American banks: Fear of failure

The collapse of a big mortgage lender sparks panic about others

BY TRADITION, sequels are pale shadows of their forerunners. In this financial crisis, each episode in the saga seems even more potent than the last. While one arm of the American government tried to allay fears about Fannie Mae and Freddie Mac, another was busily orchestrating the seizure of IndyMac Bancorp, a large mortgage lender which collapsed on July 11th. The Federal Deposit Insurance Corporation (FDIC) set up a new bank to take control of IndyMac's insured deposits and assets, and will now try to sell what it can.

Judged by the standards of Northern Rock, a British mortgage lender where the death throes lasted for months, the failure of IndyMac has been orderly. Its consequences were anything but. Worried IndyMac customers queued in the sweltering Californian sun to retrieve their money, despite FDIC guarantees on deposits of up to $100,000 (of the bank's $19 billion of deposits, $1 billion is uninsured). ...

Economics focus: Land of the rising price

Japan has long hoped for a bit of inflation--but not this sort

JAPAN, people like to argue, is one place that should greet the return of inflation with joy. The country, after all, has been in the grip of deflationary forces for over a decade. Even after an economic recovery which began in 2002, the lingering deflationary mindset has meant firms have struggled to raise prices or pay better wages. Lacking animal spirits, a long-predicted virtuous circle--where higher profits would lead to bigger pay packets, leading to more spending in the economy, and so on--has failed to come about, so the recovery has depended too much on exports. A burst of inflation, the Japan bulls say, will provide just the shot in the arm that the economy needs.

Prices are indeed on the rise (see left-hand chart). In the decade to 2007, prices fell on average by 0.2% a year. On July 15th the Bank of Japan (BoJ) raised its forecast for "core" inflation in the fiscal year ending in March 2009 to 1.8%, up from 1.1% three months ago. Goldman Sachs thinks core inflation, which strips out volatile fresh-food prices and is the most widely followed measure, reached 2% in June, up from 1.5% in May. As elsewhere in Asia, higher prices for oil and food are the main cause of the jump in headline inflation. But even Japan's "core core" inflation rate, which strips out both energy and fresh food, is ticking up, as higher prices for wholesale goods pass on to consumers. ...

Financial regulation: Grasping at shorts

America's SEC fights dirty

BEAR markets often involve bare-knuckle fights, but it is still a shock when the referee starts punching below the belt. The Securities and Exchange Commission (SEC) has intervened in the epic struggle between financial companies and the hedge funds that are short-selling their shares.

Desperate to prevent more collapses, the main stockmarket regulator has slapped a ban for up to one month on "naked shorting" of the shares of 17 investment banks, and of Fannie Mae and Freddie Mac, the two mortgage giants. Some argue that such trades, in which investors sell shares they do not yet possess, make it easier to manipulate prices. The SEC has also reportedly issued over 50 subpoenas to banks and hedge funds as part of its investigation into possibly abusive trading of shares of Bear Stearns and Lehman Brothers. ...

Aftermath of a mega-merger: Three amigos, only one conquistador

Mixed fortunes for the buyers of ABN AMRO

TO THE victors, the toils. Less than a year has passed since the bosses of Royal Bank of Scotland (RBS), Fortis, a Belgo-Dutch lender, and Santander of Spain celebrated the biggest deal in banking history, the EURO72 billion ($101 billion, at the time) acquisition of ABN AMRO, a Dutch bank. Their divergent fortunes since then reflect the woeful state of European banking.

Start with the casualties. Jean-Paul Votron lost his job as chief executive of Fortis on July 11th, paying the price for his announcement in June that the bank was raising another EURO8.3 billion of capital by selling assets, placing shares and scrapping its interim dividend. The bank tapped shareholders for EURO13.4 billion in 2007 to pay for its EURO24 billion portion of the ABN deal and had denied until recently that it needed more cash. Enraged investors asked the Dutch regulator to investigate whether those assurances amounted to misinformation--the effect was to depress the value of their holdings even further. The bank was even moved to deny rumours that depositors were withdrawing their savings on July 15th. Some think the company may be in play, with ING mooted as a possible buyer. ...

A brief family history: Toxic fudge

Chartered by Congress; out for themselves

ADAM SMITH thought that private companies chartered to fulfil government tasks had "in the long run proved, universally, either burdensome or useless". That has not stopped them thriving. America has five government-sponsored enterprises (GSEs), set up to subsidise loans to homeowners or farmers. (Sallie Mae, which deals with students, gave up GSE status in 2004.) Because they count as privately owned, GSEs are kept off the government's books. For politicians that has made them irresistible ever since the Farm Credit System's creation in 1916.

Fannie Mae and Freddie Mac dominate the GSE system, accounting for four-fifths of its total credit portfolio. Fannie was created in 1938 as a government corporation. In 1968 the Johnson administration decided to list its shares to reduce the budgetary pressures created by the Vietnam war, according to Thomas Stanton, of Johns Hopkins University. Freddie was born in 1970 and listed in 1989. Both companies aim to support the secondary mortgage market. They have succeeded all too well: they own or guarantee about half of all mortgages. ...

Buttonwood: Turning panic into opportunity

How to tell when markets may have hit bottom

WHEN all around are panicking, smart investors should be cooly asking whether it is time to buy. What signals should they be looking for?

One of the first measures is the VIX, or volatility index, which measures the variability of the American stockmarket. It is trading around the 30 level, or near its peak in March when Bear Stearns had to be rescued. ...

Prediction markets: Fortune telling

How to bet on the next bank collapse

SURPRISES, in the staid world of banking, tend to be of the unpleasant sort, as customers at IndyMac Bancorp, a California thrift, can attest. Cross a few palms with silver, however, and there is a new way to profit from others' unexpected losses. Punters can now bet on bank failures in America, thanks to 12 new contracts against individually named banks listed on July 16th by Intrade, the largest online prediction market.

Once viewed as grubby gambling dens, prediction markets have sharpened up. Intrade says it has brokered $76m of bets this year. Its data have been used as a price-discovery tool by America's Commodities Futures Trading Commission, the United States Navy, various Federal Reserve banks, and the European Central Bank. The accuracy of prediction markets makes them hard to ignore; they were better than Gallup polls in predicting the outcome of elections between 1998 and 2004. Using the wisdom of crowds, they do a good job of forecasting the outcome of sporting events. ...

America?s economy: Boxed-in Ben

For the Federal Reserve chief, even good news turns out to be bad

JITTERY investors and anxious politicians have often relied on Federal Reserve chairmen to conjure up something to steady their nerves. But when Ben Bernanke gave his twice-yearly monetary testimony to Congress on July 15th and 16th, he had little to offer but unvarnished and uncomfortable truths. There were "significant downside risks" to the economy's outlook, he said, and the chances that high inflation would persist had "intensified". Mr Bernanke did not specify which was the bigger threat: recession or inflation. This lack of a clear policy bias invited the conclusion that, for the time being at least, the Fed thinks it cannot safely move interest rates in either direction.

With financial markets buffeted by renewed fears about the credit drought and a deepening housing slump, Mr Bernanke could hardly boast of the economy's soundness. To make matters worse, figures released as the Fed chairman gave his second day of testimony showed that year-on-year inflation rose in June to 5.0% (see chart), the highest rate since 1991. Paltry pay rises, as well as job losses, mean employment income is probably growing by less than 3%, well below the inflation rate. Falling real income, slumping share and house prices and tighter credit all cast a cloud over consumer spending. Firms worried about future demand will be more cautious too about shelling out for costly capital projects, even if they could raise the finance. ...

Fannie Mae and Freddie Mac: End of illusions

A series of articles on the crisis gripping the world economy and global markets starts where it all began--with America's deeply flawed system of housing finance

THERE is a story about a science professor giving a public lecture on the solar system. An elderly lady interrupts to claim that, contrary to his assertions about gravity, the world travels through the universe on the back of a giant turtle. "But what supports the turtle?" retorts the professor. "You can't trick me," says the woman. "It's turtles all the way down."

The American financial system has started to look as logical as "turtles all the way down" this week. Only six months ago, politicians were counting on Fannie Mae and Freddie Mac, the country's mortgage giants, to bolster the housing market by buying more mortgages. Now the rescuers themselves have needed rescuing. ...

American housing: The wrecking-ball response

How to deal with a glut of empty homes

TUMBLING house prices in America, rising foreclosures and a glut of unsold homes have produced a variety of unusual, even desperate, responses from policymakers. Of the 129m housing units in America, 18.6m stand empty. At 2.9%, the home-owner vacancy rate, which measures the share of vacant homes for sale, has reached its highest point since measurement began in 1956. At the end of the first quarter there were 2.3m empty homes on the market, an increase of more than 160,000 from the end of 2007. There is a vicious circle: the huge number of houses on the market pushes home prices down, and as prices decrease, mortgages become harder to refinance, leading to more foreclosures, vacancies and so on. The more homes are on the market, the less chance that prices will stabilise.

The announcement on July 8th of a steeper-than expected 4.7% drop in pending home sales in May dashed any hopes of a quick turnaround. In cities such as Atlanta and Charlotte, formerly vibrant neighbourhoods have taken on the dilapidated air of ghost towns since the subprime crisis. Municipal taxes go unpaid, and boarded-up homes invite looting, drugs and other criminal activity. In one near-abandoned Atlanta neighbourhood, speculators who could not sell homes even paid homeless people to occupy them. Cleveland and Baltimore have filed lawsuits against subprime lenders this year, claiming their practices cost the cities millions of dollars in lost taxes because of lower property values. These cities are exploring another bold solution to the surplus of vacant houses: demolition. ...

Bank security: Bodily functions

Can biometrics make banking more secure?

VILLAINS, beware. The fight against online fraud has a new weapon--the panic finger. Banks in Europe and South Africa are testing a device that authenticates online transactions by asking customers to run their fingerprint over a reader. If the print matches a stored copy, the device, which is made by Siemens, a German firm, and AXSionics, a Swiss firm, shows a PIN code that can then confirm the transaction.

Consumers can enrol more than one finger when they start using the scanner. That adds yet another layer of security: worrywarts can set the device to require a concerto's worth of fingerprints before it gives out the PIN code. ...

Chinese and Taiwanese banks: Finally thinking Strait

The first steps in what could become more financial integration in Greater China

Correction to this article

XIAMEN, the 19th-century tea port known to the British as Amoy, became in the 20th century a fortified front line in China's struggle with Taiwan. For many years one of the only things it exchanged with Taiwan was artillery fire across the narrow strip of water that separates it from the Taiwan-controlled island of Kinmen. ...

Buttonwood: A fate worse than debt

Banking-industry woes once again disrupt the credit markets

HOLLYWOOD may love to churn out sequels but markets do not think much of them. Almost four months after the rescue of Bear Stearns, investors are again grappling with worries about the health of the banking industry. The spreads, or excess interest rates, on the riskiest corporate bonds are almost back to the levels last seen in March.

Each day brings new sources of alarm. On July 7th shares in Freddie Mac and Fannie Mae, the American housing-finance giants, were pummelled on account of a Lehman Brothers report which suggested, if accounting rules were strictly applied, that the government-backed firms would have to raise $75 billion between them. Although Lehman thought the rules would not actually be applied to Fannie and Freddie, that was brushed aside by sellers determined to assume the worst. Meanwhile, an American mortgage lender, IndyMac Bancorp, was told by regulators that it had insufficient capital. It is now slashing its loan book. ...

Economics focus: Promises, promises

How reliably aid is given can be even more important than how much is given

DEVELOPMENT aid can be as fickle as fashion. Remember those white Make Poverty History wristbands, which briefly made compassion chic in the run-up to the Gleneagles summit in 2005? Memories of the pledge made by G8 leaders there to double annual aid to Africa by 2010 also seem to have faded with time. According to the OECD, on current spending trends annual aid will fall $14 billion short of the $50 billion African target--not a statistic to savour as today's G8 leaders tucked into their eight-course banquet on the Japanese island of Hokkaido on July 7th. Once again, they vowed to honour their aid commitments to Africa, but they are not legally binding nor are they easy to pin down. As usual in the aid business, making promises is a lot easier than sticking to them.

Does that matter? After all, the effectiveness of such sweeping aid pledges has been questioned a lot lately. Last year, in his book "The Bottom Billion", Paul Collier, an Oxford economics professor, convincingly argued that aid, on its own, was unable to make a big difference to the world's poor. He saw it more as a way of stopping things from falling apart, rather than fostering growth. He and other scholars have argued that large disbursements are subject to the law of diminishing returns. Even at Gleneagles, aid sceptics warned world leaders of the dangers of "Dutch disease"--that a sudden windfall of hard currency could push up the exchange rate and damage a country's export competitiveness. ...

Private equity: Annuals horribilis

Private equity firms open up, a little

REMOVE the useful bits from annual reports--the accounts--and you are mainly left with a queasy stew of executive portraits and corporate mission statements. Jowls and jargon dominate the inaugural publications of the big private-equity firms, issued to comply with new British guidelines penned by Sir David Walker.

Sir David set the hurdle low for financial disclosure by the management firms themselves: a breakdown of investors is the main requirement. Typically that leaves the other 60-odd pages free for annual-report perennials: maps of the world, giant font sizes, the vapid ("2007 was a year of transition") and the tautological ("future outlook"). Although there are teacher's pets, such as Britain's Terra Firma, which even has a section on executive pay, there are rebels too. America's TPG produced only a two-page press release. Taken together, the reports most closely resemble publicity brochures. ...

Hedge funds: The secrets of succession

Can hedge funds outlive their star managers?

THOSE good at running money rarely run companies well. The stellar hedge funds of the 1990s failed to make it to the top-ten this decade (see chart). George Soros's Quantum Fund began to decline after a bad yen trade; Julian Robertson's Tiger Management suffered from a premature bet against the dotcom bubble; and Long-Term Capital Management? Don't ask.

Today's alchemists have taken this lesson to heart and are keen to make sure their companies last. For some this is partly a personal odyssey. Ken Griffin, the number-crunching founder of Citadel, reportedly likes to read management bibles in his office. Others have reformed their partnership structures. ...

Bank consolidation: Under the hammer

A wave of M&A deals is expected to hit the industry--eventually

LIKE plane-crash survivors forced to eat their fellow passengers, investment bankers have found some sources of nourishment amid the wreckage of the banking industry. Helping weakened institutions to raise capital has produced a useful stream of fees. Goldman Sachs, a tediously successful investment bank, notched up a 72% increase in equity-underwriting revenues in the second quarter, much of it from other banks. But many have their eyes on an even bigger prize: the wave of M&A deals that is expected, eventually, to result from the credit crisis.

That a big shake-out is coming is in little doubt. Weaknesses in funding and business models have been laid horribly bare. Some franchises were too focused on the wrong markets. Wachovia, America's fourth-largest bank, has suffered from outsize exposure to California's imploding housing market and is a potential takeover target. Others face regulations that threaten their profits. The Wall Street banks are bracing for tougher capital and liquidity requirements as the price for access to the balance sheet of the Federal Reserve. Others still are questioning whether they have the right mix of businesses. The integration of volatile investment banking and staid wealth management at UBS and Credit Suisse, two Swiss banks, is the subject of much alpine soul-searching. Allianz, a German insurer, has apparently lost patience with its foray into investment banking, and is restructuring its Dresdner Bank subsidiary. ...

Leveraged buy-outs : Private investigations

Our calculations suggest buy-out firms may come to rue some of the "mega-deals" they did when pumped up with self-belief

IN FINANCE, as in Greek tragedy, one of the commonest pairings is between hubris and sheer, toe-curling folly. In the boom years of 2006-07 nothing, it seemed, could constrain the leveraged buy-out (LBO) industry. In 24 months it pulled off deals with an enterprise value of $1.4 trillion, the equivalent, after adjusting for inflation, of about a third of all the buy-outs ever done. Thanks to the credit crunch, buy-outs have since become scarce: so far this year only $131 billion of deals have been announced, according to Dealogic. Yet those expecting private-equity executives to be cowering in fear of retribution will be disappointed. The mood remains one of almost hypnotic confidence.

Is this justified? On June 26th Chrysler, an American carmaker bought by Cerberus, a private-equity firm, in one of the highest profile deals of last year, felt obliged to deny it had filed for bankruptcy. Banks are selling loans made to LBOs at big discounts, reflecting wider fears of default. Other "mega-deals" that had not quite closed before credit markets froze last summer are suffering from a collective loss of nerve. Shareholders of Clear Channel Communications, an American media firm, will on July 24th vote on a revised offer with a lower price and debt level. The bidders for BCE, a Canadian telecoms operator, are still haggling over terms with their reluctant banks. ...

Economics focus: The domino effect

Many currencies that are backed by a current-account deficit are now falling just as the dollar has

ACCORDING to economic textbooks, the currencies of economies with large current-account deficits should depreciate relative to those of countries with surpluses. This will stimulate their exports and curb imports, thereby helping to slim the trade gaps. America has the world's biggest current-account deficit and the dollar has dutifully been falling since 2002. Oddly, however, the currencies of many other countries with large deficits had enjoyed big gains until recently. Now, at last, currency markets have started to see sense.

Britain, Australia, New Zealand and Iceland all have large current-account deficits (along with many other American-style excesses, such as housing and credit booms). Yet over several years until mid-2007, their currencies perversely rose relative to those of economies, such as Japan and Switzerland, with big surpluses. For example, despite a current-account surplus of 4.9% of GDP last year, one of the biggest of any developed economy, Japan's trade-weighted exchange rate sank by 13% from the end of 2002 to mid-2007. New Zealand, where the deficit reached 8% of GDP (bigger than America's deficit of 6% of GDP at its peak), saw its currency gain 28% over the same period. ...