Records show Fed on edge during darkest days of 2008 crisis

Federal Reserve policymakers, in a tense meeting on one of the darkest days of the financial crisis, worried Lehman Brothers' failure would wreak havoc on a teetering financial system but feared cutting interest rates might prove an over-reaction.

At a meeting the day after the investment bank filed for bankruptcy, Fed Chairman Ben Bernanke flatly told colleagues he was philosophically torn about how the U.S. central bank should respond, if at all, to the turmoil set off by Lehman's collapse.

The revelation came in transcripts of the Fed's 2008 policy deliberations released on Friday. The 1,865 pages throw light on a debate over whether to loosen monetary policy to battle a crisis that was fast engulfing global financial markets.

In a year that saw the United States and most of the developed world sink deep into a brutal recession whose scars still linger, U.S. central bankers wrestled with how to respond to panicked markets and economic data that sent mixed signals.

At the time, some officials thought the maelstrom would be resolved quickly, and many were wringing their hands over a run-up in inflation and hesitant to come to the aid of the economy.

At the Sept. 16 meeting, Bernanke struggled to weigh the moral hazard of "ad hoc" decisions to help failing banks against the possibility of "very severe consequences for the financial system and, therefore, for the economy of not taking action."

"Frankly, I am decidedly confused and very muddled about this," he said. "I think it is very difficult to make strong, bright lines given that we don't have a structure that has been well communicated and well established for how to deal with these conditions."

In the end, the Fed stood pat. Within a month, however, it had entered full crisis-fighting mode, and by the end of the year it had cut rates to near zero and launched the first of its several controversial bond-buying programs.

On Sept. 16, the day the Fed Board authorized a $85 billion loan to prevent the bankruptcy of insurer American International Group, policymakers were torn: inflation was running high, but signs of economic weakness were everywhere.

People in the tony suburbs across the bay from San Francisco were even deferring cosmetic surgery, joked then San Francisco Fed chief Janet Yellen, who succeeded Bernanke at the Fed's helm earlier this month.

Most of all, officials felt largely unable to gauge the likely fallout so soon after Lehman's bankruptcy, which turned out to be the beginning of a market sell-off that would cut the value of U.S. stocks almost in half.

Boston Fed President Eric Rosengren was one of the few who seemed certain of the fallout.

"This is already a historic week, and the week has just begun," he said, predicting firms would dump risky assets "with a vengeance."

He was the only official to call for a rate cut; others wanted to wait and see.

"Money doesn't talk; it swears," the Dallas Fed's Richard Fisher said, quoting Bob Dylan. "When you swear, you get emotional. If you blaspheme, you lose control. I think the main thing we must do in this policy decision today is not to lose control, to show a steady hand."

Bernanke, likewise, cautioned against rash action.

"We should be very certain about that change before we undertake it because I would be concerned, for example, about the implications for the dollar, commodity prices, and the like," Bernanke told the group as he summed up the discussion.

"So it is a step we should take only if we are very confident that is the direction in which we want to go."

Letting Lehman fail

As the worst recession in decades deepened, the U.S. economy shrank at an 8.3 percent rate in the fourth quarter of 2008. The unemployment rate soared to 10 percent the following year.

While the recovery has been erratic, growth has been strong enough and the jobless rate has fallen enough to prompt the Fed to start to unwind its extraordinary stimulus.

But in 2008, the crisis in the U.S. subprime mortgage market and in over-leveraged Wall Street banks quickly cascaded around the world, sparking investor panic.

On Sept. 16, tension was thick as the debate over the course of monetary policy turned to the issue of whether the Fed and the U.S. Treasury were right to let Lehman fail.

"I'm seriously interested in knowing what you ... think is the appropriate stage, if any, at which fiscal intervention becomes necessary," Bernanke asked Richmond Fed President Jeffrey Lacker.

Lacker's response: let failing banks fail and leave it to the Federal Deposit Insurance Corporation to pick up the pieces.

"We have a legislated program of fiscal intervention - deposit insurance - and the boundaries around that are very clear," Lacker said.

Kansas City Fed President Tom Hoenig, who is now vice chairman of the FDIC, concurred, and argued that easing policy to cushion the blow would merely compound the problem.

Rosengren, who like Lacker remains a Fed policy maker, countered that it was too soon to know whether letting Lehman collapse was the right thing to do.

"Given that the Treasury didn't want to put money in, what happened was that we had no choice. But we took a calculated bet ... We did what we had to do, but I hope we will find a way to not get into this position again."

In the end, only two of the five U.S. investment firms, Goldman Sachs and Morgan Stanley, survived the financial crisis - and only because of an unpopular taxpayer-funded bailout. The AIG bailout, which totaled $182 billion, also drew public scorn.

Bright side of life

Tension was also high in the lead up to JPMorgan's buyout of investment bank Bear Stearns in March, a deal guaranteed by the Fed.

On an unscheduled Jan. 9 conference call, Bernanke began the meeting by saying he thought rates needed to come down, but it would be appropriate to wait until a meeting at month's end.

Yellen said she could support a half-point rate cut "in the near future," but said she preferred to cut rates by a quarter-point immediately.

By the Jan. 21 meeting, Bernanke struck a much more urgent tone in advocating a rate-cut of three-quarters of a point, which the Fed carried out. "At this point we are facing potentially a broad-based crisis," he said. "We have to try to get it under control."

At a meeting a week later, some policymakers tried to look at positive signs, but Fed Governor Frederic Mishkin said those efforts reminded him of the Monty Python film that ends with characters that are being crucified, singing, "Always Look on the Bright Side of Life."

After an April interest rate cut of a small quarter-point to 2 percent, things looked less dire.

Indeed, the transcripts show top Fed officials thought their work was largely done. At a meeting in June, Yellen said she could see the Fed raising rates before year-end.

The market turmoil that followed the collapse of Lehman upended those expectations.

"I should say that this comes as a surprise to me," Bernanke said during an Oct. 7 call to line up support for a half-point cut. "I very much expected that we could stay at 2 percent for a long time, and then when the economy began to recover, we could begin to normalize interest rates."

"Clearly things have gone off in a direction that is quite worrisome." — Reuters

source: gmanetwork.com

US must cut $2T over 10 years to stabilize debt – federal agency

WASHINGTON - U.S. lawmakers are far from finished with the job of deficit-cutting, the Congressional Budget Office warned on Tuesday, saying that $2 trillion in additional savings is needed over the next 10 years just to stabilize long-term U.S. debt.

In new long-term forecasts that will intensify the fiscal debate in Washington as critical deadlines loom, the CBO said U.S. public debt will balloon to 100 percent of the nation's economic output in 25 years if no action is taken, increasing the risk of another financial crisis.

That's up from about 73 percent this year and a 40-year historical average of about 38 percent. And the picture looks worse if Congress does away with the "sequester" across-the-board spending cuts now in place, the non-partisan CBO said.

Revenue growth from a recovering U.S. economy and a January tax increase on the wealthy are helping to shrink near-term deficits, but this is not enough to overcome the rising pension and health care costs associated with the aging Baby Boom generation, CBO director Doug Elmendorf said.

"The bottom line remains the same as it was last year. The federal budget is on a course that cannot be sustained indefinitely," Elmendorf told a news conference.

In order to cut U.S. debt levels significantly, CBO said it would take an additional $4 trillion worth of cuts over the next decade. That would shrink U.S. public debt in 2038 to 31 percent of gross domestic product (GDP), below the 40-year average.

While the deficit is still forecast to fall from around 4 percent of GDP this year to a sustainable 2 percent in 2015, it will then start rising again. CBO projected that with no changes in tax and spending laws, the deficit will reach almost 3.5 percent of GDP by 2023 and hit 6.4 percent by 2038. Public debt will make a similar dip to 68 percent in 2018 before rising again.

The latest forecasts come as lawmakers race against a Sept. 30 deadline to pass new government spending authority to prevent a government shutdown. Congress also faces a mid-October deadline to raise the $16.7 trillion federal debt limit to avoid a potential default that would roil global financial markets.

The deadlines have also become intertwined with Republicans' desire to delay or defund "Obamacare" health insurance reforms, several of which are due to launch on Oct. 1. House Budget Committee Chairman Paul Ryan wasted no time in pinning part of the deficit blame on President Barack Obama's signature health care law.

"The report reiterates the obvious: government spending, especially on health care, is driving our debt. And Obamacare will not solve the problem. The law was a costly mistake," Ryan said in a statement.

Chris Van Hollen, the top Democrat on the House Budget Committee, acknowledged the need for further work to reduce deficits, but accused Republicans of "threatening to shut down the government" over their demands to defund or delay Obamacare.

Turning off sequester

Democrats' top priority is to turn off the sequester automatic cuts that are now hitting discretionary programs from the military to education.

But the CBO includes those cuts - about $1.2 trillion over a decade - in its long-term forecast, so canceling them without offsetting savings would worsen the deficit and deficit outlook significantly.

The report presented an alternative scenario which includes turning off the sequester and other planned spending cuts, but this would cause public debt by 2038 to hit 190 percent of GDP. That's worse than crisis-wracked Greece's current level of around 160 percent.

The extended higher debt levels would reduce economic growth, consume more revenues to pay interest, and increase the risk of a future financial crisis, the CBO said.

Should Congress fail to raise the debt limit, Elmendorf said that the United States could begin defaulting on its obligations between the end of October and mid-November. He said that the Treasury Department's own estimate that it will run out of borrowing capacity by mid-October, with a $50 billion cash balance "seems plausible to us."

That means Treasury will start to run short of cash to pay obligations starting around the end of October, but the timing depends partly on the strength of revenue collection, he said. — Reuters

source: gmanetwork.com

As Europe struggles, companies focus on cost cuts

DAGENHAM, England - Glistening chains on the turnstyles at Ford Motor Co.'s plant in east London illustrate how, even when companies unveil positive news about their European operations, it may not mean things are picking up in the economy.

Ford told investors this week that its European operation was performing better than expected and that its turnaround on this side of the Atlantic was on track.

But this recovery is largely premised on cutting costs, with demand for vehicles still falling across the continent and the industry facing overcapacity.

"The outlook for the business environment in Europe continues to be uncertain," Bob Shanks, the U.S. automaker's chief financial officer, told analysts on Wednesday.

A day later work stopped at the 750-strong Dagenham plant, which made bonnets and doors for Transit vans, and workmen lowered white concrete barriers across the entrances to employee car parks—all part of Ford's plan to create a "more efficient manufacturing footprint" in Europe.

Aggressive cost-cutting in Europe contributed to the better-than-expected second-quarter profit General Motors Co reported on Thursday.

Other sectors are also cutting back. Kimberly Clark shut a Spanish factory after the company decided to stop selling its Huggy diapers in most European markets and exit other businesses on the continent.

U.S. advertising group Interpublic, supermarket chain Carrefour, electrical goods makers Indesit and staffing group Randstad were among the companies which told investors in the past fortnight that weak European demand was forcing them to cut costs and jobs.

"Whatever earnings growth is coming is base-line activity or cost cutting. Capex [capital expenditure] is where companies are saving money, trying to keep the bottom line healthy," said Chris Weafer, senior partner with consultancy Macro-Advisory.

Recent economic data has suggested the euro zone is starting to turn a corner and Britain looks definitively to be back on a growth path.

Those improvements in leading indicators have prompted institutional investors to look at Europe with new interest.

With stock markets in Japan and the United States posting double-digit gains so far this year, investors may have squeezed as much as they can out of a recovery story there and are looking for the euro zone and Britain to pick up the growth baton.

But it will take more than the first tips of green shoots to persuade companies to invest heavily once more.

Chicken and egg

Investment plummeted after the financial crisis, with the euro zone business investment rate in the last quarter of 2012, the most recent period for which figures are available, at its second-lowest level since 2001.

The widespread focus among executives on scaling back, and the dearth of plans to spend more, highlighted how Europe was not out of the woods yet, despite some recent positive signs from Eurozone Purchasing Managers' surveys last week, said Yiannis Koutelidakis, economist at Fathom Consulting.

The absence of spending from companies is contributing to a chicken and egg situation, delaying the recovery that might prompt them to spend more.

"The lack of investment and the continued government austerity, is definitely a drag on the outlook," said Bert Colijn, economist at the Conference Board, a research organization.

"If we see a recovery in Europe in the second half of the year, which is something that is becoming more realistic, that recovery will be very slow."

Some businesses said predictions of recovery in the second half of 2013 were optimistic. Marco Milani, Chief Executive of Italy's Indesit, said he wasn't confident of recovery in 2014 and consequently was cutting back investment and shifting manufacturing out of Europe.

In June, the company published a plan that envisaged cutting its Italian workforce by a third and moving some operations to emerging markets, including Turkey.

Economists say these kinds of actions pose long-term risks for Europe, because even when demand recovers, it will increasingly be served from outside the continent.

"The crisis will leave structural scars on the economy," Koutelidakis said.

Corporate belt-tightening could even be accelerated if the United States starts withdrawing monetary stimulus, as Federal Reserve Chairman Ben Bernanke has indicated it might. Such a move could raise borrowing costs for European businesses, further eating away at profits and discouraging investment.

Not all companies are reporting falling sales in Europe.

Home-appliance manufacturers Whirlpool Corp and Electrolux AB forecast a rebound in demand from Europe, suggesting consumer confidence may be returning.

It would be natural for consumer spending to pick up before capital investment.

"While southern Europe continues to lag, there are some positive trends in Germany, the Nordics in particular and the UK," Electrolux Chief Executive Keith McLoughlin told Reuters.

But even in some cases where companies reported strong European demand and plans to increase hiring to meet it, they retained an air of caution.

Swedish truckmaker Volvo reported healthy sales and said it was increasing production in Europe to help deal with a growing order backlog.

Yet Chief Executive Olof Persson told analysts on Wednesday that Volvo, which makes trucks under brands such as Renault and Mack as well as its own name, would take on temporary workers to raise output, rather than commit to taking on new full time employees.

"This production ramp up has been done with temporary workers. And this is what we're going to focus on very much going forward ... in order to be more agile in adapting to whatever comes ahead of us," Persson said. —Reuters

source: gmanetwork.com