Lexington
The class warrior
Jim Webb would make a poor running-mate for Barack Obama
IN 1983 Jim Webb spent a while working as a journalist in Lebanon. “On any given day in Beirut, one never knew who was going to shoot at whom, or for what reason,” he recalls in his new book, “A Time to Fight”. During a typical skirmish he observed, Lebanese army soldiers started shooting at some Druze militiamen, who responded by firing on American marines (who were supposed to be keeping the peace). Then a Syrian unit let rip its heavy machineguns at both the marines and the Lebanese. Meanwhile, in the distance, Christian Phalangist militiamen “engaged in an artillery duel with another unit that we were unable to identify.”
Mr Webb's experiences in Beirut (where 241 Americans were killed in a suicide attack that year) convinced him that America should never occupy territory in the Middle East. When the idea of invading Iraq was first mooted, he opposed it. He predicted America would get stuck there for 30-50 years, that Muslims everywhere would be outraged and that Chinese and Iranian influence in the region would increase at America's expense.
In his prescience on this issue, Mr Webb, who is now a senator, has much in common with Barack Obama. The difference is that Mr Webb is a military man. He attended the Naval Academy (also John McCain's alma mater), was decorated four times and wounded twice in Vietnam, and served as Ronald Reagan's secretary of the navy. His father was in the air force; his son served in Iraq. No one, therefore, can accuse Mr Webb of being an effete peacenik. That lends weight to his views on Iraq, and leads many Democrats to conclude that Mr Obama should pick him as his running mate.
In some ways, Mr Webb would be a shrewd choice. He is from Virginia, a battleground state with 13 juicy electoral votes. At 62, he is reassuringly older than Mr Obama, but he has been a politician for less than two years, which fits nicely with Mr Obama's message of freshness and change. Among party activists he is a hero, since his white-knuckle victory in 2006 handed control of the Senate to the Democrats. And he compensates for some of Mr Obama's weaknesses. Unlike his party's flag-bearer, Mr Webb understands America's warrior culture. He also has solid experience both of grappling with bureaucrats and of running something big: the entire navy and marine corps.
Mr Obama is a scholarly and cosmopolitan chap who has so far struggled to connect with working-class whites. During the primaries, he lost in West Virginia to Hillary Clinton by a staggering 41 percentage points. Mr Webb, though also a successful writer, is a gruff warrior who glories in his humble southern roots. His mother grew up sleeping on a corn-shuck mattress and brushing her teeth with twigs. His uncle Tommy once took on three men together in a brawl. Other Democrats may talk about thumping Republicans; Mr Webb has punched Oliver North repeatedly in the face. (During a boxing match at the Naval Academy which, to be fair, Mr North won.)
Mr Obama enjoys huge support among blacks and rich white liberals. That was enough to win him the Democratic nomination. But to win the general election, he needs Reagan Democrats—working-class whites who worry about national security, are somewhat culturally conservative and whom the Gipper was able to persuade to change political sides. These folks might well prefer a plain-spoken war hero like Mr McCain to the articulate and arugula-munching Mr Obama. But they would vote for Mr Obama if he ran with another plain-spoken warrior, especially if that warrior questions the ban on school prayer and has a union card, two Purple Hearts and three tattoos.
That, at least, is what Mr Webb's boosters argue. No one but Mr Obama knows whom he will pick, but the buzz around Mr Webb is loud enough to make him the favourite on Intrade, a betting website. So it is worth examining his weaknesses, too.
On the other hand
Mr Webb is an indifferent campaigner. His speeches are awkward, he clearly dislikes all the flesh-pressing and he looks like an angry potato. He has infuriated some Democrats (but pleased others) by bucking party orthodoxy on matters of race and sex. He thinks it unfair to poor whites that racial preferences designed to atone for slavery and segregation should be extended to virtually every other minority group. And in 1979 he wrote an article opposing combat roles for women entitled, simply: “Women Can't Fight”. (He has since changed his mind.)
The main worry about Mr Webb, however, is that he is a genuine fire-breathing economic populist. He appears actually to believe the sort of stuff that Mr Obama only says during Democratic primaries. Since vice-presidents sometimes become presidents, this matters. American workers, says Mr Webb, “are at the mercy of cut-throat executives who are vastly overpaid, partly as a consequence of giving [the workers'] jobs away to other people.” Illegal immigration and globalisation “threaten to dissipate” the American middle-class way of life. He predicts that, unless the government acts to restore “economic fairness”, America “may well go the way of ancient Greece [or] greed-ridden Rome”.
America may be horribly unequal, but it is not, as Mr Webb imagines, apocalyptically so. And judging by his book, Mr Webb has only a shaky understanding of the economic system he decries. He thinks South Korea is more productive than America, and that “most” investors are among the wealthiest 1% of Americans. (In fact, about half of Americans own shares.) He is worryingly hazy about how he would make America fairer. But his instincts are plainly hostile to the free flow of goods, investment and people across borders. Mr Obama, who has recently started to sound less protectionist on the campaign trail and has appointed a team of impeccably centrist economic advisers, can surely do a bit better.
The Panglossian approach to debt
By John Gapper
As the US continues to flirt with recession and banks face credit downgrades and a rumbling crisis of confidence, one bunch of financial institutions is doing quite nicely, thank you.
The golden few years of private equity, when funds such as Blackstone and Kohlberg Kravis Roberts threw their weight around on Wall Street, went into abrupt abeyance last year. Yet these funds are buying up distressed debt and continuing to run the companies they bought at the peak.
They have been helped by the extraordinarily good terms they struck with banks – yes, them again – at the peak of private equity mania. So eager were big banks such as Citigroup and Merrill Lynch to lend money for leveraged buy-outs that they gave away protections.
Banks, which hoped to pass on the loans and bonds that they underwrote to investors, made “covenant-light” loans that did not allow them much control if a company ran into difficulties. They also offered bonds with “payment-in-kind” (PIK) clauses that allowed a troubled company – or one that felt like it – to replace cash payments with more debt.
The market for such funny paper shut down last autumn but companies hit by the downturn and raw material costs are now exercising their rights. My colleague, Henny Sender, disclosed in the Financial Times this week that four companies owned by the private equity group, Apollo Management, have told investors that they will suspend cash payments on PIK bonds.
A sorry lesson in how banks and other creditors allowed themselves to be pressed into underpricing debt and letting underwriting standards fall, you might conclude. No doubt everyone will learn a lesson and never make that mistake again, until memories have faded a bit.
But this is not the lesson that big private equity firms have drawn. Tony James, president of Blackstone, argued the other day at a conference organised by The Deal magazine that PIK bonds and covenant-light loans were not a bull market aberration at all. Instead, they ought to be built into every leveraged buy-out because they were good for society, he said.
Mr James’s argument is as follows. Debt-holders who have lent money to companies want to keep receiving interest and be sure of getting their principal back. So they are likely to push companies that get into trouble to do all things necessary to preserve their lenders’ interests, even if that involves hurting the business.
Covenant-light loans – of which Mr James is a particular fan – do not give lenders room for manoeuvre. Even if a company is hit and its earnings deteriorate, it is unlikely to breach its loan covenants. So lenders cannot wrest control from the equity-holders, which in the case of leveraged buy-outs are private equity funds. Mr James likes this state of affairs. Private equity funds employ talented managers who can get a company out of a mess if anyone can, he believes. Meanwhile, workers keep their jobs, suppliers get orders and lenders are repaid. “I firmly believe that these kinds of debt structures are in everyone’s interests,” he concluded.
Hmm. Mr James may be right that cheap debt – as represented by PIK bonds – is a boon for borrowers and those who depend on them. The reason that Apollo-owned companies have stopped paying cash is that it is very cheap to do so. Some have to pay only about half a percentage point more to make payments in paper, which is a snip these days.
But that does not make it good for lenders. Instead of getting cash from a healthy enterprise, they get a bigger slice of a troubled one. They are forced to place their faith in investors such as Mr James turning the enterprise round before they lose capital as well as cash interest.
This applies in spades to the holders of covenant-light debt, who are at the top of the capital structure and yet find themselves powerless to influence events. Normally, senior debt-holders in a company that gets into trouble are able to block mergers, force asset sales or even change the management to protect their cash. Not so with covenant-light loans.
In the best of all possible worlds envisaged by the Panglossian Mr James, this may be fine. A company may go through a temporary dip in fortunes and then recover with no permanent harm done. But how can a debt-holder know that will happen? After all, the expertise of the private-equity-appointed managers did not avoid trouble in the first place.
As Harvey Miller, a partner at the law firm, Weil, Gotshal & Manges, says, owners of troubled companies often throw good money after bad. “The bad thing for lenders and society is that some of these companies will run down everything [to stay in business] so that, by the time there is a default, there is nothing left.”
In fact, the US bankruptcy code was enacted in 1978 partly to deal with the problem that too many companies were being run into the ground. Chapter 11 is not perfect but it does recognise the reality of competing interests and the benefit of getting everyone to sit round a table – or take part in a conference call – and try to thrash them out.
Such protection for debt-holders does have a social benefit, even when it involves companies being liquidated and their assets being sold off. It prevents extended agony and it makes it more likely that investors will take the risk of lending in future.
Hopefully, the US will go through a short downturn or recession and the companies that are suspending cash payments and taking advantage of loose covenants will live to fight another day. But neither the sunny Mr James nor anyone else can be sure of that. It could also be that Apollo, Blackstone and others are storing up worse trouble for the future.
Security fears over food and fuel crisis
By Carola Hoyos and Javier Blas in London
Western countries have upgraded the food and fuel crisis into a national security concern as they fear record high energy and agriculture commodity costs are destabilising key developing regions of the world.
The concerns come as the world suffers for the first time since 1973 from the confluence of record oil and food prices. Corn, soyabean and meat prices jumped this week to all-time highs, while oil prices hit a record of almost $140 a barrel.
This shift toward a national security concern will become apparent at Sunday’s oil meeting in Jeddah, Saudi Arabia, where ministers are expected to warn that developing countries are cracking under the burden of record oil and food costs.
Saudi Arabia, the world’s largest oil producer and the only country able to raise output, has recognised the danger after developing countries, including US-ally Pakistan, pleaded for a reprieve from oil payments.
Morocco was forced last month to ask for an $800m loan from Saudi Arabia and United Arab Emirates to cushion the impact of oil and cereal imports.
One Washington official said: “What we have been watching is behaviour [that indicates] China, India, Indonesia, Vietnam [and] Malaysia simply can’t bare the burden on the central budget and that the medium to long-term confluence of oil and food prices is just too much.” He added: “It is leading to a real security issue where the streets are talking to the president.”
Martin Bartenstein, Austria’s economics minister who is travelling to Jeddah, said on Friday that the risk of social tension caused by high oil prices driving inflation to double digits will be a main tenet of his argument.
“It is very high on our agenda,” said a senior diplomat from a larger European nation.
Senior active and former US, European and United Nations officials said they had met US White House staff on the issue for briefings having been prompted in part by the unrest that toppled Haiti’s government and more recently after several Asian countries risked popular anger by cutting fuel subsidies.
June 20 (Bloomberg) -- China's central bank Governor Zhou Xiaochuan said his bank may formulate ``stronger policies'' to tackle inflation exacerbated by the government's latest fuel- price increases.
``Surely higher energy prices will send some pressure to the consumer price index, so we may have stronger policies against inflation,'' Zhou told reporters in New York today before a meeting with U.S. business groups. Zhou didn't elaborate.
The world's second-biggest oil consumer after the U.S. yesterday unexpectedly raised gasoline and diesel prices by at least 17 percent from today, and increased power tariffs to rein in energy consumption. Crude oil prices are 91 percent higher than a year ago. China's retail fuel prices are about half the levels of the world's benchmark, Wang Qing, chief China economist at Morgan Stanley in Hong Kong, wrote in a June 6 report.
Inflation climbed to 8.1 percent in the first five months, from 4.8 percent for all of 2007. Though inflation last month was off the 12-year high of 8.7 percent reached in February, Zhou yesterday cautioned against saying inflation will slow.
``It's hard to say whether inflation will continue to ease for the rest of the year,'' Zhou told reporters in Washington, after meetings earlier this week with U.S. Treasury Secretary Henry Paulson. ``We need to closely monitor it.''
Rain, Floods
Aiming to keep consumer price increases for 2008 below last year's 4.8 percent, the People's Bank of China has ordered lenders to set aside a record proportion of their deposits as reserves and increased the pace of the yuan's appreciation this year to cool price gains. Zhou has kept the nation's benchmark interest rates unchanged after six increases last year, fretting that higher rates may attract more capital inflows.
China's fuel-price increases may push up inflation in the second half of this year by 0.9 percentage point, Ha Jiming, chief China economist at China International Capital Corp. in Hong Kong, wrote in an e-mailed note yesterday. Inflation may rise as much as 7.5 percent in 2008, Ha wrote, adding China's fuel prices need to rise another 60 percent to reach global levels.
On top of higher prices of gasoline, diesel, electricity and jet fuel, the central bank's job to control inflation may also be complicated by rainstorms and floods caused by more than 10 days of downpours this month in southern China's provinces, the most in 100 years in some areas, and spoiling 1 million hectares of farm land. The floods caused economic losses of about 20.3 billion yuan ($3 billion).
Zhou is among Chinese officials led by Vice Premier Wang Qishan meeting with their counterparts, including Paulson, for the semiannual China-U.S. Strategic Economic Dialogue. The Chinese officials are in New York today to meet with U.S. business groups.
June 20 (Bloomberg) -- General Motors Corp., Ford Motor Co. and Chrysler LLC credit ratings may be lowered by Standard & Poor's as higher gas prices inflict ``financial damage'' on the auto industry.
S&P placed the carmakers' credit ratings, already five levels below investment grade, on CreditWatch negative, according to a statement today. New York-based S&P, a unit of McGraw-Hill Cos., said it may also downgrade their financing arms. While the carmakers will be able to pay their debts this year, their cash may shrink to ``undesirable levels'' by the end of 2009, S&P said.
``As we look forward, we do not see a lot of visibility on how bad things are going to get,'' S&P analyst Robert Schulz said in an interview on Bloomberg Television. ``We thought the best thing to do would be to stand back and look at these three companies and look at how the market could unfold.''
A weakening economy and soaring fuel prices are dragging U.S. auto sales to their lowest levels in 15 years. Ford, the second-biggest U.S. automaker behind GM, said today its losses will widen because sales of its large pickup trucks in the U.S. are plunging on $4-a-gallon gasoline. The Dearborn, Michigan- based automaker said its financing unit, Ford Motor Credit, will also have a loss.
Ford and GM shares dropped and the cost to protect against a default on their debt soared. Ford shares fell 51 cents, or 8 percent, to $5.81 in New York Stock Exchange composite trading. GM's shares declined $1, or 6.7 percent, to $13.79. Chrysler, based in Auburn Hills, Michigan, is owned by New York private equity firm Cerberus Capital Management LP.
Credit-Default Swaps
The cost to protect GM's debt rose to a record. Credit- default swap sellers demanded 27.5 percent upfront and 5 percent a year to protect GM debt from default for five years, according to CMA Datavision. That's up from 24 percent initially and 5 percent a year yesterday and means it would cost $2.73 million upfront and $500,000 annually to protect $10 million in debt.
The upfront payments for Ford contracts jumped 3.5 percentage points to 24.75 percent, the widest in more than three months, CMA prices show. Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.
Renewed Concerns
Moody's also changed its outlook on both Ford and Chrysler's B3 ratings to ``negative'' from ``stable'' today.
In the report, S&P's Schulz said he has renewed concerns about the companies' ``future cash outflows in light of the prospects for U.S. sales for the rest of 2008 and into 2009.''
``The erosion of demand for SUVs and pickups has been particularly troubling,'' Schulz said.
``The companies' difficulty in anticipating the pace of market deterioration was reflected today in Ford's announcement,'' Schulz said in the report. ``In addition to weak sales and adverse product mix shifts, the list of challenges also includes less receptive capital markets, higher costs for steel and other raw materials, lower residual values that hurt profitability at the finance units and reduce consumers' trade-in power, and increasing cash needs for restructuring efforts.''
Ford surprised analysts with a first quarter profit in April, and then last month abandoned its forecast for a full-year profit in 2009. Ford lost $2.7 billion last year and $12.6 billion the year before. Detroit-based GM reported $38.7 billion of losses last year after a $1.98 billion loss in 2006.
S&P rates all three automaker's debt B. For issuers rated B, ``adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment,'' according to S&P's ratings definitions.
June 20 (Bloomberg) -- U.S. stocks slid to a three-month low, led by consumer and technology companies, as threats of increased violence in the Middle East pushed oil prices higher and analysts said demand for electronics may weaken.
Benchmark indexes extended declines after Standard & Poor's said it may cut credit ratings on General Motors Corp. and Ford Motor Co. because of higher fuel costs, sending GM to its lowest level since 1982. SanDisk Corp. posted its worst drop in eight months on Citigroup Inc.'s prediction that earnings will be less than estimated because of diminished overseas demand. Citigroup led financial shares to a five-year low as UBS AG said the biggest U.S. bank may post a second-quarter loss.
Shares in Europe and Asia also tumbled and the MSCI Emerging Markets Index fell for a third day as Iran's threat to retaliate against a potential attack by Israel weighed on shares. The slide pushed the S&P 500 Index to its third-straight weekly retreat.
``Investors are continuing to lose confidence in the economy,'' said James W. Gaul, a portfolio manager at Boston Advisors LLC in Boston, which manages $2 billion. ``The idea that we're going to end the year up is probably going out the window now.''
The S&P 500 lost 24.90 points, or 1.9 percent, to 1,317.93. The Dow Jones Industrial Average dropped 220.4, or 1.8 percent, to 11,842.69. The Nasdaq Composite Index slid 55.97, or 2.3 percent, to 2,406.09. Six stocks fell for each that rose on the New York Stock Exchange.
Weekly Drop
The S&P 500 tumbled 3.1 percent this week, extending its 2008 slump to more than 10 percent. Financial shares have led the market's retreat this year, dropping 24 percent as a group, as credit-related losses approach $400 billion globally. The Dow declined 3.8 percent this week, and the Nasdaq retreated 2 percent.
More than 2 billion shares changed hands on the NYSE, the most since March 20, as today's expiration of futures and options on indexes and individual stocks spurred trading. So-called quadruple witching occurs once every three months.
The quarterly rebalancing of the S&P 500 after the close of exchanges also boosted volume as investors whose funds mimic the index buy and sell shares to reflect expected adjustments.
GM, Ford Tumble
GM, the biggest automaker, fell the most in the Dow average as 29 of the gauge's 30 stocks retreated. GM slid 6.8 percent to $13.79 and Ford, the second-largest U.S. automaker, lost 8.1 percent to $5.81. Standard & Poor's placed their credit ratings, and those of Chrysler LLC, on CreditWatch with negative implications, citing ``financial damage'' resulting from elevated gas prices. Moody's Investors Service changed Ford's outlook to negative from stable.
Ford said today that automotive losses will worsen as demand for pickups and sport-utility vehicles is ``at one of the lowest levels in decades.'' The finance units of GM and Ford may each have to write down the value of used trucks on lease by more than $1 billion, Lehman Brothers Holdings Inc. analyst Brian Johnson said in a report.
SanDisk tumbled 9.7 percent to $21.16 for the third-biggest drop in the S&P 500. Citigroup analyst Craig Ellis lowered his rating on the largest maker of flash-memory cards to ``hold'' from ``buy.'' He cut his 2008 profit estimate by 12 percent to $1.23 a share and reduced his 2009 estimate by 25 percent to $1.29.
`Demand Erosion'
``Recent card and drive end-demand erosion in Asia, and still-modest embedded handset orders from European companies have gone against our call,'' Ellis wrote in a research note dated yesterday. ``The body of evidence we see no longer argues for putting new money to work in the name and thus we move to the sidelines.''
Technology companies in the S&P 500 retreated 2.5 percent as a group and contributed the most to the index's retreat.
Citigroup, which yesterday said it will post more writedowns from subprime-infected investments, lost 4.3 percent to $19.30. The biggest U.S. bank will probably report a loss in the second quarter, UBS analyst Glenn Schorr said. Schorr reduced his second-quarter estimate to a loss of 40 cents a share from a previous prediction of 37 cents in profit.
Wachovia Corp., the fourth-biggest U.S. bank, fell 1.9 percent to $17.43 after Merrill Lynch & Co. slashed its share- price forecast by 21 percent to $15.
Merrill cut its earnings-per-share estimates for ``large cap regional'' U.S. banks by an average of 22 percent for 2008 and 19 percent for next year.
``Bank stocks now appear to be in capitulation mode,'' New York-based analyst Edward Najarian wrote in a note today.
No Relief
``You don't get relief till you start seeing earnings estimate revisions on the positive side,'' said Michael Mullaney, portfolio manager at Fiduciary Trust Co. in Boston, which manages $10 billion. ``There is no glimpse of any improvement.''
MBIA Inc., the world's largest bond insurer, fell 13 percent to $5.59 for the biggest drop in the S&P 500 after Moody's stripped it and rival Ambac Financial Group Inc. of their Aaa credit ratings. The downgrades followed cuts by Fitch Ratings and S&P, and reduce the value of the more than $2 trillion of debt securities insured by the firms. The cuts may necessitate additional writedowns by the banks that hold the securities, Oppenheimer & Co. analyst Meredith Whitney wrote in a June 9 report.
Fannie Mae lost 4.8 percent to $23.81. Lehman said the biggest U.S. mortgage company may post a second-quarter operating loss of $1.20 per share, wider than the loss of 68 cents a share that Lehman had previously predicted. Its smaller rival Freddie Mac may post a loss of 55 cents a share, wider than the 40 cents previously forecast, Lehman said. Freddie's shares fell 7.7 percent to $21.82.
`Accelerating Pace'
``The housing market continues to deteriorate at an accelerating pace,'' New York-based analysts Bruce W. Harting and Mark C. DeVries wrote in a note to clients today. We expect house prices ``to fall even farther than we believed to 20 percent from the peak,'' they added.
Among smaller financial companies, MF Global Ltd. lost 20 percent to $6.86. Deutsche Bank AG lowered its share-price target for the largest broker of exchange-traded futures contracts 35 percent to $11. MF Global fell 41 percent on June 18 after saying lower interest income and higher expenses will reduce revenue this quarter.
Crude Jumps
Crude oil for July delivery rose $2.69, or 2 percent, to $134.62 a barrel in New York as the weakening dollar enhanced the appeal of commodities as a currency hedge and the New York Times reported that Israel held a rehearsal for a potential bombing attack on nuclear targets in Iran.
Marriott International Inc., the world's largest lodging chain, and Brunswick Corp., which makes recreational boats, led the drop in consumer discretionary companies. The national average price of a gallon of regular unleaded gasoline, derived from crude oil, rose to a record $4.08 this week, according to AAA, the country's largest motoring club.
Marriott sank 5.1 percent to $27.45. Brunswick fell 58 cents, or 4.7 percent, to $11.87. Consumer discretionary companies are the second-worst performing group in the S&P 500 over the past year after financials, with a 24 percent loss.
Huntington Bancshares Inc. added $1.53, or 30 percent, to $6.67 for the biggest gain in the S&P 500. The Ohio-based bank, which had lost 60 percent of its market value this year, said uncollectible loans will be within its second-quarter forecast.
Huntington led regional banks in the S&P 500 to their first advance in four days.
Western Union Co. rose the most since October 2006, adding 8.4 percent to $25.10. The largest money-transfer business raised its long-term profit target and authorized an additional $1 billion stock buyback. Earnings per share will increase as much as 18 percent during the next three to five years, the company said in a statement.
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