naked capitalism

A good article by Clive Crook of the Financial Times discusses the improving fortunes of unions in America. Crook looks at some of the indicators their rising influence (key sign: fawning Democratic hopefuls) and how they can aid as well as impede economic activity.

Even though Crook’s piece is helpful, he somehow seems wide of the mark. He may not understand the roots of the antipathy towards unions in America. Even in their heyday, organized labor was held in less than high esteem, and it wasn’t due as much to their obstructionist role in commerce (America wasn’t in the thrall of corporate interests back then) as to their rampant corruption. Even today, quite a few union members seem ambivalent. While they acknowledge that they do better with the union than they would without, many feel the union extracts too high a toll (in terms of dues) relative to the benefits delivered. In other words, they suspect self-dealing.

And Crook misses why unions have become a more respectable cause. One reason is the widespread disgust with CEO pay. The less sympathetic executives become (and they’ve had plenty of warning that they ought to rein in their behavior, which has gone unheeded), the more measures to clip their wings look justified. If investors can’t pressure a CEO to cut his pay package, perhaps a worker revolt may. Mind you, that isn’t literally what the public is thinking, but the abuse of the power of the office by many CEOs calls for a countervailing force, and labor could credibly step into that breach.

A second reason is the Wal-Martization of workers. Employment at will and America’s weak safety nets seemed viable in a robust economy when employers felt some loyalty toward their workers. But now many companies see them as disposable, a cost rather than an asset. The degradation of job quality and security is producing a pushback.

Third is that some unions are moving away from the traditional reflexive opposition to management and are working to craft win-win situations, in which they work to improve the standing of the industry and also make certain they share in the gains. Andrew Stern, the head of the Service Employees International Union, which is the largest and fastest-growing union in America. A 2005 New York Times article discussed Stern’s approach at considerable length:

Over the years, union bosses have grown comfortable blaming everyone else — timid politicians, corrupt C.E.O.’s, greedy shareholders — for their inexorable decline. But last year, Andy Stern did something heretical: he started pointing the finger back at his fellow union leaders. Of course workers had been punished by forces outside their control, Stern said. But what had big labor done to adapt? Union bosses, Stern scolded, had been too busy flying around with senators and riding around in chauffeur-driven cars to figure out how to counter the effects of globalization, which have cost millions of Americans their jobs and their pensions. Faced with declining union rolls, the bosses made things worse by raiding one another’s industries, which only diluted the power of their workers. The nation’s flight attendants, for instance, are now divided among several different unions, making it difficult, if not impossible, for them to wield any leverage over an entire industry.

Stern put the union movement’s eroding stature in business terms: if any other $6.5 billion corporation had insisted on clinging to the same decades-old business plan despite losing customers every year, its executives would have been fired long ago…..

Having grown up around his father’s small-business clients, and having spent much of his adult life at bargaining tables, Stern had learned a few things about the way business works. He came to embrace a philosophy that ran counter to the most basic assumptions of the besieged labor movement: the popular image of greedy corporations that want to treat their workers like slaves, Stern believed, was in most cases just wrong. The truth was that companies in the global age, under intense pressure to lower costs, were simply doing what they thought they had to do to survive, and if you wanted them to behave better, you had to make good behavior viable for them.

Stern’s favorite example concerns the more than 10,000 janitors who clean the office buildings in the cities and suburbs of northern New Jersey. Five years ago, only a fraction of them were unionized, and they were making $10 less per hour than their counterparts across the river in Manhattan. Stern and his team say they were convinced from talking to employers in the fast-growing area that the employers didn’t like the low wages and poor benefits much more than the union did. Cleaning companies complained that they had trouble retaining workers, and the workers they did keep were less productive. The problem was that for any one company to offer better wages would have been tantamount to an army unilaterally disarming in the middle of a war; cheaper competitors would immediately overrun its business.

The traditional way for a union to attack this problem would be to pick the most vulnerable employer in the market, pressure it to accept a union and then try to expand from there. Instead, Stern set out to organize the entire market at once, which he did by promising employers that the union contract wouldn’t kick in unless more than half of them signed it. (Getting the first companies to enter into the agreement took some old-fashioned organizing tactics, including picket lines.) The S.E.I.U. ended up representing close to 70 percent of the janitors in the area, doubling their pay in many cases, from minimum wage to more than $11 an hour. Stern found that by bringing all of the main employers in an industry to the table at one time, rather than one after the other, he was able to effectively regulate an entire market.

This is a huge departure from the union thinking of old, and the SEIU’s success is likely to bring other unions around to a similar posture.

From the Financial Times:

The US has an unusually low rate of union membership. Barely 10 per cent of its workers are members (and as few as 7 per cent in the private sector), down from about 35 per cent in the 1950s. Whether you see this as a strength or a weakness most likely depends on whether you think the US economy is succeeding or failing. Weak unions make for flexibility and rapid growth in productivity, the engines of US economic pre-eminence. To see what strong unions do for industrial competitiveness, look at GM. But weak unions also squeeze wages at the bottom, worsen inequality and create economic insecurity, the issues that most preoccupy the country and its politicians.

Avidly courting union endorsements in the approaching presidential primaries, all the Democratic candidates are taking a pro-union stance…These are not just rhetorical commitments. All the candidates are supporting legislation promoted by the labour movement that would make it easier for unions to organise…

American workers have often been cool towards unions. In the mid-1990s polls generally found that only about a third of non-union workers wanted to join one. In the past few years, the proportion has risen to more than half. The Democrats’ beefed-up pro-union line is faithfully reflecting this shift in mood. Both spring from the economic strains and insecurity of which so many Americans complain.

But is a recovery of union power a good answer to those problems? GM notwithstanding, the idea should not be dismissed out of hand. Certainly, enough of the wrong kind of union activity can wreck an economy. Britain made that clear in the 1960s and 1970s. But unions need not be so obtusely adversarial and self-destructive. Unions and works councils in Germany and Japan have not impoverished those countries. Unions do raise wages, sympathetic economists point out. When they do, it is usually in industries where product markets are not very competitive and there is a rent for managers to share with labour. When product markets are competitive, there is no rent to divide: the effect of unions on wages is then typically smaller and no economic harm is done.

Pro-union economists also point to evidence that productivity may actually be higher when a union is present, provided that the enterprise is well run to begin with. Perhaps higher wages enable managers to hire better workers, or else encourage companies to invest in labour-saving machinery. This could make for a productive, profitable company with contented workers – although not without losers, one must remember. Because of higher-than-competitive wages, employment is lower than it would have been. The insiders gain, in the best case at little or no cost to shareholders. But outsiders are worse off.

As a rule, though, unions are bad at accommodating disruptive change – the very thing the US does best. The weakness of the country’s unions is surely no coincidence: they are weak because the economy is dynamic, and vice versa. American unionism has modernised lately, but much of what remains is still political and adversarial. Its body language says, we are out to get the bosses. It seeks a voice not just for workers in the office or factory, but for labour in the aggregate. Its agenda is anti-competitive and stridently protectionist, and consequently anti-growth.

The late Rudiger Dornbusch, ever a fount of economic wisdom, was fond of the maxim, protect the worker not the job. Unions are wired to ignore that good advice. Their leaders’ power and pay is bound up with the existence of particular jobs. They are institutionally opposed to creative destruction and economies need a lot of that to thrive. But if workers, not jobs, are to be protected, governments do need to step in. The list is familiar, and has a strongly Democratic flavour: more generous employment subsidies for the low-paid, high-quality education, universal health insurance and help for workers who fall victim to restructuring.

Although I’m not keen about the dollar’s prospects over the next 2-3 years, a Bloomberg story says that it appears to be oversold relative to the euro. However, this view is based on technical analysis, which some dismiss as a close cousin to astrology.

From Bloomberg:

The euro’s record-setting rally may not extend through the end of October, according to analysts who rely on market patterns for their predictions.

No fewer than half a dozen indicators that measure the speed and slope of a currency’s rise and foreshadowed the euro’s three biggest slumps of the past year show the best may be over after it strengthened 4.7 percent last month to its all-time high of $1.4278. Citigroup Inc., the largest U.S. bank, says the euro may drop to below $1.37 unless the currency maintains its momentum.

“We are a little more cautious,” said Tom Fitzpatrick, Citigroup’s global head of currency strategy in New York. “Whenever you see acceleration” of this magnitude, “it’s a sign we may have a correction,” he said.

The euro’s appreciation is putting pressure on the European Central Bank to find a way to curb the gains. French President Nicolas Sarkozy and Fiat SpA Chairman Luca Cordero di Montezemolo complain that the rise in the currency shared by 13 European nations is hurting their economies….

The currency may drop as low as $1.367 by the end of October, according to Citigroup and Zurich-based UBS AG, the biggest currency traders after Frankfurt-based Deutsche Bank AG. A Bloomberg survey of 45 banks and brokerages set the euro at $1.40 by January and $1.34 at the end of 2008.

Technical analysis, popularized by Charles Dow, creator of the Dow Jones Industrial Average in 1896, is based on the theory that a chart of the price of any asset or index contains clues about future movements.

Those indicators watched by traders say the euro is becoming too expensive. The currency’s 14-day relative strength indicator reached 80.65, almost double a month ago. The gauge measures the momentum of price changes. Readings above 70 and below 30 indicate a reversal may occur.

The euro dropped 3.2 percent in the five weeks following the last time the index passed 80 in December 2006. It fell 3 percent in the seven weeks after the index exceeded 70 in the last half of April, and the currency tumbled 3.5 percent in the three weeks after it topped 75 in late July.

“Most technical indicators — stochastic, momentum or relative strength — are telling us the euro is extremely overbought,” said George Davis, chief technical analyst at RBC Capital Markets in Toronto. “The prospect for a short-term correction is getting bigger every day the rally is sustained.”….

Trading envelopes, which measure how far from the mean a price has strayed, and commodity channel indicators showing when a currency is overbought also suggest that the euro has reached extreme highs.

Goldman Sachs Group Inc. advised investors last week to sell euros bought since Aug. 16 because indicators show “the probability of consolidation is quite high,” said Jens Nordvig, a New York-based strategist at the firm.

Tanta at Calculated Risk, in one of her usual colorful explanations, tells us the real pitfall of stated income loans, and it’s not one you might expect.

She works through an example of an entrepreneur who doesn’t report all his income (as an aside, she’s not keen to reward that behavior and works through the implications for the bank if issues a stated income loan with the guy claiming just enough income so that his debt-to-income ratio falls within accepted norms, versus a “full doc” which shows his true (according to the IRS) DTI of 68%.

The fully documented loan not only requires more internal sign-offs and regulatory reporting, but it is also a red flag to bank examiners and investors, almost certain to require further explanation.

So this makes the no doc look like a win-win, right? It saves the bank all kinds of hassle and expense, and is easier for the borrower too.

The problem that everyone has been ignoring is that the borrower had better be damned certain he can make good on the loan, because he is assuming liability that the bank ought to be bearing. If the loan goes bad, the borrower can be prosecuted for fraud. As Tanta informs us:

have said before that stated income is a way of letting borrowers be underwriters, instead of making lenders be underwriters. When I say make lenders be lenders, I don’t mean let’s not regulate them. I have no problem with regulatory examinations; far from it. I am someone whose signature (usually, in fact, as that second sign-off) has appeared on exactly these kinds of loans, and whose butt has been on the line for them. We all face having loans we approved go bad; the world works that way. What the stated income lenders are doing is getting themselves off the hook by encouraging borrowers to make misrepresentations. That is, they’re taking risky loans, but instead of doing so with eyes open and docs on the table, they’re putting their customers at risk of prosecution while producing aggregate data that appears to show that there is minimal risk in what they’re doing. This practice is not only unsafe and unsound, it’s contemptible.

We use the term “bagholder” all the time, and it seems to me we’ve forgotten where that metaphor comes from. It didn’t used to be considered acceptable to find some naive rube you could manipulate into holding the bag when the cops showed up, while the seasoned robbers scarpered. I’m really amazed by all these self-employed folks who keep popping up in our comments to defend stated income lending. It is a way for you to get a loan on terms that mean you potentially face prosecution if something goes wrong. Your enthusiasm for taking this risk is making a lot of marginal lenders happy, because you’re helping them hide the true risk in their loan portfolios from auditors, examiners, and counterparties. You aren’t getting those stated income loans because lenders like to do business with entrepreneurs, “the backbone of America.” You’re not getting an “exception” from a lender who puts it in writing and takes the responsibility for its own decision. You’re getting stated income loans because you’re willing to be the bagholder.

And no, this doesn’t particularly do much for my assessment of your business acumen. Frankly, I’d rather see your tax returns and your P&L and hear your story about how investments in the business you have made, with the intent to grow it wisely, have limited your income or made it highly variable, than to see you volunteer to risk prosecution for fraud because, you know, you really need to buy a house. Do you do business with people like that all the time? Are you typically attracted to deals that are claimed to be perfectly legitimate, except that it’s important not to fully disclose certain facts to certain parties? Does that maybe explain some of your accounts receivable problems and your pathetic cash flow? It certainly seems to be explaining some lenders’ cash-flow problems at the moment.

This isn’t just an issue for regulated depositories. All those claims by securities issuers and raters about how we had no idea that gambling was going on in this joint are directly comparable. The tough news for the self-employed “respectable” borrower is that I don’t care if you’re individually willing to play bagholder: you can’t afford to underwrite that collective risk. We have a major credit crisis that’s proving that.

The Wall Street Journal has broken the story that UBS will announce that it is writing down its fixed income book as much as 4 billion Swiss Francs, or roughly $3.4 billion, which will result in losses of 600 to 700 million SFr for its third quarter.

Although this write-off is greater than those taken by other investment banks like Lehman and Morgan Stanley whose quarters end a month earlier, and thus aren’t exactly comparable, UBS may have company soon. As the Journal observed:

Among banks that haven’t yet reported, Merrill Lynch & Co. faces a possible third-quarter write-down of as much $4 billion to reflect losses on mortgage-related securities and buyout-financing commitments, a Wall Street analyst predicted last week.

Part of the Journal’s discussion, however, warrants a bit of further explanation:

The write-downs represent the first big stamp made by UBS’s new CEO, Marcel Rohner, who was named in July after the bank ousted his predecessor in the wake of the shutdown of its internal fund, Dillon Read Capital Management. Mr. Rohner said shortly after taking control of UBS that he would pursue a more conservative strategy, such as limiting growth of UBS’s investment bank. In setting its write-down, UBS is valuing its assets conservatively, people familiar with the matter said. A write-down would also let Mr. Rohner try to ring-fence problems that started before he took the helm.

According to a person familiar with the matter, Mr. Rohner now will personally oversee UBS’s investment-banking division in place of investment-banking CEO Huw Jenkins. The London-based Mr. Jenkins has overseen the division for the past two years, a period in which it grew aggressively, and also took on risks linked to the U.S. subprime-mortgage market at a time when those assets were already beginning to founder. As the damage from the division’s trading strategy began to unfold Mr. Jenkins in early August replaced the bank’s fixed-income chief, but its troubles mounted in the months that followed.

First, Marcel Rohner’s “ring fencing” means he has an incentive to recognize not just actual losses, but any likely losses. It’s in his interest to take one massive, comprehensive hit now, rather than have the Chinese water torture of continuing quarterly write-downs that would reflect badly on him. That means, to the extent that there is any uncertainty in how to mark positions, they will have taken a negative view.

This in turn implies their results are likely not to be comparable to those of other firms, who don’t have cause to get all the bad news out at once. In fact, other Wall Street firms are likely exploiting whatever valuation latitude they have to show a more flattering picture, particularly since some managers doubtless believe (or at least hope) this credit contraction will reverse itself soon.

Query whether the SEC will take an interest in the almost-certain valuation disparity between UBS and its peers.

Another issue is simply one of nomenclature. Because UBS is a universal bank, meaning it is both a commercial and an investment bank, its investment banking division comprises its entire securities operation. That’s a different use of terms than you find in a pure investment bank, whose investment banking operations consist of services sold to corporations, such as corporate finance, M&A, and so on. In these firms, the various trading operations, such as fixed income and equities, are housed in separate units. Thus, the statement “the damage from the [investement banking] divisions’s trading strategy” would make no sense at, say, a Goldman. They don’t have trading operations in their investment banking division.

The story also characterizes UBS’s woes as a result of having expanded its investment banking operations too quickly when the problem appears to have been quite specific:

UBS’s fixed-income division suffered after the bank set up Dillon Read, the in-house hedge fund it started in June 2005, because the unit siphoned off many of the bond team’s best traders.

Losses from Dillon Read widened to 230 million Swiss francs in the second quarter from 150 million Swiss francs in the first quarter, UBS said. Shutting it down cost the bank $314 million in the second quarter to cover restructuring, severance payouts and write-downs of unused rental space for the traders.

The latest losses are, in part, a result of continued costs of writing off Dillon Read’s soured mortgage bets, but they are also a result of other securities held by the fixed-income division.

Whether or not UBS’s bond traders were decent traders (note that trading on a day-to-day basis and acting as a proprietary trader, which is more or less what hedge funds do, are two very different skills), they weren’t very successful at running a hedge fund. And it has now become evident that UBS didn’t have the bench depth in its fixed income unit to support a major exodus of talent. Leaving a major trading operation in unseasoned hands is a prescription for disaster.

The coverage in the Financial Times echoes the Journal’s concerns about earnings at other investment banks:

But in recent days, analysts have become more concerned about the prospects for some of the banks whose quarter ends in September. Deutsche Bank shares were hit last week amid concerns that it will take big writedowns. Analysts have also dramatically reduced their forecasts for Merrill Lynch with William Tanona at Goldman Sachs predicting it will have barely broken even because of multi-billion-dollar mark-to-market losses on leveraged loans and collateralised debt obligations.

The prolonged disconnect between the debt and equity markets is bizarre. Historically, credit market corrections precede equity downturns; once in a while, as in 1997-1998, they send a false positive, so equity investors feel justified in not taking every blip in the credit markets to heart. (And we aren’t the only ones to think along these lines, witness this post by Michael Panzner).

But although there is a good deal of variability, in the stone ages, the typical lag between a tighter credit and an equity decline was four months, and the tendency has been for it to shorten. If you put the beginning of the credit downturn at June 7, when ten year Treasury bond yields jumped upwards, breaking a long-established historical pattern that traders saw as a sign of the long decline in interest rates, the equity markets still have some time before a correction looks overdue.

Of course, the reason for the cheer in stock-land is that the Fed rode in to the rescue on September 18 with its 50 basis point cut in the Fed funds rate. But did that work as well as the bulls would have us believe?

We noted Friday that the commericial paper markets were still rocky, and the Financial Times reported Saturday the credit markets look weak:

Markets and the world economy are in a no-man’s-land 11 days after the US Federal Reserve’s dramatic half-point interest rate cut….conditions in the interbank money market and other troubled corners of the financial system remain far from normal….

If the US economy does deteriorate severely from here, sickly credit markets would have to absorb another shock: this time from rising expected defaults on a wide range of US assets. That could put the market healing process into reverse.

Even before Friday’s distress sale of Net Bank, a US internet bank, Fed officials were wary of assuming that the crisis is past.

Fed policymakers do see a welcome change in tone and sentiment since their rate cut, with investors starting to differentiate much more between assets and investment vehicles.

The effects of this have been most marked in the asset-backed commercial paper market (ABCP), where stress is now more tightly confined to paper backed by problem mortgages and special investment vehicles (SIVs) that are not backed by strong banks. Credit spreads have also narrowed.

The market for leveraged buy-outs is starting to re-open and spreads between agency conforming and non-conforming mortgages have tightened a little.

But Fed officials still believe markets are fragile. They are a little concerned by the slow progress in the non-conforming mortgage market.

While interbank lending spreads as well as rates fell in the aftermath of the rate cut – much to the relief of Fed policymakers – spreads have moved up again.

“There is still a clear dislocation in money markets and the new high in Euribor is a genuine worry,” said Dominic Konstam, head of interest rate strategy at Credit Suisse. “Volumes in the market are running at 10 per cent of normal activity.”

Officials blame the latest uptick in interbank spreads on quarter-end and year-end husbanding of liquidity. They see that big banks are still hoarding cash owing to uncertainty about how many assets currently held in investment vehicles will come back on balance sheet.

With mostly smaller and weaker banks seeking to borrow, interbank lending rates have been pushed up by so-called “adverse selection”.

Policymakers do not expect markets to recover rapidly, in part because of the overhang of securities. Weak SIVs unable to obtain financing may have to liquidate their portfolios, while banks still have a huge portfolio of leveraged loans to distribute.

Most investors still lack valuation models capable of evaluating the most complex credit products.

The Fed rate cut “does not cure the ills of the liquidity crisis”, said Jim Caron, co-head of global interest rate strategy at Morgan Stanley. Many institutions have had to rely on shorter-term funding in recent weeks, making them vulnerable to bad news….

It is possible for improvement in market functioning to co-exist with increasing concern about the economy – but not for long. Either the economic data will point upwards, in which case the market healing process should speed up, or they will point downwards and then markets are likely to take another turn for the worse.

Dennis J Snower at VoxEU reaches a similar conclusion via a different route. He believes a mere continuation of the credit crunch will hurt growth. Worse, given that the pullback was the result of overvalued US housing, and many other economies have real estate that is even more overpriced than ours was, he is worried about the possibility of housing contagion.

From VoxEU:

For years economists and policy makers have worried about the fragility of the US economy, and particularly about the un-sustainability of the US housing boom, but when the shock finally occurred, everyone – central banks, commercial banks, hedge funds, private investors – appears to have been unprepared. The big surprise was the nature of the shock. Suddenly banks stopped lending to one another, except on punitive terms. Liquidity dried up, threatening the existence of otherwise well-functioning banks and businesses. The crisis of confidence jumped across US borders with ease, as the recent run on Northern Rock has shown. How will this financial turbulence affect the world economy?….This is my purpose – not to make a forecast, but to warn of possible dangers ahead.

Investors tend to imagine that the world will continue to be approximately like it is now. Before the US Federal Reserve reduced the benchmark interest rate by one-half percentage point on Tuesday, September 18, financial markets were in despair; afterwards they were euphoric. Such myopia is dangerous. So far, economic activity – production, employment, consumption, investment and trade – have remained largely unaffected by the credit crunch. Many seem to believe this will continue. Equally dangerous.

If the credit crunch persists, there can be no doubt that economic activity will suffer. The Fed’s interest rate cut will not prevent US home foreclosures, nor will it eliminate the glut of unsold homes. If US house prices continue to fall and unemployment continues to rise, consumers will doubtlessly reduce their spending, and the fall in demand will aggravate the rise in unemployment, hurt the US stock market, and thus lead to a further fall in spending.

Meanwhile, it is worth keeping in mind that the US is not the only country where house prices have risen much faster, on average, than national incomes. On the contrary, house prices in Australia, Britain, Denmark, France, Ireland, Spain, and Sweden have all increased faster, over the past ten years, than in the US. Of course the US is a special case on account of its subprime mortgage lending towards the end of its housing boom. There, mortgage lenders with poor credit records could buy houses at virtually interest-free for a few years, before the rates were adjusted steeply upwards. But the danger of international contagion remains. The US housing slump may well lead investors in Europe to reassess the value of their properties. If that happens, then consumption spending is likely to fall in the countries listed above, leading to weaker labour markets.

This could happen at a time when the Chinese economy has overheated and will need to slow down, and when the Japanese economy is stagnating. There are no other countries to take-up the slack, to serve as a “motor” for the world economy, as the US has done for so long.

The New York Times’ Grectchen Morgenson, in “Can These Mortgages Be Saved?” looks at Countrywide’s loan modification operation (in typical bureaucratic doublespeak called HOPE: “Helping homeowners, Offering solutions, Preventing foreclosures and Envisioning success”) and finds it wanting.

Unlike some recent Morgenson pieces, this article is remarkably free of snide remarks or swashbuckling prose. Instead, Morgenson offers some examples of homeowners who were given the runaround by Countrywide when they tried to get their loans modified. These vignettes are intespersed with Countrywide’s defenses of its practices (which are remarkably unconvincing) and comments from organizations who work with delinquent borrowers, all of whom confirm that Countrywide is the less willing than other mortgage servicers to mod loans, and by a considerable margin.

But mortgage mavens will still likely find fault with the piece. Even though Morgenson gives specific details about how and when the borrowers got in trouble and how their overdue amounts escalated, she doesn’t give as much information as one would like as to how things spun out of control. It sounds as if she did, or could easily have, gotten documents from the victims. She could have put them to better use.

In addition, in one of Morgenson’s examples, it sounds as if the borrower was defrauded. Countrywide charged one Shannon Rivas-Spivey for flood insurance for reasons that turned out to be bogus, yet it appears Rivas-Spivey never got the charges reversed. Something doesn’t add up, and Morgenson didn’t get to the bottom of it.

Nevertheless, some of the quotes and factoids are compelling:

Countrywide strongly disagrees. Last week, it described its efforts on behalf of troubled homeowners. “Our No. 1 priority is to help borrowers stay in their homes,” said Steve Bailey, a Countrywide executive, in a news release. The company said it has saved 39,582 mortgages from foreclosure so far this year….

Even so, the workouts that Countrywide boasted about last week include two types of deals that wind up forcing borrowers from their homes. Almost 14 percent of its homeownership preservation efforts involved borrowers who agreed to sell their homes for less than their loan amounts, called a short sale, or involved homeowners turning over their deeds to Countrywide to prevent a foreclosure. Countrywide did not disclose in its news release that such arrangements were included in its workout figures.

“When you look under the surface, they are counting deeds-in-lieu as a modification,” said Martin Eakes, chief executive of the Center for Responsible Lending, a nonprofit and nonpartisan research organization. “When you’ve taken someone’s house, even without the foreclosure process, to count that as a modification is worse than fiction.”….

Even as Countrywide maintains that helping its borrowers modify their loans is its top priority, its investors have heard a slightly different story. In a conference call with analysts and investors in late July, Kevin Bartlett, Countrywide’s chief investment officer, counted about 2,000 loan modifications done in June. Most of those, he said, involved deferring overdue interest or adding the past due amount to a loan. The company rarely provides workouts that reduce interest rates on loans, Mr. Bartlett told investors.

Yet reducing rocketing interest rates is exactly the relief that many borrowers are seeking because, consumer advocates say, that is the only way they can afford to stay in their homes. Loan experts say that when workouts involve deferring overdue interest or tacking amounts owed onto the back of a loan, borrowers often wind up in trouble again in just a few years.

Mr. Bailey said that while Countrywide has historically done few interest rate reductions, it will be doing more. “Right now we have just about 1,000 loans facing interest rate reductions,” he said. “The pendulum is swinging that way.”

But Mark Seifert, executive director of Empowering and Strengthening Ohio’s People, a consumer advocacy group in Cleveland, is dubious. He said his experience with Countrywide, one of the dozen or so lenders and servicers with whom he works on behalf of borrowers, has been unsatisfactory.

For the first eight months of this year, he said, his group took in 132 cases in which Countrywide was the loan servicer. Of those, two ended up in what he called “very good” workouts from the company. One involved forged documents when the original loan was made, Mr. Seifert said, and the other involved a borrower who received her deal from Countrywide the day before she was set to testify before Congress last July about her problems with the company.

“We have experience with Citi, Chase and a whole litany of other lenders,” Mr. Seifert said. “Some are better than others, but we are successful more than half the time with all of them. Except Countrywide.”….

Bruce Marks is founder of the Neighborhood Assistance Corporation of America, a nonprofit advocacy and mortgage company that helps troubled borrowers get new, low-cost loans. He sees problem mortgages from across the country and works with a variety of lenders. He said that his organization has resolved 3,500 cases for imperiled borrowers this year, and that none have had to leave their homes.

Mr. Marks, too, characterizes Countrywide as the lender most unwilling to help borrowers.

“Homeowners who are desperate to keep their homes are trying to restructure the mortgages to the payment before the rates reset,” he said. “Countrywide demands their last dollar and their retirement funds to stop a foreclosure on unaffordable loans.”

You cannot make this stuff up….From the US Patent and Trademark Office:

Outsourcing of services

Abstract

A method for identifying human-resource work content to outsource offshore of an organization. The method is provided on a computer readable medium and includes the steps of identifying at least one task being performed by an organization; associating each identified task with a functional group within a plurality of functional groups related to the organization; determining information about individual human resources spent on each task; determining task information about human resources spent on the plurality of tasks, the task information based on the determined information about individual human resources spent on each task; using the determined task information to determine a value of each task; and outsourcing tasks having a value lower than a predefined limit to at least one of offshore and to a low cost supplier….

Assignee Name and Address: International Business Machines, Armonk, NY.

It seems peculiar indeed that a sea change in the world economy, namely, the decline of the international funds flow generally called “global imbalances,” has gotten so little attention.

“Global imbalances” refers to capital flows from high savings countries such as China, Taiwan and Japan, funding current account deficits (meaning consumption) in the US. They have become as fundamental to the operation of the world economy as the Gulf Stream is to the climate, and changes in it would produce a similar level of disruption.

This topic has garnered comparatively little attention in the financial press relative to its importance. There was a sobering discussion by Martin Wolf at the Financial Times recently. But for the most part, the discussion, even by Serious Economists, is on the decline of the dollar, and it seems for the most part to be considered in isolation. An exception that proves the rule is a comment by Paul Krugman (in keeping, on his blog, not in his New York Times column) that points to a recent paper of his that addresses the issue but frames it in terms of a possible “dollar plunge”:

There is little doubt that the dollar must eventually fall from current levels. Trade deficits on the current scale cannot continue forever – and we are all fond of quoting Stein’s Law: ‘If something cannot go on forever, it will stop.’ Closing the trade deficit will require a redistribution of world spending, with a fall in US spending and a rise in spending abroad. One occasionally hears assertions that this redistribution of world spending can lead to the required change in trade deficits without any need for a change in real exchange rates – a view John Williamson once felicitously described as ‘the doctrine of immaculate transfer’. In fact, however, a redistribution of world spending will require a fall in the relative prices of US-produced goods and services, because US spending falls much more heavily than the spending of other countries on those US-produced goods and services. So there must, eventually, be a real depreciation of the dollar. But this depreciation could be gradual, a few percent per year or less. Why should it take the form of a discrete drop?

There has actually been surprisingly little discussion of this question, even in papers that can seem, on a casual reading, to be about the prospects for a dollar plunge. For example, the widely cited work of Obstfeld and Rogoff about dollar adjustment, continued in their 2005 Brookings paper, is often cited as reason for alarm. But their framework is designed to estimate the size of the dollar decline needed to eliminate the current account deficit; it sheds little light on whether that decline will happen quickly, as opposed to a gradual adjustment over the course of a number of years.

The closest any paper in the 2005 Brookings symposium came to addressing that question directly was Edwards (2005), whose view is echoed less clearly in a number of discussions. The basic idea can be summarized as follows: there has been an
upward shift in the proportion of US assets that foreign investors want to hold in their portfolios. As long as foreign investors are still in the process of moving to this new, higher share of dollars in their wealth, their actions generate a large capital flow into the United States. But the capital flows needed to maintain an increased dollar share in portfolios are much smaller than those required to achieve that share. So once the desired holdings of US assets have been achieved, the argument goes, capital flows into the United States will drop off sharply, leading to an abrupt decline in both the current account deficit and in the dollar.

Note that the scenario that Krugman describes above, that foreign investors will reach a target level of dollar holdings and then become much less keen about buying more dollars to keep funding US deficits, leading to a fall of the dollar. That process appears to be underway. As we have noted before (see here and here for examples), foreign central banks, which have been the biggest buyers of the US currency, have begun to diversify away from the greenback.

A post by Michael Pettis on Brad Setser’s blog (which does a very good job on the currency beat) takes a different angle than Krugman: he anticipates that an end of global imbalances will lead to a prolonged economic slowdown, with or without a sharp correction of the dollar:

As I said in an earlier post I believe that the recycling of the US trade deficit has been the main factor underpinning the recent globalization cycle. If so, and when the current cycle ends, if history is any indication the adjustment from the insanely happy days of too much liquidity (with its attendant surge in risk appetite) to a more “normal” level of liquidity will be a very difficult one and can result in significantly reduced global growth lasting many years – especially for those countries that begin the slowdown with the weakest and most rigid financial systems.

In previous cycles, financial systems, which during the good times had evolved into greater risk-taking activity and more-tightly-stretched asset-liability structures, were suddenly caught short by the secular change in risk appetite. In many cases their ability to intermediate the flow of capital slowed considerably, and what followed often involved considerable economic slowdown.

My evidence is largely anecdotal, but it seems to me that those countries with the highest levels of financial risk-taking and the least flexible financial systems were the ones that did most poorly – the United States in the 1930s, with its reliance on thousands of small banks with rigid deposit bases, a weak and inexperienced central bank, and an investment banking industry in shock, of course did among the worst, although there were plenty of other non-financial factors that exacerbated the problem (by the way, it is worth remembering that in 1929 the US had, after several years of very high trade and capital account surpluses, very high levels of reserves, which in the end didn’t help).

The reputation of drug companies has taken a beating in recent years. Their prices have risen much faster than inflation (except for last year, when generics had some impact), makes them almost universally suspect. The industry’s claim that its fat margins are warranted by its investment in research doesn’t bear much inspection. 45% of drug R&D is government funded. Moreover, Big Pharma spends more on marketing than on research. Can you think of another business that is profitable enough to warrant in person selling to small businessmen, which is what most doctors are?

One would expect the major drug companies to be particularly image conscious these days. An industry on the defensive seldom takes pot shots at one of its main regulators. Yet that is precisely what Novartis has chosen to do. From the Financial Times:

The Food and Drug Administration has become over-cautious in its assessment of new medicines following political pressure arising from safety controversies, Dan Vasella, chief executive of Novartis, said on Friday.

Mr Vasella, the only chief executive from one of the big pharmaceutical groups to attend the three-day Clinton Global Initiative in New York this week, said the medicine regulator had gone too far in seeking to evaluate drugs on criteria beyond their safety and efficacy.

“The FDA has become subject to politics,” Mr Vasella said. “If they are assailed like they are now, the best thing to do is nothing.”

Novartis has felt the sting of the FDA’s increasing focus on safety that sprung partly from US drugmaker Merck’s withdrawal of painkiller Vioxx owing to heart risks three years ago. Two drugs in Novartis’s pipeline, Galvus for type II diabetes, and painkiller Prexige, have met significant regulatory delays with the FDA.

Both Prexige and Arcoxia, Merck’s successor to Vioxx, have been denied approval by the FDA in spite of receiving approval around the world. The US safety issue has shaped their assessment to include a broader discussion of their place in the market and alternative treatments.

“The discussion on what this [drug] brings over and above what’s on the market is a question that’s being asked. The FDA doesn’t seem to trust the physicians any more,” Mr Vasella said.

Novartis is taking an interesting gambit, in claiming that it is the true defender of consumer interests and (by implication) the FDA is a bad guy by withholding useful medicines. (I imagine that the FDA has come to regret its change in policy in 1997 to allow direct to consumer advertising, which has given drug companies another channel to influence public perceptions. Note that the US and New Zealand are the only two advanced economies that permit it).

But Vasella’s charges don’t stand up to scrutiny. in reverse order, the FDA shouldn’t trust physicians. This isn’t a matter of trust, but of findings in properly designed studies. In addition, your average MD doesn’t have the time to keep up on medical research. And very few have expertise in study design or methodology. That’s precisely why they can be manipulated by drug detailmen. So implying that physicians are in a better position to judge efficacy and safety than the FDA is bogus.

The grist of Vasella’s argument is that two drugs, his Prexige and Merck’s Arcoxia that have been approved “around the world.” The FT should have examined that claim rather than treating it as fact.

I didn’t have to look far to find problems with both drugs. I started with Australia and hit pay dirt.

Australia and New Zealand have banned Prexige. From the Australian announcement:

Prexige was withdrawn on 10 August 2007 by the Therapeutic Goods Administration because of a small number of cases of serious liver side effects. If you take Prexige, stop taking it immediately and see your doctor to discuss an alternative to this drug and to arrange any tests you may need.

New Zealand was slightly more forgiving, allowing use only in very low doses:

The New Zealand Ministry of Health’s medicine watchdog Medsafe has withdrawn the supply of 200mg and 400mg Prexige tablets.

The anti-inflammatory drug has been blamed for the deaths of two people and for two others requiring liver transplants in Australia.

Medsafe spokesman Stewart Jessamine said its medicines adverse reactions committee (MARC) discussed the overall risks and benefits of the use of Prexige with regulators in Australia, Singapore and the United Kingdom.

“This increased risk of liver damage for Prexige outweighs any of the potential benefits claimed for the 200mg and 400mg dose,” Jessamine said.

The 100mg Prexige tablets would stay on the market, though would be closely monitored.

Similarly, Australia did not approved Etoricoxib, the chemical name for Merck’s Arcoxia in its initial review in 2004, citing safety concerns. After the Vioxx scandal in the US, the Therapeutic Goods Administration decided that it would be approved only for very limited use:

It is proposed to greatly limit the approved uses of two other Cox-2 inhibitors which have not yet been marketed in Australia. They are etoricoxib and lumiracoxib. In both instances, ADEC was not sufficiently assured of the safety of these drugs for anything other than short term use in patients without increased cardiovascular risk.

So the idea that the US is tougher than other drug regulators is exaggerated. And by happenstance, a story in the New York Times yesterday depicts an FDA not only grossly understaffed in the area that oversees clinical trials, but also strongly inclined to downgrade any problems found:

In a report due to be released Friday, the inspector general of the Department of Health and Human Services, Daniel R. Levinson, said federal health officials did not know how many clinical trials were being conducted, audited fewer than 1 percent of the testing sites and, on the rare occasions when inspectors did appear, generally showed up long after the tests had been completed.

The F.D.A. has 200 inspectors, some of whom audit clinical trials part time, to police an estimated 350,000 testing sites. Even when those inspectors found serious problems in human trials, top drug officials in Washington downgraded their findings 68 percent of the time, the report found. Among the remaining cases, the agency almost never followed up with inspections to determine whether the corrective actions that the agency demanded had occurred, the report found.

“In many ways, rats and mice get greater protection as research subjects in the United States than do humans,” said Arthur L. Caplan, chairman of the department of medical ethics at the University of Pennsylvania.

So Vasella is 100% correct. Politics have a great deal to do with drug approvals. My FDA lawyer buddies tell me that the FDA enforcement area is understaffed precisely because its budgets have been cut by Congress.

But those politics already operate very much in favor of the drug industry.

A couple of stories confirm that, despite the peppy response of the equity markets and the return to more-or-less upbeat reporting in the financial media, the Fed’s 50 basis point cut has not restored normalcy to the sector most in need of aid, namely, the money markets.

Central bankers have limited and for the most part, crude tools. One of the concerns voiced in the run-up to the September FOMC meeting was that the credit market crisis was, as UCSD economist James Hamilton put it, “bank run on non-banks.” Thus, measures designed to shore up banks, like the use of the discount window, would have no impact, and a general rate reduction might or might not help the battered sector (a rate reduction won’t help problems related to transparency, and will have only a marginal impact on solvency) but would increase prices of asset classes that benefit from lower short term rates.

One sign of the limited impact of the Fed’s move: commercial paper outstandings are continuing to shrink. While the rate of decline has moderated, if the Fed’s intervention has worked, CP outstandings would instead be rising.

From Bloomberg:

The decline in the U.S. commercial paper market slowed last week, after the Federal Reserve cut interest rates to shore up confidence in the credit markets.

Debt maturing in 270 days or less fell by $13.6 billion in the period ended yesterday to a seasonally adjusted $1.86 trillion, including a $17.3 billion decline in asset-backed commercial paper, according to the Federal Reserve in Washington.

The amount outstanding has fallen by $368.1 billion, or 17 percent, over seven straight weeks to the lowest since August 2006 as some issuers were shut out of the market. The decline is smaller than the previous week’s drop of $48.1 billion, a sign that the credit crunch in short-term debt markets may be subsiding following the Fed’s half-percentage-point reduction in its benchmark rate on Sept. 18.

“The commercial paper market is not deteriorating as fast as it was in August, but as long as outstandings continue to fall, it is not out of the woods yet,” Christopher Low, chief economist at FTN Financial in New York, wrote in a note to clients.

Note that in the acute phase of the credit contraction in August, CP outstandings fell by roughly $90 billion a week for two weeks running, then $60 billion the week after that.

John Authers of the Financial Times tells us that pricing also indicates that the commercial paper market is still traumatized:

Markets have had more than a week to digest the dramatic cut in the Fed Funds rate to 4.75 per cent. Has it worked?

It has stimulated equities…Intriguingly, it has also made money for commodity investors. The S&P GSCI non-energy commodity index is up a cool 16 per cent since the Fed cut the discount rate in August.

But the Fed was not acting for these people. It wanted to relieve the crisis of confidence in money markets, where doubts about the quality of collateral had sent soaring the rates at which banks could raise funds.

Here, there are two ways to look at it. The dollar Libor rate, at which banks lend to each other, fell by the full 50 basis points. Having touched 5.725 per cent, it is now 5.23 per cent.

In asset-backed commercial paper 90-day paper rates reached 6.25 per cent and have come back down to 5.37 per cent.

So the rate cut reduced the cost of finance, bringing it back down to the levels before the crisis. This is important.

But there is a second way to look at it. Normally Libor and commercial paper are closely tied to Fed Funds. Both tend to be only slightly higher than Fed Funds, reflecting only slightly higher risks. When those spreads suddenly widened, it signalled a crisis of confidence.

Those spreads are as wide as they were before the rate cut. In July, commercial paper traded at only 4bp above Fed Funds. That spread is now 62bp. Three-month Libor usually trades at 10 or 11bp above Fed Funds: that spread is now 45bp.

So the rate cut euphoria has not flushed the underlying lack of confidence out of the system. The money market shows banks are still fearful of ugly surprises in the next few months. Maybe that should temper the roaring equity and commodity markets.