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S.&P. Cuts U.S. Debt Rating for First Time

August 6, 2011 by Leave a Comment

The company, one of three major agencies that offer advice to investors in debt securities, said it was cutting its rating of long-term federal debt to AA+, one notch below the top grade of AAA. It described the decision as a judgment about the nation’s leaders, writing that “the gulf between the political parties” had reduced its confidence in the government’s ability to manage its finances.

“The downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenge,” the company said in a statement.

The Obama administration reacted with indignation, noting that the company had made a significant mathematical mistake in a document that it provided to the Treasury Department on Friday afternoon, overstating the federal debt by about $2 trillion.

“A judgment flawed by a $2 trillion error speaks for itself,” a Treasury spokeswoman said.

The downgrade could lead investors to demand higher interest rates from the federal government and other borrowers, raising costs for governments, businesses and home buyers. But many analysts say the impact could be modest, in part because the other ratings agencies, Moody’s and Fitch, have decided not to downgrade the government at this time.

The announcement came after markets closed for the weekend, but there was no evidence of any immediate disruption. A spokesman for the Federal Reserve said the decision would not affect the ability of banks to borrow money by pledging government debt as collateral, a statement that could set the tone for the reaction of the broader market.

S. P. had prepared investors for the downgrade announcement with a series of warnings earlier this year that it would act if Congress did not agree to increase the government’s borrowing limit and adopt a long-term plan for reducing its debts by at least $4 trillion over the next decade.

Earlier this week, President Obama signed into law a Congressional compromise that raised the debt ceiling but reduced the debt by at least $2.1 trillion.

On Friday, the company notified the Treasury that it planned to issue a downgrade after the markets closed, and sent the department a copy of the announcement, which is a standard procedure.

A Treasury staff member noticed the $2 trillion mistake within the hour, according to a department official. The Treasury called the company and explained the problem. About an hour later, the company conceded the problem but did not indicate how it planned to proceed, the official said. Hours later, S. P. issued a revised release with new numbers but the same conclusion.

The company did not return a call for comment.

In a release announcing the downgrade, it warned that the government still needed to make progress in paying its debts to avoid further downgrades.

“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” it said.

The credit rating agencies have been trying to restore their credibility after missteps leading to the financial crisis. A Congressional panel called them “essential cogs in the wheel of financial destruction” after their wildly optimistic models led them to give top-flight reviews to complex mortgage securities that later collapsed. A downgrade of federal debt is the kind of controversial decision that critics have sometimes said the agencies are unwilling to make.

 On the other hand, S. P. is acting in the face of evidence that investors consider Treasuries among the safest investments in the world. Yields rose before the Congressional deal on fears of default and a possible downgrade. But after a deal was struck, yields sank as money poured into Treasuries as a safe haven from sharply falling stocks and the turmoil of the European debt markets.

 On Friday, the price of Treasuries fell sharply in heavy selling, and yields rose, reversing the moves of recent sessions. The 10-year Treasury note ended the day with a yield of 2.56 percent.

The United States has maintained the highest credit rating for decades. S. P. first designated it AAA in 1941, reflecting a steadfast belief that the richest nation in the world would not default on its debt payments. The rating was also bolstered by the role of the dollar as the world’s leading currency, ensuring that demand for American debt securities would remain strong in spite of burgeoning deficits.

“What’s changed is the political gridlock,” said David Beers, S. P.’s global head of sovereign ratings, in an e-mail several days before a debt ceiling agreement was announced. “Even now, it’s an open question as to whether or when Congress and the administration can agree on fiscal measures that will stabilize the upward trajectory of the U.S. government debt burden.”

Experts say the fallout could be modest.

The federal government makes about $250 billion in interest payments a year, so even a small increase in the rates demanded by investors in United States debt could add tens of billions of dollars to those payments.

In addition, S. P. may now move to downgrade other entities backed by the government, including Fannie Mae and Freddie Mac, the government-controlled mortgage companies, raising rates on home mortgage loans for borrowers.

However, because Treasury bonds have always been considered perfectly safe, many rules prohibiting institutions from investing in riskier securities are written as if there were no possibility that the credit rating of Treasuries would be less than stellar.

Banking regulations, for example, accord Treasuries a special status that is not contingent on their rating. The Fed affirmed that status in guidance issued to banks on Friday night. Some investment funds, too, often treat Treasuries as a separate asset category, so that there is no need to sell Treasuries simply because they are no longer rated AAA. In addition, downgrade of long-term Treasury bonds does not affect the short-term federal debt widely held by money market mutual funds.

In other words, almost no one would be precluded from investing in federal debt, and even the ratings agencies have concluded that few investors would walk away voluntarily.

Eric Dash contributed reporting from New York.

Article source: http://feeds.nytimes.com/click.phdo?i=38f85b4dc2a3d77f78fe41cb83e5e4d7

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News Analysis: Euro Builder Ends His Career on a Bitter Note

August 5, 2011 by Leave a Comment

Mr. Trichet, 68, will retire at the end of October after an eight-year term. Yet markets are crashing, bond investors have turned on Italy and Spain, and it appears certain that when Mr. Trichet returns to civilian life on Nov. 1, the European sovereign debt crisis will be far from resolved.

Indeed, the euro area threatens to become the epicenter of a global financial crisis to rival the one that followed the collapse of Lehman Brothers in September 2008 — a horror sequel that Mr. Trichet himself has said the world cannot bear.

“Our democracies would not be ready to provide once again the financial commitments to avoid a great depression in case of a new crisis of the same nature,” he told an audience in Madrid in May.

A lifelong civil servant who wraps his sang froid and political toughness in French courtliness, Mr. Trichet generally gets high marks for the way he has managed the E.C.B. He may be the most influential public official on the Continent, the person who most embodies the dream of a single coin for the European realm.

But recent days have also highlighted what some critics say are policy mistakes by Mr. Trichet, or at least the institution he leads. And just as Alan Greenspan went from being lionized to lacerated after his years at the Federal Reserve were quickly followed by the global financial collapse, these missteps threaten to tarnish Mr. Trichet’s legacy.

Mr. Trichet may be remembered “as a charming and talented leader who failed to grasp the gravity of the crisis,” said Charles Wyplosz, a professor of economics at the Graduate Institute in Geneva.

Some critics, including Mr. Wyplosz, say the E.C.B. made a fatal error when it began buying Greek, Irish and Portuguese bonds in May 2010, a decision that has left the bank holding more than €74 billion worth of questionable debt. Greece should have been allowed to default and restructure under the guidance of the International Monetary Fund, Mr. Wyplosz said.

Other analysts say the bank had no choice but to intervene in dysfunctional markets, but sabotaged its own efforts by moving too hesitantly. The E.C.B. should have shown a willingness to buy Spanish and Italian bonds as well, they say.

“What isn’t helpful is if you stop halfway,” said Frank Engels, co-head of European economics at Barclays Capital in London, who generally holds Mr. Trichet in high regard. “Either you would have abstained entirely, or you would have gone all the way.”

The E.C.B.’s interest-rate policy has also drawn scorn, with critics calling it deeply inconsistent.

The bank has raised the benchmark interest rate twice since April to prevent inflation in fast-growing countries like Germany or the Netherlands. At the same time, the E.C.B. has pursued a loose monetary policy in weaker countries like Greece and Ireland by allowing banks there to borrow central bank funds cheaply. On Thursday, amid signs of serious tension in the interbank markets, the E.C.B. expanded the availability of low-cost loans to banks.

“If this is all part of a single objective, then how can you turn one lever toward the right and one to the left?” said Marie Diron, an economist in London who advises the consulting firm Ernst Young, and previously worked at the E.C.B.

With European economies slowing and the debt crisis intensifying, critics say, the E.C.B. is making the same mistake this year that it made in July 2008. Then, the bank raised the benchmark interest rate to 4.25 percent from 4 percent even as the financial crisis was gathering force.

After the collapse of Lehman Brothers only two months later, the E.C.B. was obliged to throw monetary policy into reverse, lowering the rate to 1 percent by May 2009. It has been at 1.5 percent since July.

To be fair to Mr. Trichet, who declined through a spokeswoman to comment for this article, he has a more limited arsenal of policy tools than Ben S. Bernanke, his counterpart at the Federal Reserve. The E.C.B. charter would not allow it to flood the economy with money the way the Fed has done through its huge purchases of securities.

Article source: http://feeds.nytimes.com/click.phdo?i=e66f7d4a884046fe44a1f14e868df299

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Fed Survey Documents Worsening Economy

July 27, 2011 by Leave a Comment

A Federal Reserve survey said Wednesday that seven of the Fed’s 12 bank regions reported slower growth in June and early July compared with the spring. That’s a worse showing than in the previous survey.

Of the remaining five districts, four reported modest growth. A fifth, the Minneapolis district, said its economy was disrupted by bad weather and the shutdown of Minnesota’s state government.

The job market remained weak in most districts, the report said. Employers added few jobs in June, the government said earlier this month.

Droughts and severe flooding badly hampered seven districts with large agricultural sectors, the report said.

Manufacturing output rose overall. But many districts reported only “steady or slowing” growth, the Fed’s report said. Only two districts reported rising manufacturing activity. Companies in three districts — Philadelphia, Richmond and Atlanta — reported slower growth.

The weak picture of the national economy echoes recent data on hiring and manufacturing. Economists expect growth for the April-June quarter, which will be reported Friday, to fall below 2 percent, the second straight quarter of anemic expansion.

The report, known as the “Beige Book,” is based on anecdotal information gathered by officials at the 12 Fed regional banks. It is released eight times a year and provides an on-the-ground snapshot of the economy. Wednesday’s report covered the roughly seven weeks between May 27 and July 15.

Article source: http://feeds.nytimes.com/click.phdo?i=b804dae24d6b458aab018c9a7336bcf2

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U.S. Trade Deficit Jumped in May

July 13, 2011 by Leave a Comment

The Commerce Department report said that exports of goods and services were $174.9 billion, while imports were $225.1 billion, resulting in a deficit of $50.2 billion. That made it the largest trade deficit since October 2008, when it was $59.5 billion, and was up from a revised $43.6 billion in April.

Exports in May were the second highest level on record after the $175.8 billion in April, while imports were the second highest after the $231.6 billion in July 2008.

Still, economists said that exports from the United States were expanding at a good pace, with a lower dollar, increased competitiveness and strong growth in global markets.

“Trade is growing at a very rapid pace,” said Paul Ballew, a former Federal Reserve economist and now the chief economist at Nationwide Insurance. “Emerging markets outside of the U.S. have come back briskly. It is a very uneven recovery but there are pockets of real strength.”

The department said the April-to-May decrease in exports reflected lower sales of industrial supplies and materials; consumer goods; and foods, feeds and beverages. The rise in imports reflected more industrial supplies and materials; capital goods; and automotive vehicles, parts and engines.

The increase in imports reflected mostly $4.3 billion more for industrial supplies and materials and $1.2 billion in capital goods.

Crude oil imports were up more than 10 percent in May because of strong volume and higher prices, totaling $29.4 billion. The deficit in petroleum goods was $30.4 billion, making it the highest since October 2008, when it was $34.5 billion.

Consumer demand in the United States appeared weaker, resulting in a slack growth of less than 1 percent for non-pharmaceutical consumer products. But a rise in capital goods imports could be a good sign for domestic production down the road, economists said.

Foreign trade is expected to raise real gross domestic product growth in the second quarter, although economists expect its contribution to be smaller. Gregory Daco, a United States economist for IHS Global Insight, said that his estimate for trade’s contribution to gross domestic product has declined to 0.6 percent from 1.1 percent, based on the stronger import figures.

“One very surprising element was the rebound in automotive imports,” Mr. Daco said. “We were expecting somewhat of a drag from the disruptions in the supply chain because of Japan. We did not see that.

“That is a sign that automobile production will gradually recover as we import more vehicles and parts.”

The monthly report also showed that the United States trade deficit with China grew to $25 billion in May from $21.6 billion in April, the largest deficit the United States has with any country.

The goods and services deficit increased $8.1 billion from May 2010 to May 2011. Exports were up $22.8 billion, or 15 percent, and imports were up $30.8 billion, or 15.9 percent.

Article source: http://feeds.nytimes.com/click.phdo?i=fd8fe14cbfb30412b650e63292ccaeed

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An Inflation Hedge Carries Its Own Risks

July 10, 2011 by Leave a Comment

This year, however, the winning streak has faltered a bit as inflation expectations have shifted radically. As the United States economy has slowed, European debt worries have revived and oil prices have fallen back from their recent highs, inflation expectations have moved downward.

For Treasury inflation-protected securities, or TIPS, that has not been good news.

“TIPS have gone through a period where just about everything has gone right for them,” said Robert Johnson, director of economic analysis at Morningstar. “Now the situation has changed, and they are looking quite expensive.”

TIPS pay interest on a principal amount that rises with inflation, so investors are compensated as consumer prices rise. When the securities mature, the investor is paid the adjusted principal amount or the original principal, whichever is greater.

Investors have poured money into TIPS, particularly since last August, amid concerns that the Federal Reserve’s plan to buy $600 billion in Treasury securities would fuel inflation. Those fears grew even more frantic early this year when turmoil in the Middle East and North Africa drove crude oil prices well over $100 a barrel, and gasoline prices in the United States began to climb.

According to EPFR Global, which tracks fund flows, investors added more than $7 billion to inflation-protected bond funds in the first half of this year, roughly equaling the amount for all of 2010.

The big swings in inflation expectations have been most evident in the so-called break-even rate — which is the difference between yields on 10-year Treasury notes and 10-year TIPS and reflects trader expectations for consumer prices over the life of the debt. That rate climbed to a high of 2.67 percent in April, just as crude oil prices peaked at around $114 a barrel, from 1.5 percent last August.

But in May, as signs of an economic slowdown appeared and investors began to anticipate an end to the Fed’s bond-buying spree, inflation expectations collapsed. As measured by the break-even rate, expectations for consumer price inflation dropped to 2.14 and the TIPS market stumbled.

TIPS funds returned just 0.3 percent in May, before rebounding in June as worries eased about Greek debt and a sustained slowdown in the United States economy.

For the second quarter, inflation-linked bond funds returned about 3.1 percent according to Morningstar, compared with 3.6 percent for funds that invest in regular long-term government bonds.

Over longer periods, however, TIPS have sometimes outpaced the returns of regular Treasury funds. Over the last five years, inflation-linked bond funds have returned 6.36 percent, annualized, compared with 6.04 percent for intermediate government debt funds and 7.4 percent for long-term government bond funds.

“The TIPS market clearly got a bit exuberant going into the spring,” said Daniel O. Shackelford, manager of the $387 million T. Rowe Price Inflation Protected Bond fund. “Over the last several weeks, the market has made an adjustment to more modest inflation expectations,” he said.

The T. Rowe Price TIPS fund returned 3.3 percent in the quarter, after gains of 6.29 percent in 2010 and 10.43 percent in 2009.

DESPITE the recent adjustment, analysts say TIPS remain expensive, particularly those with shorter maturities. Bond prices and yields move in opposite directions, and TIPS maturing in five years, for example, yielded a negative 0.37 percent at the end of the second quarter. That compared with a 1.76 percent yield on a regular five-year Treasury note. Ten-year TIPS yielded 0.69 percent, compared with 3.16 percent for noninflation-linked 10-year Treasury debt.

Managers of TIPS funds say the inflation protection offered by TIPS makes sense for a portion of a portfolio.

“If you buy a two-year Treasury note yielding 40 basis points while inflation is running at 2 percent, that is wealth destruction,” Mr. Shackelford said. “TIPS may not be a formula for building wealth; they will do what they were constructed to do, which is to compensate you for increases in consumer prices.”

Some money managers say they are shifting into the longer-term end of the TIPS market, where yields for 30-year maturities were 1.7 percent as of the end of June.

“We’ve been moving out of the intermediate sector of TIPS and buying the long end,” said Martin Hegarty, co-head of global inflation-linked portfolios at BlackRock, the New York-based money manager, which oversees $3.6 trillion in assets. Mr. Hegarty said purchases of intermediate-term TIPS, those of 5 to 10 years, by foreign central banks had helped to depress yields in that sector.

The $4 billion BlackRock Inflation Protected Bond fund gained 2.6 percent in the second quarter and 4.66 percent this year through June.

Still, analysts said the current pricing of TIPS should raise at least one red flag. TIPS may be inflation-protected and backed by the full faith and credit of the United States, but they are far from being risk-free.

“If the Fed were to make any pre-emptive move against inflation, TIPS could get killed,” said Mr. Johnson at Morningstar. “People tend to think TIPS have no risk, but if you sell them before maturity, or if you own a fund that it weighted with longer-term maturities, they can have substantial risk.”

Fund managers say that while these problems are real, TIPS may still be useful.

“Investors certainly should not judge TIPS by taking a backward view of how they have performed,” said John W. Hollyer, a manager of the $35 billion Vanguard Inflation-Protected Securities fund, which returned 3.4 percent in the second quarter. “They are not a risk-free asset because they have a high sensitivity to changes in interest rates. But if inflation makes a sudden move upward, you will be compensated, and that’s important.”

Article source: http://feeds.nytimes.com/click.phdo?i=6a21159bcc8fadc6933cf490e40725b1

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Goldman Took Biggest Loan in Federal Reserve Program

July 7, 2011 by Leave a Comment

The Goldman Sachs unit borrowed $15 billion from the Federal Reserve on Dec. 9, 2008, the Fed said in data released on Wednesday. The Fed made 28-day loans from March 7, 2008, to Dec. 30, 2008, as part of an $80 billion initiative, the central bank said. The information was released in response to a Freedom of Information Act request by Bloomberg News.

The central bank resisted previous requests for more than two years and released information in March on its oldest loan facility, the discount window, only after the Supreme Court ruled it must release the data. When Congress mandated the December 2010 release of other data on the Fed’s unprecedented $3.5 trillion response to the 2007-9 collapse in credit markets, information about its so-called single-tranche open-market operations was not included.

Units of 19 banks received the loans, which were all repaid in full, according to the Fed. The units are known as primary dealers, which are designated to trade government securities directly with the New York Fed.

Lehman Brothers had two loans totaling $2 billion outstanding when its parent investment bank filed the biggest bankruptcy in American history on Sept. 15, 2008, the data show. Those loans were repaid on Oct. 8, 2008, the report said. Lehman’s peak borrowings from the program reached $18 billion on June 25, 2008, according to the data.

RBS Securities, a unit of a British bank, had $31.5 billion in loans outstanding on Oct. 8, 2008, and UBS Securities, part of Switzerland’s biggest bank, borrowed as much as $20.5 billion on Nov. 26, 2008, the Fed said.

Article source: http://feeds.nytimes.com/click.phdo?i=4443476712421c30be91b50fd5a8a2da

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Bucks: Thursday Reading: Compare College Costs on a New Web Site

June 30, 2011 by Leave a Comment

June 30

Thursday Reading: Compare College Costs on a New Web Site

A new federal Web site lets families compare college costs, Federal Reserve caps debit-card swipe fees, owning a home still retains its allure and other consumer-focused news from The New York Times.

Article source: http://feeds.nytimes.com/click.phdo?i=4b349c4e6615e5c5e90daf16603572fb

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Fed Caps Debit Card Fees for Merchants

June 30, 2011 by Leave a Comment

The cap is a defeat for banks generally, although the news was not as bad as banks expected. The limits are significantly higher than the initially proposed cap of 12 cents a transaction laid out by the Federal Reserve in December. Banks currently charge merchants an average of 44 cents for a debit card transaction.

The rules were approved on a 4-to-1 vote by the Fed’s Board of Governors.

The new limits include a transaction fee of 21 cents plus an assessment of 5 basis points — 0.05 percent of the transaction amount — for fraud reduction costs, an element that could raise the overall fee by a penny or two on average. The rules would go into effect on Oct. 21, and the Fed is asking for public comment on the fraud portion of the fee cap.

The fee cap is a result of the Dodd-Frank financial regulation act, which was signed into law last July. The law required the Federal Reserve to determine whether the fees charged to process debit card transactions were “reasonable and proportional to the cost incurred” by the bank that issued the cards.

The law allowed, but did not require, the Fed to make an allowance in its fee cap for the cost of preventing fraud, which banks say is a substantial expense. Under the new law, the revamped fees are scheduled to take effect on July 21, the first anniversary of the signing of the Dodd-Frank Act into law.

In December, the Fed proposed a rule that that would cut the allowable “swipe” fee to an average of 12 cents a transaction from an average of 44 cents in 2009, when total interchange fees on debit and prepaid cards reached $16.2 billion, according to the Federal Reserve. According to merchant trade groups, retailers paid $20.5 billion in fees last year to accept debit cards, including processing fees.

Those fees rose significantly during the 2000s, the Federal Reserve found. In the early 1990s, when debit cards were first beginning to expand in popularity, card networks and banks often compensated merchants for the cost of installing terminals that allowed them to accept debit cards at the point of sale.

The direction of fees began to reverse in the mid-1990s, however, with merchants who accepted cards paying the card networks for processing.

Merchants asserted that banks and the major credit card networks steadily raised the fees they charged even as improvements in technology and economies of scale meant that the fees should be falling. And they charged that the two major card networks, Visa and MasterCard, unfairly controlled prices and stifled competition.

The card companies, in turn, said that along with greater debit card use came greater fraud, which the banks had to pay to police. In addition, they said, the costs reflected constant investments in technology, which gave faster transaction confirmations to consumers.

Card companies also frequently offered perks or rewards to debit card users, which also affected costs.

Debit cards grew faster than any other form of electronic payment over the last decade, increasing to 37.9 billion transactions, according to Federal Reserve research.

Congress exempted banks, credit unions and other debit card issuers with assets of less than $10 billion from the cap on debit fees. But officials from the Federal Reserve and the Federal Deposit Insurance Corporation raised doubts earlier this year that regulators could effectively require large banks to charge a lower fee and still allow small banks to charge a higher fee.

Ben S. Bernanke, the Fed chairman, told members of Congress that basic economics precluded such an arrangement — that retailers would naturally favor cards that resulted in them paying lower fees, leaving smaller banks to lose business despite the exemption from the fee cap.

Credit unions and community banks argued strongly against the fee caps, saying that a reduction in those fees might cause them to have to eliminate debit cards or to charge customers higher fees for checking accounts and other services. Large banks, too, said consumers would pay for any reduction in their revenue from debit fees, and some institutions said they might set limits on debit card use.

The debit card rules were the subject of a furious lobbying battle on Capitol Hill and at the Federal Reserve. A bill to delay the rules failed in the Senate earlier this month, garnering 54 votes but falling short of the 60-vote majority required for passage.

Article source: http://feeds.nytimes.com/click.phdo?i=59fd9ab940fc6f377bd60d6f8e9a9564

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Derivatives Cloud the Possible Fallout From a Greek Default

June 23, 2011 by Leave a Comment

No one seems to be sure, in large part because the world of derivatives is so murky. But the possibility that some company out there may have insured billions of dollars of European debt has added a new tension to the sovereign default debate.

In years past, when financial crises in Argentina and Russia left those countries unable to make good on their government debts, they simply defaulted. But this time around, swaps and other sorts of contracts have become so common and so intertwined in the financial markets that there are fears among regulators and financial players about how a Greek default would play out among derivatives holders.

The looming uncertainties are whether these contracts — which insure against possibilities like a Greek default — are concentrated in the hands of a few companies, and if these companies will be able to pay out billions of dollars to cover losses during a default. If there were a single company standing behind many of these contracts, that company would be akin to the American International Group of the euro crisis. The American insurer needed a $182 billion federal bailout during the financial crisis because it had insured the performance of mortgage bonds through derivatives and could not pay on all of them.

Even regulators seem unsure of whether a Greek default would reveal such concentrated risk in the hands of just a few companies. Spokeswomen for the central banks of both Europe and the United States would not say whether their researchers had studied holdings of such contracts among nonbank entities like insurance companies and hedge funds.

Asked about derivatives tied to Europe at a Wednesday press conference, Ben S. Bernanke, the chairman of the Federal Reserve, said that the direct exposure is small but that “a disorderly default in one of those countries would no doubt roil financial markets globally. It would have a big impact on credit spreads, on stock prices and so on. And so in that respect I think the effects in the United States would be quite significant.”

Derivatives traders and analysts are debating just how much money is involved in these contracts and what sort of threat they pose to markets in Europe and the United States. On the one hand, just over $5 billion is tied up in credit-default swap contracts that will pay out if Greece defaults, according to Markit, a financial data firm based in London. That is less than 1 percent the size of Greece’s economy, but that is a conservative calculation that counts protections banks have in place offsetting their positions, and is called the net exposure.

The less conservative figure, the gross exposure, is $78.7 billion for Greece, according to Markit. And there are many other types of contracts, like about $44 billion in other guarantees tied to Greece, according to the Bank of International Settlements. The gross exposure of the five most financially pressed European Union countries — Portugal, Italy, Ireland, Greece and Spain — is about $616 billion. And the broader figure on all derivatives from those countries is unknown.

The pervasiveness of these opaque contracts has complicated negotiations for European officials, and it underscores calls for more transparency in the derivatives market.

The uncertainty, financial analysts say, has led European officials to push for a “voluntary” Greek bond financing solution that may sidestep a default, rather than the forced deals of other eras. “There’s not any clarity here because people don’t know,” said Christopher Whalen, editor of The Institutional Risk Analyst. “This is why the Europeans came up with this ridiculous deal, because they don’t know what’s out there. They are afraid of a default. The industry is still refusing to provide the disclosure needed to understand this. They’re holding us hostage. The Street doesn’t want you to see what they’ve written.”

Regulators are aware of this problem. Financial reform packages on both sides of the Atlantic mandated many changes to the derivatives market, and regulators around the globe are drafting new rules for these contracts that are meant to add transparency as well as security. But they are far from finished and could take years to put into effect.

Darrell Duffie, a professor who has studied derivatives at the Graduate School of Business at Stanford University, said that he was concerned that regulators may not have adequately studied what contagion might occur among swaps holders, in the case of a Greek default.

Regulators, he said, “have access to everything they need to have. Whether they’ve collected all the information and analyzed it is different question. I worry because many of those leaders have said there’s no way we’re going to let Greece default. Does that mean they haven’t had conversations about what happens if Greece defaults? Is their commitment so severe that they haven’t had real discussions about it in the backrooms?”

Regulators aren’t saying much. When asked what data the Federal Reserve had collected on American financial companies and their swaps tied to European debt, Barbara Hagenbaugh, a spokeswoman, referred to a speech made by Mr. Bernanke in May in which he did not mention derivatives tied to Greece. At the Wednesday press conference, Mr. Bernanke said that commonly cited data on derivatives do not take into account the offsetting positions banks have on their Greek exposures. And with those positions, he said, even if there is a Greek default, “the effects are very small.”

At the European Central Bank, Eszter Miltenyi, a spokeswoman, said: “This is much too sensitive I think for us to have a conversation on this.”

On Wall Street, traders are debating whether the industry’s process for unwinding credit-default swaps would run smoothly if Greece defaulted. The process is tightly controlled by a small group of bankers who meet in an industry group called the International Swaps and Derivatives Association.

Article source: http://www.nytimes.com/2011/06/23/business/global/23swaps.html?partner=rss&emc=rss

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Economix: Simon Johnson: The Big Banks Fight On

June 15, 2011 by Leave a Comment

Today's Economist

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

The bank lobbyists have a problem. Last week, they lost a major battle on Capitol Hill, when Congress was not persuaded to suspend implementation of the new cap on debit card fees. Despite the combined efforts of big and small banks, the proposal attracted only 54 votes of the 60 needed in the Senate.

On debit cards, the retail lobby proved a surprisingly effective counterweight to the financial sector. On the next big issue — capital standards — the bankers have a different problem: this highly technical issue is more within the purview of regulators than legislators and is harder to develop a crusade about, as it’s widely regarded as boring.

As the bankers busily rallied their forces to fight on debit cards and spent a great deal of time lobbying on Capitol Hill, they were doused with a bucket of cold water by Daniel K. Tarullo, a governor of the Federal Reserve.

In a speech on June 3, Mr. Tarullo implied capital requirements for systemically important financial institutions — a category specified in the sweeping overhaul of financial regulation last year — could be as high as 14 percent, or roughly double what is required for all banks under the Basel III agreement.

Whether the Federal Reserve will go that far is not certain; a capital requirement of an additional 3 percent of equity (on top of Basel’s 7 percent) may be more likely, but that is still 3 percent more than big banks were hoping for. (These percentages are relative to risk-weighted assets.)

The big banks are likely to mount four main arguments as they press their case against the additional capital requirements, Reuters has reported:

1. “Holding capital hostage” will hurt the struggling economy because it will mean fewer loans at a time when lending is already depressed.

2. Establishing “huge” capital buffers is an admission by regulators that last year’s Dodd-Frank financial overhaul does not accomplish its goal of reducing risk.

3. If banks hold onto more capital and make fewer loans, borrowers will turn to the “shadow banking sector” – the so-called special purpose vehicles, for example — which has little or no oversight.

4. Tough standards in the United States would create a competitive disadvantage vis à vis other countries.

Each of the bankers’ arguments is wrong in interesting and informative ways.

First, capital requirements do not hold anyone or anything hostage — they merely require financial institutions to fund themselves more with equity relative to debt. Capital requirements are a restriction on the liability side of the balance sheet — they have nothing to do with the asset side (in what you invest or to whom you lend).

There is a great deal of confusion about this on Capitol Hill, and whenever bankers (or anyone else) talk about holding capital hostage, they reinforce this confusion. This is not about holding anything; it is about funding relatively less with debt and more with loss-absorbing equity. More equity means the banks can absorb more losses before they turn to the taxpayer for help. This is a good thing.

The idea that higher capital requirements will increase costs for banks or cause their balance sheets to shrink or otherwise contract credit is a hoax — and one that has been thoroughly debunked by Anat Admati and her colleagues (as this now-standard reference, which everyone in the banking debate has read, shows us).

Professor Admati is taken very seriously in top policy circles. (Let me note, too, that she is a member of the Federal Deposit Insurance Corporation’s Systemic Resolution Advisory Committee, an unpaid group of 18 experts that meets for the first time next week; I am also a member.)

In a recent public letter to the board of JPMorgan Chase, whose chief executive, Jamie Dimon, is an opponent of higher capital requirements, Professor Admati points out that these requirements would — on top of all the social benefits — be in the interests of his shareholders. The bankers cannot win this argument on its intellectual merits.

The second argument, that establishing “huge” capital buffers is an admission by regulators that last year’s Dodd-Frank financial overhaul does not accomplish its goal of reducing risk, is an attempt to rewrite history.

During the Dodd-Frank debates last year, the Treasury Department and leading voices on Capitol Hill — including bank lobbyists — said it would be a bad idea for Congress to legislate capital requirements and should leave them to be set by regulators after the Basel III negotiations were complete.

Now the time has come to do so, and Mr. Tarullo is the relevant official — he is in charge of this issue within the Federal Reserve and is one of the world’s leading experts on capital requirements.

But the banks now want to say that this is not his job as authorized by Dodd-Frank. This argument will impress only lawmakers looking for any excuse to help the big banks.

The third bankers’ argument, that borrowers will turn to the “shadow banking sector,” contains an important point — but not what the bankers want you to focus on.

The “shadow banking sector” — special purpose vehicles, for example — grew rapidly in large part because it was a popular way for very big banks to evade existing capital requirements before 2008, even though those standards were very low.

They created various kinds of off-balance-sheet entities financed with little equity and a great deal of debt, and they convinced rating agencies and regulators that these were safe structures. Many such funds collapsed in the face of losses on their housing-related assets, which turned out to be very risky — and there was not enough equity to absorb losses.

It would be a disaster if this were to happen again. It is also highly unlikely that Mr. Tarullo and his colleagues will allow these shadows to develop without significant capital requirements.

Sebastian Mallaby, who has carefully studied hedge funds and related entities, asserted correctly last week in The Financial Times that it would be straightforward to extend higher capital requirements to cover shadow banking.

The fourth bankers’ argument, that higher equity requirements in the United States would create a competitive disadvantage vis à vis other countries, is like arguing in favor of the status quo in an industry that emits a great deal of pollution, a point made by Andrew Haldane of the Bank of England.

If China, India or any other country wants to produce electricity using a technology that severely damages local health, why would the United States want to do the same? And if the financial pollution floats from others to the United States through cross-border connections, we should take steps to limit those connections.

The Basel III issues may be boring, but they are important. The incorrect, misleading and generally false arguments of bank lobbyists should be rejected by regulators and legislators alike.

Article source: http://feeds.nytimes.com/click.phdo?i=03e5e68304a840fc482250643e11f8e7

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