Cracking the Code: Ranking Wall Street’s Systemic Risk

Mirror, mirror on the Wall (Street), who was the riskiest of them all?

It was the question at the heart of the global financial crisis, when investors pummeled the shares of companies whose exposures to various investments such as subprime-mortgage-backed securities were unclear, and it is a hot topic in Washington, D.C., as regulators seek ways to prevent another meltdown.

Into the fray have stepped researchers at New York University’s Stern School of Business. They have devised a ranking of 102 financial institutions, which measures which firm poses the greatest systemic risk to the financial system. In recent weeks, the group has shared its proposal with the Federal Reserve Bank of New York and officials at the International Monetary Fund.

Of course, measuring the impact an individual institution’s financial troubles could have on the overall financial system is tricky because, as the recent global financial crisis showed, systemic risk isn’t always apparent until the entire system is under stress.

The NYU researchers used three different methodologies. First, they looked at 5% of the trading days since the 1960s with the biggest declines and calculated how much each institution’s stock losses contributed to the market’s overall decline on those days. Second, they ranked each institution’s risk profile by calculating its losses during those particularly bad days as a percentage of its overall market value. The third measure is likely to prove the most controversial: The group proposes that each financial institution be required to take out an insurance policy that would pay out to the government in the event of a financial crisis.

While not all of the institutions are systemically significant by themselves, they present “red flags” for regulators seeking to identify vulnerable links in the financial system, says Matthew Richardson, one of the project’s authors and an NYU finance professor.

To be sure they measured the institutions’ risk before the financial crisis took hold and to test the predictive qualities of their research, the researchers calculated the rankings using data through June 2007.

Predictably, at the top of this first list, an individual institution’s contribution to the stock market decline on those down days, are the biggest financial institutions: No. 1 Citigroup; No. 2 J.P. Morgan Chase; No. 3 Bank of America; No. 4 Morgan Stanley; and No. 5 Goldman Sachs Group. (Look familiar?) At the bottom of the list were Berkshire Hathaway, United Health, Aflac Inc. and US Bancorp.

By the second criteria (stock losses duiring the 5% worst days as a percentage of a company’s overall market value), the top of the list reads: No.1 E*Trade; No. 2 Bear Stearns; No. 3 CB Richard Ellis; No. 4 Lehman Brothers Holdings; No. 5 Morgan Stanley. CIT Group, the small-business lender that recently narrowly escaped bankruptcy, ranked No. 10.

The insurance rates charged would be determined by a complex algorithm measuring an institution’s leverage (or debt load) and the volatility of its share price and how its corelates the overall market losses. As of 2007, the ranking of the highest rates reads like a Wall Street tombstone: No 1 Bear; No 2 Lehman; No. 3 Merrill Lynch; No. 5 Countryside Financial.

Under the NYU plan, rising debt loads and a stock market meltdown would trigger an insurance payout to the federal government to offset the costs of any bail out or other assistance. The idea is that the insurance fees, which could total tens of millions of dollars per firm, would discourage a bank or broker from taking too much risk in the same way that the federal tax on carbon emissions is meant to discourage pollution.

The problem is whether private insurers could afford to provide such systemic risk insurance. “You don’t want a situation like [American International Group] where insurers would be writing insurance they can’t pay off,” Richardson says.

Next up? Satisfied that they are on to something, the NYU researchers plan to bring the rankings up to date. We eagerly await those new standings.

Below is the 10 riskiest firms as of June 2007 measured by MES. Click here to see the complete list.

Marginal Expected Shortfall Ranking (%) Firm Marginal Expected Shortfall Ranking ($)*
E* TRADE FINANCIAL CORP  37 
BEAR STEARNS  20 
CB RICHARD ELLIS  54 
LEHMAN BROTHERS  12 
MORGAN STANLEY 
GOLDMAN SACHS 
MERRILL LYNCH 
CHARLES SCHWAB  16 
CIT GROUP  50 
10  TD AMERITRADE  42 
Source: New York University’s Stern School of Business


Does Health Insurance Make You Fat?

A recent economics paper may give skeptics of President Barack Obama’s push for near-universal health care new ammunition. The argument? Health insurance makes you fat.

Is it the health insurance or the hot dogs? (Getty Images)

Americans who have health insurance, either private or public, are more likely to gain weight or become obese, wrote authors Jay Bhattacharya and Kate Bundorf from Stanford University, Noemi Pace from University College London and Neeraj Sood from the RAND Corporation. According to the paper, which estimates weight gain in terms of body mass index, a measure of weight related to height, “private insurance increases BMI by 1.3 points and public insurance increases BMI by 2.1 points.”

Economists have long been saying that fat people weigh on taxpayers’ finances. A 2005 study estimated that the federal government pays for roughly half the total annual medical costs associated with obesity, resulting in an average annual $175 in per-capita taxpayers’ costs to pay for obesity expenditures among Medicaid and Medicare recipients.

And a study released today revealed that the overall cost of obesity-related health-care treatment doubled in a decade to $147 billion, growing faster than obesity rates, which went up 37% during the same time period.

The new evidence fits well with what Bhattacharya, Bundorf, Pace and Sood argue: Health insurance isn’t simply a transfer of wealth from thin taxpayers to overweight ones, but a “true economic subsidy for obesity.” According to the study, health-care coverage literally encourages obesity, because people tend to become less careful about weight-gain when they know that insurance will cover at least some of the weight-related health costs in which they may incur.

Though the study found weak evidence that more generous insurance encourages greater weight gain, or that risk-adjusted premiums discourage it, there was “strong” statistical evidence that being insured increases body mass index and obesity. So, will expanding health-care coverage to drive up U.S. obesity rates to new record-setting heights?

For those defending a U.S. health overhaul, France, the poster child of universal health care, offers handy counter-evidence.

The French have long enjoyed both some of the world’s most generous public health-care benefits and a global fame for legendary thinness. Universal health care, it seems, needs not come with a rising tide of fat.

Still, even in France obesity and generous state insurance make a toxic mix for fiscal budgets. Processed foods and sedentary lifestyle, in fact, have long been eroding the “skinny French woman’s” immunity to chubby tights, NPR reported. And rising obesity rates have added sizeable costs to the state’s health-care budget, the New York Times wrote in 2006.

With adult obesity growing at 6% annually in 2006 “the French could be — quelle horreur — as fat as Americans by 2020,” the New York Times writes. Already in 2002, obesity-related health-care costs in France amounted to between two to six billion euros (between $2.8 and $8.5 in today’s dollars), a French-language study estimated.


Hertz Tackles That Not-So-New Car Smell

Hertz Global Holdings Inc. has been working hard this year to counteract a decline in travel brought about by the recession.

An offering of stock and notes brought in about $990 million of net proceeds, with Clayton Dubilier & Rice Inc. and Carlyle Group boosting their holdings. (Merrill Lynch Global Private Equity is also a backer of the publicly traded company.) Hertz also bought the assets of Advantage Rent A Car for about $33 million in a bankruptcy auction, and has completed deals for car-sharing technology and equipment rental companies as well.

But the car rental company’s latest announcement might be of more immediate importance to customers - not to mention making the green lobby happy.

Hertz is “using the latest technology to ensure its rental cars are odor free by partnering with OMI Industries, manufacturer of Fresh Wave IAQ, an all-natural odor neutralizing technology,” according to a press release.

The products, derived from natural plant extracts, are biodegradable and non-toxic, “making them ideal for commercial businesses interested in green/sustainable practices,” Hertz said.

Private equity firms have been placing more importance on being green, with groups including Kohlberg Kravis Roberts & Co. and the Riverside Cos. doing research on the cost-effectiveness of building more environmentally friendly portfolio companies.

Still, we’re guessing that car renters who were annoyed by stinky vehicles haven’t spent a lot of time contemplating the environmental ethics of odor removal. But they do, apparently, ask for replacement cars, which illustrates that this announcement, beyond reminding us of of one or more Seinfeld episodes, does have financial relevance.

Odor problems are costly, as they “can keep cars off the road and result in dissatisfied customers,” the company said.

New York Fed Appoints Successor to Friedman

The chief executive of nonprofit business organization Partnership for New York City, Kathryn Wylde, has been named a director on the New York Federal Reserve Board.

The appointment fills the 18 months remaining on the three-year term of former Chairman Stephen Friedman, who resigned in early May amid accusations of conflict with his role at banking giant Goldman Sachs. The term expires Dec. 31, 2010.

Wylde joins the nine-member board as the only woman on the New York Fed’s board of directors, following the resignation of PepsiCo president Indra Nooyi earlier this year. Wylde is one of the three class-C directors chosen by the Board of Governors from professions outside the banking community.

The remaining six seats are elected by member banks in the Second Federal Reserve District, and split evenly between banking- and non-banking community representatives.

Wylde worked for the Partnership for New York City from 1982, and in 1996 became founding president and chief executive officer of the New York City Investment Fund, the Partnership’s economic development arm.


Deal Profile: Agilent to Aquire Varian for $1.5 Billion

Agilent Technologies agreed to acquire rival Varian for about $1.5 billion, which will expand the testing-equipment maker’s offerings in the industrial and life-sciences markets and give it entry to the nuclear-magnetic-resonance, imaging and vacuum-technology fields.

Agilent, which makes machines to analyze DNA, chemicals, sound waves and other items, will pay $52 for each Varian share, a 33% premium to Friday’s closing price. The deal is expected to generate $75 million in annual cost savings within five years.

Below is a profile of this potential deal courtesy of our friends at Dealogic.

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Economists React: Housing ‘News Sounds Better Than It Looks’

Economists and others weigh in on the month-to-month increase in June new-home sales.

  • The June gain for both new and existing homes sales puts housing on a firmer foundation, but at a highly reduced sales pace — the firm foundation now sits in a very low valley. With mortgage rates and the unemployment rate higher in June, it is easy to see some giveback in new home sales next month. Looking farther ahead, a return to positive net job creation by early 2010 will go a long way toward building the first floor of a recovering housing market. –PNC
  • This was a surprisingly strong report, and it adds to the growing body of evidence pointing to a modest rebound in the U.S. housing market. In fact, it is hard not to get a tad bit excited about the outlook for the U.S. housing market, as it appears that U.S. homebuyers may be beginning to take advantage of the favorable buying environment, particularly given the low mortgage rate, affordable prices and the many inducements coming from the federal government. Even so, the dismal state of the U.S. labor market will continue to cast a long shadow over the prospects for a meaningful recovery in the sector in the near term. –Millan L. B. Mulraine, TD Securities
  • A couple of cautionary notes. First, the report showed a sharp 6% sequential decline in June suggesting that much of the sales activity was concentrated at the lower end of the market. Second, sales contracts that were signed in June may have been tied to the lows in mortgage rates that were recorded in April and May… If the June sales pace can be sustained then the months’ supply should approach the normal range of 5.5 to 6 months by early 2010. However, if the sales pace turns lower in coming months and housing starts continue to rebound, then the inventory imbalance will persist. –David Greenlaw, Morgan Stanley
  • Unlike the prices of existing homes, the median sales price of new homes sold fell in June by 5.8% from the May median and 12% from a year ago. However, the average sales price was essentially unchanged in June and down about 7.5% from a year ago). Underlying details show suggest that sales of lower priced homes improved more than of higher priced homes. –Nomura Global Economics
  • The news sounds better than it looks … despite the jump in sales in June, new home sales remain at very low levels, and the not seasonally adjusted data show a total of 36,000 homes sold nationwide in June, the lowest sales total for June since 1982. –Richard F. Moody, Forward Capital
  • Although most evidence indicates that new housing activity (starts and sales) has bottomed, we do not anticipate anything resembling a “v-shaped” recovery. The same appears to be true of existing homes, where first-timers are being tempted by deeply discounted properties coming out of foreclosure, but activity up the price scale remains spotty at best. Moreover, supply will remain enormous, particularly with increased competition coming from distressed sales of existing homes. –Joshua Shapiro, MFR Inc.
  • The evidence continues to grow that single-family housing activity has bottomed out. Single-family new home sales have risen for three straight months (with the caveat that this series does not track cancellations, but our guess is that cancellations are declining as the financing environment improves for conforming mortgages), single-family housing starts have risen for four straight months, and the NAHB’s housing market index bottomed in January. –RDQ Economics
  • The new home sales estimates are extremely “noisy.” For this reason, we recommend focusing on recent trends instead of the latest monthly estimates. A three-month moving average shows that new home sales appeared to have hit a bottom in January, and are starting to grow ever so slightly. By region, sales have started to pick up in the West and Midwest, and are leveling off in the South and Northeast… Although the market for new homes is improving, selling a new home has never been harder. The median time that a new home sits on the market before selling rose to an all-time high of 11.8 months. The number is rising because builders must cover their costs, and do not have the option of selling homes at “fire sale” prices… One unknown is how much of the increase in sales is coming from new homeowners taking advantage of up-to-$8,000 tax credit that expires November 30. The National Association of Homebuilders in a January study estimated that the credit would boost new construction by about 40,000 units. If this is so, we are likely to see the new home sales and housing starts numbers level off for a while near the end of the year. –Patrick Newport, IHS Global Insight
  • We believe, new home sales is probably a better reflection of the underlying demand than the existing home sales which have been highly boosted by the increasing foreclosure numbers recently. The real improvement was in the months’ supply of inventories which dropped significantly to 8.8 months from 10.2 in May and its peak of 12.4 in January. Recent improvement in sales has been led by the NAHB builders’ sentiment index. It has been gradually rising this year as builders become more optimistic about the future of the housing industry in spite of high unemployment rates which still weigh heavily of housing demand. Nevertheless, the recent improvement in new home sales provides further evidence that housing cycle is on its way to recovery and that the economy is headed for a rebound. –Yelena Shulyatyeva, BNP Paribas

Compiled by Phil Izzo

Offer your reactions in the comments section.

Dig into an interactive summary of economists’ forecasts for the coming year from the latest WSJ.com survey.


Sorry, Bud: Natty Light Isn’t Just for College Anymore

It’s well known that cash-strapped Americans are trading down and giving up nonessential items like restaurant meals, designer clothes and vacations. But switching from Budweiser or Heineken to Busch and Natural Light? Yes, even that, according to July 4 sales data from Information Resources Inc.

Budweiser may be getting crowded out by discount brands. (Getty Images)

The days leading up to Independence Day are usually the biggest-selling period of the year for beer brands, according to Ad Age. If that’s any indication, 2009 isn’t shaping up to be a good year for some of the nation’s biggest brands.

Heineken sales sank 18% from the previous year in grocery, convenience and drug stores during the two-week period ended July 5, followed by Budweiser at 14%. Corona Extra sales dropped 11%, while Miller Lite declined 9% and Bud Light fell 7%. Coors Light sales held up better, falling less than 1% from a year ago.

Meanwhile, sales of “subpremium” beers including Busch, Natural Light and Keystone posted “substantial gains”, according to Ad Age, which didn’t provide the specifics.

It’s a sign that despite the cheap, frat-party image of those brands (and debatable taste), consumers are focused on one thing right now: the bottom line.


Nortel-Ericsson: Canvassing Analysts’ Reactions to the $1.3 Billion Deal

Friday, Telefon AB L.M. Ericsson’s won the bidding for Nortel Network’s profitable but declining CDMA business, which sells a key wireless voice technology prevalent in the U.S. The $1.3 billion deal also includes a group of 400 researchers working on a high-speed broadband technology called LTE.

The deal will give Ericsson synergies in sales, services and research and development, Chief Financial Officer Hans Vestberg said Monday

ericssonphone_D_20090727111313.jpgBloomberg News
A Sony Ericsson C902 Cyber Shot five-megapixel camera phone.

Analysts are all over the map on the deal. Some say it will help Ericsson ward off competition in the U.S., primarily from Nokia Siemens, a joint venture that was a bidder for Nortel’s wireless equipment. Others say it provides no obvious synergies for Ericsson, while costing money to integrate employees. Here is a roundup of what some analysts and commentators are saying about the deal.

J.P. Morgan Chase:
Strategically, we….like the deal: We believe that Ericsson gains important intellectual property associated with the conversion of CDMA networks to LTE. We also believe that the incumbent CDMA provider position for Sprint and Verizon [wireless] probably solidifies Ericsson’s positioning there, though they arguably already have a strong position with the Sprint managed services deal and Phase I Verizon LTE win.

Citigroup:
Deal significantly strengthens Ericsson’s position. Ericsson will be the dominant wireless vendor in the North American market with leading positions at AT&T, T-Mobile USA, Verizon & Sprint. By gaining a CDMA installed base and expertise, we believe Ericsson is well positioned for future 4G deployments at Sprint (where it currently has no exposure) and strengthens its position at Verizon.

Morgan Stanley:
We view Ericsson’s move as negative for both Nokia Siemens and Ericsson as: a) at the right price this would have provided [Nokia Siemens] with a great entry point into US operators; and b) we struggle to understand the strategic rationale of this expensive deal for Ericsson, as we think Ericsson was well positioned to expand in the US organically. With this deal, Ericsson will now have to integrate 10,000 people (including employees from its recent acquisition of a Sprint business), adding significant operational risk.

Meantime, Research in Motion is waiting in the wings. The maker of the BlackBerry wants the Canadian government to block the sale. RIM, which didn’t qualify as a bidder in the auction, is urging the Canadian government to intervene. “The government has the authority and responsibility to get involved to protect vital Canadian interests,” RIM said in a statement. The deal has to be approved by both U.S. and Canadian bankruptcy courts. Canada’s Industry Minister Tony Clement has said that he would like to see Nortel’s assets remain in Canada, but has yet to intervene. The government so far has said it will leave the matter to the courts.


Secondary Sources: Bernanke Reappointment, Federalism, Decoupling

A roundup of economic news from around the Web.

  • Bernanke Debate: The New York Times opinion pages this weekend had a pro and con look at whether Ben Bernanke should be reappointed. Anna Schwartz isn’t impressed: “As Federal Reserve chairman, Ben Bernanke has committed serious sins of commission and omission — and for those many sins, he does not deserve reappointment.” Nouriel Roubini takes up the banner for the Fed chairman: “Mr. Bernanke deserves to be reappointed. Both the conventional and unconventional decisions made by this scholar of the Great Depression prevented the Great Recession of 2008-2009 from turning into the Great Depression 2.0.”
  • Fiscal Federalism: James Surowiecki of the New York writes about the problems with state governments. “If you came up with a list of obstacles to economic recovery in this country, it would include all the usual suspects—our still weak banking system, falling house prices, overindebted consumers, cautious companies. But here are fifty culprits you might not have thought of: the states. Federalism, often described as one of the great strengths of the American system, has become a serious impediment to reversing the downturn.”
  • Decoupling: Sébastien Wälti looks at the decoupling myth. “Have emerging market economies decoupled from advanced economies’ business cycles? This column, looking at emerging markets’ trend growth rates, argues that decoupling was always a myth and that globalization brings national business cycles closer together.”

Compiled by Phil Izzo


Deals of the Day: U.S. Set to Renegotiate Pay at Seven Firms

Deals of the Day gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. Deal Journal’s homepage is http://blogs.wsj.com/deals. You can see real-time updates of our posts and our favorite deal-related articles on other Web sites through our Twitter feed at http://twitter.com/wsjdealjournal.

Today in the Financial Rescue

Banks and lending: Lending continues to slow as bankers and borrowers refrain from taking risks, a bearish sign for the economy. The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter. [WSJ]

Government guarantees: The U.S. guarantee on new debt issued by financial firms will save the companies about $24 billion in borrowing costs over next three years. [WSJ]

Another Citi ‘milestone’: The U.S. government is poised to take a 34% stake in Citigroup. [FT.com]
Related: Citi’s shares are starting to generate investor interest. [Barron's]

Setting pay: The U.S. pay czar will push to renegotiate packages he views as excessive as he vets compensation at businesses receiving major state aid. [WSJ]

Fed Action: Bernanke defended actions he has taken over the past two years as necessary to avoid another Great Depression. [WSJ]

The City: London’s financial district was hit harder than Wall Street and may take longer to recover. [Bloomberg]

Mergers & Acquisitions

Aetna: The insurance giant is shopping its pharmacy-benefit management business, as the industry embarks on a widescale consolidation. [WSJ]

Corus Bankshares: Several private-equity firms are considering bidding for the Chicago bank. Those considering a bid include Fortress, Barry Sternlicht of Starwood Capital, Related Companies developer Steve Ross and Colony Capital. [FT.com]

Nortel: U.S. and Canadian courts are expected to approve Ericsson’s $1.1bn bid for most of Nortel’s wireless assets on Tuesday. [FT.com]

Citigroup: The bank is looking to sell its private banking business in Italy. [FT.com]

Anglo-Xstrata: Anglo American CEO Cynthia Carroll has to convince investors that the miner holds hidden value above any premium Xstrata might yet offer — and that she can deliver it. [WSJ]

Related: In the Anglo-Xstrat takeover battle, each side can take a little heart from De Beers’s first-half results. [WSJ]

Vale: The Brazilian miner has reportedly made a takeover approach for Central African Mining & Exploration (Camec). [Daily Telegraph]

Friends Provident: The U.K. insurer rejected a revised takeover proposal from Clive Cowdery’s financial-services restructuring firm. [WSJ]

Financial Institutions

Prime push: J.P. Morgan Chase reshuffled its senior equities staff in a bid to prepare the U.S. bank for a further push into prime brokerage. [WSJ]

Buyside

Sun Capital: The 14-year-old distressed-buyout firm has fallen upon hard times. About 74% of its latest fund remains uninvested at a time when there should be plenty of distressed companies to buy. [NY Post]

Tom Hicks and George Gillett Jr.: Liverpool soccer club’s American owners have refinanced 290 million pounds of debt with RBS and Wachovia. [Bloomberg]

What do Private Equity Firms do all Day? According to a white paper by auditors Grant Thornton and the Association for Corporate growth, they are actually running and trying to improve the portfolio companies they own. [BusinessWeek]

Capital Markets

IPOs: Second-quarter earnings could provide the thrust for more companies to announce plans to go public. [WSJ]

People & Players

Keith Magnus: UBS hired Keith Magnus from Merrill Lynch to run the Swiss bank’s Singapore and Malaysia investment banking team. [WSJ]


The Morning Leverage: Yep, Lending Is Still Shrinking

In this morning’s media roundup:

News: Proposed EU rules for regulating alternative asset managers are so tough that U.S. regulators, whose own proposed rules aren’t exactly making private equity firms jump for joy, are stepping in to try and get them relaxed. The fear is that U.S. firms won’t even be able to do business in Europe if the European regulations pass, the Wall Street Journal reports.

Aetna Inc. is looking to sell its pharmacy-benefit management business, the WSJ reports. It doesn’t list any private equity firms among the potential bidders for the unit, which could be worth $2 billion.

Ericsson is the winning bidder for Nortel Networks’ CDMA unit at $1.13 billion. That bests earlier offers from Nokia Siemens Network and MatlinPatterson Global Advisers LLC. The WSJ story is here.

Bain Capital is set to buy a stake in Italian luxury eyewear chain Safilo, our colleagues at Dow Jones Newswires report.

How many financial companies are too big too fail? Probably about 25, Federal Reserve Chairman Ben Bernanke said in response to a question during a hearing. Bloomberg reports he also said many of those firms are already subject to umbrella supervision by the central bank.

New, overwrought FDIC rules? What new, overwrought FDIC rules? Among the bidders for Chicago-based Corus Bankshares are private equity firms including Fortress Investment Group, Barry Sternlicht of Starwood Capital and Colony Capital, the Financial Times reports.

Analysis: This probably won’t be news to any private equity firm that’s tried to obtain debt financing lately, but the Wall Street Journal has done an analysis that shows that lending is still shrinking. The total amount of loans held by 15 large U.S. banks shrank by 2.8% in the second quarter, the Journal finds.

A look at the historical impact of flu on the world of finance (via FT Alphaville). It wasn’t so bad, but maybe it should’ve been worse.

Just for fun: Warren Buffett has a new cartoon show (Deal Journal).

Community College: The Sitcom

First it was President Barack Obama offering $12 billion over 10 years to supercharge America’s community colleges, and now — an NBC sitcom. “Community” premieres on Thursday, Sept. 17, from directors Joe and Anthony Russo (of Arrested Development fame.)

The gist, according to NBC: “It’s been said that community college is a “halfway school” for losers, a self esteem workshop for newly divorced housewives, and a place where old people go to keep their minds active as they circle the drain of eternity. Well, at Greendale Community College…that’s all true. Community focuses on a band of misfits, at the center of which is a fast-talkin’ lawyer whose degree has been revoked (Joel McHale, The Soup). They form a study group and, in “Breakfast Club” fashion, end up learning a lot more about themselves than they do about their course work.”

For the serious-minded, the American Association of Community Colleges says it’ll initiate a blog on its Web site prior to the launch to provide a place for commentary.


Bernanke Live: Fed Chairman Faces PBS Viewers

After testifying at three congressional hearings in the past week, Ben Bernanke takes his show on the road tonight for a different kind of audience.

Bernanke, seen here during congressional testimony, faces a different kind of audience in a town-hall meeting Sunday night. (Getty Images)

The Federal Reserve chairman is in Kansas City, Mo., for a town-hall forum hosted by The NewsHour’s Jim Lehrer. The taped program will appear this week on PBS stations. But we’re here at the Federal Reserve Bank of Kansas City to bring it to you live on Real Time Economics.

It’s pretty good timing for Mr. Bernanke. He has six months and five days left in his four-year term as chairman. In the coming months, President Obama will decide whether to reappoint Mr. Bernanke or choose someone else (that is, someone with Democratic credentials) to lead the central bank.

The Fed chairman’s public standing is bruised from the deep recession and his decisions ahead of it. At the same time, the Fed is under attack from a growing number of lawmakers who want the central bank’s power reined in after its extraordinary actions to keep the economy from falling into another depression. So the former professor has spent this year moving beyond the Fed’s usual forums. He appeared before the National Press Club in February, sat down for a lengthy “60 Minutes” piece in March and lectured at Morehouse College in April to explain his actions and show he’s not afraid to take on public criticism.

Tonight, we expect he’ll explain his views on the state of the economy, discuss the pending financial-regulation overhaul and maybe even answer critics who want the Fed’s operations opened up to more scrutiny. The action gets started at 6 p.m. Central time (7 p.m. Eastern). Check back for updates.

Also follow David Wessel’s live updates on Twitter.

An executive with The NewsHour was telling reporters the program’s goal for tonight. Then Mr. Bernanke stopped by to say hello before the forum started, so one reporter asked him his goal for the event. His answer: “My goal is to talk to people outside the Beltway to hear what they are thinking, and do the best I can to try to explain what’s happening in the economy.”

Discussions to do the forum began in March after the “60 Minutes” program featuring Mr. Bernanke, said Robert Flynn, a spokesman for The NewsHour. Why Kansas City? “We wanted to be somewhere in the middle of the country, away from the coasts and away from Washington,” he said. The only two cities under serious consideration were Kansas City and St. Louis, and The NewsHour wanted to use a Federal Reserve bank given security considerations. (Jim Lehrer was born in Wichita, Kansas, and he attended the University of Missouri’s journalism school.)

The room for the taping will have 190 people, 40 of whom will have the opportunity to ask questions. They were selected by The NewsHour, local PBS affiliate KCPT and ConsensusKC, a community organization that helps select diverse audiences for events. A list of participants includes people from local chambers of commerce, unions, Kansas and Missouri universities and numerous nonprofit groups.

All were pre-interviewed by The NewsHour, but participants will ask their own questions, Mr. Flynn said. “The goal is to have sort of an open yet focused conversation about the Fed, the chairman’s role at the Fed and about what the Fed means to the man on the street,” he said.

Jim Lehrer, after explaining the mechanics of the event to the audience, opened the taped part of the program by calling on Gwen Bailey, a social worker with the Visiting Nurse Association.

Her question: “Exactly what is the Federal Reserve? I don’t have a clue what they do, how they impact our lives” and how it makes decisions.

Mr. Bernanke got the opportunity to explain not just financial stability, monetary policy and bank supervision, but that the Fed is responsible (through consumer protection) for the structure of disclosures on credit-card statements.

The explanation led Mr. Lehrer to ask for a definition of an “independent” central bank. “There’s a lot of evidence that when politicians make monetary policy, you don’t have a good result,” Mr. Bernanke said. It’ll lead to inflation, he says. “We’re very very sensitive to this issue,” he says.

Asked about the Fed being referred to as the fourth branch of government, Mr. Bernanke says “that’s a tremendous exaggeration.” He says he’s accountable to Congress and is subject to the appointments process by lawmakers. “Our independence has to be won everyday.”


After a video explaining the economy
and financial crisis, Mr. Lehrer goes into a series of questions from the public that seem to criticize the Fed’s response.

A Kansas City mother asks why money keeps going to big firms. “Why don’t we just let the behemoths lay down and make room for the small businesses?” she asks.

Mr. Bernanke explains that “it wasn’t to help the big firms that we intervened,” diving into an explanation of the too-big-to-fail problem. “When the elephant falls down, all the grass gets crushed as well,” he said.

Mr. Bernanke says the nation needs a new regulatory framework, with resolution authority for failing firms.

He hears it again from a small-business owner, who expresses frustration with “billions and billions of dollars” going to large firms and calls the government approach “too big to fail, too small to save.”

Mr. Bernanke says “nothing made me more frustrated, more angry, than having to intervene” when firms were “taking wild bets that had forced these companies close to bankruptcy.”

He says people often think the Depression was caused by the stock market crash in 1929, when it was really caused by a global financial crisis caused by an overseas bank failure in 1931.

“I was not going to be the Federal Reserve chairman who presided over the second Great Depression,” he says. Mr. Bernanke said he “had to hold my nose” and is “as disgusted as you are.”

“I absolutely understand your frustration and we’re working really hard to make it better.”


In a series of questions about the stimulus program
, Mr. Bernanke gets to explain that he had nothing to do with it. That was the administration and Congress, he says. But “it might be a little bit early to make the judgment” that the first phase of the stimulus was a failure (as the questioner, a recent economics gradate from the University of Missouri at Kansas City, suggested).

What else can the Federal Reserve do? Mr. Bernanke walks through what the Fed has done already but says financial crises make recessions worse. “The Federal Reserve has been putting the pedal to the metal,” he says. “We hope that’s going to get us going next year sometime.”

Bob Litan, a well-known economist at the Kauffman Foundation, asks about employment growth falling short with slow GDP growth. Bernanke says “economic forecasting makes weather forecasting look like physics.”

He sees the unemployment rate peaking in 2010, with 1% annualized growth in the second half of this year. Even when the economy begins growing again, he says “it’ll be a while before the job market gets back to where we want it to be.”

Responding to a question about inflation, Mr. Bernanke says inflation will be “quite low” given slack from “the softness in the global economy.” But he says once the economy is growing again, he says it’ll be “very important” to unwind the money the Fed has put into the system.

(Speaking about the debt and dollar, he gets an opportunity to say he backs the Treasury’s strong-dollar approach. He says “our whole strategy is to get the economy out of the doldrums” to support the dollar.)


The Human Toll: Farmer Suicides on the Rise

Fluctuations in oil prices over the last couple years have received no shortage of headlines, but they’re not the only commodity that has seen an increase – followed by a collapse – in prices. The same has happened in agriculture, and the impact of sharply lower prices combined with weak demand and tight credit is taking a devastating toll on farmers.

Dairy farmers have struggled during the downturn. (Getty Images)

In Colorado, for example, 14 farmers and ranchers took their lives last year, double the rate five years ago, according to the Denver Post. In Maine, the Bangor Daily News has reported of at least three known farmer suicides so far this year. Two dairy famers in California have taken their lives in the last six months. The Iowa-based “Sowing the Seeds of Hope” hotline, which serves farmers in seven Midwest states, has fielded about 11,000 calls through April, a 20% increase from the same period a year ago, according to the Post and the Iowa Independent.

“The increase in calls really started with the change in dairy prices, as they fell last fall,” Mike Rosmann, a clinical psychologist and farmer who heads the hotline jointly sponsored by AgriWellness and Iowa State University Extension, told the Post.

Scott Hoese, a Minnesota dairy farmer, described the industry’s struggles in testimony before the House Agriculture Subcommittee on Livestock, Dairy & Poultry on Tuesday.

“Dairy farmers of all sizes and across all regions of the country are enduring an unprecedented disaster,” he said. “Equity is rapidly disappearing, market prices remain at 1970 levels, creditors are cutting off producers - yet there is no relief in sight.”

“As quickly as dairy prices peaked last year, they have just as quickly collapsed and have been well below the cost of production,” he said. “Our latest data shows consumers paying $4.99 for a pound of cheddar cheese while the farmer receives less than $1.00; farmers receive $0.97 out of the $2.99 consumers pay for a gallon of fat free milk. At a time when more consumers are eating at home, thereby increasing retail dairy product sales, producers are losing money on every gallon of milk sold.”

The global nature of the current downturn has also taken a toll, he said, wiping out other nations’ demand for U.S. agricultural exports. “Time is of the essence for dairy producers. Many continue to lose $100-$200 per dairy cow per month with no immediate increase in the market on the horizon,” he said. “As a producer, it has been frustrating, to say the least, to weather one of the worst economic periods in 30 years yet it seems as though our society as a whole has not grasped how desperate our situation is.”


Bureau of Labor Statistics Releases Data on Pay in Metro Areas

The Bureau of Labor Statistics released data on occupational pay comparisons among metropolitan areas for 2008:

Average pay for civilian workers in the San Jose-San Francisco-Oakland, CA metropolitan area was 19% above the national average in 2008, the Bureau of Labor Statistics said in a report looking at 77 metropolitan areas.

In the New York City areas, average pay was 114% above the average. At the other end of the spectrum, workers in the Brownsville-Harlingen, TX metropolitan area earned an average of 77 cents for every dollar earned by workers nationwide.  The BLS calculated pay differences for nine major occupation groups in each of the surveyed metro areas.

See the full news release: http://www.bls.gov/news.release/ncspay.nr0.htm
Data soon available on the BLS website: http://www.bls.gov/ncs/ocs/payrel.htm


Winners & Losers From the Week That Was

nullAmazon: The online retailer opened up its wallet this week, buying online footwear retailer Zappos.com for about $847 million in cash and stock. The deal is Amazon’s biggest acquisition in its 14-year history and provides Amazon with greater penetration into the largest online-shopping category — one in which Amazon has had limited success in the past. Online apparel, footwear and accessories generate about about $23 billion in annual sales, ahead of personal computers at around $16 billion and consumer electronics at around $11 billion.

nullMedarex’s shareholders: Bristol-Myers Squibb agreed to buy partner Medarex for $2.1 billion. That’s represents a premium of more than 90% — the biggest premium for a sizable health-care deal this year.

nullNortel: The auction of the telecommunication equipment maker’s wireless network assets are drawing significant interest as Nortel winds its way through bankruptcy. Ericsson, Nokia Siemens Networks, and private-equity firm MatlinPatterson are all bidding for the assets, and it’s possible that the auction could drag through the weekend — a good sign for creditors seeking the highest bid. A bankruptcy judge in Delaware is scheduled to confirm the auction results on Tuesday.

nullWendelin Wiedeking: How things have changed for the former chief executive of Porsche. Last fall he was the wolf stalking Volkswagen. Now he is the biggest loser of that failed takeover attempt. Wiedeking’s mistake was taking on $14 billion in net debt to buy 51% of VW plus options for at least another 20%. He had hoped to pay down debt using cash on VW’s own balance sheet, but was thwarted.

nullCIT: The troubled lender was saved by its creditors who organized a $3 billion private-sector rescue plan. But it’s hardly out of the woods. The long-term success may still hinge on the mercy of its regulators and debtholders. That’s left CIT evaluating a breakup as the threat of bankruptcy bears down. And on Friday, it amended the terms of a cash tender offer for $1 billion of bonds critical to its future.

nullMorgan Stanley: Both Goldman and J.P. Morgan raked in the dough during the second quarter. Even Citi and BofA recorded profits. Morgan Stanley? It reported a $159 million second-quarter loss from continuing operations. But the real concern is that Morgan Stanley will decide to dial up the risk only to watch the markets crumble again.


The Nortel Auction and Canadian Pride

The auction for Nortel’s assets continued inside a Manhattan law office on Friday evening, but the drama was also playing out in Canada, where the fate of the once proud telecom giant is a matter of jobs, pride…and national security?

Yes, this week Canada’s Finance Minister Jim Flaherty sounded the nationalist call over the bankrupt Nortel. Flaherty vouched for concerns that had been raised by Canadian-based Research In Motion Ltd., the maker of the BlackBerry, that keeping Nortel assets in Canadian hands was vital to national security.

“I think he’s a great Canadian,’’ Flaherty said of RIM’s CEO Jim Balsillie. “I think he’s entirely right to ask for the government to be concerned about the issue.” RIM was excluded from the auction because the company wouldn’t agree to certain conditions.

The non-Canadian bidders include New York private-equity firm, MatlinPatterson, Nokia Siemens of Finland and Ericsson of Sweden.

It’s unclear whether the Canadian government has any grounds to intervene in a U.S. bankruptcy court proceeding. Last year, Ottawa halted the $1.33 billion sale of MacDonald Dettwiler and Associates’ satellite technology business to U.S.-based Alliant Techsystems Inc, for fear of surrendering top-secret satellite images. It marked the first time the sale of domestic company to a foreign buyer.

The Nortel wireless assets being auction could affect at least 2,500 employees, located primarily in Ontario and Texas. Nortel employs a total of about 30,000 people.

The auction is being conducted at the offices of Cleary Gottlieb, Nortel’s bankruptcy lawyer. It’s possible that the auction could drag through the weekend — a good sign for creditors seeking the highest bid. A bankruptcy judge in Delaware is scheduled to confirm the auction results on Tuesday.


Bernanke: A Facetious Answer For A Facetious Question

Sometimes it’s hard to know when lawmakers are being serious. Way back in February, members of Congress were just starting to realize that the Federal Reserve has the power to create vast sums of electronic money out of thin air.  And they were starting to get agitated about it.

So Rep. Brad Sherman (D., Calif.) used the five minutes allotted to him at a House committee hearing to ask Fed Chairman Ben Bernanke to draw a line in the sand. He suggested a limit on expanding the Fed’s balance sheet for the sake of financial stability.

“Mr. Chairman, would you actively oppose legislation that limited the total risks that you can take to $12 trillion, to say that all of the risks you take, other than the purchase of securities backed by the full faith and credit of the United States, cannot exceed $12 trillion?” Mr. Sherman asked. “And if that’s a bad dollar amount, what else do you suggest? Or is it necessary for the quantity of your power to be utterly unlimited?”

Mr. Bernanke played along: “Well, our balance sheet is currently 2 trillion [dollars], of which 95% I would say is gold-plated secure and the rest is largely secure. So 12 trillion sounds very comfortable to me. I don’t think that would be a problem.”

The response got a bit of attention from other lawmakers, along with people around the nation who want the Fed’s powers reined in.

Today, with Mr. Bernanke making his second appearance of the week before the same House Financial Services Committee, Mr. Sherman once again raised section 13(3) of the Federal Reserve Act. It allows the central bank to lend those vast sums of money in unusual and exigent circumstances — including bailing out companies like AIG or Bear Stearns.

Mr. Sherman, apparently forgetting his earlier $12 trillion number, handed over a couple trillion more: “You have powers under 13-3 that are unlimited in terms of dollar amounts. I remember once I asked you whether you’d accept a $14 trillion limit. It was a facetious question to which I got an interesting answer. But you have limited 13-3 to — close to zero-risk transactions, and I applaud you for that modest interpretation of your authority.”

The hearing had already touched on resolution authority for failing firms; the Obama administration’s financial-regulation plan would create procedures so the Fed wouldn’t have to do another messy AIG bailout.  Mr. Sherman still wanted to know how to pay for it, and whether there should be limits:  “If we continue to have 13-3 as authority for the Fed, would it be unduly burdensome — on those of you in the bailout business, or the systemic business or whatever — to put a half-trillion-dollar limit on any additional permanent TARP authority that we create in this statute?”

This time, Mr. Bernanke wouldn’t play the same game: “On 13-3, my answer to your facetious question was also facetious,” he told Mr. Sherman. “We recognize the need to be very careful in the use of this authority. And, in particular, if this Congress puts together a resolution authority that can address the problem of failing firms, then I would certainly be open — in fact, quite eager — to subordinate 13-3 authority to the request or the requirement of the resolver.”


The Week In Private Equity: One For The Locust File

Wow, you private equity executives out there sure had a tough week. And we’re not even talking about the Securities and Exchange Commission’s threat to ban placement agents and effectively destroy every smaller private equity firm within a radius of 2,800 miles of Washington (that’s the approximate distance to California, by the way). In addition to that, you were accused of everything short of being the devil, and for all we know, someone may have accused you of that too, and we just missed it. Add all these things to your locust file:

citgroup_E_20090714231941.jpgBloomberg News

You were accused of being Don Corleone! Well, really it was the lenders who came to CIT Group Inc.’s rescue who were accused of this, but hey - several of them are PE firms. According to Bloomberg, the lenders are making an instant $100 million on an investment said to be almost risk-free. “This is called Don Corleone financing,” one observer told Bloomberg. This reminds us of a previous description of how private equity is not only like the mafia but worse than it. So we guess this could be considered an upgrade.

You were accused of being a despot! “Further despotic governance could severely decrease the corporate value of the company,” said Japanese conglomerate Kokusai Kogyo Holdings Co., suing Cerberus Capital Management’s chief operating officer over a company the two firms jointly own.

beatles_E_20090724165657.jpgAssociated Press

And finally, you were accused of being anti-Beatles! (Yeah, we know this is a stretch.) According to this Bloomberg story, Tom Hicks and George Gillett are facing a lot of trouble - including death threats - from Liverpudlians over the debt troubles that the Liverpool Football Club, which they own, has run into. One fan told the news service that the club is more venerated than the Beatles. “It’s almost a religious fanaticism,” he said. Come on, people, all we need is love to get through this!

At least one private equity firm tried to fight back this week. After being called all sorts of names by its union, including asset stripper and predator, Brynwood Partners/Stella D’oro issued a statement presenting its point of view. But here’s the thing: the statement was rational and reasonable, and thus it was boring! It called the union’s comments “misleading and inaccurate,” rather than referring to them as “irascible scallywags” or some such. Better luck next time.

But not everyone despises private equity. In fact, some folks rather like you! Including the U.S. government, which had a role in appointing several private equity execs to the boards of some of the too-big-to-fail companies it now has the pleasure of overseeing. Timothy Collins, chief executive of Ripplewood Holdings LLC and an experienced bank investor, joined the board of Citigroup, while Daniel Akerson of Carlyle Group and David Bonderman of TPG Capital LP joined General Motors Corp.’s board. The powers that be also want Hellman & Friedman LLC’s Jeffrey Goldstein to become the Treasury Department’s undersecretary for domestic finance.

crossbow2_E_20090721180120.jpgCourtesy Horton Archery

Deal of the week: There are a lot to choose from this week, including Yucaipa Cos.’ PIPE investment in Great Atlantic & Pacific Tea Co., which is trendy, or Apax Partners’ take-private deal for Bankrate Inc., which is sort of gasp - “They’re going to invest how much of equity and no debt?” - worthy. Then of course there’s the private equity-backed purchase of FirstCity Bank of Commerce, another small Florida bank, which is noteworthy because it shows that the industry is still interested in banks despite the Federal Deposit Insurance Corp.’s attempts to…oh, sorry we dozed off there. But we’re picking little-known TGV Partners’ purchase of Horton Archery because…well, because CROSSBOWS is why.

IPO of the week: Vitamin Shoppe Industries Inc. filed for an initial public offering again. If the company successfully makes it out, it would be the first buyout-backed retailer to go public since…since…since Cro-magnon Partners Inc. bought the rights to the wheel from the first caveman and set up shop in his cave to sell it. More or less.

Quote of the week: We can’t print the really good ones, which had to do with what placement agents think of the SEC’s proposed ban. But here’s one that’s related, from Clayton Dubilier & Rice’s Kevin Conway, who spoke to IDDmagazine.com on regulation and other topics. “My guess is - given how badly the industry has managed its PR and how loud the cry for a villain is - the pendulum will probably swing a little further than we would like.”

Have a great weekend.

What’s So Bad About A Quick Flip, Anyway?

Among the restrictions on bank investing recently proposed by the Federal Deposit Insurance Corp. is one that would require investors in failed banks to hold their stakes for at least three years.

mnuchin_E_20090724171530.jpgReuters
Steven Mnuchin

This proposal hasn’t gone over too well with the private equity community. In a response letter to the FDIC’s proposal, OneWest Bank Group LLC - the new name for private equity-owned IndyMac - attempted to explain why the restriction would be a bad idea.

Executives of OneWest Bank said that while they don’t think quick sales are always a good idea, “there are also instances where selling all or part of the ownership could enhance the safety and soundness of the institution.”

“For example, if public ownership of a bank or a holding company provides greater access to capital over time, it would seem prudent and in the best interests of the Deposit Insurance Fund to permit such access,” OneWest Chairman Steven Mnuchin and President Terrence Laughlin said in the letter, posted on FDIC’s Web site.

Mnuchin and Laughlin suggested reducing the holding period to 18 months from three years, because 18 months is a “reasonable period” for a new bank to establish itself and for the bank’s board to determine next steps.

The duo also wrote that the 15% leverage ratio proposed by the FDIC is too high, and would make private investments in failed banks “uncompetitive and uneconomic.” They suggest there may not be any one particular appropriate leverage ratio, and that the FDIC should consider other factors, such as the purchase price of the assets and any assistance the FDIC extends to the bank, in determining the required ratio.

Short of that, Mnuchin and Laughlin suggested lowering the leverage ratio to 8%, the level currently required for de novo banks to be considered well-capitalized.

IndyMac was bought by a group of investors including private equity firm J.C. Flowers & Co. and hedge fund Paulson & Co. in March.