Oct. 28 (Bloomberg) -- U.S. life insurers are in talks with the government for potential investments as companies jockey for the remaining $90 billion of the $250 billion set aside to prop up ailing financial companies.
The Treasury has been ``asking us how we can fit into the program,'' said Jack Dolan, spokesman for the Washington, D.C.- based American Council of Life Insurers, declining to name companies that may participate.
Life insurers, including MetLife Inc. and Prudential Financial Inc., lost more than half their market value this month through yesterday on concern that investment declines will squeeze liquidity. American International Group Inc., once the world's largest insurer, ceded control to the U.S. on Sept. 16 after losses from bad bets tied to housing.
``Investor confidence in the sector has recently come under considerable pressure in the aftermath of AIG's bailout,'' Nigel Dally, an analyst at Morgan Stanley, said yesterday in a research note. ``Access to lower-cost equity would help bolster capital ratios and help put to rest lingering liquidity concerns.''
MetLife and Prudential are among companies that may receive the government assistance, Jeffrey Schuman, an analyst at KBW Inc., said yesterday in a note. MetLife spokesman Christopher Breslin and Prudential's Bob DeFillippo declined to comment.
Nine of the biggest U.S. banks including Citigroup Inc., Bank of America Corp. and Goldman Sachs Group Inc. will get $125 billion from the Treasury. In a second phase of injections, at least 22 regional lenders agreed to take about $36 billion in government cash to help thaw frozen credit markets.
Seeking Capital
Life insurers asked the Treasury last week if they would be eligible to participate in the program, said an industry official with knowledge of the discussion. Some of the firms asked the government to make participation mandatory because they don't want to identify themselves as needing funds, the person said.
Government funds may be used to finance acquisitions, prompting a potential ``wave'' of deals, Colin Devine, an analyst with Citigroup Inc. said yesterday in a research note. New York- based MetLife has a ``strong capital position'' and may bid for AIG's U.S. life insurance and retirement businesses, Devine said.
Prudential may seek capital to do a deal, while Lincoln National Corp., Principal Financial Group Inc. and Genworth Financial Inc. may consider sales, Devine said. Genworth spokesman Alfred Orendorff declined to comment. Principal spokesman Tom Graf and Lincoln's Laurel O'Brien didn't immediately return telephone calls.
MetLife advanced 54 cents, or 2.1 percent, to $26.72 at 9:36 a.m. in New York Stock Exchange composite trading and Prudential rose 67 cents, or 2.1 percent, to $32.92. Genworth gained 3.7 percent, while Principal advanced 4.8 percent and Lincoln was up 2.2 percent.
Stock Slump
Life insurance stocks are heading for their worst monthly decline in more than a decade. The 11-stock S&P Life & Health Insurance Index is down about 50 percent since Sept. 30. The next biggest drop on record, according to Bloomberg data, is a 19 percent slide in February of 2000.
Meanwhile, a group representing U.S. property-casualty insurers said the firms are well capitalized and a ``substantial majority'' won't sell stock to the government under the $700 billion bailout.
Fitch Ratings cut its outlook on the U.S. life insurance industry to ``negative'' on Sept. 29 on concern that declines in the value of fixed-income investments will erode capital. Standard & Poor's followed by lowering its outlook on Oct. 10.
`Significant Losses'
Life carriers may also suffer ``significant losses'' tied to their variable annuities businesses as equity markets decline, Jeff Mohrenweiser, a Fitch analyst, said in an Oct. 22 note. The capital needed to support variable annuities operations rose by $15 billion since the beginning of the year, Fitch said. Insurers sell retirement products that guarantee minimum returns on equity investments even when stocks slump.
Declining stock markets hurt returns in MetLife's annuity business and caused Chief Executive Officer Robert Henrikson to lower the insurer's projections for full-year earnings. Sliding stock values crimp fee income from investments on which insurers charge a percentage of the assets managed. The S&P 500 Index has dropped about 40 percent this year.
MetLife, Hartford
MetLife sold $2.3 billion in new stock this month to bolster its finances after fixed-income holdings dropped in value by $7 billion in the third quarter. Hartford Financial Services Group Inc., the life and property-casualty insurer based in the Connecticut city of the same name, agreed to sell $2.5 billion in debt and equity to Allianz SE after Fitch and Moody's Investors Service lowered the company's outlook to negative.
The largest insurers in the U.S. and Bermuda posted more than $93 billion in writedowns and unrealized losses on holdings tied to the collapse of the U.S. subprime mortgage market since the beginning of last year. AIG accounts for about $48 billion of the declines. Insurers invest policyholder premiums in bonds before paying claims.
Insurers may find competition for the government money from the automobile industry. The Bush administration said yesterday that automakers' financing units may qualify for aid as part of the government's package.
``Automakers do have financing arms, many of them do, and it's possible that some of those financing arms could be a part of the rescue package,'' White House spokeswoman Dana Perino said at a briefing.
Commentary by Caroline Baum
Oct. 28 (Bloomberg) -- Three months ago, the world was running out of oil.
Seriously. I kid you not. Everywhere you turned, you heard whispers that the day of petroleum reckoning was at hand.
Now there's too much oil, prodding OPEC to cut production targets for the first time in two years. Last week, the Organization of Petroleum Exporting Countries, confronted with the halving of oil prices since July, announced a 1.5 million barrel-a-day cut in output.
World markets greeted the news of reduced oil supply by pushing prices down further. Crude oil fell $3.69 a barrel Friday to $64.15. Yesterday, oil dropped another 93 cents to $63.22, a 17-month low.
How quickly things change. Or do they?
All speculative bubbles have a kernel of truth behind them to justify their existence. This time around it was China and India. These emerging Asian giants were gobbling up all the commodities the world could produce to fuel their rapid industrialization.
It wasn't that the story was untrue; it was old. Growing global demand probably was the reason for the gradual rise in oil prices from $20 a barrel to $40 earlier in the decade, and even to $60 by mid-2005.
It was the moon shot to $147 that took on a life, and a litany, of its own. Emerging nations didn't start gobbling up crude, coal and copper all of a sudden in the middle of 2007.
Diversification Justification
Yet analysts on TV and in print told us with a straight face that the doubling in oil prices from July 2007 to July 2008 was a result of fundamental demand, not speculative buying or investors, including pension funds, ``diversifying'' into ``alternative investments'' in search of ``uncorrelated returns.'' (It sounds a lot better than admitting you got suckered into buying what was going up and are now stuck with a pile of stuff that no one wants.)
``It happens in every market,'' says Michael Aronstein, president of Marketfield Asset Management in New York. ``Once it goes up an enormous amount, creating unfathomable wealth for the fortunate participants, someone makes an ex-post case as to why we are only at a beginning and it's not too late to get in.''
This advice is ``generally formulated by someone who has a vested interest in selling the stuff,'' he says.
By the early 1980s, following two oil shocks in the previous decade, the running crude commentary went something like this: Oil prices couldn't go down because they were controlled by a cartel (OPEC). Banks extended credit to the Oil Patch based on -- you guessed it -- a belief that the underlying asset couldn't go down.
When prices plunged to about $11 a barrel in 1986, that myth went down with them.
Oil `Peaked'
The spike in crude oil earlier this year had the support of the popular theory of ``peak oil.'' In a 2005 book, ``Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,'' investment banker Matthew Simmons argued that oil production by Saudi Arabia, the world's largest producer, is ``at or near peak sustainable volume'' and likely to decline in the foreseeable future.
Just a few years before the peak-oil theory was hot, the world was ``Drowning in Oil,'' according to the Economist magazine's March 6, 1999, cover story.
Oil was trading at $13.50 a barrel at the time. ``We may be heading for $5,'' the Economist predicted. ``Consumers everywhere will rejoice at the prospect of cheap, plentiful oil for the foreseeable future.''
Oil prices took off and never looked back.
Like the world of fashion, trends in markets come and go. Oil is a limited, albeit vast, resource. At some point in the future, we probably will run out of petroleum, at least as we know it.
Curve Balls
Man's ingenuity is equally vast. When the time comes, given all the tax incentives that will be thrown in the direction of alternative energy, I have full confidence the world will not return to travel by horse and buggy.
The silliness that accompanies speculative bubbles isn't to be outdone by what passes for economic analysis. It's just over three months since commodities began their sharp, swift descent, and already the nonsense is starting: Lower oil prices are going to boost consumer demand.
Whoa! The price of oil (and other raw materials) is falling because of a cutback in demand, both actual and expected. Expressed as a graph, the demand curve for oil has shifted back, to the left. Consumers demand less energy (gasoline, heating oil) at any given price than they did before.
To say that lower prices will stimulate demand, a widely held misconception, confuses a movement along the demand curve (lower price, higher quantity) with a shift back in the curve (lower price, lower quantity).
Cause and Effect
Why this is such a hard concept to understand, I'm not sure. People imbue oil prices with all kinds of mystical powers. They see a falling price and treat it as a cause, not an effect.
That oil prices are falling in the face of OPEC's announced production cuts -- a reduction in supply would tend to raise the price, not lower it -- suggests that demand is falling even faster than OPEC can reduce supply.
That won't boost demand, but who knows? Maybe it will help recapitalize the banks!
Oct. 28 (Bloomberg) -- U.S. consumer confidence fell to the lowest level on record in October as stocks plunged and banks shut off credit, raising the risk spending will tumble.
The Conference Board's confidence index decreased to 38, less than forecast and the lowest reading since monthly records began in 1967, the New York-based research group said today. A separate report showed home values continued to drop in August.
Household wealth has evaporated as the Standard & Poor's 500 index verged on its worst one-month loss in 70 years, home equity shrank and job losses mounted. The dimming outlook signals consumer spending, which accounts for more than two-thirds of the economy, will deteriorate further, deepening the U.S. slump.
``The economy feels like it is contracting at a rapid pace,'' Lewis Alexander, chief economist at Citigroup Global Markets Inc. in New York, said in a Bloomberg Television interview. ``It's clear that consumers have really been affected by the volatility we've seen in the last six weeks.''
The report underscores voter discontent with the country's direction heading into the Nov. 4 presidential election. A majority of voters think Illinois Senator Barack Obama, the Democrat, will be better able to handle the economic turmoil than Republican rival John McCain, according to polls.
Consumer confidence was projected to drop to 52, according to the median estimate in a Bloomberg News survey of 66 economists. Forecasts ranged from 45 to 56.6. September's reading was revised up to 61.4 from an originally reported 59.8.
Market Reaction
Stocks gave up some of their earlier gains following the report. The Standard & Poor's 500 index rose 15.3 points, or 1.8 percent, to 864.2 at 10:24 a.m. in New York, after being up almost 33 points earlier. Treasury securities fell.
The 23.4-point drop this month was the third biggest on record, trailing two plunges in the early 1970s linked to oil shocks. Measures on current conditions and expectations both declined.
``It doesn't get much worse than this,'' said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. ``There's a risk of a deeper, longer-lasting recession.''
Home prices in 20 U.S. metropolitan areas dropped 16.6 percent in August from the same month in 2007, the fastest pace since year-over-year records began in 2001, a report from S&P/Case-Shiller today also showed. For a fifth consecutive month, all areas showed a decrease in prices from a year earlier.
The housing slump is likely to extend well into a fourth year as foreclosures put more properties on the market and drive down prices even more.
Components Drop
The Conference Board's measure of present conditions dropped to 41.9 from 61.1 the prior month. The gauge of expectations for the next six months slumped to 35.5 from 61.5.
The share of consumers who said jobs are plentiful dropped to 8.9 percent from 12.6 percent last month. The proportion of people who said jobs are hard to get jumped 5 points to 37.2 percent.
The proportion of people who expect their incomes to rise over the next six months dropped to 10.8 percent from 15.1 percent. The share expecting more jobs decreased to 7.4 percent from 11.9 percent.
The confidence figures corroborate declines seen in other measures. A report earlier this month showed the Reuters/University of Michigan preliminary index of consumer sentiment decreased in October by the most on record.
The Conference Board's index tends to be more influenced by attitudes about the labor market, economists have said.
Job Losses
The economy lost jobs for nine consecutive months through September, bringing the total drop in payrolls to 760,000 this year, Labor Department figures showed. Some economists anticipate job losses accelerated in October.
Consumer spending probably dropped last quarter by the most in almost two decades, economists forecast a Commerce Department report will show in two days. As a result, the economy probably shrank from July to September, the survey showed.
Today's confidence report showed fewer people planned to purchase automobiles and major appliances. Home-buying plans improved.
The slump in spending may be even bigger this quarter as consumers retrench. The International Council of Shopping Centers predicts the November-December holiday season, which brings in more than a third of some retailers' annual sales, will be the weakest since 2002.
The credit freeze ``impacted consumers' attitudes,'' Farooq Kathwari, chief executive officer of home-furnishings retailer Ethan Allen Interiors Inc., said in a Bloomberg Television interview this month. ``People are cautious, people are holding back.''
Monday, October 27, 2008
A Sound Dollar is the Key to Recovery
“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch its currency,” John Maynard Keynes once wrote. “Lenin was surely right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
Those words seem especially relevant today. The Wall Street meltdown has provoked a frenzy of finger-pointing among politicians and pundits. Yet few commentators have identified the root cause of the crisis: the Federal Reserve’s weak-dollar policy. Instead, they have blamed deregulation, “Wall Street greed,” a global savings glut, and the sharp decline in U.S. housing prices. Some have mentioned the rank corruption of Fannie Mae and Freddie Mac, which indeed played a significant role in triggering the crisis. But Fannie and Freddie’s high leverage and asset growth were ultimately a result of easy money. Their abuses would have been far fewer in a sound money regime.
Just how loose was the Fed’s monetary policy? One broad measure of the money supply, MZM (Money with Zero Maturity), grew from $3.2 trillion to $7.8 trillion between 1998 and 2007. This monetary expansion enabled many of the excesses that fueled the housing boom. Growing bank assets went searching for more loans; misguided federal policies promoted lax lending practices; and securitization ratified both the process and intermediaries’ profit streams. Government-certified ratings agencies were encouraged to keep the party going, and international investors awash in dollar liquidity were happy to snap up the ceaseless supply of ostensibly safe but high-yielding mortgage-backed securities. The endless monetary injections into the banking system also engendered moral hazard and led to imprudent leverage levels.
Monetary expansion enabled many of the excesses that fueled the housing boom.
It is crucial to understand that without a sound dollar, there will be no sustained economic recovery, only stagflation. “Sound” money means a stable-valued currency and a price system that reflects true scarcities. When the dollar is strong, it retains purchasing power over time against goods and other currencies.
Why does this matter? First, sound money supports prosperity by facilitating trade through specialization and the division of labor, which radically improves productivity and output. Second, by reducing variability in purchasing power, sound money stimulates better entrepreneurial decision-making and capital investment.
When the U.S. dollar in unstable, that often means its value is depreciating, investment in the United States is declining, resources are being misallocated, and the country is losing wealth. Over time, societies with weak or fluctuating currencies are unambiguously poorer.
Why, then, does the Federal Reserve ever tolerate dollar weakness? The Fed has two statutory tasks: 1) promote stable money and 2) induce economic growth. In the long run, the former begets the latter. But in the short run, there are winners from currency depreciation. For example, a weak dollar tends to boost exports, which helped to buoy U.S. economic growth in recent years. As the world’s largest borrower, the U.S. government benefits from a weak dollar, too, since it can repay its debts in a depreciated currency.
Monetary policy is thus driven by short-term goals, and keeping interest rates artificially low can temporarily increase lending and economic activity. This means ignoring the money supply, which the Fed felt justified in doing as long as inflation remained acceptably low.
In the long run, societies with weak or fluctuating currencies are unambiguously poorer.
Over the long term, however, interest rate management is a questionable policy instrument. Data going back to 1971 show little correlation between the federal funds rate and GDP growth. And while exports have boomed during this weak-dollar decade, currency decline is not a necessary condition for growth.
The costs of the Fed’s continuous monetary expansion are now obvious. Easy money created a classic asset bubble in the U.S. housing market. Money supply increases distorted the structure of relative prices, and many of the capital projects subsequently undertaken were not justified by real demand and real savings. Fed policy guaranteed such errant capital allocation through false interest rate signals.
How severe will the correction be? Despite the dollar’s recent surge due to a flight to safety, a period of 1970s-style stagflation is possible, because the Fed plans to monetize the debt incurred by Treasury as part of the financial bailout. Such an action is inherently inflationary, and it will weaken the dollar, which over the past eight years has seen its share of official foreign exchange reserve holdings drop from 71 percent to 63 percent.
What should be done? The fundamental problem in the banking system—and in the broader U.S. economy—is a shortage of capital. According to the Fed, the fourth quarter of 2008 will mark the fifth consecutive quarter in which U.S. household net worth declined. U.S. market capitalization is down by $8 trillion since last summer. The banking sector is now earning collective losses for the first time in 18 years.
In the years ahead, U.S. policymakers should seek to make the United States more capital-friendly. Their immediate priorities should include the following:
An early recovery will occur only if the United States becomes a magnet for capital.
(1). Consider the “Sound Dollar and Economic Stimulus Act of 2008.” Introduced by Congressman Ted Poe (R-TX), this bill would define the U.S. dollar in terms of gold. As former Republican presidential candidate Steve Forbes points out, if the Fed abandoned interest rate targeting and instead targeted the price of gold, it would have an electrifying effect on global markets. All dollar-denominated assets would rally, currency speculation would decelerate, most interest rates would fall, and consumer prices would stabilize. Maintenance of a gold-tracking dollar would require fiscal and monetary discipline, but it would guarantee a huge inflow of needed capital.
(2). Make the 2001 and 2003 tax cuts permanent—this would cancel a $280 billion tax increase scheduled to arrive in 2011, when those tax cuts expire—and pursue pro-growth capital gains and corporate tax cuts. Investment-friendly tax cuts would lead to an immediate stock market rally, job growth, and recapitalization of the U.S. economy.
(3). Restrain government spending. Lower spending will hasten an economic recovery by encouraging job-creating investment, reducing interest rates, and spurring recapitalization.
The United States is facing a painful economic downturn, and some experts argue that monetary expansion and fiscal loosening will be needed to soften the blow in 2009. But these are the policies that led to this disaster. An early recovery will occur only if the United States becomes a magnet for capital.
To that end, we should be pursuing a sound dollar, pro-growth tax cuts, and spending restraint. Such policies would help to sustain the dollar’s recent rally. They would also hasten an economic recovery, promote sound banking practices, and provide an enormous boost to capital accumulation worldwide.
John L. Chapman is a researcher in economics at the American Enterprise Institute.
The Controversy over the Milton Friedman Institute--Richard Posner
Milton Friedman was one of the twentieth century's most distinguished economists, and one of the century's three economists (the other two being John Maynard Keynes and Friedrich Hayek) who had the greatest political influence--and he was the only American in the group. Friedman spent most of his career at the University of Chicago, so it is natural that the University should name a major new component of the University, devoted to economic research, after him. The Institute is essentially a joint venture of the University's economics department, graduate school of business, and law school. The use of his name will help the University raise the funds required for the new Institute.
The decision, announced five months ago, has generated controversy on the University campus, sharpened by the current economic crisis that is thought in some circles to have damaged Friedman's legacy (it has certainly damaged Alan Greenspan's legacy). Some 170 faculty members have signed a petition circulated by a Committee for Open Research on Economy and Society--which opposes the decision naming the new institute after Friedman--asking that a meeting of the University Senate (which consists of some University administrators and all faculty members who have been on the faculty for more than a year) be convened to discuss the decision. The stated ground of opposition is that naming the Institute after Friedman would constitute the University's endorsement of his political views and would bias the research conducted by the Institute in favor of the free-market ideology that Friedman promoted so strongly. But the opposition is also and probably primarily powered by distaste for Friedman's political and policy views and for his willingness to provide economic advice to the Chilean dictator Augusto Pinochet. Friedman's association with policies that are either liberal or politically neutral, such as the volunteer army, the earned income tax credit (the negative income tax), the legalization of the laws against marijuana and other mind-altering drugs, and even affirmative action, is overlooked.
I don't think anyone would quarrel with the idea of an institute devoted to the support of academic research on economic issues, even though many of the issues that economists examine have political implications. The name is the focus of the controversy. Friedman was an advocate of politically controversial policies with which a number of University faculty do not want the University to be associated. When buildings, classrooms, institutes, schools, etc. in universities are named after someone, it is usually a donor. Especially when an institute, which is likely to be a special-purpose organization, is named after a public figure, it is natural to associate the mission of the organization with the name of that figure: the Hoover Institution of Stanford University was named after Herbert Hoover and is indeed conservative, though it is noteworthy that the Institution's conservative reputation has not extended to Stanford University as a whole, and no more would one expect the University of Chicago to be branded as conservative merely because it contains an institute named after a conservative economist. The University of Chicago is not a conservative institution, though it is not as monolithically liberal as its peer institutions.
The purpose of naming the new institute after Friedman was presumably to encourage fund-raising; one economics professor at the University has been quoted as saying that Friedman's name would "resonate with the donors." So a further worry is that most of the donors will be conservatives who support Friedman's political views (that is to say, his conservative political views, as many of his views were not conservative), and that the new Institute will perhaps unconsciously bias hiring and promotion in favor of economists who support those views. The Institute might (again, whether consciously or unconsciously), it is feared, conceive its mission as being to promote the ideas of the "Chicago School of Economics," of which Friedman was perhaps the leading (though not the founding), and certainly the most influential, member.
But that is unlikely. Economics is a highly competitive academic field, and piety toward distinguished predecessors is not the path to academic success. It is odd that the opponents of the Friedman naming should think that economists, of all people, would subordinate career motives to loyalty to Friedman's memory or the "Chicago School" (especially young economists for whom Friedman is just a name). If the religion professor who is leading the movement against the naming is right that "Friedman's over"--that the current economic crisis has consigned Friedman, along with Greenspan, to the dustbin of economic history--he should have no fear that the new Institute will be biased in favor of Friedman's views. If a physics institute were named after Albert Einstein, would the institute's researchers reject quantum theory?
It might seem that the controversy could be easily resolved by simply changing the name of the Institute. But that would be costly to the University in several respects. First, it would doubtless offend many donors, and probably leave the Institute in worse financial shape than had it not been named after Friedman in the first place. Second, it would weaken the University administration and encourage the encroachment by faculty on administration prerogatives. There is a whiff of the 1960s in the effort by faculty (joined by a number of students) to move the University of Chicago leftward. Even if the original naming of the Institute after Friedman was a mistake, there is now too much at stake for the University administration to back down.
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