Money markets
The big thaw
Frozen credit markets are coming back to life
THE world’s banking system may still be in intensive care, kept alive largely with the help of generous infusions of capital, liquidity and guarantees on lending from governments. Yet there are hopeful—albeit tentative—signs of recovery.
An important indicator of its health is the price that banks say they expect to pay to borrow money for three months, which is usually expressed as the London Interbank Offered Rate (LIBOR), or its European equivalent, EURIBOR. These have been ticking down slowly, often by only fractions of a percentage point a day. Yet on Tuesday October 21st the rate for borrowing euros passed an important milestone, falling to 4.96%, a level last seen before Lehman Brothers collapsed in mid-September. The LIBOR spread over three-month American Treasury bills has also narrowed sharply. The recent improvements were partly stirred by the latest lavish intervention from the Federal Reserve. It made available $540 billion to buy assets from money-market funds, to encourage them to start buying commercial paper issued by banks and companies again.
The pace of LIBOR’s recovery may look glacial, but it is actually faster than meets the eye. This is because LIBOR, the heart-rate monitor of the financial markets, seems to have gone on the blink. When markets were at their most stressed it underestimated the full cost to banks of borrowing—partly, in its defence, because there was so little lending in the interbank markets. The rates now being paid by banks to borrow may actually be half the level during the most intense moments of panic earlier this month.
More importantly, money is once again starting to flow through the system. “Compared with three weeks ago borrowing volumes are up by as much as ten times,” says Tim Bond of Barclays Capital. The trouble, however, is that the banks still need a lifeline from central banks, which have opened the floodgates of dollars and euros. The European Central Bank, for instance, has loaned €773 billion ($1 trillion) to banks.
The best indicator of a healthy financial system would be banks once again lending money to one another. There is improvement here, too. American banks including JPMorgan Chase and Citigroup have, in the past week, made loans to European counterparts for up to three months. And HSBC, Europe’s biggest bank, says it is providing billions in three- and six-month funding to banks.
Markets for longer-term credits for banks are also gradually returning to life as institutional investors regain their nerve. On October 17th Lloyds TSB managed to sell £400m ($690m) worth of ten-year bonds—the first such issue by a European bank since the collapse of Lehman. As of Wednesday Barclays was planning to borrow €3 billion over three years by issuing notes backed by the government. But the cost of borrowing remains uncomfortably high. Lloyds TSB, for instance, paid 2.25 percentage points above the interest rate on an equivalent government bonds. Barclays, which will be charged about 1.5 percentage points by the government for the guarantee of its bonds, may end up paying almost as much as Lloyds for its borrowing.
Meanwhile, banks are exposed to further possible write-downs which could strain money markets once more. More businesses are going bust, which will put further pressure on the vast credit-derivative markets. Consumer loans are souring. If another big bank were to come close to failing, the financial system might yet be back on life support.
Oct. 22 (Bloomberg) -- Argentina's stocks headed for their biggest drop since 1990 and dollar bond yields topped 30 percent as a planned takeover of pension funds heightened concern the government is headed for its second default this decade.
The benchmark Merval stock index tumbled 17.3 percent on speculation President Cristina Fernandez de Kirchner plans to use the funds' $29 billion to meet financing needs that have swelled as prices on the country's commodity exports tumbled. Argentina hasn't had access to international debt markets since its 2001 default and demand for its local bonds has dried up on concern the government is underreporting inflation.
``They're taking people's pensions away and using that to fund the government,'' said David Bessey, who manages more than $8 billion of emerging-market debt in Newark, New Jersey, for Prudential Financial Inc. ``It's yet another unorthodox approach to trying to deal with the country's economic situation rather than taking the bitter medicine.''
Yields on Argentina's 8.28 percent bonds due in 2033 surged 4.15 percentage points to 28.84 percent at 2:37 p.m. in New York, after earlier topping 30 percent, according to JPMorgan Chase & Co. The bonds yielded 12.16 percent a month ago.
The price on the bonds, which were issued as part of a 2005 debt restructuring, dropped 5.11 cents to 24 cents on the dollar after falling 7.8 cents yesterday. The benchmark Merval stock index sank to a four-year low, extending its decline this week to 29 percent.
Region-Wide Declines
The rout in Argentine markets sparked declines across developing nations. Neighboring Brazil's currency, the real, sank 6 percent while Turkey's lira dropped 6.6 percent. The extra yield investors demand to own developing-nation debt swelled 75 basis points, or 0.75 percentage point, to 7.64 percentage points, the most since December 2002, according to JPMorgan's EMBI+ index.
Fernandez, 55, announced her plan to take over 10 private pension funds during a speech in Buenos Aires yesterday. She said the proposal would protect retirees from the global financial crisis and denied trying to ``grab the cash'' to pay off debt or to finance new programs or projects. The last time Argentina sought to tap workers' savings was in 2001, just before it halted payments on $95 billion of bonds.
``Tapping into the pension funds makes it blatantly obvious that it needs funds,'' said Aryam Vazquez, an emerging markets economist with Wells Fargo & Co. in New York. ``This is bad news any way you look at it.''
International Lawsuits
The private retirement system, set up in 1994 to help bolster capital markets, owns about 5 percent of companies listed on the Buenos Aires stock exchange and 27 percent of shares available for public trading, data compiled by pension funds show.
The government's proposal to take control of the funds, including units of London-based HSBC Holdings Plc and Bilbao, Spain-based Banco Bilbao Vizcaya Argentaria SA, needs congressional approval. BBVA fell 9.1 percent today.
Argentina's borrowing needs will swell to as much as $14 billion next year from $7 billion in 2008, RBC Capital Markets, a Toronto-based unit of Canada's largest bank, said yesterday.
Fernandez made a bid to regain access to international markets last month, instructing her economic aides to pursue a renegotiation with creditors who rejected the country's 2005 payout of 30 cents for every dollar of defaulted debt.
Holders of about $20 billion of bonds turned down that 30- cent offer, which was the harshest sovereign restructuring since World War II, and many have filed lawsuits against Argentina.
Bond Insurance Jumps
The cost of protecting Argentina's bonds against default soared today. Five-year credit-default swaps based on Argentina's debt jumped 4.24 percentage points to 36.40 percentage points, according to Bloomberg data.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality.
The peso was little changed today, sliding 0.2 percent to 3.2238 per dollar, as traders said the central bank sold dollars in the foreign exchange market to shore up the currency. A central bank spokesman didn't return a phone call seeking comment.
About 55 percent of the 94.4 billion pesos held by the private pension funds is invested in Argentine government debt, according to the pension regulator's Web site. A takeover would allow the Fernandez administration to write off those bonds, said Javier Salvucci, an analyst with Buenos Aires-based Silver Cloud Advisors.
`Short-Term Fix'
``It's a short-term fix that may cause more fiscal and macro pain in the long haul,'' said Will Landers, who manages $5 billion in Latin American equities at BlackRock Inc.
Nestor Kirchner, Fernandez's husband and predecessor as president, began tightening restrictions on private pension funds last year, requiring them to keep more investments in the country to sustain economic growth.
South America's second-biggest economy is faltering as the global financial crisis fuels a tumble in commodity prices that has curbed the country's export revenue on wheat, soybeans and corn. Commodities are down 43 percent from a record high in July, according to the UBS Bloomberg CMCI Index. The slowdown was evident in August: Argentina's construction sector shrank while industrial output growth weakened.
Growth will slow to 5 percent this year and 2.5 percent in 2009, RBC Capital Markets said. The economy expanded 8.8 percent on average over the past five years as Kirchner and Fernandez used surging tax receipts to boost government spending on everything from civil servant pay rises to energy subsidies.
`Much, Much Worse'
Seven years ago, as the government tried in vain to stave off a debt default, it pressured the pension funds to participate in bond swaps that pushed forward repayment dates. Strapped for cash to pay salaries, it ordered the funds to transfer $3.2 billion in bank deposits to state-owned Banco de la Nacion.
The latest move is ``much, much worse,'' said Paul McNamara, who helps manage $1.2 billion of emerging-market assets at Augustus Asset Managers Ltd. in London. ``It's not just shoving a little bit of debt in at the edge, it's taking over the whole system.''
Oct. 22 (Bloomberg) -- Bank of England policy makers voted unanimously to lower the benchmark interest rate by the most since 2001 in an emergency meeting this month on signs that Britain had entered a recession.
The nine-member Monetary Policy Committee, led by Governor Mervyn King, said the economy had ``deteriorated substantially,'' which would slow inflation from more than double the 2 percent target, according to minutes of the Oct. 8 decision released by the Bank of England today in London. They cut the bank rate by a half point to 4.5 percent in a joint global action.
``The risk of a sharper monetary contraction had risen, and hence of a more pronounced slowing in activity and employment than was needed to keep inflation at target in the medium term,'' the minutes said. ``Given the global nature of the financial market turbulence, there was a strong argument for participating in the proposed coordinated international action.''
King said for the first time yesterday that a U.K. recession ``seems likely,'' comments which sent the pound to a five-year low against the dollar. Home Retail Group Plc, the owner of Argos stores, reported a first-half loss today and the National Institute of Economic and Social Research predicted the economy's first full-year contraction since 1991.
`More Urgent'
``Though inflation has picked up the recession risks have become so much more urgent,'' Sarah Hewin, an economist at Standard Chartered Bank in London, told Bloomberg Television. ``The Bank of England is very eager to cut interest rates further. There will be a cut at the November meeting, possibly as high as 50 basis points.''
The pound dropped today to $1.6203, the lowest since September 2003, and traded at $1.6349 at 9:40 a.m. in London.
The bank took its decision in tandem with the European Central Bank, the U.S. Federal Reserve and other central banks around the world. King briefed policy makers about discussions he had with his overseas counterparts and asked the committee if they wanted to participate.
``Conditions in international credit and money markets had deteriorated very markedly over the course of the past month,'' the minutes said. ``The balance of risks to inflation in the medium term had shifted decisively to the downside.''
Oil and Jobs
Policy makers cited lower oil prices, the weakening economy and rising unemployment as reasons why the current 5.2 percent inflation, more than double the 2 percent target, was unlikely to become embedded in the economy through faster wage growth, the minutes showed. U.K. unemployment rose to the highest level in almost two years in September.
Manufacturing confidence is at the lowest since 1980, the Confederation of British Industry said yesterday, and house prices fell at the fastest annual rate in at least six years this month, Rightmove Plc said Oct. 20. Gross domestic product will fall 0.9 percent in 2009 and consumer spending will drop 3.4 percent, Niesr said today.
Home Retail Group reported a first-half loss after writing down the value of its Homebase chain and said annual profit may be at the lower end of analysts' estimates as spending slumps.
The British government this month took stakes in Royal Bank of Scotland Group Plc and other banks in exchange for 37 billion pounds ($60 billion) in cash. Financial firms have reported at least $635 billion in losses and writedowns worldwide from U.S. mortgage-related investments since the beginning of last year.
Bank Bailout
``The committee noted that cuts in official interest rates could not be expected to resolve the current problems in financial markets and that a significant increase in the capital sector would be required,'' minutes of the Bank of England meeting showed.
Economists including Citigroup Inc.'s Michael Saunders and UBS AG's Amit Kara predict that the Bank of England will follow this month's emergency interest-rate reduction with another half-point cut at the next scheduled meeting on Nov. 6.
``The combination of a squeeze on real take-home pay and a decline in the availability of credit poses the risk of a sharp and prolonged slowdown in domestic demand,'' King said in a speech to executives in Leeds, England yesterday. The Monetary Policy Committee ``will act promptly to ensure that inflation remains on track to meet our target.''
Oct. 22 (Bloomberg) -- The euro fell below $1.28 for the first time since November 2006 and the pound tumbled to a five- year low on speculation Europe's central banks will cut interest rates as the global economy heads for a recession.
The single European currency also slid to the weakest in almost five years versus the yen as global stocks declined, encouraging investors to sell higher-yielding assets and pay back low-cost loans in Japan. The pound dropped to a one-week low versus the euro after Bank of England Governor Mervyn King said the U.K. is probably in a recession.
``The market came to realize that many more rate reductions are needed in Europe,'' said Robert Blake, a strategist in Boston at State Street Global Markets LLC, which has $15.3 trillion in assets under custody. ``Dollar repatriation has much further room to run.''
The euro dropped 1.7 percent to $1.2843 at 3:30 p.m. in New York, from $1.3063 yesterday, after touching $1.2743. It fell 4.3 percent to 125.16 yen from 103.80, after reaching 124.97, the lowest level since November 2003. Japan's currency rose 2.8 percent to 97.35 per dollar from 100.14.
Sterling declined 2.2 percent to $1.6334 after touching $1.6139, the lowest since September 2003. It dropped as much as 3.4 percent, the biggest decline since September 1992, when investor George Soros drove the currency out of Europe's system of linked exchange rates. The pound slid for a third day against the euro, weakening 0.8 percent to 78.75 pence.
Emerging-market currencies weakened as Argentina's planned seizure of private pension funds stoked concern the nation faces its second default this decade. The government of President Cristina Fernandez de Kirchner proposed yesterday taking control of 10 funds, including units of HSBC Holdings Plc and Banco Bilbao Vizcaya Argentaria SA.
Russia's Ruble
Russia's ruble fell for a sixth day against the dollar to the lowest level in two years, dropping as much as 1.1 percent to 26.9916. The South Korean won lost 3.1 percent to 1,363.13 per dollar, Brazil's real dropped 5.9 percent to 2.3790, and Mexico's peso declined 3.4 percent to 13.706. Argentina's peso was little changed at 3.2238 per dollar as traders said the central bank sold reserves to shore up the currency.
The declines caught companies investing in currency derivatives, or financial instruments derived from stocks, bonds, loans, currencies and commodities, on the wrong side of the trade.
Vitro SAB, the century-old Mexican glassmaker which sells in more than 45 countries, may be forced into creditor protection because of derivative losses, according to analysts at ING Groep NV and Deutsche Bank AG. Taesan LCD Co., the South Korean supplier of flat-screen parts to Samsung Electronics Co., failed on Sept. 16 because of losses on derivatives.
Worldwide Recession
The euro extended losses today on speculation efforts by global governments and central banks to revive credit markets will fail to avoid a worldwide recession.
``What is becoming clear is that the steps taken to shore up the capital bases of the major financial institutions and to provide liquidity may well prove successful, but those steps in themselves will not stem the appetite for deleveraging further,'' Derek Halpenny, head of currency research at Bank of Tokyo-Mitsubishi in London, wrote in a note to clients today.
Investors bet the European Central Bank will lower borrowing costs by another 0.75 percentage point by June after cutting the main refinancing rate by a half-percentage point to 3.75 percent on Oct. 8, part of coordinated reductions by major central banks.
The implied yield on the three-month Euribor contract expiring in June fell to 3.15 percent, the lowest level in three years. The yield has been 0.23 percentage point higher than the benchmark rate on average over the past year.
Risk Reversal
The premium traders demand to buy options granting them the right to sell euros against the dollar rose today to the most in at least five years. The currency's one-month 25-delta risk- reversal rate against the dollar widened to minus 1.48 percent, the most since Bloomberg began collecting data in October 2003. The premium is the amount traders demand for euro puts, which allow for sales, over calls, which grant the right to buy.
Citigroup Inc. told its clients to ``take profit'' on its bet on the decline of the euro versus the dollar today, according to a research note written by Tom Fitzpatrick, global head of currency strategy at Citigroup Global Markets in New York. The bank initiated the recommendation on Oct. 20, when the dollar was at $1.33 per euro.
The dollar has gained 20 percent since touching a record low of $1.6038 per euro on July 15 on speculation the U.S. currency will benefit as the European economy slows.
``I am short on the euro-dollar,'' said Benedikt Germanier, a currency strategist at UBS AG in Stamford, Connecticut. ``It's a strong trend. It's more about psychology than fundamentals.''
U.S. investors have repatriated about $60 billion of the nearly $1 trillion in foreign stocks and bonds purchased since 2003, leaving an ``enormous pool of capital'' that may flow back into the U.S. and bolster the dollar, according to an Oct. 16 note by Citigroup.
Weaker Pound
The British pound fell for a fourth day against the greenback after a report yesterday showed U.K. manufacturing confidence dropped to its weakest level in almost three decades.
``It now seems likely that the U.K. economy is entering a recession,'' BOE Governor King said in a speech to executives in Leeds, England, yesterday. ``The balance of risks to inflation in the medium term shifted decisively to the downside.''
Policy makers voted unanimously to lower the benchmark U.K. interest rate by a half-percentage point to 4.5 percent in an emergency meeting on Oct. 8, according to minutes of the decision released by the Bank of England today in London. The nine-member Monetary Policy Committee said the economy had ``deteriorated substantially,'' which would slow inflation from more than double the 2 percent target.
The pound may weaken toward $1.60, wrote Kevin Edgeley, a technical analyst at Goldman Sachs Group Inc. in London, citing weekly and monthly stochastic and trend strength indicators.
Oct. 22 (Bloomberg) -- U.S. stocks sank and the Standard & Poor's 500 Index dropped to the lowest level since April 2003 on concern a worsening global economic slump will damp corporate profits.
Exxon Mobil Corp. tumbled 9.7 percent and Freeport-McMoRan Copper & Gold Inc. plunged 18 percent as crude, copper and gold fell. Coventry Health Care Inc. tumbled 51 percent as the health insurer's earnings were hurt by bad investments and rising medical costs. SanDisk Corp. sank 32 percent after Samsung Electronics Co. abandoned its takeover bid. European and Asian shares fell, while an index of emerging market stocks slumped 8.4 percent on concern Argentina may default on its debt.
The Standard & Poor's 500 Index lost 58.13 points, or 6.1 percent, to 896.92. The Dow Jones Industrial Average plunged 514.45, or 5.7 percent, to 8,519.21. The Nasdaq Composite Index lost 80.93, or 4.8 percent, 1,615.75. About 20 stocks dropped for each that rose on the New York Stock Exchange.
``Everyone's got to lower their expectations,'' Keith Wirtz, president and chief investment officer of Fifth Third Asset Management, said on Bloomberg Television. ``This year we're looking at operating earnings somewhere in the mid-$90 range for S&P 500 companies. Who knows what next year might be. It might be somewhere in the mid-$70s.''
Benchmark indexes declined as growing concern over the fate of the global economy overshadowed another decrease in money- market rates. The three-month London interbank offered rate for dollars dropped for an eighth straight day to 3.54 percent after the U.S. government's latest initiative to resuscitate bank lending, a $540 billion commitment to buy troubled assets from money-market mutual funds.
Dollar Rally
The U.S. dollar traded for less than $1.28 against the euro for the first time since November 2006 and the pound tumbled to a five-year low on speculation European central banks will cut interest rates to bolster their economies.
Stocks fell yesterday after companies from Texas Instruments Inc. to Freeport-McMoRan posted results that failed to meet analysts' estimates. At least 139 S&P 500 companies are scheduled to report third-quarter earnings this week.
Yesterday's drop halted a rebound in the S&P 500 from an almost 5 1/2-year low on Oct. 10. The benchmark index for U.S. equities climbed 9.6 percent from that date through Oct. 20 as borrowing costs declined, the government planned to buy stakes in banks and Federal Reserve Chairman Ben S. Bernanke endorsed another economic-stimulus package.
The Chávez Democrats
What is it about Democrats and Hugo Chávez? Even as the Venezuelan strongman was threatening war last week against Colombia, Congress was threatening to hand him a huge strategic victory by spurning Colombia's free trade overtures to the U.S.
This isn't the first time Democrats have come to Mr. Chávez's aid, but it would be the most destructive. The Venezuelan is engaged in a high-stakes competition over the political and economic direction of Latin America. He wants the region to follow his path of ever greater state control of the economy, while assisting U.S. enemies wherever he can. He's already won converts in Bolivia and Ecuador, and he came far too close for American comfort in Mexico's election last year.
Meanwhile, Colombian President Álvaro Uribe is embracing greater economic and political freedom. He has bravely assisted the U.S fight against narco-traffickers, and he now wants to link his country more closely to America with a free-trade accord. As a strategic matter, to reject Colombia's offer now would tell everyone in Latin America that it is far more dangerous to trust America than it is to trash it.
![[Hugo Chavez]](http://s.wsj.net/public/resources/images/HC-FS342_Chavez_20051022060029.gif)
Yet Democrats on Capitol Hill are doing their best to help Mr. Chávez prevail against Mr. Uribe. Even as Mr. Chávez was doing his war dance, Senate Finance Chairman Max Baucus was warning the White House not to send the Colombia deal to the Hill for a vote without the permission of Democratic leaders. He was seconded by Ways and Means Chairman Charlie Rangel, who told Congress Daily that "they don't have the votes for it, it's not going to come on the floor," adding that "what they [the White House] don't understand it's not the facts on the ground, it's the politics that's in the air."
Mr. Rangel is right about the politics. No matter what U.S. strategic interests may be in Colombia, this is an election year in America. And Democrats don't want to upset their union and anti-trade allies. The problem is that the time available to pass anything this year is growing short. The closer the election gets, the more leverage protectionists have to run out the clock on the Bush Presidency. The deal has the support of a bipartisan majority in the Senate, and probably also in the House. Sooner or later the White House will have to force the issue.
![[Nancy Pelosi]](http://s.wsj.net/public/resources/images/HC-GJ068_Pelosi_20061116181246.gif)
Our guess is that Messrs. Baucus and Rangel understand the stakes and privately favor the accord. The bottleneck is Speaker Nancy Pelosi, who is refusing to allow a vote under pressure from her left-wing Members. These Democrats deride any link between Hugo Chávez and trade as a "scare tactic," as if greater economic prosperity had no political consequences. "President Bush's recent fear-mongering on trade shows just how desperate he is to deliver one final victory for multinational corporations," declared Illinois Democrat Phil Hare, who is one of Ms. Pelosi's main trade policy deputies.
These are the same Democrats who preach the virtues of "soft power" and diplomacy, while deriding Mr. Bush for being too quick to use military force. But trade is a classic form of soft power that would expand U.S. and Latin ties in a web of commercial interests. More than 8,000 U.S. companies currently export to Colombia, nearly 85% of which are small and medium-sized firms. Colombia is already the largest South American market for U.S. farm products, and the pact would open Colombia to new competition and entrepreneurship.
Which brings us back to Mr. Chávez and his many Democratic friends. Connecticut Senator Chris Dodd's early support helped the strongman consolidate his power. Former President Jimmy Carter blessed Mr. Chávez's August 2004 recall victory, despite evidence of fraud. And then there are the many House Democrats, current and former, who have accepted discount oil from Venezuela and then distributed it in the U.S. to boost their own political fortunes. Joseph P. Kennedy II and Massachusetts Congressman Bill Delahunt have been especially cozy with Venezuela's oil company. If Democrats spurn free trade with Colombia, these Democratic ties with Mr. Chávez will deserve more political scrutiny.
Senators Hillary Clinton and Barack Obama are both competing for union support. But if they wanted to demonstrate their own Presidential qualities, they'd be privately telling Ms. Pelosi to pass the Colombia pact while Mr. Bush is still in office. That would spare either one of them from having to spend political capital to pass it next year.
Instead, both say they oppose the deal on grounds that Mr. Uribe has not done more to protect "trade unionists." In fact, Mr. Uribe has done more to reduce violence in Colombia than any modern leader in Bogotá. The real question for Democrats is whether they're going to choose Colombia -- or Hugo Chávez.
A Move towards Market Socialism
The recent financial crisis has renewed interest in old issues. The Bush administration has announced plans to buy $85 billion in preferred stock in what are (for the time being) private financial institutions, like Bank of America, J.P. Morgan, Wells Fargo, and Morgan Stanley. The total commitment by the Treasury is set at $250 billion. While this move by the Treasury Department into the financial industry is unique in American history, it has precedents elsewhere, and has been debated many times.
Karl Marx proposed "centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly." Years later, so-called "market socialists" like Oscar Lange, Abba Lerner, and H.D. Dickinson proposed state control over credit and financial capital. While these market socialists accepted trade and the use of money with consumer goods, markets for capital goods would be simulated and markets for financial capital would be wholly replaced by central planning. Capital investment would therefore be determined by state officials, rather than by competition for funds in financial markets. Lange was particularly clear about how the state would determine the overall rate and pattern of capital investment. State officials would set the overall rate of capital accumulation, instead of interest rates. State officials would also determine the pattern of investment, instead of profit-seeking capitalists and entrepreneurs.
Ludwig von Mises and Friedrich Hayek defended capitalism from its Marxian and market-socialist enemies. Mises attributed special significance to financial markets and private financial institutions. After all, it is financial markets that determine the rate and pattern of future capital investment in capitalism.[1] Since socialism is defined by communal control of capital, this system requires state control of investment and finance. Socialism therefore means replacing private dividends with social dividends and interest rates with edicts. All private speculation and credit must be prohibited if capital is truly to become communal property. Capitalism works because it eliminates inept managers of production automatically through bankruptcy, while extending greater industrial control to competent capitalists.
The elimination of markets for capital goods and financial capital introduces arbitrary and political forces into the determination of capital investment. In capitalism, money prices direct capital investment. Socialist officials necessarily lack money prices relating to capital goods because the markets that form these prices are incompatible with socialist aims and ideals. Socialist officials will not determine investment by rational calculations in terms of money, but will be guided by political expediency.
The collapse of the Soviet Union was seen by many people as a final verdict on socialism as an economic system. Whatever one might have thought about socialist ideals, the system was itself seen as unworkable. Yet, in only fifteen years, we have come to a point where a Lange-type system is close to being implemented. Of course, the federal government already holds strong regulatory powers over financial institutions. The regulation of American finance introduces an element of politics in financial markets. However, federal regulation of financial markets puts the voting public in the position of an active stakeholder in financial markets. With limited government and laissez faire, voters are passive stakeholders in financial markets. To put it simply, regulation changes the role but not the position of voters and interest groups in these markets.
The purchase of preferred stock by the federal government alters the position of the general citizenry regarding financial institutions. If implemented, this plan will move voting citizens from the position of active stakeholders to that of actual shareholders. It is not yet clear if the federal government will be an active or silent partner in the aforementioned financial institutions.[2] But, given the historical record, it seems highly unlikely that the federal government would gain a $250 billion interest in these institutions without asserting some influence over their operations. It appears likely that the American public will become active shareholders in some of the largest and most important financial institutions.
The Bush buyout plan is being implemented "to restore confidence in the battered banking system." The Bush approach is not, however, the only way. The Bank of East Asia has also faced difficulties. When depositors began to withdraw money en masse, Hong Kong tycoon Li Ka-Shing began buying up shares. This move by Li Ka-Shing helped restore depositor confidence, and rightly so. The Bank of East Asia is well capitalized and has minimal stakes in Lehman and AIG. Of course, Li Ka-Shing made this move for personal profit, but this did help stabilize the financial situation in the Far East. The Hong Kong approach stands in stark contrast to the Bush administration's new policy. Hong Kong is standing by its capitalist institutions by allowing private investors to deal with the current crisis, as well they should. Free-market capitalism transformed Hong Kong from a poverty-stricken victim of the Second World War to its current prosperous condition.
The Bush administration is going beyond its well-established record of intervention by implementing partial socialization of numerous financial firms. It does seem that we are at the crossroads. Will we move in the direction of Lange's market socialism, or will we opt for greater freedom and prosperity?
The prospects for avoiding further losses of economic freedom seem poor. Presidential candidate Barack Obama has declared that the current financial crisis is the result of deregulation that has "shredded" necessary regulatory controls. While Obama's belief in recent deregulation of financial markets is factually incorrect, his call for greater regulation might actually be preferable to the Bush administration's plan for partial socialization of banking and finance.
The overall record of private capital markets is one of unprecedented economic success. Financial capitalism has raised living standards to previously unimagined heights. Government regulation of financial markets has caused problems and setbacks. In fact, our current crisis is due largely to the strictures of the Community Reinvestment Act and Federal Reserve interest-rate policy. But regulation has not reversed the general trend towards greater prosperity.
The track record of state-controlled capital investment through state-owned banking and financial institutions is equally clear, but opposite in its results. Socialized investment has failed so consistently that one must wonders why the Bush administration would claim that its buyout of banks will restore public confidence. Why would anyone have confidence in the federal government's ability to direct matters of finance and investment? One need only look at the federal deficit and the burden of unfunded entitlements like Social Security to gauge the ineptitude of federal financial management. We are at the crossroads, and, unfortunately, our future course is being charted by George W. Bush and Henry Paulson.
China's economy
Slower boat from China
Growth slows in China, as the global economic slump takes its toll
PERHAPS it should not be considered surprising. On Monday October 20th China’s National Bureau of Statistics announced that economic growth in the third quarter was 9% year-on-year, heady by American or European standards, but down from 10.1% in the previous three months (which itself was lower than the quarter before that), and the worst overall since early 2003. Consensus predictions had been for a more modest decline amid fading hope that China’s economy was fundamentally “decoupled” from the West. It is now becoming necessary, on a near daily basis, to re-evaluate just how much independence its economy enjoys.
It is growing harder to say that China is relatively immune from global financial and economic problems. This month alone, two big companies, Smart Union Group, a toymaker, and FerroChina, a steel producer, have gone into liquidation. For the rare company whose closing receives publicity, thousands, if not tens of thousands, shut without a sound. Early this year, southern China suffered from shortages of workers and shoe factories were discouraging orders of boots or any other product that required lots of work and materials. All of that has now reversed. There is a surplus of workers and an absence of orders, with no sign of any recovery.
One of the most important events in the sales calendar for China is the historic Canton Trade Fair, which brings together a vast number of the country’s manufacturers with swarms of buyers from around the world. The first part of the autumn session ended on October 19th and there was little happy news to report. In a good year hotels will double rates and turn away guests. This time around, rates were high but rooms were abundant. The fair itself was far from empty but the crowds, by usual standards, were thin, with a notable absence of Americans and Europeans, and many complaints about a lack of orders. A year ago sellers demanded escalation clauses in their contracts because of rising commodity prices. This time a buyer from an Oman construction-materials company said that he was receiving a similar benefit from any price decline, and prices, he added, were falling much faster now than they had been rising then.
China’s slowing cannot, however, be blamed on exports alone. There were warning signs all over the place, says Stephen Green, an economist at Standard Chartered, pointing to investment, consumption (despite a nominal, year-on-year rise in retail sales in September of 23%) and government spending. Sales of cars, clothing, air tickets and property have all fallen; production of steel has declined too. A bit, but only a bit, of this could be attributed to planned shut-downs at the time of the Olympics.
If there is any cause for optimism it is that some of the drag was the result of the government’s own efforts in the past year—a different era, in hindsight—to prevent overheating. In this, there is some hope. China’s financial position is not perfect, as non-performing loans are rising and some city banks are suspected of having problems, but there appears to be substantial room to relax fiscal and monetary policies. Inflation is declining. The big national banks appear to be in good condition, with abundant liquidity because of lending caps that have become increasingly stringent over the past two years. China’s government is in a strong financial position. Savings rates for the Chinese are high.
As a result, there is abundant room for more aggressive fiscal policies, continuance—if not expansion—of credit, and domestic growth in consumption. Rumours of the potential government response are widespread. Export-targeted tax rebates that were repealed last year will be resumed. Also in the pipeline is the removal of transaction fees on sales of property. Bigger government spending on water and transport projects is also expected. All this should stimulate demand, if not immediately. Collectively, these actions should mitigate some of the impact of the global downturn, but mitigate is not the same as offset. If the global panic has done nothing else, it has been brilliant at revealing the collective dependency of even the fastest developing economy on the developed world’s prosperity.
Oct. 22 (Bloomberg) -- U.S. Representative Barney Frank is walking through Statuary Hall in the Capitol, a portrait of rumples and wrinkles. His left shirttail hangs out over his belt. Reporters and photographers are hounding him. Cameras are whirring. Questions are being shouted.
``How's it going?'' one reporter shouts.
``If you let me get in, I can find out,'' Frank says, before disappearing into House Speaker Nancy Pelosi's office to begin negotiations with Treasury Secretary Henry Paulson and a handful of lawmakers on a $700 billion legislative package to rescue troubled financial institutions.
The talks on this Saturday night in late September drone on for hours. After returning from a dinner break, Frank again faces reporters.
``I have nothing to say except I know how Britney Spears feels,'' Frank says.
Rare are the times when Barney Frank has had nothing to say during his 40 years in public life. He has defended President Bill Clinton during impeachment hearings, skewered President George W. Bush's economic policies and argued in favor of gay and lesbian rights.
Frank's Moment
Since the Oct. 3 passage of the law designed to jumpstart America's troubled credit markets, Frank has met his moment. The Massachusetts Democrat, chairman of the House Financial Services Committee, is leading the congressional response to the crisis that has toppled the nation's largest investment banks, spurred record foreclosures and prompted levels of government intervention in markets not seen in 75 years.
As a new administration takes office in January, Frank -- who has served 14 terms in the House of Representatives -- will be at the center of almost all major decisions Congress makes to overhaul the U.S. financial system.
Frank says more regulations -- and perhaps additional regulators -- are needed.
``You need a new tool kit for new phenomena, and that's our job next year is to develop that tool kit,'' he says in an October interview in his Newton, Massachusetts, office.
He's training his sights on private equity firms and on hedge funds as well as on investment banks.
Reining in Risk
``There are insufficient constraints on risk taking outside of banks, outside of regulated entities,'' Frank says. ``We have to decide who's going to do the regulation and what it will consist of.'' He also wants to consider creating an exchange for the credit-default-swap market.
The bailout, passed in the twilight of the Bush administration, was only the beginning. ``Part one was figuring out what legislation is necessary to deal with the financial crisis,'' says H. Rodgin Cohen, chairman of New York law firm Sullivan & Cromwell LLP. ``The second will be to build a regulatory structure so that this never happens again.
``It's hard to imagine that anybody is going to be more important than Frank is in developing this,'' says Cohen, a specialist in bank acquisitions who advised Bear Stearns Cos. in its government-orchestrated sale to JPMorgan Chase & Co, which was completed in May.
In his 27 years in the House, Frank, 68, has exhibited a passion for helping the poor by creating affordable housing and advocating higher wages for the working class. He's also espoused legalizing online gambling and the medical use of marijuana. His role now in leading the financial market overhaul is of far greater scale and scope.
Liberal Policies
How will he define success? ``When the stock market comes back up, when people are able to borrow money and when we get back into job creation instead of job destruction,'' he says.
Frank says liberal policies and a healthy economy aren't mutually exclusive. ``I think it's possible to make the world fairer without making it less efficient,'' Frank says.
He wants to strengthen industry oversight, boost lenders' accountability to borrowers and curb the excessive leveraging that he says allowed the U.S. credit markets to implode.
Frank's committee oversees the Treasury, the Federal Reserve, the Federal Deposit Insurance Corp. and the Securities and Exchange Commission, and it develops policy governing the securities, banking, insurance and real estate industries.
The real estate industry has been the biggest contributor to Frank's campaign in the current election cycle, donating $182,101. The securities and investment industry, which gave $176,400, was No. 2, according to the Center for Responsive Politics, a Washington-based group that tracks campaign contributions.
Affordable Housing
Since the meltdown began, Frank has urged the mortgage industry to prevent foreclosures and has prodded the Fed into writing new rules to strengthen consumer protections in mortgage and credit card lending. He's also continued to push for affordable housing.
Congress approved a foreclosure prevention measure in July that Frank helped write and negotiate; it includes a provision to create a trust fund for constructing and preserving homes for low- income families.
The law empowered the Federal Housing Administration to insure as much as $300 billion in refinanced mortgages for struggling homeowners once the companies that hold the loans agree to forgive part of the mortgage amount.
Fashioning a solution to the current economic crisis will require no small combination of wit, wiliness and smarts -- all qualities that even Frank's political opponents say he has in abundance.
`Smartest' Member of Congress
``I think he's probably Congress's smartest member in sheer IQ,'' says Jim Leach, the former Republican Congressman from Iowa who preceded Frank as committee chairman. ``I've worked with him for 30 years,'' says Leach, who led a group of Republicans supporting Democratic Senator Barack Obama for president.
``He has a lot of experience and perspectives that are a bit different than many people assume. He is more pro-industry than someone would expect from someone who is very liberal.''
National Journal assessed Frank's voting record in 2006 as 90 percent liberal and 9 percent conservative. In 2007, he opposed Bush's policies 96 percent of the time, according to Congressional Quarterly Inc.
In October, Frank fended off criticism from Republicans including presidential candidate John McCain that Democrats opposed efforts to tighten restrictions on Fannie Mae and Freddie Mac.
Obama's ``Democratic allies in Congress opposed every effort to rein them in,'' McCain said in an Oct. 11 radio address. Frank dismissed that assertion, saying he moved legislation through his committee that would have strengthened oversight of Fannie and Freddie right after he became chairman. The House approved the bill in May 2007.
Conservative Resistance
Frank's efforts to increase regulation of financial firms will face resistance from free-market conservatives.
``The case for regulation is very weak,'' says Peter Wallison, a fellow specializing in financial policy at the Washington-based American Enterprise Institute and a former Treasury Department lawyer. ``Banks are heavily regulated. Despite that, many of them have failed and many others are in trouble.''
A plan Frank unveiled in March calls for Congress to either create a new regulator or give authority to an existing one to assess risk across financial markets and intervene where appropriate.
The regulator, which would report regularly to Congress on the health of the financial system, would inspect companies and get timely market information from them in an effort to prevent a build-up of excessive risk.
`Discipline of Old'
Mortgage-lending practices will be another of Frank's targets. He says he wants to examine securitization, the bundling of mortgages into securities for sale to investors, which he says has reduced lenders' accountability for the loans they make.
``It used to be that most money was lent to people who were going to pay it back to the person who lent it to them,'' Frank says. ``We need to find some kind of regulatory substitute for the lender-borrower discipline of old.''
Frank says he wants to focus on mortgage servicers -- companies that collect and process loan payments -- and the investors who buy the mortgage securities. A servicer has the power to modify terms to protect the lender from defaults. Servicers have cited the threat of investor lawsuits and their contractual obligations to investors as a reason for resisting changes to loan terms.
Frank also says he will continue to push the mortgage industry to modify loans that are at risk of foreclosure. Frank, FDIC Chairman Sheila Bair and policy makers have criticized the industry for not acting quickly and broadly enough to help homeowners avert foreclosure.
Threats
Frank isn't above threatening mortgage companies to get what he wants done. ``All we do is make it clear to them that the less cooperative they are, the worse it's going to be legislatively,'' he says.
As if Frank's ``to do'' list weren't long enough, he'll also have to decide how to restructure Fannie Mae and Freddie Mac. The government seized the mortgage-finance companies in September after their combined $14.9 billion in net losses over four quarters threatened to further disrupt the U.S. housing market.
In his push to get things done, Frank can be brash, rude and condescending -- even to members of his own party.
``I ask my questions quickly and succinctly,'' says Representative Luis Gutierrez, an Illinois Democrat who sits on Frank's committee. ``My greatest fear of asking my chairman a question is he'll say, 'Now that's an asinine question, Luis. '''
Frank has posted a sign on his office door in Capitol Hill quoting one of George Washington's 110 ``Rules of Civility and Decent Behavior in Company and Conversation'': ``Be not tedious in discourse, make not many digressions, nor repeat often the same manner of discourse.''
Who's Stupid?
At a February 2007 hearing, one witness testifying before Frank's committee argued against letting national security concerns prompt the building of new barriers to foreign investment in the U.S.
``So with all do [sic] respect to the members of this committee: It's the economy, stupid,'' David Heyman, director of the homeland security program at the Washington-based Center for Strategic and International Studies, wrote in his prepared remarks.
``Mr. Heyman, I can't resist,'' Frank said when Heyman finished his testimony. ``When you misspell a three-letter word, don't call people stupid.''
Frank lambasted the Republicans after the House voted against the financial rescue package on Sept. 29. The bill fell 12 votes short. Some GOP lawmakers blamed the bill's failure that day on what they considered a partisan speech by House Speaker Pelosi ahead of the vote.
``Because somebody hurt their feelings, they decide to punish the country,'' Frank said at a news conference.
New Jersey Childhood
``I'll make an offer,'' Frank said. ``Give me those 12 people's names and I will go talk uncharacteristically nicely to them and tell them what wonderful people they are, and maybe they'll now think about the country.''
Frank's support for the poor can partly be traced to his childhood in Bayonne, New Jersey, a working-class industrial town that was also home to the boxer Chuck Wepner, the inspiration for the movie Rocky who was known as the ``Bayonne Bleeder.'' In Frank's youth, it was a place dominated by Italian, Irish and Polish immigrants.
``I thought I'd be a lawyer,'' Frank says. ``I was always into politics, but I thought that being both Jewish and gay meant that I would probably never be able to be elected to anything.''
Frank, the son of a Jersey City truck stop operator and a homemaker, went to Harvard University in Cambridge, Massachusetts. He graduated with a Bachelor of Arts in government in 1962, then began studying at Harvard toward a Ph.D., which he didn't complete.
Frank Enters Politics
Frank entered public life when Democrat Kevin White tapped him in September 1967 to help in White's mayoral campaign in Boston. White went on to win and became the city's longest-serving mayor.
``I remember that it did not take me very long to figure out that this was about the smartest guy I have ever come across,'' says Dick Flavin, White's former press secretary. ``He also understands politics as well as he understands issues. That's what made him -- even back then -- special.''
White won, and Frank became his executive assistant. Frank threw himself into his work.
``He was quite slovenly in his appearance,'' says Flavin, 71, who's now a playwright. ``All he did was work and eat. At restaurants, he would gobble down two main courses, and go back to work.''
Frank leveraged the connections he was making in the world of Democratic politics to help his own career. He won a seat in the Massachusetts state legislature in 1972. While serving there, Frank attended Harvard Law School and continued to build his political network.
`100 Words a Minute'
He worked the press along with the pols. ``He always had that aspect of being a great quote,'' Flavin says. ``One guy said of his speaking style that 'Barney Frank speaks 100 words a minute with gusts to 125.'''
Soon after Frank's 40th birthday, he had a stroke of luck that led him to Washington. Father Robert Drinan, a House member whose district included the Boston suburbs of Newton and Brookline, announced he wouldn't seek re-election after Pope John Paul II called for all Catholic priests to resign public office.
Frank ran for the office in 1980 and won with 52 percent of the vote.
His career has been controversial. In 1987, Frank announced that he was gay, a rare display of candor for an elected official at the time. Before that, he had met with House Speaker Thomas P. ``Tip'' O'Neill of Massachusetts to tell him of the revelation he was about to make.
`Out of the Room'
O'Neill was both angry and disappointed because he'd thought that Frank could become the first Jewish speaker. After Frank left his office, a secretary asked the visibly upset O'Neill what was wrong, according to an account in Tip O'Neill and the Democratic Century by John Aloysius Farrell (Little Brown & Co., 2001).
``Oh, it's Barney Frank. He's decided to come out of the room,'' O'Neill said.
Two years later, Frank was embroiled in scandal after the Washington Times reported that a personal assistant, Stephen Gobie, had operated a prostitution ring out of Frank's Washington apartment. Frank admitted hiring Gobie but denied that he knew about the prostitution business.
Such a scandal would have brought down most politicians. Frank decided to deal with it with characteristic bluntness, apologizing for his relationship with Gobie to members of the House in a speech on the floor. He invited an ethics investigation of himself.
Reprimand
While Frank could have been censured, his colleagues decided on a milder form of punishment: a formal reprimand.
``I think members will agree I have had a reputation for honesty, not always tact or tolerance,'' Frank said at the time.
The Ethics Committee found Frank had no knowledge of any prostitution that may have taken place in his apartment. Gobie was not convicted of prostitution in connection with his association with Frank.
In 1994, when Republicans took control of the House for the first time since the Eisenhower era, Frank found himself in the congressional minority with little power.
Though he was a spirited defender of President Clinton during impeachment proceedings in 1998, he was otherwise not a major figure in Congress. Frank said that the charges against Clinton amounted to little more than ``what did he touch, and when did he touch it?''
Frank can be self-deprecating. One of his old campaign posters, displayed in his office, bears the slogan ``Neatness isn't everything.''
`Rapier Wit'
Frank has been known as much for what he says and how he says it as he is for what he does. ``He has probably the most rapier wit on Capitol Hill,'' Leach says. ``He has a thoroughly interesting personality. He would be the antithesis of the legislative dullard.''
That personality has been more visible since November 2006, when the Democrats regained control of the House and the party caucus named Frank chairman of the Financial Services Committee.
During committee hearings, Frank has squared off with Fed Chairman Ben S. Bernanke, who makes semiannual appearances before the panel. At a July 2006 hearing, Frank, who never uses prepared remarks, grilled Bernanke, arguing that wages have lagged inflation, productivity and corporate profits. Bernanke told Frank that he expected wages to rise.
``You expect them,'' Frank said. ``But, you know, I don't mean to be rude -- nobody can eat your expectations.''
Ties to Bernanke
Frank has forged strong ties with Bernanke, a relationship that Frank says has been strengthened by the housing meltdown. He says Bernanke's predecessor, Alan Greenspan, believed that ``the market was always going to be better than regulation.'' Frank calls Bernanke the ``anti-Greenspan'' for his willingness to write rules to stem abuses in mortgage and credit card lending.
On Sept. 24, as negotiations on the $700 billion rescue plan were getting under way, Frank closed a committee hearing on the financial market crisis by telling Bernanke and Paulson: ``I hope neither will take offense if I express the sincere wish -- after some time in the next few days -- not to speak to either of them for some time.''
``Wish granted,'' replied Paulson, who along with Bernanke had briefed Frank and other congressional leaders the week before on the grave state of the U.S. economy.
Frank has developed a close working relationship with Paulson, a former Goldman Sachs chief executive officer and a Bush appointee.
Common Ground
``He's very pragmatic and also has the administration's confidence, which his predecessors didn't have, so you could deal with him,'' Frank says. ``He's also somebody you can get right down to business with.''
Frank says he discovered common ground with Paulson when they worked together on legislation to strengthen oversight of Fannie Mae and Freddie Mac that required the mortgage finance companies to set aside funds for affordable housing. The measure passed the House and was later incorporated into a broad housing bill that Congress passed in July.
Frank says Paulson is ``a free-market guy with a social conscience, and that's what I've tried to be.''
Frank's time with Paulson, however, is probably numbered in days, since Paulson has said he won't stay in his post after the end of the Bush term.
As the global financial crisis continues to engulf Wall Street, Frank will be one of the principal policy architects. He's leading the biggest reshaping of U.S. financial services regulation since Congress created the SEC in 1934.
Frank says he's up to the task. ``I think we have proved that it is a myth that liberal Democrats can't understand the financial markets and the private sector,'' he says.
Face Off
Frank will face off with free-market conservatives who believe the market knows best.
``If you regulate every kind of company that is participating in the capital markets in some way so that you control their activities or their capital or something else, then these companies will move out of this country,'' the American Enterprise Institute's Wallison says.
Frank will also have to work with colleagues on the financial services committee. ``Overall, I believe he's a fair man,'' says Representative Jeb Hensarling, a Texas Republican. ``Occasionally, the input is taken; mostly it is not. I've come to him with about 100 ideas. I think he's accepted two or three.''
On Oct. 3, the day Congress approved the rescue plan, Frank told reporters that he's still adjusting to life in the limelight. ``It's like an out-of-body experience,'' he said. ``I have to go home, take out the garbage, hope I get to the laundry before it closes at 5 o'clock. I'm on my last clean shirt. And then you're doing things that are historic.''
Whatever history says about the results of the 2008 economic crisis, it will bear Frank's imprint.
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