Nastalgia: 3-6-3 and the Federal Reserve

Barron’s has issued an insightful article on the mortgage market back in its apogee.

Back when thrift institutions were the main provider of home mortgage loans, it was said their executives had a very specific management strategy. Long before there was Six-Sigma, thrift managers had perfected the Three-Six-Three System. That could be summarized as paying 3% on deposits, make mortgages at 6%, all so they could be on the first tee by 3 PM.

Those were the halcyon days of the mortgage business. Thrifts could count on an assured profit margin between the cost of deposits, which were capped by regulators, and simple, fixed-rate loans that, more often than not, went to customers the thrift’s officers knew personally. And after 30 years, the loan would be paid off. But that’s been relegated to sepia-toned memories of when gentlemen wore ties and jackets, even to ball games, and for ladies they opened doors to big cars with tailfins.

Of course, the mortgage market has been transformed in ways of those 3-6-3 bankers could never imagine. Mortgages have become “products” that are sold and repackaged as securities. Then they were sliced and diced in ways that defied comprehension, so that subprime loans got turned into triple-A-rated derivatives. And we know what happened when that house of cards collapsed in 2007 and 2008.

An excerpt from the speech has been included below. The rest may be found here.

Chairman Ben S. Bernanke
At the Conference on “New Building Blocks for Jobs and Economic Growth,” Washington, D.C.
May 16, 2011
Promoting Research and Development: The Government’s Role

I am pleased to speak at this conference on new building blocks for jobs and economic growth. The conference organizers have gathered an outstanding group of participants and have set an ambitious agenda. The topics you will address today and tomorrow, bearing on innovation and intangible capital, are central to understanding how we can best promote robust economic growth in the long run.

I won’t have to spend much time convincing this audience of the importance of long-run economic growth. The Nobel Prize-winning economist Robert E. Lucas, Jr., wrote that once one starts thinking about long-run growth and economic development, “it is hard to think about anything else.”1 Although I don’t think I would go quite that far, it is certainly true that relatively small differences in rates of economic growth, maintained over a sustained period, can have enormous implications for material living standards. A growth rate of output per person of 2-1/2 percent per year doubles average living standards in 28 years–about one generation–whereas output per person growing at what seems a modestly slower rate of 1-1/2 percent a year leads to a doubling in average living standards in about 47 years–roughly two generations. Compound interest is powerful! Of course, factors other than aggregate economic growth contribute to changes in living standards for different segments of the population, including shifts in relative wages and in rates of labor market participation. Nonetheless, if output per person increases more rapidly, the prospects for greater and more broad-based prosperity are significantly enhanced.

Over long spans of time, economic growth and the associated improvements in living standards reflect a number of determinants, including increases in workers’ skills, rates of saving and capital accumulation, and institutional factors ranging from the flexibility of markets to the quality of the legal and regulatory frameworks. However, innovation and technological change are undoubtedly central to the growth process; over the past 200 years or so, innovation, technical advances, and investment in capital goods embodying new technologies have transformed economies around the world. In recent decades, as this audience well knows, advances in semiconductor technology have radically changed many aspects of our lives, from communication to health care. Technological developments further in the past, such as electrification or the internal combustion engine, were equally revolutionary, if not more so. In addition, recent research has highlighted the important role played by intangible capital, such as the knowledge embodied in the workforce, business plans and practices, and brand names. This research suggests that technological progress and the accumulation of intangible capital have together accounted for well over half of the increase in output per hour in the United States during the past several decades.2

Innovation has not only led to new products and more-efficient production methods, but it has also induced dramatic changes in how businesses are organized and managed, highlighting the connections between new ideas and methods and the organizational structure needed to implement them. For example, in the 19th century, the development of the railroad and telegraph, along with a host of other technologies, were associated with the rise of large businesses with national reach. And, as transportation and communication technologies developed further in the 20th century, multinational corporations became more feasible and prevalent.

Economic policy affects innovation and long-run economic growth in many ways. A stable macroeconomic environment; sound public finances; and well-functioning financial, labor, and product markets all support innovation, entrepreneurship, and growth, as do effective tax, trade, and regulatory policies. Policies directed at objectives such as the protection of intellectual property rights and the promotion of research and development, or R&D, promote innovation and technological change more directly.

In the remainder of my remarks, I will focus on one important component of innovation policy–namely, government support for R&D. As I have already suggested, the effective commercial application of new ideas involves much more than just pure research. Many other factors are relevant, including the extent of market competition, the intellectual property regime, and the availability of financing for innovative enterprises. That said, the tendency of the market to supply too little of certain types of R&D provides a rationale for government intervention; and no matter how good the policy environment, ultimately, big new ideas are often rooted in well-executed R&D.

Northeast Utilities And Its Subsidiaries Are Raised To ‘BBB+’ 16-May-2011
12:37 EST

Ratings On New South Wales Affirmed On Continuing Sound Financial Position; Outlook Is Stable 16-May-2011
01:02 EST

NEW YORK (AP) — As 2010 drew to a close, the mayor of Newark, N.J., was staring into a budget abyss so deep that he sold 16 city buildings to pay the bills. They included the architecturally significant Newark Symphony Hall and the police and fire headquarters.

In New York, the transit authority may sell its Madison Avenue headquarters, complete with an underground tunnel connected to Grand Central Terminal and air rights to build a skyscraper on top.

And soon, if state legislators have their way, private investors will be able to buy plenty of other municipal treasures: power plants in Wisconsin, prisons in Louisiana and Ohio and municipal buildings in Boston.

The Great Government Tag Sale is on. As states and cities struggle with billions of dollars in shortfalls, elected officials are increasingly selling public assets to cover their costs. Sometimes municipalities sell the buildings to pocket a one-time pile of cash and then lease them back so they can continue to use them.

The rest of this story can be found here.

For the year of 2011, costs are up 7.3%. This trend will be continuing in 2012, I can assure you.

Health care costs for a family of four rose again in 2011, with employees paying a much larger share of the rising expenses, according to a new industry report Wednesday.

American families who are insured through their jobs average health care costs of $19,393 this year, up 7.3%, or $1,319 from last year, according to the seventh-annual Milliman Medical Index from independent actuarial and health care consulting firm Milliman Inc.

More significantly, employers are making workers shoulder an even bigger share of total health care expenses.

Of the $1,319 annual increase, workers’ out-of-pocket costs this year rose 9.2% compared to a 6.6% increase last year and their payroll deductions for insurance coverage rose 9.3% compared to an 8% increase in 2010.

However, employers’ share of workers’ health care costs fell 6% in 2010, compared to 8% the year prior.

Of the $1,319 more that companies and workers are spending on health costs, employers are paying $641.

Employees are shouldering a bigger chunk, paying $403 in payroll contributions and $275 in additional costs.

Of the $19,393 overall annual cost, employees’ share is inching closer to 50%, said Lorraine Mayne, principal and consulting actuary with Milliman.

“Employees are paying $8,000 of the $19,000. That’s a decent amount much larger than other areas of consumer spending,” said Mayne.

“What we’ve observed in the past few years is employers have increasingly been offering health plans with higher deductibles and co-insurance, co-payment limits,” she said.

Companies are doing this in order to control their own costs and to force workers to use medical care more selectively, she said.

Health reform so far has had very limited impact on curtailing these costs, said Mayne.

While reform’s new provisions such as eliminating lifetime benefit limits and removing copays on preventive care have changed rules for who pays for cost of care, they haven’t made any impact on the total costs of care, she said.

Most expensive parts of your health care: The report showed that physician costs represent 33% of a family’s overall health cost.

Elsewhere, hospital inpatient costs account for 31%, out patient costs 17% and pharmacy costs 15% and other expenses such as for medical equipment about 4%.

Milliman also looked at 14 cities across the United States where health care expenses are substantially higher than the national average.

Among them, Miami, New York City, Chicago and Boston ranked as the top four where health care costs for an insured family of four is more than 100% higher than the national average of $19,393.

But those same costs in Phoenix, Atlanta, and Seattle are under $19,000, the report said.

The Milliman Index is based on industry data and a survey of more than 4,000 employers.

An excerpt from the full conversation is below:

Fearing runaway inflation and a much higher than expected trade surplus in March, China is changing its tune on currency appreciation. Chinese officials won’t make any official statement changes but “there was a marked change in the tenor of conversations over China’s yuan policy from previous negotiations” at this week’s high-level talks between China and the U.S., reports the Wall Street Journal.

China’s enormous trade surplus raised eyebrows on Tuesday after it grew dramatically in April to $11.4 billion from only $139 million in March, according to data from the General Administration of Customs. The wide spread is likely the result of China’s policies to curb “domestic overheating and what they saw as excessive credit growth,” says Martin Wolf, Financial Times economics commentator, in the accompanying video.

In the interview with the Daily Ticker’s Aaron Task, Wolf notes China will likely allow the yuan to appreciate at a much faster clip, but that’s not because of U.S. pressure. “In the end, the Chinese do what is convenient and appropriate for them and they don’t pay much attention to the rest of the world,” he says. So far, China has stuck to the plan it laid out last year to boost the value of the currency by about 0.5% a month. That may soon change as Beijing policymakers do what they can to battle inflation.

Specifically to MGM Detroit, their revenues are up 5.2%, or $52.2 million from this time last year.

The rail system built with the $200M will purpotedly extend between Chicago and Detroit, and Michigan will receive a share of another $336M for the trains that will ride along this route.

This is part of the $2 billion that Florida turned down for their own federally funded high speed rail system earlier this year. That money has been divided amongst 15 states, including Michigan.

The Department of Transportation claims that these rails will provide access to 80% of Americans in 25 years. How exactly the creation of new railways (which will presumably built alongside or over existing track) is going to provide access to more Americans than current rail cars currently manage to provide, is never explained.

“These projects will put thousands of Americans to work, save hundreds of thousands of hours for American travelers every year, and boost U.S. manufacturing by investing hundreds of millions of dollars in next-generation, American-made locomotives and railcars,” said Vice President Joe Biden.

According to a FoxNews contributor (opinion piece), an informant inside the IRG has passed along information telling of a standing order given by the Supreme Leader of Iran to potentially seize all government operations and purge all active government employees – in all ranks.

The Basij militia is supposedly being situated to best carry out this order.

United States Cellular Corp. Proposed Senior Unsecured Notes Assigned ‘BBB-‘ Rating 09-May-2011
11:31 EST

Rating On NZF Money Ltd. Lowered To ‘CCC-‘ On Ongoing Liquidity Concerns; Remains On CreditWatch Negative 09-May-2011
01:43 EST

An interesting opinion, and probably one of the first I’ve heard openly calling for the Chinese economy to start facing missteps and crumble.

Zuckerman says “a lot of people are betting against China, or trying to figure out ways to bet that China will have real deep problems. Obviously they have got too much growth right now, not too little growth.” China’s economy grew 9.70% in the first quarter of 2011 as compared to the same time period last year, according to China’s National Bureau of Statistics. But inflation is rising, and Zuckerman adds, “betting that there’s real deep problems in China is a little bit out of the box, it’s not conventional wisdom.”

According to the article, statistics follow as below:

Average home prices are down 8% from a year ago, 3% over the quarter, and are falling at about 1% every month, according to Zillow.

And the percentage of homeowners in negative-equity positions — with a home worth less than its mortgage — has rocketed to 28%, a new crisis high.

Zillow no longer feels the housing market will bottom before 2012.

WASHINGTON (AP) — Fannie Mae asked the government Friday for an additional $8.5 billion in aid after declining home prices caused more defaults on loans guaranteed by the mortgage giant.

The company said it lost $8.7 billion in the first three months of the year. Those losses led Fannie to request more than three times the federal aid it sought in the previous quarter. The total cost of rescuing the government-controlled mortgage buyer is nearing $100 billion — the most expensive bailout of a single company.

Combined with the bailout of sibling company Freddie Mac, the government expects their rescue to cost taxpayers about $259 billion. That money will cover the mortgage giants’ losses on soured loans made in the midst of the housing bubble.

Home prices declined on average 1.8 percent across the country during the January-March quarter, Fannie Mae said. That led to more foreclosures and to homeowners abandoning houses that were worth less than they owed on their mortgages.

“We expect our credit-related losses to remain elevated in 2011 as we continue to be negatively impacted by the prolonged decline in home prices,” President and CEO Michael Williams said in a statement.

The losses incurred in the first three months of the year are related to loans that were extended before 2009, Fannie Mae said. The company expects to make money on home loans that it acquired since January 2010.

WASHINGTON (AP) — Congress and President Barack Obama are proposing ways to automatically trigger budget savings if they can’t rein in deficits the old-fashioned way, by enacting laws to cut spending or raise taxes. Similar efforts in the past have a spotty record.

The last quarter-century has seen plenty of missed deficit and spending targets and inventive evasions of budget curbs. This is because the same legislators who put in place those budget constraints can pass laws to ignore them.

That history has convinced analysts that automatic triggers work best when lawmakers already have approved spending cuts, taxes increases or both. They’re least effective when used as an incentive to force legislators into such agreements in the first place.

“Process alone is never going to bring about fiscal responsibility,” said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that wants to erase federal deficits. “If the political actors are not willing or ready to make hard choices, they won’t.”

This year’s expected record deficit of $1.5 trillion and a cumulative national debt topping $14 trillion have snowballed into a major political issue that probably will color presidential and congressional elections in 2012.

As a result, Washington is awash with proposals from Obama, lawmakers and anti-deficit groups such as the Bipartisan Policy Center to automatically trigger budget savings if ceilings on spending, the national debt or other benchmarks are pierced.

A quarter-century ago, lawmakers were looking for similar mechanisms.

When Reagan-era deficits reached the unprecedented $200 billion-a-year range, Congress in 1985 enacted the Gramm-Rudman law, sponsored by Sens. Phil Gramm, R-Texas, Warren Rudman, R-N.H., and Ernest Hollings, D-S.C.

Securus Holdings Inc.’s Proposed First-Lien Credit Facility Rated ‘B+’; Second-Lien Term Loan Rated ‘CCC+’ 06-May-2011
14:36 EST

Ukrainian Agricultural Producer Agroton Assigned ‘B-‘ Long-Term Rating; Outlook Stable 06-May-2011
04:24 EST

In their latest press release on May 4, Moody’s rating service confirms what many had the common sense to understand on their own. It is impossible to legislate oneself out of a crisis, and credibility and accompanying credit comes as a product of fullfilling obligations and successes, not international finance laws.

New York, May 04, 2011 — Moody’s Investors Service says in a new report that although Basel 3 is credit positive for banks, the standalone financial strength of banks weakened by the global financial crisis is unlikely to return to pre-crisis levels in the short term. The report discusses the likely impact of Basel 3 on bank credit profiles and how different groups of banks may be affected in the new Basel 3, post-crisis environment.

The framework agreed by the Basel Committee on Banking Supervision in the aftermath of the financial crisis sets new standards for global bank regulation. “Basel 3 will be positive for bank creditors overall, as it will improve the resilience of the global banking system by adding sizeable capital and liquidity buffers,” says Vice President and co-author of the report Tobias Moerschen. The recovery of banks’ credit profiles, however, is constrained by the pressures many institutions still face given the fragile economic recovery in developed markets, skittish financial markets, and new global risks.

“While directionally positive, Basel 3 does not cure the structural challenges banks continue to face from a credit perspective, such as illiquidity and high leverage, nor does it alleviate the tension between profit-maximizing equity holders and bank managers in contrast to risk-averse bondholders,” notes Senior Vice President and co-author of the report Alain Laurin. While important, the new regulatory framework is therefore only one part of the broader effort to improve banks’ resilience to economic downturns.

Stricter regulatory standards and investors’ elevated focus on risks in the post-crisis environment will not affect banks in a uniform manner. The report discusses three different groups of banks: 1) institutions that are able to raise additional capital and bolster liquidity to meet Basel 3 requirements, which may see their credit strength improve; 2) weaker banks that will be challenged to comply with the new rules, and may see their credit profiles deteriorate; and 3) banks that are already largely compliant with Basel 3, whose credit strength likely will remain stable. With the new rules acting as a catalyst for change, weaker banks may seek acquirers, seek government support, or wind down part or all of their operations, with potentially adverse consequences for creditors.

The report notes that considerable uncertainty remains about the effects of Basel 3 due to the long transition period (banks have until 2019 to fully comply) and the likelihood that parts of the proposed framework may change. Additionally, jurisdictions may differ in how they adopt the new rules, with the potential for regulatory arbitrage. Banks are also just beginning to formulate how they will adapt to the Basel 3, post-crisis world and their strategies could have a significant impact on their intrinsic financial strength.

Sadly, for the body of politicians who participated in the Basel process, increasing buffers and reserve requirements when the economy is on the fringe and no financial institution has the funds available to contribute to said buffers (which was sort of the problem to begin with), can hardly be helpful to the immediate release of the system.

And even worse for them, enacting a banking reform after a banking crisis is hardly great enough of an endevour to immediately reduce all pessimism in the system.

Perhaps Basel 3 will be helpful down the road, but for now, it isn’t.

Banco Mercantil Santa Cruz ‘B/B’ Counterparty Ratings Affirmed, Outlook Stays Positive; Good Liquidity, Funding Cited 05-May-2011
13:03 EST

SCB’s Proposed Senior Unsecured Notes Issue Under Its Euro Medium-Term Notes Program Rated ‘BBB+’ 05-May-2011
00:52 EST

According to Reuters, Google’s Android platform has now surpassed Apple’s iPhone as the superior phone OS.

Android now consitutes something like 35% of the market.

SHANGHAI — For three decades, wealthy nations have invested hundreds of billions of dollars in China, helping drive one of the most remarkable economic booms in history.

Now, China is poised to return the investment favor. The question is whether the United States will be willing and able to fully participate, according to a new study to be released Thursday.

Flush with capital from its enormous trade surpluses and armed with the world’s largest foreign exchange reserves, China has begun spreading its newfound riches to every corner of the world — whether copper mines in Africa, iron ore facilities in Australia or even a gas shale project in the heart of Texas.

The study, commissioned by the Asia Society in New York and the Woodrow Wilson Center for International Scholars in Washington, forecasts that over the next decade China could invest as much as $2 trillion in overseas companies, plants or property, money that could help reinvigorate growth in the United States and Europe.

But the report, to be released at a Washington news conference that Commerce Secretary Gary Locke plans to attend, also warns that the United States risks missing out on a large share of the Chinese investment boom because of politics, a growing rivalry between the two nations and deep-seated perceptions that Chinese investments are unwelcome in America.

“If political interference is not tempered,” the study warns, some of the benefits of Chinese investment — “such as job creation, consumer welfare and even contributions to U.S. infrastructure renewal — risk being diverted to our competitors.” While Wall Street banks have lobbied for more Chinese investments in the United States, hoping that will bring bigger deals for the banks, Washington has remained wary — even though the Obama administration says it welcomes Chinese money.

But anti-China rhetoric is hot in Washington and among many state and local officials. One frequently cited worry is that Chinese companies, many of them owned partly or entirely by the government, will use their purchases to gain military secrets. Another concern is that Chinese companies will buy American companies with manufacturing operations in the United States, close those factories and move production to China.

China, of course, is already a force in global markets. Over the last few years, it has made multibillion-dollar loans to developing nations and let its state-owned companies acquire minority stakes in global powerhouses like Rio Tinto, Morgan Stanley and the Blackstone Group.

China is also a major player in the global debt markets, holding about $1.6 trillion in United States Treasury bonds, an investment that helps keep American interest rates low and finances America’s enormous debt.

But China is still a relatively small player in overseas direct investments, which include purchases of large, voting stakes in foreign companies and plants. That also includes investments in new construction projects on previously undeveloped land — so-called greenfield facilities.

Last year, China’s overseas direct investments amounted to about $59 billion. By comparison, the United States’ figure was over $300 billion.

But with Beijing pushing its big companies to go overseas and invest in resources and technology, China’s investments could soon reach $100 billion to $200 billion a year, according to the Asia Society study.

The potential problem for Beijing is that Chinese companies are not always welcomed overseas — not only because China wields enormous economic clout but because state-owned giants are believed to be subsidized by the state and possibly working in the interest of the government.

Congressional critics of China’s investment aspirations including Senator Jack Reed, Democrat of Rhode Island. “Many of these companies are so closely intertwined with the government of China that it is hard to see where the company stops and the country begins, and vice versa,” Mr. Reed recently told Reuters.

A series of proposed Chinese deals in the United States have been blocked by regulators or attacked by local politicians, who say they are worried China could gain access to sensitive military technology or take control of valuable natural resources.

In 2005, one of China’s giant oil companies, Cnooc, dropped its bid to acquire the American oil giant Unocal after a Congressional investigation into the purchase. And in recent years, the Chinese telecommunications giant, Huawei, has repeatedly been rebuffed from making deals in the United States, over national security concerns.

More recently, the Anshan Iron and Steel Group, a Chinese company seeking to build a relatively unsophisticated steel rebar factory in Mississippi, had to fight fierce political opposition in the state, including fears the project would result in job losses and threaten national security.

Angered at what it says is protectionism masquerading as national security concern, Beijing has lodged sharp complaints with Washington.

The Treasury Department has placed the topic on the agenda for a high-level dialogue with Chinese officials scheduled for next week in Washington.

“We strongly welcome investment from around the world, including China,” says Lael Brainard, one of the highest-ranking Treasury Department officials.

Still, some experts say anti-China sentiment is so high across the country that the United States is unlikely to attract the huge investments over the next few years that the Asia Society study suggests are possible.

“There’s no chance this is going to happen,” says Derek Scissors, an expert on China at the Heritage Foundation, a conservative policy institute in Washington. “They want to invest a lot, but no one here’s going to let them. The political climate in Washington is too anti-China right now.”

Daniel H. Rosen, co-author of the study with Thilo Hanemann, and a principal at the Rhodium Group, an economic advisory firm in New York, says that if Chinese companies are turned away, it could significantly reduce investment opportunities in the United States.

And, he warns, it could prompt China to retaliate against American businesses that operate in China, while also discouraging Beijing from pushing ahead with reforms that would make its business and financial markets more open and transparent.

“America has been debating this kind of thing for hundreds of years,” Mr. Rosen said. “But time and time again, America has decided” to be open to investment from overseas, he said. “Our conclusion is China is no different.”

To ensure that America gets its share of China’s money, the study calls on Washington to send a clear, bipartisan message that Chinese investment in the United States is welcome, to protect any national security review process from political interference and to work with China to enhance its own transparency when it proposes investing in the United States.

Some analysts say China deserves some of the blame for opposition to its overseas investments, not just in the United States but elsewhere.

Chinese companies are not very transparent, and much of the investing by China is done by a handful of government-owned companies that have access to cheap state financing, giving them what some analysts say is an unfair advantage in competing for resources or assets.

But many analysts say China and the United States clearly need each other. China now has the capital American business so desperately seeks, and the United States has technology and a highly skilled work force.

Orville Schell, director of the Center on U.S.-China Relations at the Asia Society and the person who commissioned the study, says the United States must do its part to improve relations with China.

“I feel increasingly alarmed and discouraged by the willful ignorance of Americans to the competitive challenge the Chinese pose to the U.S., including in foreign investment,” Mr. Schell said in an interview. “China is looking for places to park its money, and it could be to our advantage. If we don’t find a way to be open to China, it’s undeniable the money will go elsewhere.”

New York, May 03, 2011 — While drug-makers face increasing pressure to divest non-pharmaceutical businesses, selling assets may undermine credit ratings by reducing business diversity and scale, according to a new report from Moody’s Investors Service.

As share prices remain depressed some pharma giants may sell assets in order to fund share repurchases and dividends, while others may consider such businesses no longer core parts of their overall business strategy. Recent higher market valuations for consumer-product businesses could also prompt companies to consider divestitures.

However, asset sales are often credit-negative if the proceeds are not deployed to debt reduction. Negative credit implications may result from lower diversity and a smaller business scale in addition to potential loss of more stable revenue streams.

Companies primarily focused on pharmaceuticals but still owning some non-pharma assets include Merck & Co., Inc., Pfizer Inc., GlaxoSmithKline plc and sanofi-aventis. Companies that are considerably more diverse and broad-based in healthcare include Johnson & Johnson, Abbott Laboratories and Novartis AG.

“Beyond assets sales, a more radical and transformative option would be for pharmaceutical businesses to split themselves into two,” said Michael Levesque, a Moody’s Senior Vice President.

A split along growth or geographical lines could unlock value if equity valuations for the two smaller companies are greater than that of the combined entity, according to the report.

“This strategy remains hypothetical, but if undertaken, the credit quality of the two segments could be significantly weaker than that of the whole company,” cautioned Levesque.

The new Special Comment, “Global Pharmaceutical Industry: Asset Sales Come With Risks,” is available on Moodys.com.