offered only a modestly better return than a $35 million investment in ultra-safe Treasury bonds, which would have paid about $1.5 million a year, with virtually no risk.
The boards, as part of their deal, received thick packets of documents.
“I’ve never read the prospectus,” said Marc Hujik, a local financial adviser and a member of the Kenosha school board who spent 13 years on Wall Street. “We had all our questions answered satisfactorily by Dave Noack, so I wasn’t worried.”
Wisconsin schools were not the only ones to jump into such complicated financial products. More than $1.2 trillion of C.D.O.’s have been sold to buyers of all kinds since 2005 — including many cities and government agencies — an increase of 270 percent from the four previous years combined, according to Thomson Reuters.
“Selling these products to municipalities was pretty widespread,” said Janet Tavakoli, a finance industry consultant in Chicago. “They tend to be less sophisticated. So bankers sell them products stuffed with junk.”
From the Wisconsin deal, the Royal Bank of Canada received promises of payments totaling about $11.2 million, according to documents. Stifel Nicolaus made about $1.2 million. Mr. Noack’s total salary was about $300,000 a year, according to someone with knowledge of his finances. And Depfa received interest on its loans.
In separate statements, the Royal Bank of Canada and Stifel Nicolaus said board members signed documents indicating they understood the investments’ risks. Both companies said they were not financial advisers to the boards but merely sold them products or services. Stifel Nicolaus said its relationship with the boards ended in 2007. Mr. Noack now works for a rival firm.
“Everyone knew New York guys were making tons of money on these kinds of deals,” said Mr. Hujik, of the school board. “It wasn’t implausible that we could make money, too.”
A Bank Goes Global
By the time Depfa financed the Wisconsin schools’ investment, it had already become an emblem of the new global economy. It was founded 86 years ago as a sleepy German lender, and for most of its history had focused on its home market.
But in 2002 a new chief executive, Gerhard Bruckermann, moved Depfa to the freewheeling financial center of Dublin to take advantage of low corporate taxes. He soon pushed the company into São Paulo, Mumbai, Warsaw, Hong Kong, Dallas, New York, Tokyo and elsewhere. Depfa became one of Europe’s most profitable banks and was famous for lavish events and large paychecks. In 2006, top executives took home the equivalent of $33 million at today’s exchange rates.
Mr. Bruckermann was a gregarious leader who joked that he hoped to make all employees into millionaires. He divided his time between a London home and a vast farm in Spain, where he grew exotic medicinal plants. And his success fueled an arrogance, former colleagues say.
Mr. Bruckermann once told a trade publication that Depfa, unlike German banks, understood how to benefit from the global economy. “With our efforts, we are like the one-eyed man who becomes king in the land of the blind,” he was quoted as saying.
Mr. Bruckermann, who left the bank earlier this year, did not respond to requests for an interview.
But as Depfa grew, other European banks began competing with the firm. So executives stretched into riskier deals — the sort that would eventually send shockwaves across Europe and the United States.
Some of Mr. Bruckermann’s employees grew concerned about deals like one struck in 2005 with the Metropolitan Transportation Authority of New York, the agency overseeing the city and suburban subways, buses and trains.
For years, municipal agencies like the M.T.A. had raised money by issuing plain-vanilla bonds with fixed interest rates. But then bankers began telling officials that there was a way to get cheaper financing.
Bankers said that cities, like home buyers, could save money with adjustable-rate loans, where the payments started low and changed over time. What they did not emphasize was that such payments could eventually skyrocket. Such borrowing — known as variable-rate bonds — also carried big fees for Wall Street.
The pitches were very successful. Municipalities issued twice as many variable-rate bonds last year as they did a decade earlier.
But variable-rate bonds had a hitch: many investors would purchase them only if a bank like Depfa was hired as a buyer of last resort, ready to acquire bonds from investors who could find no other buyers. Depfa collected fees for serving that role, but expected it would rarely have to honor such pledges.
Mr. Bruckermann’s salespeople traveled the world encouraging officials to sign up for variable-rate loans. And bureaucrats and politicians, including some in New York, jumped in.
By 2006 Depfa was the largest buyer of last resort in the world, standing behind $2.9 billion of bonds issued that year alone. It backed a $200 million bond issued by the M.T.A.
But as Depfa grew, it became more reliant on enormous short-term loans to finance its operations. Those loans cost less, and thus helped the bank achieve higher profits, but only when times were good. Indeed, some employees were worried about that debt.
But Mr. Bruckermann plowed ahead, and it paid off. In 2007, even as the global economy was softening, Mr. Bruckermann persuaded one of Germany’s biggest lenders, Hypo Real Estate, to purchase Depfa for $7.8 billion. Mr. Bruckermann’s cut was more than $150 million. He left the company to grow oranges on his Spanish estate.
The Risks Turn Bad
Last March the delicate web tying Wisconsin, Dublin and Manhattan became an anchor dragging everyone down.
Mr. Yde, the director of business services for the Whitefish Bay district, began receiving troubling messages indicating the district’s investments were declining. Worried, he started coming into his office at dawn, before the hallways of Whitefish Bay High School filled with students.
As the sun rose, Mr. Yde searched for explanations by the light of his computer screen. He Googled “C.D.O.’s.” He called bankers in London and New York. Each person referred him to someone else.
Then notices arrived saying that the bonds insured by Whitefish Bay’s C.D.O.’s were defaulting. It became increasingly likely that the district’s money would be seized to pay off other bondholders. Most, if not all, of the $200 million would probably be lost.
As other districts received similar notices, panic grew. For some boards, interest payments on borrowed money were now larger than revenue from the investments. Officials began quietly warning that they might have to dip into school funds.
“This is going to have a tremendous financial impact,” said Robert F. Kitchen, a member of the West Allis-West Milwaukee school board. Officials say some districts may have to cut courses like art and drama, curtail gym and classroom maintenance, or forgo replacing teachers who retire.
Problems were emerging elsewhere, as well.
Depfa’s executives were realizing that their loans to the Wisconsin schools were unlikely to be repaid. Additionally, bonds all over the world were declining in value, exposing the company to the possibility they would have to make good on their pledges as a buyer of last resort. And Depfa was still borrowing billions each month to cover its short-term loans. By autumn, the short-term debt of the bank and its parent company, Hypo, totaled $81 billion.
Then, in mid-September, the American investment bank Lehman Brothers went bankrupt. Short-term lending markets froze up. Ratings agencies, including Standard & Poor’s, downgraded Depfa, citing the company’s difficulties borrowing at affordable rates.
That set off a crisis in Germany, where officials worried that Depfa’s sudden need for cash would drag down its parent company and set off a chain reaction at other banks. The German government and private banks extended $64 billion in credit to Hypo to stop it from imploding.
“We will not allow the distress of one financial institution to endanger the entire system,” Angela Merkel, the German chancellor, said at the time.
That crisis spread almost immediately to the M.T.A.
The transportation authority, guided by Gary Dellaverson, a rumpled, cigarillo-smoking chief financial officer, had $3.75 billion of variable-rate debt outstanding.
About $200 million of that debt was backed by Depfa. When the bank was downgraded, investors dumped those transportation bonds, because of worries they would get stuck with them if Depfa’s problems worsened. Depfa was forced to buy $150 million of them, and bonds worth billions of dollars issued by other municipalities.
Then came the twist: Depfa’s contracts said that if it bought back bonds, the municipalities had to pay a higher-than-average interest rate. The New York transportation authority’s repayment obligation could eventually balloon by about $12 million a year on the Depfa loans alone.
On its own, that cost could be absorbed by the agency. But, as the economy declined, the M.T.A. had lost hundreds of millions because tax receipts — which finance part of its budget — were falling. And its ability to renew its variable-rate bonds at low interest rates was hurt by the trouble at Depfa and other banks. The transportation authority now faces a $900 million shortfall, according to officials. It is “fairly breathtaking,” Mr. Dellaverson told the M.T.A.’s finance committee. “This is not a tolerable long-term position for us to be in.”
In a recent interview, Mr. Dellaverson defended New York’s use of variable bonds.
“Variable-rate debt has helped M.T.A. save millions of dollars, and we’ve been conservative in issuing it,” he said. “But there are risks, which we work hard to mitigate. Usually it works. But what’s happening today is a total lack of marketplace rationality.”
In a statement, the transportation authority said that it was exploring options to reduce the cost of the Depfa-backed bonds, that its variable-rate bonds had delivered savings even during the current turmoil and that the agency had remained within its budget on debt payments this year.
However, the transportation authority has already announced it will raise subway and train fares next year because of various fiscal problems, and may be forced to shrink the work force and reduce some bus routes. Some analysts say fares will probably rise again in 2010.
The Depfa fallout doesn’t end there. Rating agencies have downgraded the bonds of more than 75 municipal agencies backed by Depfa, including in California, Connecticut, Illinois and South Dakota. Officials in Florida, Massachusetts and Montana have cut budgets because of C.D.O.’s or similar risky bets.
And Hypo, the German company that bought Depfa, last week asked the German government for financial help for the third time. Depfa has frozen much of its business, according to Wall Street bankers, and though it continues to honor its commitments, some wonder for how long.
The Wisconsin school districts have filed suit against the Royal Bank of Canada and Stifel Nicolaus alleging misrepresentations. Board members hope they will prevail and schools and retirement plans will emerge unscathed. The companies dispute the lawsuit’s claims. Mr. Noack is not named as a defendant and is cooperating with the school boards.
In Mrs. Velvikis’s classroom at Grewenow Elementary in Kenosha, students have recently completed a lesson in which each first grader contributed a vegetable to a common vat of “stone soup.” The project — based on a children’s book — teaches the benefits of working together. The schools have learned that when everyone works together, they can also all starve.
“Our funding is already so limited,” Mrs. Velvikis said. “We rely on parent donations for some supplies. You hear about all these millions of dollars that have been lost, and you think, that’s got to come out of somewhere.”
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