By JOE BEL BRUNO and SARA LEPRO, AP Business Writers Joe Bel Bruno And Sara Lepro, Ap Business Writers 35 mins ago
NEW YORK – Wall Street hit levels not seen since 2003 on Wednesday, with the Dow Jones industrial average plunging below the 8,000 mark as the fate of Detroit's Big Three automakers amid a slumping economy disheartened investors.
A cascade of selling occurred in the final minutes of the session as investors yanked money out of the market. For many, the real fear is that the recession might be even more protracted if Capitol Hill is unable to bail out the troubled auto industry.
Investors also scoured economic data that included minutes from the last meeting of the Federal Reserve in which policymakers lowered projections for economic activity this year and next. Economic worries caused across-the-board selling, with financial stocks particularly hard hit.
The S&P 500, widely considered the broadest snapshot of corporate America, slipped 6.12 percent to 806.58; and the Dow gave up 5.07 percent to 7,997.28. Both closed at their lowest levels since March 2003.
The financial crisis has already wiped out $6.69 trillion of value from the S&P 500 since its October 2007 high, and many fear more is to come. Stocks have traded with high volatility in the past few months, with the major indexes soaring only to plunge an hour later as the market looks for a bottom.
"I don't know what the catalyst is going to be where we turn the corner and people start buying stocks wholeheartedly again," said Jon Biele, head of capital markets at Cowen & Co. "People got out of the way. The financial situation hasn't changed."
The selling on the New York Stock Exchange was staggering — only 158 companies that trade there finished the day positive while 2,943 declined. Volume again was light, a symptom of the market's recent volatility, with 1.63 million shares exchanging hands by the close.
Smaller stocks also got clobbered. The Russell 2000 index gave up 35.13, or 7.85 percent, to 412.38.
Wednesday, November 19, 2008
more bad news
Fed Sharply Lowers Forecasts, Signals Another Rate Cut Coming- AP
The Federal Reserve on Wednesday sharply lowered its projections for economic activity this year and next, and signaled that additional interest rate reductions may be needed to help combat the worst financial crisis to jolt the country in more than a half-century.
* Stocks sink as fate of automakers hangs in balance- AP
* Democrats seek to lower expectations for bailout- AP
* No auto bailout? Investors may just say 'no problem'- CNBC
* Ballmer dismisses Yahoo buyout but open on search- AP
* Oil prices fall below $54 a barrel, down 60% in 4 months- AP
* US home construction sinks to new record low- AP
* Consumer prices drop record 1 percent in October- AP
* e-Commerce Growth Screeches to a Halt- Tech Ticker
* Automaker Bailout Hits Major Pothole- Tech Ticker
The Federal Reserve on Wednesday sharply lowered its projections for economic activity this year and next, and signaled that additional interest rate reductions may be needed to help combat the worst financial crisis to jolt the country in more than a half-century.
* Stocks sink as fate of automakers hangs in balance- AP
* Democrats seek to lower expectations for bailout- AP
* No auto bailout? Investors may just say 'no problem'- CNBC
* Ballmer dismisses Yahoo buyout but open on search- AP
* Oil prices fall below $54 a barrel, down 60% in 4 months- AP
* US home construction sinks to new record low- AP
* Consumer prices drop record 1 percent in October- AP
* e-Commerce Growth Screeches to a Halt- Tech Ticker
* Automaker Bailout Hits Major Pothole- Tech Ticker
Tuesday, November 18, 2008
SiPort struggling to recover from killing of executives
Executives at 4-year-old start-up SiPort struggled Monday to get the promising maker of mobile chips running again after the murder of three colleagues last week in their Santa Clara office.
They hope to reopen in a day or two, but it's clear the killings devastated the close-knit engineering staff.
On Friday, hours after police say former SiPort employee Jing Hua Wu gunned down three top officials, the company's six-member board appointed co-founder and vice president of engineering Aiman Kabakibo as chief executive.
The recently fired Wu is expected to face charges in Santa Clara County Superior Court on Wednesday in connection with the murders of SiPort CEO Sid Agrawal and executives Marilyn Lewis and Brian Pugh. Police say Wu shot them after requesting a meeting.
"Our first and foremost priority is for the families of Sid, Marilyn and Brian,'' said Sunder Velamuri, SiPort's vice president of marketing. "We want to make sure they are doing well.''
Like any Silicon Valley startup, SiPort's diverse 38-member staff shares long hours together working to build a successful company. SiPort recently shipped its first product, a computer chip manufactured by a Taiwan company and used in high-definition radio, which enhances the quality of traditional FM radio.
"There are many, many able people there,'' said Vish Mishra, venture director at Clearstone Venture Partners, which once looked at SiPort as a potential investment.
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"(Agrawal) really had a good team. They have a product. It's a good product.''
On Monday, a guard was posted in front of the startup. Shades were drawn and a sign made from computer paper read "Do Not Enter."
Employees agreed that the best course of action was to get back to work as soon as possible, Velamuri said.
"We got together as a team and talked,'' said Velamuri, who has been in "round-the-clock" meetings since Friday. "We all agreed that the best thing to do for us, and for those people taken away from us, was to move forward.''
That is sure to be difficult, though.
"They've been traumatized" said a Morgenthaler Ventures executive who sits on SiPort's board but who did not want his name revealed. "Some of them have witnessed this."
Velamuri said 47-year-old Wu, who was fired "for performance reasons,'' never gave any hint of threatening violence.
"I knew him. I saw him. I talked with him,'' he recalled. "I met his wife and kids. He has 6-year-old twins and a 2-year-old boy. He was a normal employee, like anybody else."
It is unclear if the company will eventually move to another office.
"That's a good question," Velamuri said. "There are the practical realities — but, yes, we are looking at that."
At times, the executive, who has worked at SiPort for 21/2 years, was overcome with emotion.
"It's not an easy thing," he said. "It's a very difficult. My emotions run the gamut every day."
The company is comforted by support from the valley community. Not just friends, but also corporations, partners and customers, have offered everything from thoughtful words to grief counseling for employees.
"The outpouring has been tremendous,'' Velamuri said.
Velamuri, who had just returned from a work trip to Japan, was not at the office at the time of the killings Friday afternoon. Yet he shared his co-workers stunned disbelief.
"Last week, I would have said this only happens in movies, on TV shows," he said. "This is not reality. It does not happen here. And then when it happens, you don't know how to react."
They hope to reopen in a day or two, but it's clear the killings devastated the close-knit engineering staff.
On Friday, hours after police say former SiPort employee Jing Hua Wu gunned down three top officials, the company's six-member board appointed co-founder and vice president of engineering Aiman Kabakibo as chief executive.
The recently fired Wu is expected to face charges in Santa Clara County Superior Court on Wednesday in connection with the murders of SiPort CEO Sid Agrawal and executives Marilyn Lewis and Brian Pugh. Police say Wu shot them after requesting a meeting.
"Our first and foremost priority is for the families of Sid, Marilyn and Brian,'' said Sunder Velamuri, SiPort's vice president of marketing. "We want to make sure they are doing well.''
Like any Silicon Valley startup, SiPort's diverse 38-member staff shares long hours together working to build a successful company. SiPort recently shipped its first product, a computer chip manufactured by a Taiwan company and used in high-definition radio, which enhances the quality of traditional FM radio.
"There are many, many able people there,'' said Vish Mishra, venture director at Clearstone Venture Partners, which once looked at SiPort as a potential investment.
Advertisement
Click Here
"(Agrawal) really had a good team. They have a product. It's a good product.''
On Monday, a guard was posted in front of the startup. Shades were drawn and a sign made from computer paper read "Do Not Enter."
Employees agreed that the best course of action was to get back to work as soon as possible, Velamuri said.
"We got together as a team and talked,'' said Velamuri, who has been in "round-the-clock" meetings since Friday. "We all agreed that the best thing to do for us, and for those people taken away from us, was to move forward.''
That is sure to be difficult, though.
"They've been traumatized" said a Morgenthaler Ventures executive who sits on SiPort's board but who did not want his name revealed. "Some of them have witnessed this."
Velamuri said 47-year-old Wu, who was fired "for performance reasons,'' never gave any hint of threatening violence.
"I knew him. I saw him. I talked with him,'' he recalled. "I met his wife and kids. He has 6-year-old twins and a 2-year-old boy. He was a normal employee, like anybody else."
It is unclear if the company will eventually move to another office.
"That's a good question," Velamuri said. "There are the practical realities — but, yes, we are looking at that."
At times, the executive, who has worked at SiPort for 21/2 years, was overcome with emotion.
"It's not an easy thing," he said. "It's a very difficult. My emotions run the gamut every day."
The company is comforted by support from the valley community. Not just friends, but also corporations, partners and customers, have offered everything from thoughtful words to grief counseling for employees.
"The outpouring has been tremendous,'' Velamuri said.
Velamuri, who had just returned from a work trip to Japan, was not at the office at the time of the killings Friday afternoon. Yet he shared his co-workers stunned disbelief.
"Last week, I would have said this only happens in movies, on TV shows," he said. "This is not reality. It does not happen here. And then when it happens, you don't know how to react."
As Congress takes a look at whether to help the struggling U.S. automakers, here is what you need to know about what's at stake for the Big Three.
Detroit bailout: 7 key questions
NEW YORK (CNNMoney.com) -- Congress is set to begin a heated debate on whether Detroit's Big Three automakers -- General Motors, Ford Motor and Chrysler LLC -- will be next in line for a federal bailout.
Democratic leaders in Congress are in favor of some kind of help, as is President-elect Obama. But the Bush administration has balked on proposals to let the automakers tap the $700 billion Wall Street bailout approved in October.
Many leading Congressional Republicans have suggested that a better option is bankruptcy, enabling the Big Three to restructure and ultimately emerge as leaner and viable businesses.
How this debate plays out could determine whether this important industry survives -- and in what form. Here are some quick answers to seven key questions about the crisis.
What do the automakers want?
The automakers are asking for about $25 billion in loans to help them survive until 2010. Advocates for a bailout argue that if the Big Three can hang on until then, they'll be in position to be competitive long-term.
That's because billions of dollars in annual savings won in the 2007 labor agreement with the United Auto Workers union kick in that year, including shifting the responsibility for retirees' health care costs to union-controlled trust funds.
What's more, it's likely that car sales will pick up again by 2010 and that plant closings between now and then will bring the Big Three's capacity in line with this demand.
How many jobs are at stake?
GM (GM, Fortune 500) has about 120,000 U.S. employees. Ford (F, Fortune 500) has about 80,000 and closely-held Chrysler LLC has about 66,000.
In addition, the three automakers have about 14,000 U.S. dealerships that between them employ another 740,000 workers.
The suppliers used by the Big Three also employ an estimated 610,000 people.
Add that up and you have more than 1.6 million jobs tied to the auto industry.
What happens if there's no bailout?
GM risks running out of money later this year or early in 2009 without a bailout.
GM burned through $6.9 billion during the third quarter, leaving it with only $16 billion on hand as of Sept. 30. But it needs $11 billion to $14 billion to continue normal operations.
Ford and Chrysler have more cash relative to their needs, mostly from money they borrowed prior to the current credit crunch.
But each of those automakers could also run out of cash during 2009 without federal assistance.
What happens if an automaker goes bankrupt?
There are two types of corporate bankruptcy under U.S. law.
Chapter 11 allows a company to continue to operate as it sheds debts and contracts it can not afford.
In Chapter 7 bankruptcy, the company goes out of business fairly rapidly as its assets are sold off to try to satisfy its creditors.
What are advantages of an automaker going into bankruptcy?
Some argue that bankruptcy judges will be able to force the automakers to shed brands and dealerships as well as get the Big Three out of labor contracts they can not afford.
Other U.S. industries, such as steel companies and airlines, have used bankruptcy in the past to return to profitability without putting federal dollars at risk.
What are the arguments against a Chapter 11 bankruptcy?
Given the current credit crunch, many experts question whether automakers would be able to get necessary financing from lenders to help them during the reorganization process.
There are also doubts whether consumers would buy new vehicles from a bankrupt automaker due to concerns over their resale value and warranty. In effect, an automaker that files for Chapter 11 could eventually wind up going out of business anyway.
What are some of the other broader economic impacts if an automaker goes out of business?
Nearly 2 million Americans get their health insurance directly from one of the Big Three automakers. Most of them would lose that coverage if their company goes out of business. A failure of one of the Big Three could also cause a string of bankruptcies among suppliers.
And beyond the job losses at the automakers, dealerships and suppliers, media companies that generate a lot of revenue from auto advertising as well as retailers in towns where plants are located could also have to cut many jobs. The Center for Automotive Research, a Michigan think tank that supports the bailout, estimates that between 1.4 million and 1.7 million jobs indirectly tied to the Big Three would be lost in the first year following widespread auto failures
NEW YORK (CNNMoney.com) -- Congress is set to begin a heated debate on whether Detroit's Big Three automakers -- General Motors, Ford Motor and Chrysler LLC -- will be next in line for a federal bailout.
Democratic leaders in Congress are in favor of some kind of help, as is President-elect Obama. But the Bush administration has balked on proposals to let the automakers tap the $700 billion Wall Street bailout approved in October.
Many leading Congressional Republicans have suggested that a better option is bankruptcy, enabling the Big Three to restructure and ultimately emerge as leaner and viable businesses.
How this debate plays out could determine whether this important industry survives -- and in what form. Here are some quick answers to seven key questions about the crisis.
What do the automakers want?
The automakers are asking for about $25 billion in loans to help them survive until 2010. Advocates for a bailout argue that if the Big Three can hang on until then, they'll be in position to be competitive long-term.
That's because billions of dollars in annual savings won in the 2007 labor agreement with the United Auto Workers union kick in that year, including shifting the responsibility for retirees' health care costs to union-controlled trust funds.
What's more, it's likely that car sales will pick up again by 2010 and that plant closings between now and then will bring the Big Three's capacity in line with this demand.
How many jobs are at stake?
GM (GM, Fortune 500) has about 120,000 U.S. employees. Ford (F, Fortune 500) has about 80,000 and closely-held Chrysler LLC has about 66,000.
In addition, the three automakers have about 14,000 U.S. dealerships that between them employ another 740,000 workers.
The suppliers used by the Big Three also employ an estimated 610,000 people.
Add that up and you have more than 1.6 million jobs tied to the auto industry.
What happens if there's no bailout?
GM risks running out of money later this year or early in 2009 without a bailout.
GM burned through $6.9 billion during the third quarter, leaving it with only $16 billion on hand as of Sept. 30. But it needs $11 billion to $14 billion to continue normal operations.
Ford and Chrysler have more cash relative to their needs, mostly from money they borrowed prior to the current credit crunch.
But each of those automakers could also run out of cash during 2009 without federal assistance.
What happens if an automaker goes bankrupt?
There are two types of corporate bankruptcy under U.S. law.
Chapter 11 allows a company to continue to operate as it sheds debts and contracts it can not afford.
In Chapter 7 bankruptcy, the company goes out of business fairly rapidly as its assets are sold off to try to satisfy its creditors.
What are advantages of an automaker going into bankruptcy?
Some argue that bankruptcy judges will be able to force the automakers to shed brands and dealerships as well as get the Big Three out of labor contracts they can not afford.
Other U.S. industries, such as steel companies and airlines, have used bankruptcy in the past to return to profitability without putting federal dollars at risk.
What are the arguments against a Chapter 11 bankruptcy?
Given the current credit crunch, many experts question whether automakers would be able to get necessary financing from lenders to help them during the reorganization process.
There are also doubts whether consumers would buy new vehicles from a bankrupt automaker due to concerns over their resale value and warranty. In effect, an automaker that files for Chapter 11 could eventually wind up going out of business anyway.
What are some of the other broader economic impacts if an automaker goes out of business?
Nearly 2 million Americans get their health insurance directly from one of the Big Three automakers. Most of them would lose that coverage if their company goes out of business. A failure of one of the Big Three could also cause a string of bankruptcies among suppliers.
And beyond the job losses at the automakers, dealerships and suppliers, media companies that generate a lot of revenue from auto advertising as well as retailers in towns where plants are located could also have to cut many jobs. The Center for Automotive Research, a Michigan think tank that supports the bailout, estimates that between 1.4 million and 1.7 million jobs indirectly tied to the Big Three would be lost in the first year following widespread auto failures
Friday, November 14, 2008
Lehman Brothers: The Rise and Fall of Lehman Brothers. A History that Goes Beyond the Great Depression.
Lehman Brothers, an investment bank that dates back to 1850, prior to the Civil War has now filed for bankruptcy. A storied institutions that has survived two World Wars, the Great Depression, and practically every other calamity in its 158-year history is no longer solvent. As of 1am on September 15, 2008 the investment bank announced that it would file for Chapter 11 bankruptcy protection.
This astonishing news comes during a weekend when most of the market on Friday was expecting that someone would surely come to the table to help the firm. Whether it was a private purchase or a government sponsored bailout like what occurred with Bear Stearns and JP Morgan, bankruptcy was not expected by many. Early talks indicated that Bank of American and Barclays were in close talks to take over the troubled investment bank. The Federal Reserve which aided in helping the Bear Stearns deal and the U.S. Treasury which just last weekend entered into the biggest bailout known to humankind by aiding Fannie Mae and Freddie Mac both seemed unwilling to come to the aid of Lehman Brothers. I am sure as time goes on more and more details will emerge as to why this occurred.
Bank of America in an unprecedented move went ahead and managed to get their hands on Merrill Lynch for a stunning $29 a share deal. It is stunning enough that Bank of America went after Merrill Lynch especially given that the Friday close per share value was $17. This is the same Bank of America who recently completed its take over of troubled mortgage lender Countrywide Financial. If you recall the deal, BofA offered a higher share price than the current market price for Countrywide but only months later, implied that they would not be back stopping all the debt of Countrywide. The Federal Home Loan Bank had extended a stunning amount of loans to Countrywide so it is yet to be seen how things playout with the Merrill Lynch purchase since the fate of Merrill was very likely going to precede that of Lehman Brothers.
It is unprecedented that in only six months, 3 of the top 5 investment houses on Wall Street are no longer in their previous form. I can imagine that at this point all eyes must be on Goldman Sachs and Morgan Stanley.
The story of Lehman Brothers takes us back to 1844 when a 23 year old Henry Lehman emigrated to the United States from Bavaria. He decided to settle in all places Montgomery Alabama where he decided to open a dry-goods store. In 1847 another brother arrived and in 1850 yet another. The firm changed its name in 1850 to the current Lehman Brothers name.
Cotton had a high market value and seeing a market for this, the 3 brothers started to accept payment in cotton for goods and also created a secondary market for trading in cotton. It makes you wonder how many tranches can be spun from a shipment of cotton? Seeing the need to be closer to the liquid market of cotton in New York the firm relocated to New York in 1858. It later joined the Coffee Exchange and also the New York Stock Exchange. It was sometime before the initial founding of the firm that Lehman Brothers actually underwrote its first public offering. In 1899 it underwrote a public offering for the International Steam Pump Company. It wasn’t until 1906 that the firm started underwriting some bigger public offerings. The names of Sears Roebuck and Company, Woolworth, Macy & Company, and B.F. Goodrich where all part of their earlier team deals with Goldman Sachs. It was making a big name for itself on Wall Street.
During the Great Depression, much of the focus of Lehman went toward venture capital as the equity markets were being hammered. In the 1930s Lehman Brothers underwrote the IPO for DuMont and also helped to provide capital to get RCA going. It also had its hand in financing Halliburton. Like I said, Lehman Brothers has a storied past.
In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank. The merger didn’t go quite as planned and strife arose in the firm. The firm was sold to American Express. AMEX started to break away from banking and brokerage operations and sold off operations to Primerica which in 1994 was broken off as an IPO for the current Lehman Brothers ticker. The firm did exceptionally well purchasing fixed income such as Lincoln Capital Management and Neuberger Berman which still are profitable today. Since the IPO in 1994 Lehman had steadily increased revenues and grew in employees from 8,500 to approximately 28,000.
As glorious as this past may seem Lehman could not resist the subprime markets. In August of 2007 Lehman closed its subprime lender BNC Mortgage which left 1,200 positions gone. This clearly was only the beginning for Lehman and their mortgage and credit problems. In 2008 Lehman was posting unprecedented losses. For the most part their problems arose from holding onto lower grade tranches and holding on too long to subprime mortgages. It is up in the air whether they held onto to these assets because of a foolish investment move or whether their simply wasn’t a market for these assets. For the 2nd quarter the frim had $2.8 billion in losses and was forced to liquidate $6 billion in assets. It is simply stunning to see the stock movement for the firm:
Lehman Brothers
It is hard to believe that only one year ago, this once behemoth of Wall Street had a $47 billion market cap and now is filing for bankruptcy. As the troubles mounted in late August rumors started piling on that a bailout from the Korea Development Bank was in the works. This never materialized. On September 10 Lehman announced another stunning loss of $3.9 billion and made it clear that they were also in the works of selling off the prized jewel in Neuberger Berman to raise capital. The rest we already know and weekend talks broke down and Lehman was forced with no other option but to file for bankruptcy.
Now truly these are unparalleled times. The ink is only drying on the Fannie Mae and Freddie Mac deal which puts at risk $200 billion of taxpayers’ money and given the current housing market is very likely to use up every single penny. Even though many pundits are quick to tell us no money is lost most unbiased analyst are quick to point out that some money will come out of the taxpayers’ wallet. This is the first major bankruptcy of a major investment bank and it is yet to be seen how the already weak markets are going to respond. The Federal Reserve also announced that they will be accepting equities which is simply astounding. Clearly this weekend meeting has the smell of panic more than anything else.
It is easy to lose perspective of what really is going on. You need to remember that debt is at the center of all this. Most of the debt is secured by residential housing but also commercial real estate. We can all rest assured that most of the balance sheets of many of these firms have been overly generous in estimating the value of their assets. A forced mark to market in today’s market is not going to go well. It is a game of financial brinkmanship and many are trying to offload as many toxic debt products without being stuck with the debt. The financial musical chairs are quickly running out. We go from Fannie Mae and Freddie Mac to this in one week. Clearly the balance sheets of these companies are weaker than anticipated. And with housing showing no signs of recovery, we can expect more of the same. The next question that comes to mind is what will happen to Goldman Sachs and Morgan Stanley? The mortgage market looks to be dominated by the government for the foreseeable future through Fannie Mae and Freddie Mac so it makes you wonder what role these companies will have in the debt markets.
If anyone had any doubts that too much leverage is a bad thing, we are quickly realizing how a small dry-goods store can turn into a massive investment bank years later that has brought the entire world’s attention onto it. A systemic crisis seems more and more probable as the year progresses.
This astonishing news comes during a weekend when most of the market on Friday was expecting that someone would surely come to the table to help the firm. Whether it was a private purchase or a government sponsored bailout like what occurred with Bear Stearns and JP Morgan, bankruptcy was not expected by many. Early talks indicated that Bank of American and Barclays were in close talks to take over the troubled investment bank. The Federal Reserve which aided in helping the Bear Stearns deal and the U.S. Treasury which just last weekend entered into the biggest bailout known to humankind by aiding Fannie Mae and Freddie Mac both seemed unwilling to come to the aid of Lehman Brothers. I am sure as time goes on more and more details will emerge as to why this occurred.
Bank of America in an unprecedented move went ahead and managed to get their hands on Merrill Lynch for a stunning $29 a share deal. It is stunning enough that Bank of America went after Merrill Lynch especially given that the Friday close per share value was $17. This is the same Bank of America who recently completed its take over of troubled mortgage lender Countrywide Financial. If you recall the deal, BofA offered a higher share price than the current market price for Countrywide but only months later, implied that they would not be back stopping all the debt of Countrywide. The Federal Home Loan Bank had extended a stunning amount of loans to Countrywide so it is yet to be seen how things playout with the Merrill Lynch purchase since the fate of Merrill was very likely going to precede that of Lehman Brothers.
It is unprecedented that in only six months, 3 of the top 5 investment houses on Wall Street are no longer in their previous form. I can imagine that at this point all eyes must be on Goldman Sachs and Morgan Stanley.
The story of Lehman Brothers takes us back to 1844 when a 23 year old Henry Lehman emigrated to the United States from Bavaria. He decided to settle in all places Montgomery Alabama where he decided to open a dry-goods store. In 1847 another brother arrived and in 1850 yet another. The firm changed its name in 1850 to the current Lehman Brothers name.
Cotton had a high market value and seeing a market for this, the 3 brothers started to accept payment in cotton for goods and also created a secondary market for trading in cotton. It makes you wonder how many tranches can be spun from a shipment of cotton? Seeing the need to be closer to the liquid market of cotton in New York the firm relocated to New York in 1858. It later joined the Coffee Exchange and also the New York Stock Exchange. It was sometime before the initial founding of the firm that Lehman Brothers actually underwrote its first public offering. In 1899 it underwrote a public offering for the International Steam Pump Company. It wasn’t until 1906 that the firm started underwriting some bigger public offerings. The names of Sears Roebuck and Company, Woolworth, Macy & Company, and B.F. Goodrich where all part of their earlier team deals with Goldman Sachs. It was making a big name for itself on Wall Street.
During the Great Depression, much of the focus of Lehman went toward venture capital as the equity markets were being hammered. In the 1930s Lehman Brothers underwrote the IPO for DuMont and also helped to provide capital to get RCA going. It also had its hand in financing Halliburton. Like I said, Lehman Brothers has a storied past.
In 1975 the firm merged with Kuhn, Loeb and Company to form at the time the 4th largest investment bank. The merger didn’t go quite as planned and strife arose in the firm. The firm was sold to American Express. AMEX started to break away from banking and brokerage operations and sold off operations to Primerica which in 1994 was broken off as an IPO for the current Lehman Brothers ticker. The firm did exceptionally well purchasing fixed income such as Lincoln Capital Management and Neuberger Berman which still are profitable today. Since the IPO in 1994 Lehman had steadily increased revenues and grew in employees from 8,500 to approximately 28,000.
As glorious as this past may seem Lehman could not resist the subprime markets. In August of 2007 Lehman closed its subprime lender BNC Mortgage which left 1,200 positions gone. This clearly was only the beginning for Lehman and their mortgage and credit problems. In 2008 Lehman was posting unprecedented losses. For the most part their problems arose from holding onto lower grade tranches and holding on too long to subprime mortgages. It is up in the air whether they held onto to these assets because of a foolish investment move or whether their simply wasn’t a market for these assets. For the 2nd quarter the frim had $2.8 billion in losses and was forced to liquidate $6 billion in assets. It is simply stunning to see the stock movement for the firm:
Lehman Brothers
It is hard to believe that only one year ago, this once behemoth of Wall Street had a $47 billion market cap and now is filing for bankruptcy. As the troubles mounted in late August rumors started piling on that a bailout from the Korea Development Bank was in the works. This never materialized. On September 10 Lehman announced another stunning loss of $3.9 billion and made it clear that they were also in the works of selling off the prized jewel in Neuberger Berman to raise capital. The rest we already know and weekend talks broke down and Lehman was forced with no other option but to file for bankruptcy.
Now truly these are unparalleled times. The ink is only drying on the Fannie Mae and Freddie Mac deal which puts at risk $200 billion of taxpayers’ money and given the current housing market is very likely to use up every single penny. Even though many pundits are quick to tell us no money is lost most unbiased analyst are quick to point out that some money will come out of the taxpayers’ wallet. This is the first major bankruptcy of a major investment bank and it is yet to be seen how the already weak markets are going to respond. The Federal Reserve also announced that they will be accepting equities which is simply astounding. Clearly this weekend meeting has the smell of panic more than anything else.
It is easy to lose perspective of what really is going on. You need to remember that debt is at the center of all this. Most of the debt is secured by residential housing but also commercial real estate. We can all rest assured that most of the balance sheets of many of these firms have been overly generous in estimating the value of their assets. A forced mark to market in today’s market is not going to go well. It is a game of financial brinkmanship and many are trying to offload as many toxic debt products without being stuck with the debt. The financial musical chairs are quickly running out. We go from Fannie Mae and Freddie Mac to this in one week. Clearly the balance sheets of these companies are weaker than anticipated. And with housing showing no signs of recovery, we can expect more of the same. The next question that comes to mind is what will happen to Goldman Sachs and Morgan Stanley? The mortgage market looks to be dominated by the government for the foreseeable future through Fannie Mae and Freddie Mac so it makes you wonder what role these companies will have in the debt markets.
If anyone had any doubts that too much leverage is a bad thing, we are quickly realizing how a small dry-goods store can turn into a massive investment bank years later that has brought the entire world’s attention onto it. A systemic crisis seems more and more probable as the year progresses.
JPMorgan buys WaMu
In the biggest bank failure in history, JPMorgan Chase will acquire massive branch network and troubled assets from Washington Mutual for $1.9 billion.
By David Ellis and Jeanne Sahadi, CNNMoney.com staff writers
Last Updated: September 26, 2008: 12:18 PM ET
AMERICA'S MONEY CRISIS
* Fidelity adds 1,700 to job cuts
* Hartford Financial looks for bailout capital
* Mayors seek bailout funding
* Dear Obama: Send loans fast
* Credit freeze: 2 months after Lehman
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Biggest bank failures
WaMu became the biggest failure in U.S. history following its stunning collapse Thursday.
Bank Size (by assets) Date
Washington Mutual $307B Sept. 2008
Continental Illinois $67.7B* May 1984
First RepublicBank Corp. $49.2B* July 1988
American Savings & Loan Assoc. $45.7B* Sept. 1988
Bank of New England Corp. $29.4B* Jan. 1991
Source:Federal Deposit Insurance Corporation *Asset size in 2008 dollars
Quick Vote
What will happen if no bailout agreement is reached?
*
Serious economic crisis
*
Wall Street will resolve the matter itself
*
Nothing, the crisis talk is overblown
or View results
NEW YORK (CNNMoney.com) -- JPMorgan Chase acquired the banking assets of Washington Mutual late Thursday after the troubled thrift was seized by federal regulators, marking the biggest bank failure in the nation's history and the latest stunning twist in the ongoing credit crisis.
Under the deal, JPMorgan Chase will acquire all the banking operations of WaMu, including $307 billion in assets and $188 billion in deposits.
To put the size of WaMu in context, its assets are equal to about two-thirds of the combined book value assets of all 747 failed thrifts that were sold off by the Resolution Trust Corp. - the former government body that handled the S&L crisis from 1989 through 1995.
In exchange for scooping up WaMu, JPMorgan Chase (JPM, Fortune 500) will pay approximately $1.9 billion to the Federal Deposit Insurance Corporation.
Separately, JPMorgan announced Thursday that it plans to raise $8 billion in additional capital through the sale of stock as part of the deal. The bank expanded the offering to $10 billion on Friday.
The acquisition is JPMorgan Chase's second major purchase this year following the mid-March acquisition of investment bank Bear Stearns, a deal that was also engineered by the government.
"We think it is a great thing for our company," JPMorgan Chase Chairman and CEO Jamie Dimon said in a conference call with investors late Thursday night.
As a result of the acquisition, the New York City-based JPMorgan Chase will now boast some 5,400 branches in 23 states.
Federal regulators, who helped shepherd the deal, stressed that the transition for WaMu customers would be "seamless."
"There will be no interruption in services and bank customers should expect business as usual come Friday morning," FDIC Chairman Sheila Bair said in a statement.
WaMu is the 13th bank to fail so far this year and earns the title of the nation's biggest bank failure by assets on record, ahead of Continental Illinois, which had about $40 billion in assets ($67.7 billion in 2008 dollars) when it failed in May of 1984.
The FDIC, however, was quick to point out Thursday evening that the WaMu-JPMorgan Chase deal would not have any impact to its insurance fund which covers customer deposits when banks fail.
"WaMu's balance sheet and the payment paid by JPMorgan Chase allowed a transaction in which neither the uninsured depositors nor the insurance fund absorbed any losses," Bair said.
The FDIC insures the assets held by 8,451 banking institutions with a total of $13.4 trillion.
A road to collapse
WaMu had been one of the most hard-hit banks during the financial crisis after it bet big, like many of its competitors, on the strength of the U.S. housing market -- only to see its fortunes sour as housing prices fell.
Following several ratings agency downgrades this week and a freefall in the company's stock, many analysts were speculating that the endgame for the embattled savings and loan was imminent.
WaMu (WM, Fortune 500) shares were close to worthless Friday, falling 90% to just 16 cents a share. JPMorgan Chase shares gained more than 2.5% in midday trading.
In a press conference held late Thursday, Bair said regulators deemed it was necessary to act as the company had come under "severe" liquidity pressure. Regulators said that WaMu was experiencing a "run on the bank", as roughly 10% of WaMu deposits were pulled on Monday.
As a result, regulators saw the need to act this week, even as Congress and the White House continued to hash out a bank bailout plan.
Bair added that the company was on the FDIC's latest so-called "problem bank" list for the third quarter, which has yet to be published.
All told, Bair said four banks made bids for WaMu but JPMorgan Chase ultimately won out when the auction was held Wednesday. Several other large institutions, including Wells Fargo (WFC, Fortune 500), Citigroup (C, Fortune 500) and HSBC (HBC), were poring over the company's books, according to news reports last week.
JPMorgan Chase won because they were "the highest bid and the lowest cost resolution," Bair said.
"It was our cheapest option," she said.
Analysts were largely encouraged by the news even as JPMorgan Chase absorbs WaMu's toxic subprime and option-ARM mortgages as part of the deal.
"My initial impression is that this deal is 'generally OK'," wrote Nancy Bush, managing member at investment advisory firm NAB Research LLC, adding that there would be questions about whether the loan losses that JPMorgan took as part of the deal would be sufficient.
All told, JPMorgan Chase said it would recognize projected losses on the loan portfolio upfront by marking down the value of the loans by a whopping $31 billion.
Questions remain
Quite possibly the biggest losers in Thursday's deal, however, are WaMu's stock and debt holders, who were effectively wiped out.
Among that group was the private equity giant TPG, which was part of a consortium of investors that acquired a stake in WaMu for $7 billion in April.
JPMorgan's Dimon said in a conference call with reporters Friday morning that his firm was in talks to buy WaMu earlier this year but that JPMorgan never made a formal offer.
When pressed about what might be next for JPMorgan following two massive deals this year, Dimon didn't close the door altogether on acquiring another commercial bank.
"This is still a big country and there are a lot of places we are not in," he said.
But he and other executives offered little insight about what would happen to WaMu personnel.
Neither Dimon nor Charlie Scharf, JPMorgan's head of retail financial services, were able to provide any estimate as to how many workers could lose jobs as a result of the deal or whether top execs at WaMu, including recently installed CEO Alan Fishman, would remain with the combined firm.
"It's just too early to know right now," said Scharf.
Tough times for banks
The fall of WaMu is the latest turn in a dizzying two weeks that have seen the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America (BAC, Fortune 500) and the near collapse of insurance giant AIG (AIG, Fortune 500).
The widening credit crisis has prompted President Bush to seek from Congress extraordinary authority to spend as much a $700 billion to bail out the nation's financial system by purchasing toxic assets from banks.
President Bush, in a televised address Friday morning, said the nation's economy is at risk, adding he believed that Congress will move quickly on a bailout proposal.
"We've got a big problem," he said.
Regulators acknowledged they were encouraged to get a deal done but Dimon stressed to investors that a potential bailout by the government was not a factor. To top of page
By David Ellis and Jeanne Sahadi, CNNMoney.com staff writers
Last Updated: September 26, 2008: 12:18 PM ET
AMERICA'S MONEY CRISIS
* Fidelity adds 1,700 to job cuts
* Hartford Financial looks for bailout capital
* Mayors seek bailout funding
* Dear Obama: Send loans fast
* Credit freeze: 2 months after Lehman
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Biggest bank failures
WaMu became the biggest failure in U.S. history following its stunning collapse Thursday.
Bank Size (by assets) Date
Washington Mutual $307B Sept. 2008
Continental Illinois $67.7B* May 1984
First RepublicBank Corp. $49.2B* July 1988
American Savings & Loan Assoc. $45.7B* Sept. 1988
Bank of New England Corp. $29.4B* Jan. 1991
Source:Federal Deposit Insurance Corporation *Asset size in 2008 dollars
Quick Vote
What will happen if no bailout agreement is reached?
*
Serious economic crisis
*
Wall Street will resolve the matter itself
*
Nothing, the crisis talk is overblown
or View results
NEW YORK (CNNMoney.com) -- JPMorgan Chase acquired the banking assets of Washington Mutual late Thursday after the troubled thrift was seized by federal regulators, marking the biggest bank failure in the nation's history and the latest stunning twist in the ongoing credit crisis.
Under the deal, JPMorgan Chase will acquire all the banking operations of WaMu, including $307 billion in assets and $188 billion in deposits.
To put the size of WaMu in context, its assets are equal to about two-thirds of the combined book value assets of all 747 failed thrifts that were sold off by the Resolution Trust Corp. - the former government body that handled the S&L crisis from 1989 through 1995.
In exchange for scooping up WaMu, JPMorgan Chase (JPM, Fortune 500) will pay approximately $1.9 billion to the Federal Deposit Insurance Corporation.
Separately, JPMorgan announced Thursday that it plans to raise $8 billion in additional capital through the sale of stock as part of the deal. The bank expanded the offering to $10 billion on Friday.
The acquisition is JPMorgan Chase's second major purchase this year following the mid-March acquisition of investment bank Bear Stearns, a deal that was also engineered by the government.
"We think it is a great thing for our company," JPMorgan Chase Chairman and CEO Jamie Dimon said in a conference call with investors late Thursday night.
As a result of the acquisition, the New York City-based JPMorgan Chase will now boast some 5,400 branches in 23 states.
Federal regulators, who helped shepherd the deal, stressed that the transition for WaMu customers would be "seamless."
"There will be no interruption in services and bank customers should expect business as usual come Friday morning," FDIC Chairman Sheila Bair said in a statement.
WaMu is the 13th bank to fail so far this year and earns the title of the nation's biggest bank failure by assets on record, ahead of Continental Illinois, which had about $40 billion in assets ($67.7 billion in 2008 dollars) when it failed in May of 1984.
The FDIC, however, was quick to point out Thursday evening that the WaMu-JPMorgan Chase deal would not have any impact to its insurance fund which covers customer deposits when banks fail.
"WaMu's balance sheet and the payment paid by JPMorgan Chase allowed a transaction in which neither the uninsured depositors nor the insurance fund absorbed any losses," Bair said.
The FDIC insures the assets held by 8,451 banking institutions with a total of $13.4 trillion.
A road to collapse
WaMu had been one of the most hard-hit banks during the financial crisis after it bet big, like many of its competitors, on the strength of the U.S. housing market -- only to see its fortunes sour as housing prices fell.
Following several ratings agency downgrades this week and a freefall in the company's stock, many analysts were speculating that the endgame for the embattled savings and loan was imminent.
WaMu (WM, Fortune 500) shares were close to worthless Friday, falling 90% to just 16 cents a share. JPMorgan Chase shares gained more than 2.5% in midday trading.
In a press conference held late Thursday, Bair said regulators deemed it was necessary to act as the company had come under "severe" liquidity pressure. Regulators said that WaMu was experiencing a "run on the bank", as roughly 10% of WaMu deposits were pulled on Monday.
As a result, regulators saw the need to act this week, even as Congress and the White House continued to hash out a bank bailout plan.
Bair added that the company was on the FDIC's latest so-called "problem bank" list for the third quarter, which has yet to be published.
All told, Bair said four banks made bids for WaMu but JPMorgan Chase ultimately won out when the auction was held Wednesday. Several other large institutions, including Wells Fargo (WFC, Fortune 500), Citigroup (C, Fortune 500) and HSBC (HBC), were poring over the company's books, according to news reports last week.
JPMorgan Chase won because they were "the highest bid and the lowest cost resolution," Bair said.
"It was our cheapest option," she said.
Analysts were largely encouraged by the news even as JPMorgan Chase absorbs WaMu's toxic subprime and option-ARM mortgages as part of the deal.
"My initial impression is that this deal is 'generally OK'," wrote Nancy Bush, managing member at investment advisory firm NAB Research LLC, adding that there would be questions about whether the loan losses that JPMorgan took as part of the deal would be sufficient.
All told, JPMorgan Chase said it would recognize projected losses on the loan portfolio upfront by marking down the value of the loans by a whopping $31 billion.
Questions remain
Quite possibly the biggest losers in Thursday's deal, however, are WaMu's stock and debt holders, who were effectively wiped out.
Among that group was the private equity giant TPG, which was part of a consortium of investors that acquired a stake in WaMu for $7 billion in April.
JPMorgan's Dimon said in a conference call with reporters Friday morning that his firm was in talks to buy WaMu earlier this year but that JPMorgan never made a formal offer.
When pressed about what might be next for JPMorgan following two massive deals this year, Dimon didn't close the door altogether on acquiring another commercial bank.
"This is still a big country and there are a lot of places we are not in," he said.
But he and other executives offered little insight about what would happen to WaMu personnel.
Neither Dimon nor Charlie Scharf, JPMorgan's head of retail financial services, were able to provide any estimate as to how many workers could lose jobs as a result of the deal or whether top execs at WaMu, including recently installed CEO Alan Fishman, would remain with the combined firm.
"It's just too early to know right now," said Scharf.
Tough times for banks
The fall of WaMu is the latest turn in a dizzying two weeks that have seen the bankruptcy of Lehman Brothers, the acquisition of Merrill Lynch by Bank of America (BAC, Fortune 500) and the near collapse of insurance giant AIG (AIG, Fortune 500).
The widening credit crisis has prompted President Bush to seek from Congress extraordinary authority to spend as much a $700 billion to bail out the nation's financial system by purchasing toxic assets from banks.
President Bush, in a televised address Friday morning, said the nation's economy is at risk, adding he believed that Congress will move quickly on a bailout proposal.
"We've got a big problem," he said.
Regulators acknowledged they were encouraged to get a deal done but Dimon stressed to investors that a potential bailout by the government was not a factor. To top of page
GM failure: The shockwave
If General Motors declares bankruptcy, industry watchers say, the entire domestic auto industry could be badly hurt.
By Peter Valdes-Dapena, CNNMoney.com senior writer
Last Updated: November 14, 2008: 12:36 PM ET
NEW YORK (CNNMoney.com) -- If General Motors really does run out of money by the end of the year, as it predicted was possible, the impact would be felt far and wide - to hundreds of suppliers, rival automakers and ultimately dealers across the nation.
"Once the first domino falls, it rapidly takes out all the other dominoes," said Dennis Virag, president of the Automotive Consulting Group.
Suppliers would be among the first to feel those effects since GM only manufactures the body, the engine and the transmission used in its cars.
In the United States alone, GM spends $31 billion on parts from 2,100 different suppliers. These include the "direct suppliers" involved in producing a vehicle - those that provide everything from steering wheels and seatbelts to brakes and airbags - as well as "indirect suppliers" - those that make things such as gloves, protective eyewear, shop rags and lightbulbs.
Although lawmakers appear to be souring on providing a $25 billion bailout to automakers, the impact of a GM failure on the industry as a whole - and therefore the economy as a whole - is weighing heavily in their decisions.
So far this year, 23 major auto-related companies, most of them parts suppliers, have filed for bankruptcy, according to consulting firm Grant Thornton. They are struggling since car makers have cut back as sales have slowed and raw-material prices have risen.
"I would argue that in today's environment, with the stress that's already on the supply base, they can't take another hit," said Kimberly Rodriguez, a principal at Grant Thornton's automotive practice. "The ripple effect would be huge," she added.
Impact on rival car makers
As supplier companies fail, that would have a direct impact on Ford and Chrysler, since the three domestic auto manufacturers share about 70% of their suppliers, Rodriguez estimated.
One executive who works for a Detroit automaker, and who did not want to be named, said the impact of GM - or any of the three - failing would be dramatic and very challenging.
Not all those affected would suffer equally, but it is hard to predict which companies would be hit hardest, because the relationships among the various suppliers and automakers are complex, he said.
Impact on dealers
A GM failure would also affect about 14,000 dealers in the United States, according to the industry newspaper Automotive News. That is almost half of the nation's 29,000 dealerships that specialize in domestic vehicles.
But even if those 14,000 GM dealers also offer foreign cars, the risk of losing their supply of domestic vehicles could force many of them out of business, said Paul Taylor, an economist with the National Automobile Dealers Association. Already, he noted, the industry is expected to lose about 700 dealers by the end of this year, up to 80% of which will be domestic-brand stores.
Car companies are wary of publicly discussing the possibility of financial disaster because it makes it harder to sell the cars that are on dealer lots today, said consultant Virag. Customers don't want to buy from a company they fear may soon be insolvent.
"It's a difficult situation that the automakers are in," said Virag. "To talk about bankruptcy would only exacerbate the situation, but not talking about it isn't helping."
But whether a bankruptcy would help suppliers and everyone dependent upon GM is still uncertain.
If it is determined that GM could file for bankruptcy under Chapter 11 rules, rather than a Chapter 7 liquidation, the automaker could potentially reorganize. That way the company could seek permission to pay outstanding bills to "critical suppliers" that it absolutely needs, said Robert Sanker, a Cleveland bankruptcy attorney who has represented creditors of bankrupt auto suppliers.
Still, Sanker said, relatively few suppliers would be granted "critical supplier" status in court, leaving many more that would have payments cut off.
And GM is says it is not considering Chapter 11, but rather is continuing to seek government assistance. "Bankruptcy reorganization is not an option for GM because it would create more problems than it would solve," said spokesman Dan Flores. To top of page
First Published: November 14, 2008: 12:25 PM ET
By Peter Valdes-Dapena, CNNMoney.com senior writer
Last Updated: November 14, 2008: 12:36 PM ET
NEW YORK (CNNMoney.com) -- If General Motors really does run out of money by the end of the year, as it predicted was possible, the impact would be felt far and wide - to hundreds of suppliers, rival automakers and ultimately dealers across the nation.
"Once the first domino falls, it rapidly takes out all the other dominoes," said Dennis Virag, president of the Automotive Consulting Group.
Suppliers would be among the first to feel those effects since GM only manufactures the body, the engine and the transmission used in its cars.
In the United States alone, GM spends $31 billion on parts from 2,100 different suppliers. These include the "direct suppliers" involved in producing a vehicle - those that provide everything from steering wheels and seatbelts to brakes and airbags - as well as "indirect suppliers" - those that make things such as gloves, protective eyewear, shop rags and lightbulbs.
Although lawmakers appear to be souring on providing a $25 billion bailout to automakers, the impact of a GM failure on the industry as a whole - and therefore the economy as a whole - is weighing heavily in their decisions.
So far this year, 23 major auto-related companies, most of them parts suppliers, have filed for bankruptcy, according to consulting firm Grant Thornton. They are struggling since car makers have cut back as sales have slowed and raw-material prices have risen.
"I would argue that in today's environment, with the stress that's already on the supply base, they can't take another hit," said Kimberly Rodriguez, a principal at Grant Thornton's automotive practice. "The ripple effect would be huge," she added.
Impact on rival car makers
As supplier companies fail, that would have a direct impact on Ford and Chrysler, since the three domestic auto manufacturers share about 70% of their suppliers, Rodriguez estimated.
One executive who works for a Detroit automaker, and who did not want to be named, said the impact of GM - or any of the three - failing would be dramatic and very challenging.
Not all those affected would suffer equally, but it is hard to predict which companies would be hit hardest, because the relationships among the various suppliers and automakers are complex, he said.
Impact on dealers
A GM failure would also affect about 14,000 dealers in the United States, according to the industry newspaper Automotive News. That is almost half of the nation's 29,000 dealerships that specialize in domestic vehicles.
But even if those 14,000 GM dealers also offer foreign cars, the risk of losing their supply of domestic vehicles could force many of them out of business, said Paul Taylor, an economist with the National Automobile Dealers Association. Already, he noted, the industry is expected to lose about 700 dealers by the end of this year, up to 80% of which will be domestic-brand stores.
Car companies are wary of publicly discussing the possibility of financial disaster because it makes it harder to sell the cars that are on dealer lots today, said consultant Virag. Customers don't want to buy from a company they fear may soon be insolvent.
"It's a difficult situation that the automakers are in," said Virag. "To talk about bankruptcy would only exacerbate the situation, but not talking about it isn't helping."
But whether a bankruptcy would help suppliers and everyone dependent upon GM is still uncertain.
If it is determined that GM could file for bankruptcy under Chapter 11 rules, rather than a Chapter 7 liquidation, the automaker could potentially reorganize. That way the company could seek permission to pay outstanding bills to "critical suppliers" that it absolutely needs, said Robert Sanker, a Cleveland bankruptcy attorney who has represented creditors of bankrupt auto suppliers.
Still, Sanker said, relatively few suppliers would be granted "critical supplier" status in court, leaving many more that would have payments cut off.
And GM is says it is not considering Chapter 11, but rather is continuing to seek government assistance. "Bankruptcy reorganization is not an option for GM because it would create more problems than it would solve," said spokesman Dan Flores. To top of page
First Published: November 14, 2008: 12:25 PM ET
The Rise and Fall of Subprime Mortgages
by Danielle DiMartino and John V. Duca
After booming the first half of this decade, U.S. housing activity has retrenched sharply. Single-family building permits have plunged 52 percent and existing-home sales have declined 30 percent since their September 2005 peaks (Chart 1).
Chart 1: Housing activity drops off
A rise in mortgage interest rates that began in the summer of 2005 contributed to the housing market's initial weakness. By late 2006, though, some signs pointed to renewed stability. They proved short-lived as loan-quality problems sparked a tightening of credit standards on mortgages, particularly for newer and riskier products. As lenders cut back, housing activity began to falter again in spring 2007, accompanied by additional rises in delinquencies and foreclosures. Late-summer financial-market turmoil prompted further toughening of mortgage credit standards.
The recent boom-to-bust housing cycle raises important questions. Why did it occur, and what role did subprime lending play? How is the retrenchment in lending activity affecting housing markets, and will it end soon? Is the housing slowdown spilling over into the broader economy?
Rise of Nontraditional Mortgages
Monitoring housing today entails tracking an array of mortgage products. In the past few years, a fast-growing market seized upon such arrangements as "option ARMs," "no-doc interest-onlys" and "zero-downs with a piggyback." For our purposes, it's sufficient to distinguish among prime, jumbo, subprime and near-prime mortgages.
Prime mortgages are the traditional—and still most prevalent—type of loan. These go to borrowers with good credit, who make traditional down payments and fully document their income. Jumbo loans are generally of prime quality, but they exceed the $417,000 ceiling for mortgages that can be bought and guaranteed by government-sponsored enterprises.
Subprime mortgages are extended to applicants deemed the least creditworthy because of low credit scores or uncertain income prospects, both of which reflect the highest default risk and warrant the highest interest rates. Near-prime mortgages, which are smaller than jumbos, are made to borrowers who qualify for credit a notch above subprime but may not be able to fully document their income or provide traditional down payments. Most mortgages in the near-prime category are securitized in so-called Alternative-A, or Alt-A, pools.
Some 80 percent of outstanding U.S. mortgages are prime, while 14 percent are subprime and 6 percent fall into the near-prime category. These numbers, however, mask the explosive growth of nonprime mortgages. Subprime and near-prime loans shot up from 9 percent of newly originated securitized mortgages in 2001 to 40 percent in 2006.[1]
The nonprime boom introduced practices that made it easier to obtain loans. Some mortgages required little or no proof of income; others needed little or no down payment. Homebuyers could take out a simultaneous second, or piggyback, mortgage at the time of purchase, make interest-only payments for up to 15 years, skip payments by reducing equity or, in some cases, obtain a mortgage that exceeded the home's value.
These new practices opened the housing market to millions of Americans, pushing the homeownership rate from 63.8 percent in 1994 to a record 69.2 percent in 2004. Although low interest rates bolstered homebuying early in the decade, the expansion of nonprime mortgages clearly played a role in the surge of homeownership.
Two crucial developments spurred nonprime mortgages' rapid growth. First, mortgage lenders adopted the credit-scoring techniques first used in making subprime auto loans. With these tools, lenders could better sort applicants by creditworthiness and offer them appropriately risk-based loan rates.
By itself, credit scoring couldn't have fostered the rapid growth of nonprime lending. Banks lack the equity capital needed to hold large volumes of these risky loans in their portfolios. And lenders of all types couldn't originate and then sell these loans to investors in the form of residential mortgage-backed securities, or RMBS—at least not without added protection against defaults.
The spread of new products offering default protection was the second crucial development that fostered subprime lending growth. Traditionally, banks made prime mortgages funded with deposits from savers. By the 1980s and 1990s, the need for deposits had eased as mortgage lenders created a new way for funds to flow from savers and investors to prime borrowers through government-sponsored enterprises (GSEs) (Chart 2, upper panel).
Chart 2: Mortgage financial flows
Fannie Mae and Freddie Mac are the largest GSEs, with Ginnie Mae being smaller. These enterprises guarantee the loans and pool large groups of them into RMBS. They're then sold to investors, who receive a share of the payments on the underlying mortgages. Because the GSEs are federally chartered, investors perceive an implicit government guarantee of them. Fannie Mae and Freddie Mac, however, haven't packaged many nonprime mortgages into RMBS.
Lacking the same perceived status, nonagency RMBS—those not issued by Fannie Mae, Freddie Mac and Ginnie Mae—faced the hurdle of paying investors extremely large premiums to compensate them for high default risk. These high costs would have pushed nonprime interest rates to levels outside the reach of targeted borrowers.
This is where financial innovations came into play. Some—like collateralized debt obligations (CDOs), a common RMBS derivative—were designed to protect investors in nonagency securities against default losses. Such CDOs divide the streams of income that flow from the underlying mortgages into tranches that absorb default losses according to a preset priority.
The lowest-rated tranche absorbs the first defaults on the pool of underlying mortgages, with successively higher ranked and rated tranches absorbing any additional defaults. If defaults turn out to be low, there may be no losses for higher-ranked tranches to absorb. But if defaults are much greater than expected, even higher-rated tranches may face losses.
Having confidence in the ability of quantitative models to accurately measure nonprime default risk, a brisk market emerged for securities backed by nonprime loans. The combination of new credit-scoring techniques and new nonagency RMBS products enabled nonprime-rated applicants to qualify for mortgages, opening a new channel for funds to flow from savers to a new class of borrowers in this decade (Chart 2, lower panel).
Nonprime Boom Unravels
As problems began to emerge in late 2006, investors realized they had purchased nonprime RMBS with overly optimistic expectations of loan quality.[2] Much of their misjudgment plausibly stemmed from the difficulty of forecasting default losses based on the short history of nonprime loans.
Subprime loan problems had surfaced just before and at the start of the 2001 recession but then rapidly retreated from 2002 to 2005 as the economy recovered (Chart 3). This pre-2006 pattern suggested that as long as unemployment remained low, so, too, would default and delinquency rates.
Chart 3: Quality of prime and subprime mortgages deteriorates
This interpretation ignored two other factors that had helped alleviate subprime loan problems earlier in the decade. First, this was a period of rapidly escalating home prices. Subprime borrowers who encountered financial problems could either borrow against their equity to make house payments or sell their homes to settle their debts. Second, interest rates declined significantly in the early 2000s. This helped lower the base rate to which adjustable mortgage rates were indexed, thereby limiting the increase when initial, teaser rates ended.
Favorable home-price and interest rate developments likely led models that were overly focused on unemployment as a driver of problem loans to underestimate the risk of nonprime mortgages. Indeed, swings in home-price appreciation and interest rates may also explain why prime and subprime loan quality have trended together in the 2000s. This can be seen once we account for the fact that past-due rates—the percentage of mortgages delinquent or in some stage of foreclosure—typically run five times higher on subprime loans (Chart 3). When the favorable home-price and interest rate factors reversed, the past-due rate rose markedly, despite continued low unemployment.
Failure to appreciate the risks of nonprime loans prompted lenders to overly ease credit standards.[3] The result was a huge jump in origination shares for subprime and near-prime mortgages.
Compared with conventional prime loans in 2006, average down payments were lower, at 6 percent for subprime mortgages and 12 percent for near-prime loans.[4] The relatively small down payments often entailed borrowers' taking out piggyback loans to pay the portion of their home prices above the 80 percent covered by first-lien mortgages.
Another form of easing facilitated the rapid rise of mortgages that didn't require borrowers to fully document their incomes. In 2006, these low- or no-doc loans comprised 81 percent of near-prime, 55 percent of jumbo, 50 percent of subprime and 36 percent of prime securitized mortgages.
The easier lending standards coincided with a sizeable rise in adjustable-rate mortgages (ARMs). Of the mortgages originated in 2006 that were later securitized, 92 percent of subprime, 68 percent of near-prime, 43 percent of jumbo and 23 percent of prime mortgages had adjustable rates. Now, with rates on one-year adjustable and 30-year fixed mortgages close, ARMs' market share has dwindled to 15 percent, less than half its recent peak of 35 percent in 2004.
In early 2007, investors and lenders began to realize the ramifications of credit-standard easing. Delinquency rates for 6-month-old subprime and near-prime loans underwritten in 2006 were far higher than those of the same age originated in 2004.
Other signs of deterioration also surfaced. The past-due rate for outstanding subprime mortgages rose sharply and neared the peak reached in 2002, with the deterioration much worse for adjustable- than fixed-rate mortgages. In first quarter 2007, the rate at which residential mortgages entered foreclosure rose to its fastest pace since tracking of these data began in 1970.
Lenders reacted to these signs by initially tightening credit standards more on riskier mortgages. In the Federal Reserve's April 2007 survey of senior loan officers, 15 percent of banks indicated they had raised standards for mortgages to prime borrowers in the prior three months, but a much higher 56 percent had done so for subprime mortgages. Responses to the July 2007 survey were similar.
However, in the October 2007 survey the share of banks tightening standards on prime mortgages jumped to 41 percent, while 56 percent did so for subprime loans. Many nonbank lenders have also imposed tougher standards or simply exited the business altogether. This likely reflects lenders' response to the financial disruptions seen since last summer.
The stricter standards meant fewer buyers could bid on homes, affecting prices for prime and subprime borrowers alike. Foreclosures added to downward pressures on home prices by raising the supply of houses on the market. And after peaking in September 2005, single-family home sales fell in September 2007 to their lowest level since January 1998.
The number of unsold homes on the market has risen, sharply pushing up the inventory-to-sales ratio for existing single-family homes from their low in January 2005 to their highest level since the start of this series in 1989 (Chart 4). Condominium supply, which is reflected in the all-home numbers, has experienced an even sharper increase since early 2005.
Chart 4: Existing-home inventories rise from late-2004 lows
These high inventories will likely weigh on construction and home prices for months to come. After peaking in early 2005, the Standard & Poor's/Case-Shiller index of year-over-year home-price appreciation in 10 large U.S. cities was down 5 percent in August—its biggest drop since 1991. While a Freddie Mac gauge of home prices posted a small year-over-year gain in the second quarter, the pace was dramatically off its highest rate, reported in third quarter 2005 (Chart 5).
Chart 5: Home-price appreciation plunges into negative territory
In the absence of home-price appreciation, many households are finding it difficult to refinance their way out of adjustable-rate mortgages obtained at the height of the housing boom. Larger mortgage payments could exacerbate delinquencies and foreclosures, especially with interest rate resets expected to remain high for the next year (Chart 6). This suggests mortgage quality will likely continue to fall off for some time.
Scheduled resets on adjustable-rate mortgages remain high
Financial Turmoil
By August 2007, the housing market's weaknesses were apparent: loan-quality problems, uncertainty about inventories, interest rate resets and spillovers from weaker home prices. These, coupled with ratings agencies' downgrading of many subprime RMBS, led to a dramatic thinning in trading for subprime credit instruments, many of which carried synthetic, rather than market, values based on models because of the instruments' illiquidity.
On Aug. 14, the paralysis in the capital markets led three investment funds to halt redemptions because they couldn't reasonably calculate the prices at which their shares could be valued. This event triggered widespread concern about the pricing of many new instruments, calling into question many financial firms' market values and disrupting the normal workings of the financial markets.
Investors sought liquidity, putting upward pressure on overnight interest rates and sparking a sharp upward repricing of risk premiums on assets, particularly those linked to nonprime mortgages. One outcome was an interest rate spike for both mortgage-backed commercial paper and jumbo mortgages, which heightened financial market uncertainty. In this environment, nonagency RMBS were viewed as posing more liquidity and default risk than those packaged by Fannie Mae and Freddie Mac.
Facing greater perceived default risk, investors began demanding much higher risk premiums on jumbo mortgage securities, pushing up the cost of funding such loans via securitization and encouraging lenders to incur the extra cost of holding more of these loans in their portfolios. This contributed to a 1 percentage point jump in jumbo interest rates between June and late August, an especially important increase given that jumbos accounted for about 12 percent of mortgage originations last year.
Although spreads between jumbo and conforming loan rates have fallen off their late-summer highs, they're still elevated. The higher rates have dampened the demand for more expensive homes, just as tighter credit standards reduced the number of buyers for lower-end homes.
Macroeconomic Effects
A housing slowdown mainly affects gross domestic product by curtailing housing construction and home-related spending. It also reins in spending by consumers who have less housing wealth against which to borrow.[5]
Residential construction likely exerted its largest negative effect in third quarter 2006, when it subtracted 1.3 percentage points from the annual pace of real GDP growth. Last year, many forecasts predicted home construction would stop restraining GDP growth by the end of 2007 and the industry would start recovering in 2008. These predictions were made before the tightening of nonprime credit standards began in late 2006. The change in standards will likely prolong the housing downturn and delay the recovery, although it's hard to tell precisely for how long. Since single-family permits have already fallen 52 percent from their September 2005 peak, however, the worst of the homebuilding drag may be behind us.
The same may not be true for housing's indirect effect on consumption. Since the late 1990s, many homeowners have borrowed against housing wealth, using home equity lines of credit or cash-out refinancing or not fully rolling over capital gains on one house into a down payment or improvements on the next one. These mortgage equity withdrawals gave people access to lower cost, collateralized loans, which bolstered spending on consumer goods. By one measure, these withdrawals were as large as 6 to 7 percent of labor and transfer income in the early to mid-2000s.
The magnitude and timing of these withdrawals may have changed in hard-to-gauge ways. New research suggests housing wealth's impact on consumer spending grew as recent financial innovations expanded the ability to tap housing equity.[6] This is consistent with prior research on housing's connection to U.S. consumer spending.[7] Aside from the interest-rate-related refinancing surge of 2002 and 2003, mortgage equity-withdrawal movements have become increasingly sensitive to swings in home-price appreciation since a 1986 law granted a federal income tax deduction for home equity loans (Chart 7).
Chart 7: Mortgage equity withdrawals increasingly move with housing inflation and mortgage refinancings
Compounding the uncertain outlook for consumption is the likely reversal of the early 2000s' mortgage credit liberalization.[8] This will put further downward pressure on home prices and housing wealth and may curtail home equity loans and cash-out refinancings. Finally, the homebuying enabled by the easing of credit standards in recent years may have been at the expense of later sales, further dampening the market going forward.
The timing of housing wealth's impact on consumption may have also changed. For example, before the advent of equity lines and cash-out refinancings, housing wealth increases may have affected U.S. consumption mainly by reducing homeowners' need to save for retirement. Since then, such financial innovations have enabled households to spend their equity gains before retirement. It's unclear how much this may be reversed by the 2007 retrenchment in mortgage availability.
Looking Ahead
The rise and fall of nonprime mortgages has taken us into largely uncharted territory. Past behavior, however, suggests that housing markets' adjustment to more realistic lending standards is likely to be prolonged. [9]
One manifestation of the slow downward adjustment of home prices and construction activity is the mounting level of unsold homes. The muted outlook for home-price appreciation, coupled with the resetting of many nonprime interest rates, suggests foreclosures will increase for some time.
The sharp reversal of trends in home-price appreciation will also dampen consumer spending growth, an effect that may worsen if the pullback in mortgage availability limits people's ability to borrow against their homes.
Although recent financial market turmoil will likely add to the housing slowdown, there are mitigating factors.
First, the effect of slower home-price gains on consumer spending is likely to be drawn out, giving monetary policy time to adjust if necessary.
Second, the Federal Reserve has been successful in slowing core inflation while maintaining economic growth. This gives policymakers inflation-fighting credibility, which enables them to coax down market interest rates should the economy need stimulus.
Third, even if the tightening of mortgage credit standards undesirably slows aggregate demand, monetary policy could still, if need be, help offset the overall effect by stimulating the economy via lower interest rates. This would bolster net exports and business investment and help cushion the impact of higher risk premiums on the costs of financing for firms and households.[10]
About the Authors
DiMartino is an economics writer and Duca a vice president and senior policy advisor in the Research Department of the Federal Reserve Bank of Dallas.
Notes
The authors thank Jessica Renier for research assistance.
1. See "The Subprime Slump and the Housing Market," by Andrew Tilton, US Economics Analyst, Goldman Sachs, Feb. 23, 2007, pp. 4–6. Securitized mortgages account for roughly 70 to 75 percent of outstanding, first-lien U.S. residential mortgages, according to estimates in "Mortgage Liquidity du Jour: Underestimated No More," Credit Suisse, March 13, 2007, p. 28.
2. See, for example, Federal Reserve Chairman Ben Bernanke's remarks, "Housing, Housing Finance, and Monetary Policy," Off-siteat the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyo., Aug. 31, 2007.
3. Part of the reason lenders eased credit standards was that they planned to sell, rather than hold, the mortgages. The earlier easing of standards may have partly owed to the potential moral hazard entailed when nonconforming loans are originated with the intent to fully sell them to investors. Bernanke discusses this in his remarks at the 2007 Jackson Hole symposium (note 2).
4. The figures are for securitized mortgages. See "Mortgage Liquidity du Jour" (note 1).
5. "Making Sense of the U.S. Housing Slowdown," by John Duca, Federal Reserve Bank of Dallas Economic Letter, November 2006.
6. See "How Large Is the Housing Wealth Effect? A New Approach," by Christopher D. Carroll, Misuzu Otsuka and Jirka Slacalek, National Bureau of Economic Research Working Paper no. 12746, December 2006; and "Housing, Credit and Consumer Expenditure," by John Muellbauer, paper presented at the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyo., Aug. 31–Sept. 1, 2007. Also see "Booms and Busts in the UK Housing Market," by John Muellbauer and Anthony Murphy, Economic Journal, vol. 107, November 1997, pp. 1701–27; and "House Prices, Consumption, and Monetary Policy: A Financial Accelerator Approach," by Kosuke Aoki, James Proudman and Gertjan Vlieghe, Journal of Financial Intermediation, vol. 13, October 2004, pp. 414–35.
7. "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences," by Alan Greenspan and James Kennedy, Finance and Economics Discussion Series Working Paper no. 2005-41, Board of Governors of the Federal Reserve System, September 2005; and "Mutual Funds and the Evolving Long-Run Effects of Stock Wealth on U.S. Consumption," by John V. Duca, Journal of Economics and Business, vol. 58, May/June 2006, pp. 202–21.
8. This is a possibility to which Muellbauer (2007, note 6) alludes.
9. See Duca (note 5).
10. For a discussion of the channels of monetary policy, see "Aggregate Disturbances, Monetary Policy, and the Macroeconomy: The FRB/US Perspective," by David Reifschneider, Robert Tetlow and John Williams, Federal Reserve Bulletin, January 1999, pp. 1–19.
Economic Letter is published monthly by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.
Articles may be reprinted on the condition that the source is credited and a copy is provided to the Research Department of the Federal Reserve Bank of Dallas.
Economic Letter is available free of charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906; by fax at 214-922-5268; or by telephone at 214-922-5254. This publication is available on the Dallas Fed web site, www.dallasfed.org.
After booming the first half of this decade, U.S. housing activity has retrenched sharply. Single-family building permits have plunged 52 percent and existing-home sales have declined 30 percent since their September 2005 peaks (Chart 1).
Chart 1: Housing activity drops off
A rise in mortgage interest rates that began in the summer of 2005 contributed to the housing market's initial weakness. By late 2006, though, some signs pointed to renewed stability. They proved short-lived as loan-quality problems sparked a tightening of credit standards on mortgages, particularly for newer and riskier products. As lenders cut back, housing activity began to falter again in spring 2007, accompanied by additional rises in delinquencies and foreclosures. Late-summer financial-market turmoil prompted further toughening of mortgage credit standards.
The recent boom-to-bust housing cycle raises important questions. Why did it occur, and what role did subprime lending play? How is the retrenchment in lending activity affecting housing markets, and will it end soon? Is the housing slowdown spilling over into the broader economy?
Rise of Nontraditional Mortgages
Monitoring housing today entails tracking an array of mortgage products. In the past few years, a fast-growing market seized upon such arrangements as "option ARMs," "no-doc interest-onlys" and "zero-downs with a piggyback." For our purposes, it's sufficient to distinguish among prime, jumbo, subprime and near-prime mortgages.
Prime mortgages are the traditional—and still most prevalent—type of loan. These go to borrowers with good credit, who make traditional down payments and fully document their income. Jumbo loans are generally of prime quality, but they exceed the $417,000 ceiling for mortgages that can be bought and guaranteed by government-sponsored enterprises.
Subprime mortgages are extended to applicants deemed the least creditworthy because of low credit scores or uncertain income prospects, both of which reflect the highest default risk and warrant the highest interest rates. Near-prime mortgages, which are smaller than jumbos, are made to borrowers who qualify for credit a notch above subprime but may not be able to fully document their income or provide traditional down payments. Most mortgages in the near-prime category are securitized in so-called Alternative-A, or Alt-A, pools.
Some 80 percent of outstanding U.S. mortgages are prime, while 14 percent are subprime and 6 percent fall into the near-prime category. These numbers, however, mask the explosive growth of nonprime mortgages. Subprime and near-prime loans shot up from 9 percent of newly originated securitized mortgages in 2001 to 40 percent in 2006.[1]
The nonprime boom introduced practices that made it easier to obtain loans. Some mortgages required little or no proof of income; others needed little or no down payment. Homebuyers could take out a simultaneous second, or piggyback, mortgage at the time of purchase, make interest-only payments for up to 15 years, skip payments by reducing equity or, in some cases, obtain a mortgage that exceeded the home's value.
These new practices opened the housing market to millions of Americans, pushing the homeownership rate from 63.8 percent in 1994 to a record 69.2 percent in 2004. Although low interest rates bolstered homebuying early in the decade, the expansion of nonprime mortgages clearly played a role in the surge of homeownership.
Two crucial developments spurred nonprime mortgages' rapid growth. First, mortgage lenders adopted the credit-scoring techniques first used in making subprime auto loans. With these tools, lenders could better sort applicants by creditworthiness and offer them appropriately risk-based loan rates.
By itself, credit scoring couldn't have fostered the rapid growth of nonprime lending. Banks lack the equity capital needed to hold large volumes of these risky loans in their portfolios. And lenders of all types couldn't originate and then sell these loans to investors in the form of residential mortgage-backed securities, or RMBS—at least not without added protection against defaults.
The spread of new products offering default protection was the second crucial development that fostered subprime lending growth. Traditionally, banks made prime mortgages funded with deposits from savers. By the 1980s and 1990s, the need for deposits had eased as mortgage lenders created a new way for funds to flow from savers and investors to prime borrowers through government-sponsored enterprises (GSEs) (Chart 2, upper panel).
Chart 2: Mortgage financial flows
Fannie Mae and Freddie Mac are the largest GSEs, with Ginnie Mae being smaller. These enterprises guarantee the loans and pool large groups of them into RMBS. They're then sold to investors, who receive a share of the payments on the underlying mortgages. Because the GSEs are federally chartered, investors perceive an implicit government guarantee of them. Fannie Mae and Freddie Mac, however, haven't packaged many nonprime mortgages into RMBS.
Lacking the same perceived status, nonagency RMBS—those not issued by Fannie Mae, Freddie Mac and Ginnie Mae—faced the hurdle of paying investors extremely large premiums to compensate them for high default risk. These high costs would have pushed nonprime interest rates to levels outside the reach of targeted borrowers.
This is where financial innovations came into play. Some—like collateralized debt obligations (CDOs), a common RMBS derivative—were designed to protect investors in nonagency securities against default losses. Such CDOs divide the streams of income that flow from the underlying mortgages into tranches that absorb default losses according to a preset priority.
The lowest-rated tranche absorbs the first defaults on the pool of underlying mortgages, with successively higher ranked and rated tranches absorbing any additional defaults. If defaults turn out to be low, there may be no losses for higher-ranked tranches to absorb. But if defaults are much greater than expected, even higher-rated tranches may face losses.
Having confidence in the ability of quantitative models to accurately measure nonprime default risk, a brisk market emerged for securities backed by nonprime loans. The combination of new credit-scoring techniques and new nonagency RMBS products enabled nonprime-rated applicants to qualify for mortgages, opening a new channel for funds to flow from savers to a new class of borrowers in this decade (Chart 2, lower panel).
Nonprime Boom Unravels
As problems began to emerge in late 2006, investors realized they had purchased nonprime RMBS with overly optimistic expectations of loan quality.[2] Much of their misjudgment plausibly stemmed from the difficulty of forecasting default losses based on the short history of nonprime loans.
Subprime loan problems had surfaced just before and at the start of the 2001 recession but then rapidly retreated from 2002 to 2005 as the economy recovered (Chart 3). This pre-2006 pattern suggested that as long as unemployment remained low, so, too, would default and delinquency rates.
Chart 3: Quality of prime and subprime mortgages deteriorates
This interpretation ignored two other factors that had helped alleviate subprime loan problems earlier in the decade. First, this was a period of rapidly escalating home prices. Subprime borrowers who encountered financial problems could either borrow against their equity to make house payments or sell their homes to settle their debts. Second, interest rates declined significantly in the early 2000s. This helped lower the base rate to which adjustable mortgage rates were indexed, thereby limiting the increase when initial, teaser rates ended.
Favorable home-price and interest rate developments likely led models that were overly focused on unemployment as a driver of problem loans to underestimate the risk of nonprime mortgages. Indeed, swings in home-price appreciation and interest rates may also explain why prime and subprime loan quality have trended together in the 2000s. This can be seen once we account for the fact that past-due rates—the percentage of mortgages delinquent or in some stage of foreclosure—typically run five times higher on subprime loans (Chart 3). When the favorable home-price and interest rate factors reversed, the past-due rate rose markedly, despite continued low unemployment.
Failure to appreciate the risks of nonprime loans prompted lenders to overly ease credit standards.[3] The result was a huge jump in origination shares for subprime and near-prime mortgages.
Compared with conventional prime loans in 2006, average down payments were lower, at 6 percent for subprime mortgages and 12 percent for near-prime loans.[4] The relatively small down payments often entailed borrowers' taking out piggyback loans to pay the portion of their home prices above the 80 percent covered by first-lien mortgages.
Another form of easing facilitated the rapid rise of mortgages that didn't require borrowers to fully document their incomes. In 2006, these low- or no-doc loans comprised 81 percent of near-prime, 55 percent of jumbo, 50 percent of subprime and 36 percent of prime securitized mortgages.
The easier lending standards coincided with a sizeable rise in adjustable-rate mortgages (ARMs). Of the mortgages originated in 2006 that were later securitized, 92 percent of subprime, 68 percent of near-prime, 43 percent of jumbo and 23 percent of prime mortgages had adjustable rates. Now, with rates on one-year adjustable and 30-year fixed mortgages close, ARMs' market share has dwindled to 15 percent, less than half its recent peak of 35 percent in 2004.
In early 2007, investors and lenders began to realize the ramifications of credit-standard easing. Delinquency rates for 6-month-old subprime and near-prime loans underwritten in 2006 were far higher than those of the same age originated in 2004.
Other signs of deterioration also surfaced. The past-due rate for outstanding subprime mortgages rose sharply and neared the peak reached in 2002, with the deterioration much worse for adjustable- than fixed-rate mortgages. In first quarter 2007, the rate at which residential mortgages entered foreclosure rose to its fastest pace since tracking of these data began in 1970.
Lenders reacted to these signs by initially tightening credit standards more on riskier mortgages. In the Federal Reserve's April 2007 survey of senior loan officers, 15 percent of banks indicated they had raised standards for mortgages to prime borrowers in the prior three months, but a much higher 56 percent had done so for subprime mortgages. Responses to the July 2007 survey were similar.
However, in the October 2007 survey the share of banks tightening standards on prime mortgages jumped to 41 percent, while 56 percent did so for subprime loans. Many nonbank lenders have also imposed tougher standards or simply exited the business altogether. This likely reflects lenders' response to the financial disruptions seen since last summer.
The stricter standards meant fewer buyers could bid on homes, affecting prices for prime and subprime borrowers alike. Foreclosures added to downward pressures on home prices by raising the supply of houses on the market. And after peaking in September 2005, single-family home sales fell in September 2007 to their lowest level since January 1998.
The number of unsold homes on the market has risen, sharply pushing up the inventory-to-sales ratio for existing single-family homes from their low in January 2005 to their highest level since the start of this series in 1989 (Chart 4). Condominium supply, which is reflected in the all-home numbers, has experienced an even sharper increase since early 2005.
Chart 4: Existing-home inventories rise from late-2004 lows
These high inventories will likely weigh on construction and home prices for months to come. After peaking in early 2005, the Standard & Poor's/Case-Shiller index of year-over-year home-price appreciation in 10 large U.S. cities was down 5 percent in August—its biggest drop since 1991. While a Freddie Mac gauge of home prices posted a small year-over-year gain in the second quarter, the pace was dramatically off its highest rate, reported in third quarter 2005 (Chart 5).
Chart 5: Home-price appreciation plunges into negative territory
In the absence of home-price appreciation, many households are finding it difficult to refinance their way out of adjustable-rate mortgages obtained at the height of the housing boom. Larger mortgage payments could exacerbate delinquencies and foreclosures, especially with interest rate resets expected to remain high for the next year (Chart 6). This suggests mortgage quality will likely continue to fall off for some time.
Scheduled resets on adjustable-rate mortgages remain high
Financial Turmoil
By August 2007, the housing market's weaknesses were apparent: loan-quality problems, uncertainty about inventories, interest rate resets and spillovers from weaker home prices. These, coupled with ratings agencies' downgrading of many subprime RMBS, led to a dramatic thinning in trading for subprime credit instruments, many of which carried synthetic, rather than market, values based on models because of the instruments' illiquidity.
On Aug. 14, the paralysis in the capital markets led three investment funds to halt redemptions because they couldn't reasonably calculate the prices at which their shares could be valued. This event triggered widespread concern about the pricing of many new instruments, calling into question many financial firms' market values and disrupting the normal workings of the financial markets.
Investors sought liquidity, putting upward pressure on overnight interest rates and sparking a sharp upward repricing of risk premiums on assets, particularly those linked to nonprime mortgages. One outcome was an interest rate spike for both mortgage-backed commercial paper and jumbo mortgages, which heightened financial market uncertainty. In this environment, nonagency RMBS were viewed as posing more liquidity and default risk than those packaged by Fannie Mae and Freddie Mac.
Facing greater perceived default risk, investors began demanding much higher risk premiums on jumbo mortgage securities, pushing up the cost of funding such loans via securitization and encouraging lenders to incur the extra cost of holding more of these loans in their portfolios. This contributed to a 1 percentage point jump in jumbo interest rates between June and late August, an especially important increase given that jumbos accounted for about 12 percent of mortgage originations last year.
Although spreads between jumbo and conforming loan rates have fallen off their late-summer highs, they're still elevated. The higher rates have dampened the demand for more expensive homes, just as tighter credit standards reduced the number of buyers for lower-end homes.
Macroeconomic Effects
A housing slowdown mainly affects gross domestic product by curtailing housing construction and home-related spending. It also reins in spending by consumers who have less housing wealth against which to borrow.[5]
Residential construction likely exerted its largest negative effect in third quarter 2006, when it subtracted 1.3 percentage points from the annual pace of real GDP growth. Last year, many forecasts predicted home construction would stop restraining GDP growth by the end of 2007 and the industry would start recovering in 2008. These predictions were made before the tightening of nonprime credit standards began in late 2006. The change in standards will likely prolong the housing downturn and delay the recovery, although it's hard to tell precisely for how long. Since single-family permits have already fallen 52 percent from their September 2005 peak, however, the worst of the homebuilding drag may be behind us.
The same may not be true for housing's indirect effect on consumption. Since the late 1990s, many homeowners have borrowed against housing wealth, using home equity lines of credit or cash-out refinancing or not fully rolling over capital gains on one house into a down payment or improvements on the next one. These mortgage equity withdrawals gave people access to lower cost, collateralized loans, which bolstered spending on consumer goods. By one measure, these withdrawals were as large as 6 to 7 percent of labor and transfer income in the early to mid-2000s.
The magnitude and timing of these withdrawals may have changed in hard-to-gauge ways. New research suggests housing wealth's impact on consumer spending grew as recent financial innovations expanded the ability to tap housing equity.[6] This is consistent with prior research on housing's connection to U.S. consumer spending.[7] Aside from the interest-rate-related refinancing surge of 2002 and 2003, mortgage equity-withdrawal movements have become increasingly sensitive to swings in home-price appreciation since a 1986 law granted a federal income tax deduction for home equity loans (Chart 7).
Chart 7: Mortgage equity withdrawals increasingly move with housing inflation and mortgage refinancings
Compounding the uncertain outlook for consumption is the likely reversal of the early 2000s' mortgage credit liberalization.[8] This will put further downward pressure on home prices and housing wealth and may curtail home equity loans and cash-out refinancings. Finally, the homebuying enabled by the easing of credit standards in recent years may have been at the expense of later sales, further dampening the market going forward.
The timing of housing wealth's impact on consumption may have also changed. For example, before the advent of equity lines and cash-out refinancings, housing wealth increases may have affected U.S. consumption mainly by reducing homeowners' need to save for retirement. Since then, such financial innovations have enabled households to spend their equity gains before retirement. It's unclear how much this may be reversed by the 2007 retrenchment in mortgage availability.
Looking Ahead
The rise and fall of nonprime mortgages has taken us into largely uncharted territory. Past behavior, however, suggests that housing markets' adjustment to more realistic lending standards is likely to be prolonged. [9]
One manifestation of the slow downward adjustment of home prices and construction activity is the mounting level of unsold homes. The muted outlook for home-price appreciation, coupled with the resetting of many nonprime interest rates, suggests foreclosures will increase for some time.
The sharp reversal of trends in home-price appreciation will also dampen consumer spending growth, an effect that may worsen if the pullback in mortgage availability limits people's ability to borrow against their homes.
Although recent financial market turmoil will likely add to the housing slowdown, there are mitigating factors.
First, the effect of slower home-price gains on consumer spending is likely to be drawn out, giving monetary policy time to adjust if necessary.
Second, the Federal Reserve has been successful in slowing core inflation while maintaining economic growth. This gives policymakers inflation-fighting credibility, which enables them to coax down market interest rates should the economy need stimulus.
Third, even if the tightening of mortgage credit standards undesirably slows aggregate demand, monetary policy could still, if need be, help offset the overall effect by stimulating the economy via lower interest rates. This would bolster net exports and business investment and help cushion the impact of higher risk premiums on the costs of financing for firms and households.[10]
About the Authors
DiMartino is an economics writer and Duca a vice president and senior policy advisor in the Research Department of the Federal Reserve Bank of Dallas.
Notes
The authors thank Jessica Renier for research assistance.
1. See "The Subprime Slump and the Housing Market," by Andrew Tilton, US Economics Analyst, Goldman Sachs, Feb. 23, 2007, pp. 4–6. Securitized mortgages account for roughly 70 to 75 percent of outstanding, first-lien U.S. residential mortgages, according to estimates in "Mortgage Liquidity du Jour: Underestimated No More," Credit Suisse, March 13, 2007, p. 28.
2. See, for example, Federal Reserve Chairman Ben Bernanke's remarks, "Housing, Housing Finance, and Monetary Policy," Off-siteat the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyo., Aug. 31, 2007.
3. Part of the reason lenders eased credit standards was that they planned to sell, rather than hold, the mortgages. The earlier easing of standards may have partly owed to the potential moral hazard entailed when nonconforming loans are originated with the intent to fully sell them to investors. Bernanke discusses this in his remarks at the 2007 Jackson Hole symposium (note 2).
4. The figures are for securitized mortgages. See "Mortgage Liquidity du Jour" (note 1).
5. "Making Sense of the U.S. Housing Slowdown," by John Duca, Federal Reserve Bank of Dallas Economic Letter, November 2006.
6. See "How Large Is the Housing Wealth Effect? A New Approach," by Christopher D. Carroll, Misuzu Otsuka and Jirka Slacalek, National Bureau of Economic Research Working Paper no. 12746, December 2006; and "Housing, Credit and Consumer Expenditure," by John Muellbauer, paper presented at the Federal Reserve Bank of Kansas City's Economic Symposium, Jackson Hole, Wyo., Aug. 31–Sept. 1, 2007. Also see "Booms and Busts in the UK Housing Market," by John Muellbauer and Anthony Murphy, Economic Journal, vol. 107, November 1997, pp. 1701–27; and "House Prices, Consumption, and Monetary Policy: A Financial Accelerator Approach," by Kosuke Aoki, James Proudman and Gertjan Vlieghe, Journal of Financial Intermediation, vol. 13, October 2004, pp. 414–35.
7. "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences," by Alan Greenspan and James Kennedy, Finance and Economics Discussion Series Working Paper no. 2005-41, Board of Governors of the Federal Reserve System, September 2005; and "Mutual Funds and the Evolving Long-Run Effects of Stock Wealth on U.S. Consumption," by John V. Duca, Journal of Economics and Business, vol. 58, May/June 2006, pp. 202–21.
8. This is a possibility to which Muellbauer (2007, note 6) alludes.
9. See Duca (note 5).
10. For a discussion of the channels of monetary policy, see "Aggregate Disturbances, Monetary Policy, and the Macroeconomy: The FRB/US Perspective," by David Reifschneider, Robert Tetlow and John Williams, Federal Reserve Bulletin, January 1999, pp. 1–19.
Economic Letter is published monthly by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.
Articles may be reprinted on the condition that the source is credited and a copy is provided to the Research Department of the Federal Reserve Bank of Dallas.
Economic Letter is available free of charge by writing the Public Affairs Department, Federal Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX 75265-5906; by fax at 214-922-5268; or by telephone at 214-922-5254. This publication is available on the Dallas Fed web site, www.dallasfed.org.
The Fall of Bear Stearns: A Quickie Guide
So, the Wall Street Journal today has a big story walking us through the events leading up to the collapse of Bear Stearns this past week. But perhaps you haven't gotten to it yet. It's so large and inky, and you've been busy, going to meetings and calculating your annual income should you become a high-class hooker. Still, you don't want to look like an idiot, should someone, somewhere, bring up What Happened at Bear Stearns. You will want to nod knowledgably and pontificate on how it Might Affect the Economy. Which is why, using handy bullet points, we've summarized how the bank's dalliance with subprime lending, coupled with a dope-smoking CEO, finally caught up with them in a stunning week-or-so period. To keep things in perspective, we started at the beginning. The very beginning.
• 1923: Bear Stearns is founded as an equity trading house by Joseph Bear, Robert Stearns, and Harold Mayer with $500,000 in capital. According to the inflation calculator, that's about $6.1 billion dollars today.
• 1969: At a New York bridge tournament, future Bear Stearns CEO Alan "Ace" Greenberg meets a 35-year-old Jimmy Cayne, then a professional card player. Impressed by Cayne's stage presence, pluck, and no doubt, bridge skills, Greenberg offers him a job as a Bear stockbroker on the spot.
• 1985: The bank becomes a publicly traded company.
• 1998: Bear Stearns, now under the watchful eye of Jimmy Cayne, is the one investment-bank holdout in the Wall Street–led rescue of collapsed hedge fund Long Term Capital Management. This move (along with Cayne's comment that they ought to "let them fail," as recorded in Roger Lowenstein's When Genius Failed) will prove ironic later.
• March 2002: The New York Sun announces that Bear Stearns CEO James Cayne will be writing a bridge column for the paper.
• June 2007: Bear Stearns ponies up $3.2 billion to bail out two hedge funds created to invest in subprime mortgages: the High Grade Structured Credit Strategies Fund and the High Grade Structured Credit Strategies Enhanced Leverage Fund.
• July 2007: Bear Stearns writes to inform clients that the two hedge funds now contain "very little" or "effectively no value" for investors. By August, both funds file for bankruptcy.
• October 2007: Cayne reassures investors: "Most of our businesses are beginning to rebound." Later that month, state-owned Chinese lender Citic pays $1 billion for a 6 percent stake in Bear, giving the firm an approximately $20 billion valuation.
• December 2007: Bear Stearns posts fourth-quarter loss of $854 million on massive mortgage-related write-downs, the first quarterly loss in its 85-year history.
• January 2008: Cayne is more or less forced to resign as CEO in the wake of a Wall Street Journal article detailing his recreational pot use, monthlong vacations to play cards, and other high jinks at 383 Madison Avenue. The board kept Cayne on as chairman, and Alan D. Schwartz takes over as CEO.
• March 10–13, 2008: Amid rumors that Bear is teetering and has liquidity problems — and the small matter of $46 billion in mortgages and other questionable "assets" on its books — new CEO Schwartz goes on the public-relations offensive, appearing on CNBC on Monday (via live feed from the Breakers Resort at Palm Beach). "We don't see any pressure on our liquidity, let alone a liquidity crisis," he says. As if to prove it, ex-CEO Cayne closes on a $28 million pad at the Plaza. But to little avail: The perception of trouble quickly becomes a reality as hedge funds and other financial parties engaged with the firm take their money and get out. Enough people decide, all at the same time, that they don't want to be within 200 feet of Bear, and by the evening of Thursday, March 13, Bear finds itself, unquestionably, in the midst of a liquidity crisis. It was kind of like the "run on the bank" at the Bailey Brothers Savings and Loan in It's a Wonderful Life, only no one was wearing fedoras.
• Friday night, March 13–14, 2008: In a desperate scramble to avoid having no funds to operate its businesses, Bear executives pull an all-nighter trying to figure out how "fix this thing." At 5 a.m., they wake Federal Reserve chairman Ben Bernanke and a bunch of other dudes to discuss the matter, and ultimately decide to secure an emergency agreement with JPMorgan and the Federal Reserve Bank of New York in the largest-ever bailout of a U.S. securities firm. The Fed had to invoke a little-used securities law to lend funds through JPMorgan, in order to avoid having Bear Stearns disintegrate and threaten the (remaining) stability of the U.S. financial system. Bear Stearns shares tumbled 47 percent to close at $30. Jimmy Cayne, showing courage in the face of great difficulty and the potential collapse of the 85-year-old firm, takes part in a bridge tournament in Detroit. Using humor as a coping mechanism, Bear employees joke nervously about not bothering to come in on Monday, since the firm will probably be bought over the weekend. They are a prescient bunch.
• March 16–17, 2008: On late Sunday, after forcing a bunch of bankers to work over the weekend, JPMorgan decides it will buy Bear Stearns so that BSC can avoid bankruptcy, but only with the Fed's backing. The going price? $2 a share, which puts the valuation of the once giant firm at $236 million. Remember that $6 billion estimate at the beginning of this timeline? Ouch. JPMorgan, meanwhile, gets the Federal Reserve's protection for some of Bear's potential (and manifold) liabilities, plus a $1.2 billion building. Morgan also gets the firm's viable businesses, like its prime brokerage, for practically nothing. CEO Jamie Dimon looks like a genius (also he's quite handsome, we'd never noticed!), and the Fed looks like a hero.
• Moving forward: Divisions like Bear's investment bank, etc., are probably on their way out, including the employees manning the desks. Conservative estimates regarding the carnage range from a third to half of all of Bear Stearns's 14,000 employees. Everything that just went down is what's known in the business as "not good" for anyone working for Bear right this second, i.e. the people holding 33 percent of the now-devalued stock. The market is placing odds that Lehman Brothers, also a big mortgage player, is next to be taken out and shot. Like Bear did last week, Lehman puts the word out on Monday that they are awash with liquidity, though it doesn't stop the stock from falling to a six-year low. The Fed, in basically backing JPMorgan's rescue of Bear, is setting a dangerous precedent for itself in saving Wall Street's tuchis. There's also the question of who would be willing to play JPMorgan to Lehman's Bear Stearns, should it come to that. —Bess Levin, editor, DealBreaker.com
• 1923: Bear Stearns is founded as an equity trading house by Joseph Bear, Robert Stearns, and Harold Mayer with $500,000 in capital. According to the inflation calculator, that's about $6.1 billion dollars today.
• 1969: At a New York bridge tournament, future Bear Stearns CEO Alan "Ace" Greenberg meets a 35-year-old Jimmy Cayne, then a professional card player. Impressed by Cayne's stage presence, pluck, and no doubt, bridge skills, Greenberg offers him a job as a Bear stockbroker on the spot.
• 1985: The bank becomes a publicly traded company.
• 1998: Bear Stearns, now under the watchful eye of Jimmy Cayne, is the one investment-bank holdout in the Wall Street–led rescue of collapsed hedge fund Long Term Capital Management. This move (along with Cayne's comment that they ought to "let them fail," as recorded in Roger Lowenstein's When Genius Failed) will prove ironic later.
• March 2002: The New York Sun announces that Bear Stearns CEO James Cayne will be writing a bridge column for the paper.
• June 2007: Bear Stearns ponies up $3.2 billion to bail out two hedge funds created to invest in subprime mortgages: the High Grade Structured Credit Strategies Fund and the High Grade Structured Credit Strategies Enhanced Leverage Fund.
• July 2007: Bear Stearns writes to inform clients that the two hedge funds now contain "very little" or "effectively no value" for investors. By August, both funds file for bankruptcy.
• October 2007: Cayne reassures investors: "Most of our businesses are beginning to rebound." Later that month, state-owned Chinese lender Citic pays $1 billion for a 6 percent stake in Bear, giving the firm an approximately $20 billion valuation.
• December 2007: Bear Stearns posts fourth-quarter loss of $854 million on massive mortgage-related write-downs, the first quarterly loss in its 85-year history.
• January 2008: Cayne is more or less forced to resign as CEO in the wake of a Wall Street Journal article detailing his recreational pot use, monthlong vacations to play cards, and other high jinks at 383 Madison Avenue. The board kept Cayne on as chairman, and Alan D. Schwartz takes over as CEO.
• March 10–13, 2008: Amid rumors that Bear is teetering and has liquidity problems — and the small matter of $46 billion in mortgages and other questionable "assets" on its books — new CEO Schwartz goes on the public-relations offensive, appearing on CNBC on Monday (via live feed from the Breakers Resort at Palm Beach). "We don't see any pressure on our liquidity, let alone a liquidity crisis," he says. As if to prove it, ex-CEO Cayne closes on a $28 million pad at the Plaza. But to little avail: The perception of trouble quickly becomes a reality as hedge funds and other financial parties engaged with the firm take their money and get out. Enough people decide, all at the same time, that they don't want to be within 200 feet of Bear, and by the evening of Thursday, March 13, Bear finds itself, unquestionably, in the midst of a liquidity crisis. It was kind of like the "run on the bank" at the Bailey Brothers Savings and Loan in It's a Wonderful Life, only no one was wearing fedoras.
• Friday night, March 13–14, 2008: In a desperate scramble to avoid having no funds to operate its businesses, Bear executives pull an all-nighter trying to figure out how "fix this thing." At 5 a.m., they wake Federal Reserve chairman Ben Bernanke and a bunch of other dudes to discuss the matter, and ultimately decide to secure an emergency agreement with JPMorgan and the Federal Reserve Bank of New York in the largest-ever bailout of a U.S. securities firm. The Fed had to invoke a little-used securities law to lend funds through JPMorgan, in order to avoid having Bear Stearns disintegrate and threaten the (remaining) stability of the U.S. financial system. Bear Stearns shares tumbled 47 percent to close at $30. Jimmy Cayne, showing courage in the face of great difficulty and the potential collapse of the 85-year-old firm, takes part in a bridge tournament in Detroit. Using humor as a coping mechanism, Bear employees joke nervously about not bothering to come in on Monday, since the firm will probably be bought over the weekend. They are a prescient bunch.
• March 16–17, 2008: On late Sunday, after forcing a bunch of bankers to work over the weekend, JPMorgan decides it will buy Bear Stearns so that BSC can avoid bankruptcy, but only with the Fed's backing. The going price? $2 a share, which puts the valuation of the once giant firm at $236 million. Remember that $6 billion estimate at the beginning of this timeline? Ouch. JPMorgan, meanwhile, gets the Federal Reserve's protection for some of Bear's potential (and manifold) liabilities, plus a $1.2 billion building. Morgan also gets the firm's viable businesses, like its prime brokerage, for practically nothing. CEO Jamie Dimon looks like a genius (also he's quite handsome, we'd never noticed!), and the Fed looks like a hero.
• Moving forward: Divisions like Bear's investment bank, etc., are probably on their way out, including the employees manning the desks. Conservative estimates regarding the carnage range from a third to half of all of Bear Stearns's 14,000 employees. Everything that just went down is what's known in the business as "not good" for anyone working for Bear right this second, i.e. the people holding 33 percent of the now-devalued stock. The market is placing odds that Lehman Brothers, also a big mortgage player, is next to be taken out and shot. Like Bear did last week, Lehman puts the word out on Monday that they are awash with liquidity, though it doesn't stop the stock from falling to a six-year low. The Fed, in basically backing JPMorgan's rescue of Bear, is setting a dangerous precedent for itself in saving Wall Street's tuchis. There's also the question of who would be willing to play JPMorgan to Lehman's Bear Stearns, should it come to that. —Bess Levin, editor, DealBreaker.com
The rise and fall of Merrill Lynch CEO Stanley O’Neal
The ouster of Stanley O’Neal as chairman and CEO of Merrill Lynch & Co., the giant Wall Street investment bank and brokerage house, is one more indication of the deep crisis gripping major US financial institutions. It also provides an insight into the corporate culture and social types that have come to dominate the US financial establishment.--Barry Grey
By Barry Grey
30 October 2007
WSWS: It was widely reported Monday that the Merrill Lynch board of directors had decided over the weekend to demand O’Neal’s retirement and was negotiating the terms of his separation package. Last week, the 93-year-old firm announced it had lost over $2.2 billion in the third quarter and written off $8.4 billion in failed investments, of which $7.9 billion was due to the downward valuation of highly speculative securities linked to subprime mortgage debt.
The massive write-off, equivalent to 13 percent of the value of the firm’s shares on the stock market, exceeded Merrill’s net earnings for all of 2006 and equaled 42 percent of gross revenue in the first nine months of 2007. Financial analysts predict that the company will be forced to write down another $4 billion in the fourth quarter.
This spring, Merrill’s stock was trading at around $95 a share, and O’Neal was being hailed as a financial genius for transforming Merrill Lynch from primarily a retail brokerage business into an aggressive, risk-taking institution. Last week, the stock sank to as low as $59 and the credit service Standard & Poor’s downgraded the firm’s credit.
Of the major Wall Street banks, Merrill Lynch has suffered the highest losses from the collapse of high-yield, high-risk investments linked to speculation in the housing market, especially the market in subprime mortgages to borrowers with marginal credit worthiness. The company, under O’Neal, recorded huge profits from 2002, when he took over as chairman and CEO, until the last quarter as a result of O’Neal’s single-minded focus on underwriting so-called collateralized debt obligations (CDOs)—loans linked to home mortgages and the financing of leveraged buyouts that are bundled and resold to other financial companies and big investors.
According to the New York Times, Merrill’s exposure to the CDO market soared to more than $40 billion from around $1 billion some 18 months ago—that is, precisely during the period when the housing market was collapsing and warnings were being issued about the stability of housing-linked securities.
The meltdown in the housing market and surge in subprime home foreclosures led over the summer to a collapse in the market for CDOS and other forms of debt, exposing the reckless speculation that had fueled the stock market boom of recent years and generated huge profits and paychecks for top Wall Street executives. O’Neal was paid $48 billion in 2006. Of the major Wall Street bank CEOs, only Goldman Sachs head Lloyd Blankfein was paid more.
The housing crisis and credit crunch have hit a wide spectrum of US and international banks and financial institutions. The world’s largest banks and securities firms announced more than $30 billion of third-quarter losses from write-downs on bad debt.
O’Neal is the first Wall Street CEO to be sacked, but a growing list of bank executives have lost their jobs. Swiss-based UBS in July dismissed its CEO and earlier this month announced the departure of two additional top officers. Others who have been ousted or have departed in management shakeups include Bear Stearns’ co-president and Citigroup’s trading head.
Bank of America reported last week that its investment banking profit had dropped 93 percent. It cut 3,000 jobs and removed the heads of its investment banking and structured products divisions.
The future of Citigroup CEO Charles Prince is in doubt following the number one bank’s announcement of billions in mortgage-related losses.
While O’Neal’s position was shaky, Wall Street insiders were nonetheless shocked by the speed with which the board of directors—hand-picked by O’Neal—decided to oust him. According to sources within Merrill cited by press reports, the decision was precipitated by the news, leaked to the New York Times and published Friday, that O’Neal had, without the knowledge or authorization of the board of directors, contacted the head of Wachovia Bank to see whether he was interested in buying Merrill.
One likely reason for the overture was the personal windfall that would accrue to O’Neal if such a takeover were effected.
The New York Times wrote on Monday: “If he leaves, O’Neal could be paid at least $159 million, according to an analysis by James F. Reda & Associates, a compensation consulting firm. Had he succeed in putting together a merger, he might have left with as much as $274 million.”
O’Neal’s career and tenure as Merrill CEO exemplify the combination of recklessness, short-sightedness, ruthlessness and greed that has become the hallmark of those who have risen to the top of the US corporate establishment over the past quarter century—a period that has seen an unprecedented redistribution of wealth from the working population to a financial aristocracy that wallows in previously unheard of personal wealth.
His rise to the summit of Wall Street, to become the first African-American CEO of a major bank, also reflects the social results of the policy of racial preferences and affirmative action pursued by the US political and corporate establishment in the aftermath of the ghetto eruptions of the 1960s. A thin layer of blacks and other minorities have been elevated to lucrative positions in business and government, while the living standards of the mass of minority workers have stagnated or declined.
O’Neal, 56, was born into a poor family in Alabama, and subsequently moved to Atlanta. There he got a job at a General Motors plant and was evidently spotted by GM as a minority worker who could be groomed for a position in corporate management. He graduated from General Motors Institute, now Kettering University, and obtained a scholarship from GM to study at Harvard Business School.
After receiving his MBA, O’Neal was given a position in GM’s treasurer’s office. In 1986, at the age of 35, he joined Merrill’s high-yield, or “junk bond,” department. Within three years he was running the department, competing with Michael Milken’s Drexel Burnham Lambert Inc. When Milken pleaded guilty to securities fraud in 1990, it enabled O’Neal’s unit at Merrill to become the biggest junk bond operator for five consecutive years.
In 1997, O’Neal became co-head of Merrill’s corporate and institutional client group, which includes investment banking and securities trading. A year later, he was promoted to chief financial officer. In 2000, O’Neal was promoted once again to head the brokerage division, Merrill’s more prominent department.
He quickly redirected Merrill’s army of 15,000 brokers to focus on winning more millionaires as clients, and after the 9/11 terrorist attack on the World Trade Center he eliminated more than 20,000 employees and closed 266 offices around the world. This ruthless cost-cutting gave him an inside track to the top position, which he was awarded in 2002.
Soon after becoming chairman and CEO he set the tone for his tenure by purging the firm of dozens of its longtime senior employees and firing those who had been considered his rivals for the CEO post. Later he forced out some of his former allies, including Executive Vice President Thomas Patrick, who had campaigned for his elevation to head the company.
As the Wall Street Journal put it on Monday: “With his restructuring, Mr. O’Neal was seen as rejecting the longtime culture of a company known internally as “Mother Merrill.” For years, the brokerage giant was willing to accept lower profit margins in order to keep longtime loyal employees on the payroll, much like International Business Machines Corp. had a no-layoff policy during its 1980s heyday...
“Merrill’s board gave him leeway because he more than doubled the firm’s profit level to an average topping $5 billion annually from 2003 to 2006. Those at the company said he was proud of cutting through the cozy corporate culture.”
According to various press reports, O’Neal’s management style was little short of despotic. “Merrill Chief Executive Stan O’Neal would grill his executives about why, for instance, Goldman Sachs was showing faster growth in bond-trading profits,” wrote the Journal. “Subordinates would scurry to analyze the Goldman earnings to get answers to Mr. O’Neal. ‘It got to the point where you didn’t want to be in the office’ on Goldman earnings days, one former Merrill executive recalls.”
In July of 2006, O’Neal ousted three senior bond executives. They were, according to the Journal, “summoned upstairs, one after another, for 5- to 15-minute meetings” and told “there was no role for them.”
Winthrop Smith, who left as head of Merrill’s international brokerage after O’Neal became president, told Bloomberg.com, “He got rid of people with hundreds of years of [combined] experience.”
Earlier this month, after the end of the third quarter, O’Neal fired two top bond executives and, the New York Times reports, he was looking to fire his chief financial officer and replace him with a longtime friend.
Little wonder than a large number of former executives have been involved in discussions to launch a proxy fight if O’Neal was not removed.
The O’Neal saga is not primarily a matter of the business methods of a single individual. He is rather a representative of the social types and corporate policies that predominate throughout corporate America and, increasingly, the world.
The short-sighted and reckless striving for immediate profit returns at previously unheard of and unsustainable levels is, in the end, driven by profound and insuperable contradictions of a crisis-ridden capitalist system. Unable to generate sufficient rates of profit from productive investment, the entire system is increasingly based on the creation of wealth from speculative and parasitic forms of financial manipulation.
The immense fortunes of the modern American gilded age, unlike the days of the robber barons, are not bound up with the creation of industrial empires, but rather go hand in hand with the decay of industry and the rotting out of the socio-economic infrastructure. All the more intense and explosive are the social and class contradictions building up beneath the surface of American society.
By Barry Grey
30 October 2007
WSWS: It was widely reported Monday that the Merrill Lynch board of directors had decided over the weekend to demand O’Neal’s retirement and was negotiating the terms of his separation package. Last week, the 93-year-old firm announced it had lost over $2.2 billion in the third quarter and written off $8.4 billion in failed investments, of which $7.9 billion was due to the downward valuation of highly speculative securities linked to subprime mortgage debt.
The massive write-off, equivalent to 13 percent of the value of the firm’s shares on the stock market, exceeded Merrill’s net earnings for all of 2006 and equaled 42 percent of gross revenue in the first nine months of 2007. Financial analysts predict that the company will be forced to write down another $4 billion in the fourth quarter.
This spring, Merrill’s stock was trading at around $95 a share, and O’Neal was being hailed as a financial genius for transforming Merrill Lynch from primarily a retail brokerage business into an aggressive, risk-taking institution. Last week, the stock sank to as low as $59 and the credit service Standard & Poor’s downgraded the firm’s credit.
Of the major Wall Street banks, Merrill Lynch has suffered the highest losses from the collapse of high-yield, high-risk investments linked to speculation in the housing market, especially the market in subprime mortgages to borrowers with marginal credit worthiness. The company, under O’Neal, recorded huge profits from 2002, when he took over as chairman and CEO, until the last quarter as a result of O’Neal’s single-minded focus on underwriting so-called collateralized debt obligations (CDOs)—loans linked to home mortgages and the financing of leveraged buyouts that are bundled and resold to other financial companies and big investors.
According to the New York Times, Merrill’s exposure to the CDO market soared to more than $40 billion from around $1 billion some 18 months ago—that is, precisely during the period when the housing market was collapsing and warnings were being issued about the stability of housing-linked securities.
The meltdown in the housing market and surge in subprime home foreclosures led over the summer to a collapse in the market for CDOS and other forms of debt, exposing the reckless speculation that had fueled the stock market boom of recent years and generated huge profits and paychecks for top Wall Street executives. O’Neal was paid $48 billion in 2006. Of the major Wall Street bank CEOs, only Goldman Sachs head Lloyd Blankfein was paid more.
The housing crisis and credit crunch have hit a wide spectrum of US and international banks and financial institutions. The world’s largest banks and securities firms announced more than $30 billion of third-quarter losses from write-downs on bad debt.
O’Neal is the first Wall Street CEO to be sacked, but a growing list of bank executives have lost their jobs. Swiss-based UBS in July dismissed its CEO and earlier this month announced the departure of two additional top officers. Others who have been ousted or have departed in management shakeups include Bear Stearns’ co-president and Citigroup’s trading head.
Bank of America reported last week that its investment banking profit had dropped 93 percent. It cut 3,000 jobs and removed the heads of its investment banking and structured products divisions.
The future of Citigroup CEO Charles Prince is in doubt following the number one bank’s announcement of billions in mortgage-related losses.
While O’Neal’s position was shaky, Wall Street insiders were nonetheless shocked by the speed with which the board of directors—hand-picked by O’Neal—decided to oust him. According to sources within Merrill cited by press reports, the decision was precipitated by the news, leaked to the New York Times and published Friday, that O’Neal had, without the knowledge or authorization of the board of directors, contacted the head of Wachovia Bank to see whether he was interested in buying Merrill.
One likely reason for the overture was the personal windfall that would accrue to O’Neal if such a takeover were effected.
The New York Times wrote on Monday: “If he leaves, O’Neal could be paid at least $159 million, according to an analysis by James F. Reda & Associates, a compensation consulting firm. Had he succeed in putting together a merger, he might have left with as much as $274 million.”
O’Neal’s career and tenure as Merrill CEO exemplify the combination of recklessness, short-sightedness, ruthlessness and greed that has become the hallmark of those who have risen to the top of the US corporate establishment over the past quarter century—a period that has seen an unprecedented redistribution of wealth from the working population to a financial aristocracy that wallows in previously unheard of personal wealth.
His rise to the summit of Wall Street, to become the first African-American CEO of a major bank, also reflects the social results of the policy of racial preferences and affirmative action pursued by the US political and corporate establishment in the aftermath of the ghetto eruptions of the 1960s. A thin layer of blacks and other minorities have been elevated to lucrative positions in business and government, while the living standards of the mass of minority workers have stagnated or declined.
O’Neal, 56, was born into a poor family in Alabama, and subsequently moved to Atlanta. There he got a job at a General Motors plant and was evidently spotted by GM as a minority worker who could be groomed for a position in corporate management. He graduated from General Motors Institute, now Kettering University, and obtained a scholarship from GM to study at Harvard Business School.
After receiving his MBA, O’Neal was given a position in GM’s treasurer’s office. In 1986, at the age of 35, he joined Merrill’s high-yield, or “junk bond,” department. Within three years he was running the department, competing with Michael Milken’s Drexel Burnham Lambert Inc. When Milken pleaded guilty to securities fraud in 1990, it enabled O’Neal’s unit at Merrill to become the biggest junk bond operator for five consecutive years.
In 1997, O’Neal became co-head of Merrill’s corporate and institutional client group, which includes investment banking and securities trading. A year later, he was promoted to chief financial officer. In 2000, O’Neal was promoted once again to head the brokerage division, Merrill’s more prominent department.
He quickly redirected Merrill’s army of 15,000 brokers to focus on winning more millionaires as clients, and after the 9/11 terrorist attack on the World Trade Center he eliminated more than 20,000 employees and closed 266 offices around the world. This ruthless cost-cutting gave him an inside track to the top position, which he was awarded in 2002.
Soon after becoming chairman and CEO he set the tone for his tenure by purging the firm of dozens of its longtime senior employees and firing those who had been considered his rivals for the CEO post. Later he forced out some of his former allies, including Executive Vice President Thomas Patrick, who had campaigned for his elevation to head the company.
As the Wall Street Journal put it on Monday: “With his restructuring, Mr. O’Neal was seen as rejecting the longtime culture of a company known internally as “Mother Merrill.” For years, the brokerage giant was willing to accept lower profit margins in order to keep longtime loyal employees on the payroll, much like International Business Machines Corp. had a no-layoff policy during its 1980s heyday...
“Merrill’s board gave him leeway because he more than doubled the firm’s profit level to an average topping $5 billion annually from 2003 to 2006. Those at the company said he was proud of cutting through the cozy corporate culture.”
According to various press reports, O’Neal’s management style was little short of despotic. “Merrill Chief Executive Stan O’Neal would grill his executives about why, for instance, Goldman Sachs was showing faster growth in bond-trading profits,” wrote the Journal. “Subordinates would scurry to analyze the Goldman earnings to get answers to Mr. O’Neal. ‘It got to the point where you didn’t want to be in the office’ on Goldman earnings days, one former Merrill executive recalls.”
In July of 2006, O’Neal ousted three senior bond executives. They were, according to the Journal, “summoned upstairs, one after another, for 5- to 15-minute meetings” and told “there was no role for them.”
Winthrop Smith, who left as head of Merrill’s international brokerage after O’Neal became president, told Bloomberg.com, “He got rid of people with hundreds of years of [combined] experience.”
Earlier this month, after the end of the third quarter, O’Neal fired two top bond executives and, the New York Times reports, he was looking to fire his chief financial officer and replace him with a longtime friend.
Little wonder than a large number of former executives have been involved in discussions to launch a proxy fight if O’Neal was not removed.
The O’Neal saga is not primarily a matter of the business methods of a single individual. He is rather a representative of the social types and corporate policies that predominate throughout corporate America and, increasingly, the world.
The short-sighted and reckless striving for immediate profit returns at previously unheard of and unsustainable levels is, in the end, driven by profound and insuperable contradictions of a crisis-ridden capitalist system. Unable to generate sufficient rates of profit from productive investment, the entire system is increasingly based on the creation of wealth from speculative and parasitic forms of financial manipulation.
The immense fortunes of the modern American gilded age, unlike the days of the robber barons, are not bound up with the creation of industrial empires, but rather go hand in hand with the decay of industry and the rotting out of the socio-economic infrastructure. All the more intense and explosive are the social and class contradictions building up beneath the surface of American society.
Thursday, November 13, 2008
Nation's foreclosure rate in October increases 25 percent year-over-year, with Nevada on top
MIAMI (AP) -- The number of homeowners caught in the wave of foreclosures in October grew 25 percent nationally over the same month in 2007, data released Thursday showed.
More than 279,500 U.S. homes received at least one foreclosure-related notice in October, an increase of 5 percent over September, according to RealtyTrac Inc. One in every 452 housing units received a foreclosure filing, such as a default notice, auction sale notice or bank repossession.
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More than 84,000 properties were repossessed in October, RealtyTrac said.
A nasty brew of strict lending standards, falling home values and a tough economy is filtering through the housing market. By the end of the year, the company expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.
The collateral damage in the financial markets forced the government to pass a $700 billion financial rescue package last month. The plan was initially to buy bad assets from banks, but Treasury Secretary Henry Paulson said Wednesday that the rescue package won't purchase those troubled assets.
That plan would have taken too much time, he said, so instead the Treasury will rely on buying stakes in banks and encouraging them to resume more normal lending.
Also Wednesday, Housing and Urban Development Secretary Steve Preston said the government may let more borrowers qualify for a $300 billion program designed to let troubled homeowners swap risky loans for more affordable ones. The program was launched Oct. 1, but there are concerns that lenders won't participate because they have to voluntarily reduce the value of a loan and take a loss.
In RealtyTrac's report, three states -- Nevada, Arizona, Florida -- had the nation's top foreclosure rates. Nevada posted the nation's highest rate for the 22nd consecutive month in October.
In Nevada, one in every 74 homes received a foreclosure filing last month. Arizona saw one in every 149 housing units receive a foreclosure filing, and in Florida it was one in every 157 homes.
Other states in the top 10 were California, Colorado, Georgia, Michigan, New Jersey, Illinois and Ohio.
However, RealtyTrac noted that, while California had the highest total number of foreclosures in October, the rate in that state was down 18 percent from the previous month.
James J. Saccacio, chief executive officer of RealtyTrac, said new laws requiring delays in the foreclosure process have reduced the volume of foreclosure filings in several states. In California, lenders are now required to contact borrowers at least 30 days before filing a default notice. A similar law in North Carolina gives borrowers an extra 45 days.
"While the intention behind this legislation -- to prevent more foreclosures -- is admirable, without a more integrated approach that includes significant loan modifications, the net effect may be merely delaying inevitable foreclosures," Saccacio said. "And in the meantime, the apparent slowing of foreclosure activity understates the severity of the foreclosure problem in these states."
Among cities, Las Vegas had the highest October foreclosure rate among the 230 metro areas tracked in the report, with one in every 62 housing units receiving a foreclosure filing.
Four Florida metro areas ranked in top 10 -- Cape Coral-Fort Myers was second, Miami third, Fort Lauderdale eighth and Orlando 10th. California also had four metro areas in the top 10: Stockton fourth, Merced fifth, Riverside-San Bernardino seventh and Modesto ninth.
The remaining member of the top 10 was Phoenix, which came in sixth.
More than 279,500 U.S. homes received at least one foreclosure-related notice in October, an increase of 5 percent over September, according to RealtyTrac Inc. One in every 452 housing units received a foreclosure filing, such as a default notice, auction sale notice or bank repossession.
ADVERTISEMENT
More than 84,000 properties were repossessed in October, RealtyTrac said.
A nasty brew of strict lending standards, falling home values and a tough economy is filtering through the housing market. By the end of the year, the company expects more than a million bank-owned properties to have piled up on the market, representing around a third of all properties for sale in the U.S.
The collateral damage in the financial markets forced the government to pass a $700 billion financial rescue package last month. The plan was initially to buy bad assets from banks, but Treasury Secretary Henry Paulson said Wednesday that the rescue package won't purchase those troubled assets.
That plan would have taken too much time, he said, so instead the Treasury will rely on buying stakes in banks and encouraging them to resume more normal lending.
Also Wednesday, Housing and Urban Development Secretary Steve Preston said the government may let more borrowers qualify for a $300 billion program designed to let troubled homeowners swap risky loans for more affordable ones. The program was launched Oct. 1, but there are concerns that lenders won't participate because they have to voluntarily reduce the value of a loan and take a loss.
In RealtyTrac's report, three states -- Nevada, Arizona, Florida -- had the nation's top foreclosure rates. Nevada posted the nation's highest rate for the 22nd consecutive month in October.
In Nevada, one in every 74 homes received a foreclosure filing last month. Arizona saw one in every 149 housing units receive a foreclosure filing, and in Florida it was one in every 157 homes.
Other states in the top 10 were California, Colorado, Georgia, Michigan, New Jersey, Illinois and Ohio.
However, RealtyTrac noted that, while California had the highest total number of foreclosures in October, the rate in that state was down 18 percent from the previous month.
James J. Saccacio, chief executive officer of RealtyTrac, said new laws requiring delays in the foreclosure process have reduced the volume of foreclosure filings in several states. In California, lenders are now required to contact borrowers at least 30 days before filing a default notice. A similar law in North Carolina gives borrowers an extra 45 days.
"While the intention behind this legislation -- to prevent more foreclosures -- is admirable, without a more integrated approach that includes significant loan modifications, the net effect may be merely delaying inevitable foreclosures," Saccacio said. "And in the meantime, the apparent slowing of foreclosure activity understates the severity of the foreclosure problem in these states."
Among cities, Las Vegas had the highest October foreclosure rate among the 230 metro areas tracked in the report, with one in every 62 housing units receiving a foreclosure filing.
Four Florida metro areas ranked in top 10 -- Cape Coral-Fort Myers was second, Miami third, Fort Lauderdale eighth and Orlando 10th. California also had four metro areas in the top 10: Stockton fourth, Merced fifth, Riverside-San Bernardino seventh and Modesto ninth.
The remaining member of the top 10 was Phoenix, which came in sixth.
Jobless claims surge while trade deficit narrows in reflection of weakening economy
WASHINGTON (AP) -- Applications for unemployment benefits soared to the highest level since just after the Sept. 11, 2001, terrorist attacks while the trade deficit shrank more than expected as demand for imports plunged, further evidence of the struggling U.S. economy.
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The Labor Department reported Thursday that jobless claims shot up by 32,000 last week to a seasonally adjusted 516,000, the highest total in seven years. The tally was much higher than analysts expected and a further indication of how much the labor market is deteriorating amid the shrinking economy. The government reported last week that the unemployment rate surged to a 14-year high of 6.5 percent in October.
Meanwhile, the Commerce Department said the trade deficit declined by a bigger-than-expected amount in September, falling by 4.4 percent to $56.5 billion as imports experienced a record plunge.
The import decline was led by a huge fall in imported oil as the average price for crude dropped by a record $12.41 per barrel and the volume of shipments fell to the lowest level in five years. But demand for other types of imports also fell, with imported cars and car parts dropping to the lowest level in more than five years, an indication that foreign automakers are feeling the pinch hitting U.S. consumers.
President-elect Barack Obama has said that dealing with the worst financial crisis to hit this country in seven decades will be his No. 1 priority when he takes office.
Treasury Secretary Henry Paulson announced Wednesday that the administration had scrapped the original centerpiece of the rescue program -- a proposal to buy troubled assets to get them off the books of banks as a way of promoting increased lending.
Instead, Paulson said the administration will proceed with an alternative plan to spend $250 billion to buy stock in the banks as a way of bolstering their financial situation and accomplishing the same goal -- getting the institutions to return to more normal lending.
However, critics contend the administration should be imposing more restrictions on the stock purchases as a way of insuring the banks will use the government resources to increase lending rather than just hoarding the cash, or using it to acquire other banks or boost dividends for stockholders.
Sen. Charles Schumer, D-N.Y., said he was still disappointed in the administration's unwillingness to issue strict guidelines to ensure that participating firms use the funds to increase lending.
Another report detailing the difficulties facing the economy is expected later Thursday with the government announcing the budget deficit for October.
The deficit is expected to show a big increase in October, the first month of the new budget year, rising to $101.5 billion, compared to $57 billion in October 2007. The soaring costs of the bank rescue and the weak economy are expected to put the country on track to run up a record deficit for the current budget year of between $700 billion and $1 trillion, a staggering sum for a single year.
Despite its new flexibility, the administration said Wednesday it remains opposed to using the rescue fund to bail out the ailing auto industry or to provide guarantees for home loans, an idea that supporters contend offers the greatest hope for helping legions of Americans who are facing foreclosure.
Congressional Democrats felt otherwise on autos, and strongly. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid were pressing for quick passage of a major package for carmakers during a postelection session that begins Nov. 18, and one key House Democrat was putting together legislation that would send $25 billion in emergency loans to the beleaguered industry in exchange for a government ownership stake in the Big Three car companies.
Paulson told reporters Wednesday that the administration was exploring the possibility of setting up a program in conjunction with the Federal Reserve that would provide support for the $1 trillion market in securities that fund such vital consumer products as credit cards, auto loans and students loans. About 40 percent of consumer credit is supplied through the sale of these securities that are backed by payments consumers make on their credit cards and other loans.
The administration already has spoken for all but $60 billion of the initial $350 billion supplied by Congress, including the $250 billion for direct stock purchases from banks and $40 billion for a new loan supplied on Monday to help stabilize troubled insurance giant American International Group.
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The Labor Department reported Thursday that jobless claims shot up by 32,000 last week to a seasonally adjusted 516,000, the highest total in seven years. The tally was much higher than analysts expected and a further indication of how much the labor market is deteriorating amid the shrinking economy. The government reported last week that the unemployment rate surged to a 14-year high of 6.5 percent in October.
Meanwhile, the Commerce Department said the trade deficit declined by a bigger-than-expected amount in September, falling by 4.4 percent to $56.5 billion as imports experienced a record plunge.
The import decline was led by a huge fall in imported oil as the average price for crude dropped by a record $12.41 per barrel and the volume of shipments fell to the lowest level in five years. But demand for other types of imports also fell, with imported cars and car parts dropping to the lowest level in more than five years, an indication that foreign automakers are feeling the pinch hitting U.S. consumers.
President-elect Barack Obama has said that dealing with the worst financial crisis to hit this country in seven decades will be his No. 1 priority when he takes office.
Treasury Secretary Henry Paulson announced Wednesday that the administration had scrapped the original centerpiece of the rescue program -- a proposal to buy troubled assets to get them off the books of banks as a way of promoting increased lending.
Instead, Paulson said the administration will proceed with an alternative plan to spend $250 billion to buy stock in the banks as a way of bolstering their financial situation and accomplishing the same goal -- getting the institutions to return to more normal lending.
However, critics contend the administration should be imposing more restrictions on the stock purchases as a way of insuring the banks will use the government resources to increase lending rather than just hoarding the cash, or using it to acquire other banks or boost dividends for stockholders.
Sen. Charles Schumer, D-N.Y., said he was still disappointed in the administration's unwillingness to issue strict guidelines to ensure that participating firms use the funds to increase lending.
Another report detailing the difficulties facing the economy is expected later Thursday with the government announcing the budget deficit for October.
The deficit is expected to show a big increase in October, the first month of the new budget year, rising to $101.5 billion, compared to $57 billion in October 2007. The soaring costs of the bank rescue and the weak economy are expected to put the country on track to run up a record deficit for the current budget year of between $700 billion and $1 trillion, a staggering sum for a single year.
Despite its new flexibility, the administration said Wednesday it remains opposed to using the rescue fund to bail out the ailing auto industry or to provide guarantees for home loans, an idea that supporters contend offers the greatest hope for helping legions of Americans who are facing foreclosure.
Congressional Democrats felt otherwise on autos, and strongly. House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid were pressing for quick passage of a major package for carmakers during a postelection session that begins Nov. 18, and one key House Democrat was putting together legislation that would send $25 billion in emergency loans to the beleaguered industry in exchange for a government ownership stake in the Big Three car companies.
Paulson told reporters Wednesday that the administration was exploring the possibility of setting up a program in conjunction with the Federal Reserve that would provide support for the $1 trillion market in securities that fund such vital consumer products as credit cards, auto loans and students loans. About 40 percent of consumer credit is supplied through the sale of these securities that are backed by payments consumers make on their credit cards and other loans.
The administration already has spoken for all but $60 billion of the initial $350 billion supplied by Congress, including the $250 billion for direct stock purchases from banks and $40 billion for a new loan supplied on Monday to help stabilize troubled insurance giant American International Group.
Bush: Economic crisis not a failure of free market
NEW YORK – President George W. Bush asserted Thursday that the global financial crisis is "not a failure of the free market" and urged world leaders to adopt modest financial reforms that stop short of the tighter regulations Europeans favor.
"Our aim should not be more government. It should be smarter government," Bush said during a speech in New York, a day before about two dozen world leaders converge on Washington for a weekend summit he is hosting.
Bush called on the leaders to embrace "reasonable" reforms, saying changes won't work if they shun the free market system or restrict trade.
The president delivered a vigorous defense of free-market capitalism and easier global trade to frame his approach to the high-level gathering. Bush invited representatives of some of the world's biggest industrial democracies, emerging nations and international bodies to Washington to start developing a more coordinated world response to the economic woes that have millions of people struggling to keep their jobs, their homes and their hopes.
With the severe economic downturn threatening to end Bush's tenure on a sour note before President-elect Barack Obama takes over, he will host the leaders at a White House dinner Friday and review causes and solutions for the financial mess Saturday.
It was fitting that Bush's argument against regulatory overreach was delivered not in Washington but from the heart of Wall Street. He spoke at venerable Federal Hall, which was home to the first Congress and is within shouting distance of New York Stock Exchange.
Bush called for reforms to strengthen the global economy long-term and said leaders at this weekend's meeting would "discuss specific actions we can take."
Among the areas for possible agreement, Bush listed:
_bolstering accounting rules for stocks, bonds and other investments so investors have a clearer sense of the true value of what they buy.
_requiring "credit default swaps" — a type of corporate debt insurance — to be processed through a central clearinghouse. That would help provide crucial information on the parties involved in these complex, unregulated products. Prices for this insurance soared in the aftermath of the Lehman Brothers' bankruptcy and imperiled American International Group, a major insurer of this kind of corporate debt.
_taking a fresh look at rules aimed at preventing fraud and manipulation in trading of stocks and other securities.
_better coordinating financial regulations among countries.
_Giving a wider variety of countries voting power at the International Monetary Fund and the World Bank.
Notably absent from his speech was any talk about what the U.S. might do to bail out the troubled auto industry or the debate over a second U.S. stimulus package.
"The crisis was not a failure of the free market system," Bush said. "And the answer is not to try to reinvent that system."
But Bush's argument that "government intervention is not a cure-all" came as some critics think his administration already is overstepping in private markets. The federal dollars being spent or put on the line to rebuild the nation's financial system could easily run into the trillions. Already the Bush administration has enacted a $700 financial rescue package, backed the purchase of investment bank Bear Stearns, bought stock in leading banks, engineered a government takeover of mortgage giants Fannie Mae and Freddie Mac, guaranteed money market fund holdings and funneled billions to stabilize troubled insurance giant American International Group.
"I'm a market-oriented guy, but not when I'm faced with the prospect of a global meltdown," Bush said.
At the same time, the president aggressively defended the U.S. against charges from around the world that insufficient U.S. regulation led to the credit collapse worldwide. This was his way of pushing back against both the criticism and the calls by allies for more intrusive rules. Heading into the meeting, Europeans are seen as looking more urgently for broad changes and tighter universal banking regulations than is the United States.
"Many European countries had much more extensive regulations and still experienced problems almost identical to our own," Bush said.
Some critics have said that lax oversight by U.S. and other regulators failed to detect problems and respond with action that could have prevented the meltdown. The crisis began with the collapse of the U.S. housing market, which froze credit, then shook the broader financial sector and finally rippled overseas.
"History has shown that the greater threat to economic prosperity is not too little government involvement in the market, it is too much government involvement in the market," he said. "It would a terrible mistake to allow a few months of crisis to undermine 60 years of success."
Dan Price, Bush's deputy national security adviser for international economic affairs, rejected suggestions of discord with other nations and said it was "grossly inaccurate" to suggest the U.S. was not taking a firm lead in reform.
"We are no less committed to fixing the problems, and addressing regulatory and other deficiencies, than any other leader," he said.
While in New York, the president addressed a conference at the United Nations on religious tolerance and met privately with King Abdullah of Saudi Arabia.
The summit is just the first in a series intended to deal with the enormity of the economic meltdown, and the next meeting won't be until after Bush leaves office on Jan. 20.
In the United States alone, the nation's jobless ranks zoomed past 10 million last month, the most in a quarter-century, as 240,000 more people lost jobs. In the latest dire sign, American automakers say they are struggling to survive.
Obama is steering clear of the summit but will have a couple representatives available to meet with leaders on his behalf.
Besides the United States, the countries represented will be Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea and Turkey. Those countries and the European Union make up the so-called G-20.
"Our aim should not be more government. It should be smarter government," Bush said during a speech in New York, a day before about two dozen world leaders converge on Washington for a weekend summit he is hosting.
Bush called on the leaders to embrace "reasonable" reforms, saying changes won't work if they shun the free market system or restrict trade.
The president delivered a vigorous defense of free-market capitalism and easier global trade to frame his approach to the high-level gathering. Bush invited representatives of some of the world's biggest industrial democracies, emerging nations and international bodies to Washington to start developing a more coordinated world response to the economic woes that have millions of people struggling to keep their jobs, their homes and their hopes.
With the severe economic downturn threatening to end Bush's tenure on a sour note before President-elect Barack Obama takes over, he will host the leaders at a White House dinner Friday and review causes and solutions for the financial mess Saturday.
It was fitting that Bush's argument against regulatory overreach was delivered not in Washington but from the heart of Wall Street. He spoke at venerable Federal Hall, which was home to the first Congress and is within shouting distance of New York Stock Exchange.
Bush called for reforms to strengthen the global economy long-term and said leaders at this weekend's meeting would "discuss specific actions we can take."
Among the areas for possible agreement, Bush listed:
_bolstering accounting rules for stocks, bonds and other investments so investors have a clearer sense of the true value of what they buy.
_requiring "credit default swaps" — a type of corporate debt insurance — to be processed through a central clearinghouse. That would help provide crucial information on the parties involved in these complex, unregulated products. Prices for this insurance soared in the aftermath of the Lehman Brothers' bankruptcy and imperiled American International Group, a major insurer of this kind of corporate debt.
_taking a fresh look at rules aimed at preventing fraud and manipulation in trading of stocks and other securities.
_better coordinating financial regulations among countries.
_Giving a wider variety of countries voting power at the International Monetary Fund and the World Bank.
Notably absent from his speech was any talk about what the U.S. might do to bail out the troubled auto industry or the debate over a second U.S. stimulus package.
"The crisis was not a failure of the free market system," Bush said. "And the answer is not to try to reinvent that system."
But Bush's argument that "government intervention is not a cure-all" came as some critics think his administration already is overstepping in private markets. The federal dollars being spent or put on the line to rebuild the nation's financial system could easily run into the trillions. Already the Bush administration has enacted a $700 financial rescue package, backed the purchase of investment bank Bear Stearns, bought stock in leading banks, engineered a government takeover of mortgage giants Fannie Mae and Freddie Mac, guaranteed money market fund holdings and funneled billions to stabilize troubled insurance giant American International Group.
"I'm a market-oriented guy, but not when I'm faced with the prospect of a global meltdown," Bush said.
At the same time, the president aggressively defended the U.S. against charges from around the world that insufficient U.S. regulation led to the credit collapse worldwide. This was his way of pushing back against both the criticism and the calls by allies for more intrusive rules. Heading into the meeting, Europeans are seen as looking more urgently for broad changes and tighter universal banking regulations than is the United States.
"Many European countries had much more extensive regulations and still experienced problems almost identical to our own," Bush said.
Some critics have said that lax oversight by U.S. and other regulators failed to detect problems and respond with action that could have prevented the meltdown. The crisis began with the collapse of the U.S. housing market, which froze credit, then shook the broader financial sector and finally rippled overseas.
"History has shown that the greater threat to economic prosperity is not too little government involvement in the market, it is too much government involvement in the market," he said. "It would a terrible mistake to allow a few months of crisis to undermine 60 years of success."
Dan Price, Bush's deputy national security adviser for international economic affairs, rejected suggestions of discord with other nations and said it was "grossly inaccurate" to suggest the U.S. was not taking a firm lead in reform.
"We are no less committed to fixing the problems, and addressing regulatory and other deficiencies, than any other leader," he said.
While in New York, the president addressed a conference at the United Nations on religious tolerance and met privately with King Abdullah of Saudi Arabia.
The summit is just the first in a series intended to deal with the enormity of the economic meltdown, and the next meeting won't be until after Bush leaves office on Jan. 20.
In the United States alone, the nation's jobless ranks zoomed past 10 million last month, the most in a quarter-century, as 240,000 more people lost jobs. In the latest dire sign, American automakers say they are struggling to survive.
Obama is steering clear of the summit but will have a couple representatives available to meet with leaders on his behalf.
Besides the United States, the countries represented will be Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea and Turkey. Those countries and the European Union make up the so-called G-20.
The Obama Transition: What Will Change Look Like?
By KAREN TUMULTY Karen Tumulty 16 mins ago
It is one of the ironies of politics and history that when the candidate of change was pondering what he would do if he actually got elected President, he turned to the man who eight years before handed over the White House keys to George W. Bush. Former Clinton White House chief of staff John Podesta had met Barack Obama only a few times before the Democratic nominee summoned him to Chicago in August to ask him to begin planning a transition. Podesta supported Hillary Clinton in the Democratic primaries and had little in common with Obama beyond the fact that they are both skinny guys from Chicago. Yet it is hard to think of a Democrat in Washington who can match Podesta's organizational abilities or his knowledge of the inner workings of government. And Obama was already giving plenty of thought to the crucial 76 days between the election and the Inauguration. "He understood that in order to be successful, he had to be ready," says Podesta, who is now a co-chairman of the transition team. "And he had to be ready fast."
Even in the calmest of times, the transfer of presidential power is a tricky maneuver, especially when it involves one party ceding the office to another. But not since Franklin D. Roosevelt took office in the midst of the Depression has a new President faced a set of challenges quite as formidable as those that await Obama. That's why Obama has been quicker off the blocks in setting up his government than any of his recent predecessors were, particularly Bill Clinton, who did not announce a single major appointment until mid-December. As the President-elect put it in his first radio address, "We don't have a moment to lose." (See pictures of Obama's victory celebration in Chicago.)
Not only did Obama name a White House chief of staff two days after the election, but he also began to fill 120,000 sq. ft. (11,000 sq m) of office space in downtown Washington with a transition operation that is ultimately expected to have a staff of 450 and a budget of $12 million, more than half of which must be raised from private funds. Obama's goal, says his old friend Valerie Jarrett, another co-chair of the transition operation, "is to be able to be organized, efficient, disciplined and transparent to the American people." More disciplined than transparent: Washington's quadrennial parlor game is in full swing, with scores of names being circulated as contenders for top jobs in the Obama Administration. But the number of people who actually know anything is small, and they are not prone to leaking.
The transition provides an early glimpse of how the Obama team will conduct itself in power - and a test of how much change it really will bring to Washington. As the cascade of crises grows - the collapse of General Motors being the latest - the President-elect won't have time to settle in before making big decisions. In a real sense, the moves Obama makes in the next six weeks may help define what kind of President he will be. The appointments he makes, the way he engineers his government, how fast he gets everything in place - each of those things will determine whether he stumbles or bursts out of the starting gate and whether he sets forth a clear or an incoherent agenda for governing.
Planning Ahead
By all indications, this is shaping up to be one of the most amicable transfers of power between the parties in recent years - thanks in no small part to the extraordinary efforts of the current occupant of the Oval Office. Planning for the handoff was under way well before the Obamas paid a visit to the Bushes at the White House on Nov. 10 for a tour of the place that they, their daughters and the new President's mother-in-law will soon be calling home. Since September, Podesta has been quietly working with current White House chief of staff Josh Bolten and Bolten's deputy, Blake Gottesman, to make sure the transition is as smooth as possible. Bolten and Gottesman have been offering advice on which posts need to be filled quickest and making their personnel available to Obama advisers. More than 100 interim security clearances have already been granted to Obama aides. "If a crisis hits on Jan. 21, they're the ones who are going to have to deal with it," Bolten said in an interview with C-SPAN. "We need to make sure that they're as well prepared as possible."
The most labor-intensive phase is about to begin, as teams of Obama aides descend on more than 100 federal departments and agencies to begin poring over their operations. Meanwhile, the new Administration is looking for more than 300 Cabinet secretaries, deputies and assistant secretaries, plus upwards of 2,500 political appointees who do not require Senate confirmation. Not that there will be any lack of candidates: in the first five days after Obama's team set up its Change.gov website, 144,000 applications poured in.
Obama seems determined to avoid the mistakes of Bill Clinton's chaotic transition in 1992, which helped set the stage for what turned out to be a rocky first year in office. Whereas Clinton put most of his early efforts into picking a diverse Cabinet that he said would look like America - and required three attempts to come up with a female Attorney General - Obama will initially focus on building his White House operation, much as Ronald Reagan did in 1980. Cabinet appointments are likely to begin coming by the end of the month, which is still early by recent historical standards. But Podesta says Obama intends to make the White House the locus of policy formulation and decision-making.
The strongest signal of how that White House will operate has been Obama's pick of Illinois Congressman Rahm Emanuel to be its chief of staff. Emanuel is a win-at-any-cost partisan but not an ideologue; in his earlier White House stint as a top aide to Clinton, he was a key figure in shepherding through the North American Free Trade Agreement, a crime bill and welfare reform - none of them popular with the Democratic Party's liberal base. The appointment of someone who has been a savvy operator at both ends of Pennsylvania Avenue also shows that, for all Obama's talk of change, he does not intend to make the mistake of earlier Presidents who ran as outsiders and brought in top advisers who did not understand the folkways of Washington. (See pictures of the world reacting to Obama's win.)
But there are those who worry that Emanuel's hard-edged style - he's famously profane and once sent an enemy a dead fish - will stifle dissent and debate in a White House that, Jarrett says, Obama wants to function using a "team-of-rivals approach, with differences of opinion." Comparing Emanuel with Richard Nixon's ruthless chief of staff, New York University government expert Paul Light predicts, "He's going to make Bob Haldeman look like a cupcake."
The Agenda Dilemma
Beyond personnel, the transition period is likely to yield insights into Obama's executive abilities and his agenda. Obama, following a model set by F.D.R. during his transition, has signaled that he does not intend to get deeply involved in the wrangling between Bush and Congress over an economic-stimulus package. Nor does he intend to return to Washington from Chicago to vote on one if it should come to the Senate chamber, where he technically still serves.
But given the urgency of the challenges - guarding against another terrorist attack and dealing with an economic crisis - Obama knows he doesn't have time on his side. His top priority will be stabilizing the financial system, he said in an interview with CNN shortly before the election, followed by investing in renewable energy, universal health care, middle-class tax cuts and education reform. Then there are the other things he talked about at various points in the campaign: closing GuantÁnamo, withdrawing from Iraq, renegotiating trade deals, reforming immigration. How quickly those now secondary goals will follow is a major question and source of debate among Obama's advisers. Publicly, they insist that he can do it all, and there is plenty of talk about putting these issues on parallel tracks. But it is hard to see how he can afford such expensive undertakings alongside a $700 billion federal bailout of the financial system (which Obama now wants to extend to the collapsing auto industry) and a new economic-stimulus package.
One relatively easy way that he can put early points on the change board once in office is by issuing a series of Executive Orders - for instance, reversing Bush policies on stem-cell research, offshore drilling and the prohibition against using foreign-aid money for abortion counseling. Congress, with its stronger Democratic majorities in both houses, is likely to quickly pass legislation that previously died under a Bush veto, beginning with expanded funding for the children's health-insurance program that is administered by the states. And lawmakers may also begin passing parts of Obama's economic and energy plans piecemeal.
The question is whether that will build Obama's momentum for bigger change or merely squander his honeymoon. Here too, Clinton's history is telling. In his first year, he put so much energy and capital into his deficit-reduction package and NAFTA that, in the view of some who served with him, he had little left for health care in his second.
The greatest challenge of all for President Obama will be the one set for him by candidate Obama. A Diageo/Hotline poll conducted after his election showed that two-thirds of those surveyed are now confident that "real change" is coming to Washington. How long are they willing to wait for it? Hope can fuel a campaign, but Presidents are measured by results.
- With reporting by Jay Newton-Small / Washington
It is one of the ironies of politics and history that when the candidate of change was pondering what he would do if he actually got elected President, he turned to the man who eight years before handed over the White House keys to George W. Bush. Former Clinton White House chief of staff John Podesta had met Barack Obama only a few times before the Democratic nominee summoned him to Chicago in August to ask him to begin planning a transition. Podesta supported Hillary Clinton in the Democratic primaries and had little in common with Obama beyond the fact that they are both skinny guys from Chicago. Yet it is hard to think of a Democrat in Washington who can match Podesta's organizational abilities or his knowledge of the inner workings of government. And Obama was already giving plenty of thought to the crucial 76 days between the election and the Inauguration. "He understood that in order to be successful, he had to be ready," says Podesta, who is now a co-chairman of the transition team. "And he had to be ready fast."
Even in the calmest of times, the transfer of presidential power is a tricky maneuver, especially when it involves one party ceding the office to another. But not since Franklin D. Roosevelt took office in the midst of the Depression has a new President faced a set of challenges quite as formidable as those that await Obama. That's why Obama has been quicker off the blocks in setting up his government than any of his recent predecessors were, particularly Bill Clinton, who did not announce a single major appointment until mid-December. As the President-elect put it in his first radio address, "We don't have a moment to lose." (See pictures of Obama's victory celebration in Chicago.)
Not only did Obama name a White House chief of staff two days after the election, but he also began to fill 120,000 sq. ft. (11,000 sq m) of office space in downtown Washington with a transition operation that is ultimately expected to have a staff of 450 and a budget of $12 million, more than half of which must be raised from private funds. Obama's goal, says his old friend Valerie Jarrett, another co-chair of the transition operation, "is to be able to be organized, efficient, disciplined and transparent to the American people." More disciplined than transparent: Washington's quadrennial parlor game is in full swing, with scores of names being circulated as contenders for top jobs in the Obama Administration. But the number of people who actually know anything is small, and they are not prone to leaking.
The transition provides an early glimpse of how the Obama team will conduct itself in power - and a test of how much change it really will bring to Washington. As the cascade of crises grows - the collapse of General Motors being the latest - the President-elect won't have time to settle in before making big decisions. In a real sense, the moves Obama makes in the next six weeks may help define what kind of President he will be. The appointments he makes, the way he engineers his government, how fast he gets everything in place - each of those things will determine whether he stumbles or bursts out of the starting gate and whether he sets forth a clear or an incoherent agenda for governing.
Planning Ahead
By all indications, this is shaping up to be one of the most amicable transfers of power between the parties in recent years - thanks in no small part to the extraordinary efforts of the current occupant of the Oval Office. Planning for the handoff was under way well before the Obamas paid a visit to the Bushes at the White House on Nov. 10 for a tour of the place that they, their daughters and the new President's mother-in-law will soon be calling home. Since September, Podesta has been quietly working with current White House chief of staff Josh Bolten and Bolten's deputy, Blake Gottesman, to make sure the transition is as smooth as possible. Bolten and Gottesman have been offering advice on which posts need to be filled quickest and making their personnel available to Obama advisers. More than 100 interim security clearances have already been granted to Obama aides. "If a crisis hits on Jan. 21, they're the ones who are going to have to deal with it," Bolten said in an interview with C-SPAN. "We need to make sure that they're as well prepared as possible."
The most labor-intensive phase is about to begin, as teams of Obama aides descend on more than 100 federal departments and agencies to begin poring over their operations. Meanwhile, the new Administration is looking for more than 300 Cabinet secretaries, deputies and assistant secretaries, plus upwards of 2,500 political appointees who do not require Senate confirmation. Not that there will be any lack of candidates: in the first five days after Obama's team set up its Change.gov website, 144,000 applications poured in.
Obama seems determined to avoid the mistakes of Bill Clinton's chaotic transition in 1992, which helped set the stage for what turned out to be a rocky first year in office. Whereas Clinton put most of his early efforts into picking a diverse Cabinet that he said would look like America - and required three attempts to come up with a female Attorney General - Obama will initially focus on building his White House operation, much as Ronald Reagan did in 1980. Cabinet appointments are likely to begin coming by the end of the month, which is still early by recent historical standards. But Podesta says Obama intends to make the White House the locus of policy formulation and decision-making.
The strongest signal of how that White House will operate has been Obama's pick of Illinois Congressman Rahm Emanuel to be its chief of staff. Emanuel is a win-at-any-cost partisan but not an ideologue; in his earlier White House stint as a top aide to Clinton, he was a key figure in shepherding through the North American Free Trade Agreement, a crime bill and welfare reform - none of them popular with the Democratic Party's liberal base. The appointment of someone who has been a savvy operator at both ends of Pennsylvania Avenue also shows that, for all Obama's talk of change, he does not intend to make the mistake of earlier Presidents who ran as outsiders and brought in top advisers who did not understand the folkways of Washington. (See pictures of the world reacting to Obama's win.)
But there are those who worry that Emanuel's hard-edged style - he's famously profane and once sent an enemy a dead fish - will stifle dissent and debate in a White House that, Jarrett says, Obama wants to function using a "team-of-rivals approach, with differences of opinion." Comparing Emanuel with Richard Nixon's ruthless chief of staff, New York University government expert Paul Light predicts, "He's going to make Bob Haldeman look like a cupcake."
The Agenda Dilemma
Beyond personnel, the transition period is likely to yield insights into Obama's executive abilities and his agenda. Obama, following a model set by F.D.R. during his transition, has signaled that he does not intend to get deeply involved in the wrangling between Bush and Congress over an economic-stimulus package. Nor does he intend to return to Washington from Chicago to vote on one if it should come to the Senate chamber, where he technically still serves.
But given the urgency of the challenges - guarding against another terrorist attack and dealing with an economic crisis - Obama knows he doesn't have time on his side. His top priority will be stabilizing the financial system, he said in an interview with CNN shortly before the election, followed by investing in renewable energy, universal health care, middle-class tax cuts and education reform. Then there are the other things he talked about at various points in the campaign: closing GuantÁnamo, withdrawing from Iraq, renegotiating trade deals, reforming immigration. How quickly those now secondary goals will follow is a major question and source of debate among Obama's advisers. Publicly, they insist that he can do it all, and there is plenty of talk about putting these issues on parallel tracks. But it is hard to see how he can afford such expensive undertakings alongside a $700 billion federal bailout of the financial system (which Obama now wants to extend to the collapsing auto industry) and a new economic-stimulus package.
One relatively easy way that he can put early points on the change board once in office is by issuing a series of Executive Orders - for instance, reversing Bush policies on stem-cell research, offshore drilling and the prohibition against using foreign-aid money for abortion counseling. Congress, with its stronger Democratic majorities in both houses, is likely to quickly pass legislation that previously died under a Bush veto, beginning with expanded funding for the children's health-insurance program that is administered by the states. And lawmakers may also begin passing parts of Obama's economic and energy plans piecemeal.
The question is whether that will build Obama's momentum for bigger change or merely squander his honeymoon. Here too, Clinton's history is telling. In his first year, he put so much energy and capital into his deficit-reduction package and NAFTA that, in the view of some who served with him, he had little left for health care in his second.
The greatest challenge of all for President Obama will be the one set for him by candidate Obama. A Diageo/Hotline poll conducted after his election showed that two-thirds of those surveyed are now confident that "real change" is coming to Washington. How long are they willing to wait for it? Hope can fuel a campaign, but Presidents are measured by results.
- With reporting by Jay Newton-Small / Washington
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