Chevron Corp. said Friday its third-quarter profit more than doubled on the back of record crude prices this summer, though worldwide production fell during the period.
The San Ramon, Calif.-based company, the second-largest U.S. oil company, said it made $7.89 billion, or $3.85 a share, in the three months ended Sept. 30, versus $3.72 billion, or $1.75 per share, at the same time last year.
Analysts were expecting average earnings of $3.25 per share based on a survey by Thomson Reuters.
Revenue shot up 43% to $78.87 billion from $55.2 billion.
Shares in premarket trading slipped 19 cents to $73.99.
Chevron (CVX, Fortune 500) capped off a continued string of robust quarterly profit reports from the world's major oil companies, including another U.S. corporate profit record for No. 1 Exxon Mobil Corp. (XOM, Fortune 500)
Crude prices peaked at $147 near the start of the quarter in mid-July before embarking on a dramatic slide that has continued into the fourth quarter. When the third quarter ended Sept. 30, benchmark crude prices were still around $100 a barrel. In early trading Friday, they slipped below $64 a barrel.
"Our disciplined capital spending and tight control over costs remain extremely important in today's uncertain economic climate," said Chevron chairman and chief executive Dave O'Reilly. "Our strong balance sheet enables Chevron to continue investing in attractive projects that increase the production of oil and gas and improve the efficiency of our refinery network."
Chevron said earnings from its exploration and production, or upstream, business rose about 80% in the quarter to $6.18 billion, buoyed by crude prices.
However, global production fell nearly 6% to an average of 2.44 million barrels of oil equivalent a day, hurt in part from late-summer hurricanes that shut down output in the Gulf of Mexico.
At its U.S. upstream arm, Chevron said the average sales price for a barrel of crude and natural gas liquids was $107 in the third quarter, up from $67 a year ago.
Friday, October 31, 2008
Sunday, October 26, 2008
Tough transition for new president
The next United States president won't have long to savor victory after Election Day.
Facing the worst economic storm since Franklin Delano Roosevelt won the 1932 election, this president-elect will have to quickly announce his key staffers and policy priorities to reassure both the nation and the world.
"The incoming president will be facing many bigger challenges than any president since Roosevelt," said John Kamensky, senior researcher at the IBM Center for The Business of Government, which focuses on public management. "The president will have to have a very organized transition to be able to address it."
Spokesmen for Senator Barack Obama's and Senator John McCain's campaigns declined to comment on the transition, which lasts 77 days. It is widely reported that former Clinton Chief of Staff John Podesta is working with Obama, while former Reagan Navy Secretary John Lehman Jr. is guiding McCain's team.
Presidential transitions are often tumultuous, but this incoming president is facing a host of pressing matters, not the least of which is the global financial crisis. Don't forget, he also must be prepared to address the wars in Iraq and Afghanistan, as well as national security, on Day One of his administration on Jan. 20.
Lining up the cabinet. Traditionally, the president-elect first assembles his key White House appointees, particularly the chief of staff, budget and personnel directors and counsel. The secretaries of State, Treasury and Defense, along with the attorney general, are next in line. The rest of the cabinet is usually in place by Christmas.
This year, however, the Treasury secretary pick is more important than ever. Henry Paulson, the current office holder, is leading the largest federal intervention into the financial sector since the Great Depression. His successor will inherit the effort, which is less than six weeks old and still very much under construction.
Also on the schedule is a global economic summit on Nov. 15 in Washington, D.C. World leaders will look to the incoming president and his economic team -- including the White House Council of Economic Advisers and the National Economic Council -- for guidance on his policy initiatives.
So will the American public, who are waiting to see how the next president addresses critical issues such as the tidal wave of foreclosures and the bailout of the financial system.
Some 71% of people surveyed in a recent USA Today/Gallup poll feel the next president faces more serious or much more serious challenges than any new president in the past 50 years. More than two-thirds feel that stabilizing the economy should be the next president's top priority, compared to 12% who say managing the wars overseas comes first, the poll found.
Experts agree.
"I would expect the Treasury secretary and other economic appointees to be the first priority," said John Burke, professor of political science at the University of Vermont. "The sooner they can announce the key appointments, the better."
Handling the transition. Both campaigns are already working on transition plans. This is the first time nominees can submit names for national security clearance before Election Day. Each camp has already given up to 100 names to the FBI, Kamensky said.
Paulson is briefing the candidates, and the White House has already started working on its transition plans to smooth the way for the next president, experts said.
Past presidents have moved swiftly during their transition periods. Ronald Reagan, for instance, named James Baker his chief of staff shortly after Election Day. Bill Clinton held an economic summit in Little Rock, Ark., and George W. Bush's White House staff met daily before taking office.
Still, the incoming commander-in-chief must remember that he is not yet in office, experts said. While he can name his appointees and discuss his priorities, he can't actually act.
"What can you really do as a president-elect?" asked Martha Joynt Kumar, director of the White House Transition Project, a research group made up of scholars and policy institutions. "It's a really fine line you have to walk because you have to do something but you aren't president."
Facing the worst economic storm since Franklin Delano Roosevelt won the 1932 election, this president-elect will have to quickly announce his key staffers and policy priorities to reassure both the nation and the world.
"The incoming president will be facing many bigger challenges than any president since Roosevelt," said John Kamensky, senior researcher at the IBM Center for The Business of Government, which focuses on public management. "The president will have to have a very organized transition to be able to address it."
Spokesmen for Senator Barack Obama's and Senator John McCain's campaigns declined to comment on the transition, which lasts 77 days. It is widely reported that former Clinton Chief of Staff John Podesta is working with Obama, while former Reagan Navy Secretary John Lehman Jr. is guiding McCain's team.
Presidential transitions are often tumultuous, but this incoming president is facing a host of pressing matters, not the least of which is the global financial crisis. Don't forget, he also must be prepared to address the wars in Iraq and Afghanistan, as well as national security, on Day One of his administration on Jan. 20.
Lining up the cabinet. Traditionally, the president-elect first assembles his key White House appointees, particularly the chief of staff, budget and personnel directors and counsel. The secretaries of State, Treasury and Defense, along with the attorney general, are next in line. The rest of the cabinet is usually in place by Christmas.
This year, however, the Treasury secretary pick is more important than ever. Henry Paulson, the current office holder, is leading the largest federal intervention into the financial sector since the Great Depression. His successor will inherit the effort, which is less than six weeks old and still very much under construction.
Also on the schedule is a global economic summit on Nov. 15 in Washington, D.C. World leaders will look to the incoming president and his economic team -- including the White House Council of Economic Advisers and the National Economic Council -- for guidance on his policy initiatives.
So will the American public, who are waiting to see how the next president addresses critical issues such as the tidal wave of foreclosures and the bailout of the financial system.
Some 71% of people surveyed in a recent USA Today/Gallup poll feel the next president faces more serious or much more serious challenges than any new president in the past 50 years. More than two-thirds feel that stabilizing the economy should be the next president's top priority, compared to 12% who say managing the wars overseas comes first, the poll found.
Experts agree.
"I would expect the Treasury secretary and other economic appointees to be the first priority," said John Burke, professor of political science at the University of Vermont. "The sooner they can announce the key appointments, the better."
Handling the transition. Both campaigns are already working on transition plans. This is the first time nominees can submit names for national security clearance before Election Day. Each camp has already given up to 100 names to the FBI, Kamensky said.
Paulson is briefing the candidates, and the White House has already started working on its transition plans to smooth the way for the next president, experts said.
Past presidents have moved swiftly during their transition periods. Ronald Reagan, for instance, named James Baker his chief of staff shortly after Election Day. Bill Clinton held an economic summit in Little Rock, Ark., and George W. Bush's White House staff met daily before taking office.
Still, the incoming commander-in-chief must remember that he is not yet in office, experts said. While he can name his appointees and discuss his priorities, he can't actually act.
"What can you really do as a president-elect?" asked Martha Joynt Kumar, director of the White House Transition Project, a research group made up of scholars and policy institutions. "It's a really fine line you have to walk because you have to do something but you aren't president."
Tuesday, October 21, 2008
Stocks hit by recession fears
Stocks slumped Tuesday as mixed corporate earnings reports gave investors a reason to retreat after the previous session's big rally.
The Dow Jones industrial average (INDU) lost 231 points or 2.5%. The Standard & Poor's 500 (SPX) index lost 3.1% and the Nasdaq composite (COMP) lost 4.1%.
Lending rates continued to improve, helping to reassure investors that the efforts of world governments to try and stabilize financial markets are starting to work. But relief about the credit markets was countered by broader fears about a recession and the health of American corporations.
"The credit market is improving, which is good, but the problem is that everyone is focused right now on earnings as a representation of the economy," said Greg Church, founder and president of Church Capital. "And while there will be exceptions, the overwhelming number of earnings reports won't be positive."
With 21% of S&P 500 companies already having reported results, third-quarter profits are currently on track to have fallen almost 10% from a year ago, according to the latest estimates from Thomson Reuters.
After the close, Yahoo (YHOO, Fortune 500) reported earnings of four cents a share, versus 11 cents a year ago and short of analysts' forecasts for a profit of 9 cents per share. The company also said it will cut at least 10% of its workforce, or around 1,500 people, through the end of the year as a result of the weak economy.
Looking forward, Yahoo warned that 2008 revenue won't meet its earlier forecasts. However, shares gained 7% in extended-hours trading.
Also after the close, Apple (AAPL, Fortune 500) reported fourth-quarter sales and earnings that jumped from a year ago due to strong sales of its new iPhone. Earnings topped forecasts, while sales missed expectations.
Looking forward, Apple forecast fiscal first-quarter sales and earnings that are short of analysts' projections. The company said forecasting the December quarter was a challenge because of the weak economy. Shares gained 4% in extended-hours trading.
The Dow gained 413 points Monday on improved lending rates and comments from Federal Reserve Chairman Ben Bernanke that supported a second fiscal stimulus package. It was the Dow's eighth-biggest one-day point advance ever, but did not spark a follow-up rally Tuesday.
"I think the tone in the stock market has been a little better recently with the credit spreads coming down," said Robert Loest, portfolio manager at Integrity Funds. "But I'm reluctant to get too optimistic because the economy is going to continue to deteriorate both in the U.S. and abroad."
Earnings: Dow component American Express (AXP, Fortune 500) reported weaker quarterly profit after the close of trade Monday. However, the results were better than expected and shares gained 8.4% Tuesday. (Full story)
Four other Dow components reported results Tuesday morning, including 3M (MMM, Fortune 500), which reported higher quarterly sales and earnings that topped estimates. Shares gained 4.8%.
DuPont (DD, Fortune 500) reported a big drop in earnings due to manufacturing disruptions in the wake of Hurricane Ike. The chemical giant also warned that full-year results won't meet forecasts. Shares fell 8%.
Caterpillar (CAT, Fortune 500) reported lower earnings and higher revenue versus a year ago, and shares fell 5%. Pfizer (PFE, Fortune 500) reported higher quarterly earnings that topped estimates. Shares were little changed.
Texas Instruments (TXN, Fortune 500) reported reduced third-quarter profit after the close Monday and forecast fourth-quarter revenue would fall sharply, missing estimates. The chipmaker also said it is looking to sell part of its wireless operations. Shares fell 6.3% Tuesday.
Among other companies releasing results, troubled bank National City (NCC, Fortune 500) reported a bigger-than-expected loss Tuesday and said it was cutting 4,000 jobs. However, investors lifted the shares, which have been battered soundly over the last few months on fears about the firm's solvency. The stock added 3%.
Citigroup (C, Fortune 500) slumped 6% in tune with the broader selloff and also in response to Goldman Sachs' reinstatement of its sell rating on the company.
In other company news, Kirk Kerkorian's Tracinda is dumping 7.3 million shares of Ford Motor (F, Fortune 500) and could end up selling the rest of his 6% stake in the automaker. Ford shares lost 6.9%.
A number of stocks that had led the advance Monday retreated Tuesday, including oil services firms Chevron (CVX, Fortune 500), Exxon Mobil (XOM, Fortune 500), ConocoPhilips (COP, Fortune 500) and BP (BP).
Market breadth was negative. On the New York Stock Exchange, decliners topped advancers by over two to one on volume of 1.16 billion shares. On the Nasdaq, losers beat winners by five to two on volume of 2.17 billion shares.
Credit market: Lending rates continued to improve Tuesday, extending the weeklong recovery.
Libor, the overnight bank-to-bank lending rate, fell to 1.28% from 1.51% Monday, according to Bloomberg.com. That set the rate below the Fed's benchmark lending rate of 1.5%, a good sign for the credit market. Libor hit a record 6.88% earlier this month at the height of the market panic.
The 3-month Libor rate, which banks charge each other to borrow for three months, fell to 3.83% from 4.06% late Monday.
The TED spread, which is the difference between what banks pay to borrow from each other for three months and what the Treasury pays, narrowed to 2.63% from 2.97% late Monday. The spread hit a record 4.65% earlier this month. The narrower the spread, the more willing banks are to lend to each other.
The improvement in bank lending over the last week is critical and analysts say it must continue to improve in the months ahead. Credit froze up in the wake of the housing market collapse, the subprime lending fallout and contraction in the bank sector.
The lack of available credit has punished the already weak economy, making it hard for businesses to function on a daily basis and for consumers to get loans.
The Federal Reserve and banks around the world have made potentially trillions of dollars available to lending institutions. On Tuesday, the Fed said it will start buying commercial paper from money market mutual funds. Commercial paper is a short-term funding source that companies need for daily operations.
Treasury prices rallied, lowering the yield on the 10-year note to 3.70% from 3.84% late Monday. Treasury prices and yields move in opposite directions.
The yield on the 3-month Treasury bill, seen as the safest place to put money in the short term, rose to 1.19% from 1.05% late Monday as investors began to pull money out of the safer investment and put it back in stocks.
Last week, the 3-month fell to below 0.2%. Last month, it reached a 68-year low around 0% as investor panic hit its peak.
Other markets: In global trade, Asian markets ended higher and European markets ended lower.
U.S. light crude oil for November delivery fell $3.36 to settle at $70.89 a barrel on the New York Mercantile Exchange after hitting a 13-month low last week.
Oil prices have been slowing since crude peaked at an all-time high of $147.27 a barrel on July 11. But the decline has been a mix of speculators leaving the market and investors betting that a slowing global economy means weaker oil demand. As a result, the falling oil prices haven't helped stock investor sentiment much.
Gasoline prices fell another 3.4 cents overnight, to a national average of $2.889 a gallon, according to a survey of credit-card activity by motorist group AAA. It was the 34th consecutive day that prices have decreased - in the past month alone, they're down more than 93 cents a gallon.
COMEX gold for December delivery fell $22 to $768 an ounce.
In currency trading, the dollar rose against the euro and yen.
The Dow Jones industrial average (INDU) lost 231 points or 2.5%. The Standard & Poor's 500 (SPX) index lost 3.1% and the Nasdaq composite (COMP) lost 4.1%.
Lending rates continued to improve, helping to reassure investors that the efforts of world governments to try and stabilize financial markets are starting to work. But relief about the credit markets was countered by broader fears about a recession and the health of American corporations.
"The credit market is improving, which is good, but the problem is that everyone is focused right now on earnings as a representation of the economy," said Greg Church, founder and president of Church Capital. "And while there will be exceptions, the overwhelming number of earnings reports won't be positive."
With 21% of S&P 500 companies already having reported results, third-quarter profits are currently on track to have fallen almost 10% from a year ago, according to the latest estimates from Thomson Reuters.
After the close, Yahoo (YHOO, Fortune 500) reported earnings of four cents a share, versus 11 cents a year ago and short of analysts' forecasts for a profit of 9 cents per share. The company also said it will cut at least 10% of its workforce, or around 1,500 people, through the end of the year as a result of the weak economy.
Looking forward, Yahoo warned that 2008 revenue won't meet its earlier forecasts. However, shares gained 7% in extended-hours trading.
Also after the close, Apple (AAPL, Fortune 500) reported fourth-quarter sales and earnings that jumped from a year ago due to strong sales of its new iPhone. Earnings topped forecasts, while sales missed expectations.
Looking forward, Apple forecast fiscal first-quarter sales and earnings that are short of analysts' projections. The company said forecasting the December quarter was a challenge because of the weak economy. Shares gained 4% in extended-hours trading.
The Dow gained 413 points Monday on improved lending rates and comments from Federal Reserve Chairman Ben Bernanke that supported a second fiscal stimulus package. It was the Dow's eighth-biggest one-day point advance ever, but did not spark a follow-up rally Tuesday.
"I think the tone in the stock market has been a little better recently with the credit spreads coming down," said Robert Loest, portfolio manager at Integrity Funds. "But I'm reluctant to get too optimistic because the economy is going to continue to deteriorate both in the U.S. and abroad."
Earnings: Dow component American Express (AXP, Fortune 500) reported weaker quarterly profit after the close of trade Monday. However, the results were better than expected and shares gained 8.4% Tuesday. (Full story)
Four other Dow components reported results Tuesday morning, including 3M (MMM, Fortune 500), which reported higher quarterly sales and earnings that topped estimates. Shares gained 4.8%.
DuPont (DD, Fortune 500) reported a big drop in earnings due to manufacturing disruptions in the wake of Hurricane Ike. The chemical giant also warned that full-year results won't meet forecasts. Shares fell 8%.
Caterpillar (CAT, Fortune 500) reported lower earnings and higher revenue versus a year ago, and shares fell 5%. Pfizer (PFE, Fortune 500) reported higher quarterly earnings that topped estimates. Shares were little changed.
Texas Instruments (TXN, Fortune 500) reported reduced third-quarter profit after the close Monday and forecast fourth-quarter revenue would fall sharply, missing estimates. The chipmaker also said it is looking to sell part of its wireless operations. Shares fell 6.3% Tuesday.
Among other companies releasing results, troubled bank National City (NCC, Fortune 500) reported a bigger-than-expected loss Tuesday and said it was cutting 4,000 jobs. However, investors lifted the shares, which have been battered soundly over the last few months on fears about the firm's solvency. The stock added 3%.
Citigroup (C, Fortune 500) slumped 6% in tune with the broader selloff and also in response to Goldman Sachs' reinstatement of its sell rating on the company.
In other company news, Kirk Kerkorian's Tracinda is dumping 7.3 million shares of Ford Motor (F, Fortune 500) and could end up selling the rest of his 6% stake in the automaker. Ford shares lost 6.9%.
A number of stocks that had led the advance Monday retreated Tuesday, including oil services firms Chevron (CVX, Fortune 500), Exxon Mobil (XOM, Fortune 500), ConocoPhilips (COP, Fortune 500) and BP (BP).
Market breadth was negative. On the New York Stock Exchange, decliners topped advancers by over two to one on volume of 1.16 billion shares. On the Nasdaq, losers beat winners by five to two on volume of 2.17 billion shares.
Credit market: Lending rates continued to improve Tuesday, extending the weeklong recovery.
Libor, the overnight bank-to-bank lending rate, fell to 1.28% from 1.51% Monday, according to Bloomberg.com. That set the rate below the Fed's benchmark lending rate of 1.5%, a good sign for the credit market. Libor hit a record 6.88% earlier this month at the height of the market panic.
The 3-month Libor rate, which banks charge each other to borrow for three months, fell to 3.83% from 4.06% late Monday.
The TED spread, which is the difference between what banks pay to borrow from each other for three months and what the Treasury pays, narrowed to 2.63% from 2.97% late Monday. The spread hit a record 4.65% earlier this month. The narrower the spread, the more willing banks are to lend to each other.
The improvement in bank lending over the last week is critical and analysts say it must continue to improve in the months ahead. Credit froze up in the wake of the housing market collapse, the subprime lending fallout and contraction in the bank sector.
The lack of available credit has punished the already weak economy, making it hard for businesses to function on a daily basis and for consumers to get loans.
The Federal Reserve and banks around the world have made potentially trillions of dollars available to lending institutions. On Tuesday, the Fed said it will start buying commercial paper from money market mutual funds. Commercial paper is a short-term funding source that companies need for daily operations.
Treasury prices rallied, lowering the yield on the 10-year note to 3.70% from 3.84% late Monday. Treasury prices and yields move in opposite directions.
The yield on the 3-month Treasury bill, seen as the safest place to put money in the short term, rose to 1.19% from 1.05% late Monday as investors began to pull money out of the safer investment and put it back in stocks.
Last week, the 3-month fell to below 0.2%. Last month, it reached a 68-year low around 0% as investor panic hit its peak.
Other markets: In global trade, Asian markets ended higher and European markets ended lower.
U.S. light crude oil for November delivery fell $3.36 to settle at $70.89 a barrel on the New York Mercantile Exchange after hitting a 13-month low last week.
Oil prices have been slowing since crude peaked at an all-time high of $147.27 a barrel on July 11. But the decline has been a mix of speculators leaving the market and investors betting that a slowing global economy means weaker oil demand. As a result, the falling oil prices haven't helped stock investor sentiment much.
Gasoline prices fell another 3.4 cents overnight, to a national average of $2.889 a gallon, according to a survey of credit-card activity by motorist group AAA. It was the 34th consecutive day that prices have decreased - in the past month alone, they're down more than 93 cents a gallon.
COMEX gold for December delivery fell $22 to $768 an ounce.
In currency trading, the dollar rose against the euro and yen.
Monday, October 20, 2008
The bright spot in a dark economy
The economic storm pelting the U.S. economy is going to do plenty more damage to already flattened job and housing markets.
But as dark as the next three or four quarters could be, the U.S. economy appears to be undergoing a more lasting, and ultimately uplifting, shift.
Americans who for decades have spent an increasing share of their incomes and taken on more and more debt are now, for the first time in years, saving instead.
The personal savings rate, which measures the amount of disposable personal income that isn't spent, ticked up to almost 3% in the second quarter of 2008, after almost four years below 1%.
While Americans still aren't going to win any awards for thrift - consumers save more than 10% of their paychecks in creditor nations such as Germany and Japan, for instance - the return to saving carries big implications for U.S. economic health.
More saving is good over the long haul, because domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time.
A growing domestic savings pool could also reduce America's need to borrow money overseas - which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year.
The trouble with virtue
Unfortunately, thrift will cost in the short run. Saving more means spending less - which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday's steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Economists had been looking for a 0.7% drop.
Given that two-thirds of economic activity is consumer spending, today's thrift will exacerbate a general downturn and will weaken the impact of the massive interventions the government has made in the financial markets.
"The breadth of the decline shows a broad-based pullback in consumer spending that will not quickly turn around," writes PNC economist Stuart Hoffman, "even with the arsenal of federal firepower now aimed at the Great Financial Crisis of 2008."
Federal actions such as a $250 billion plan to buy preferred shares in banks, along with a public guarantee of bank deposits and bank debt, are aimed at unlocking credit markets and boosting economic activity. Policymakers have promised to get banks lending again, to restore economic growth that has clearly been ebbing even as government data chalked up modest gains in gross domestic product for the first half of the year.
"This plan is a means to an end," Hoffman says of the Treasury's agreement to make capital injections in banks such as Citi (C, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Bank of America (BAC, Fortune 500). "The key concept is that reasonably prudent lending should be supported."
But as the economy shows further signs of deceleration - factory production and industrial capacity utilization fell sharply in September, the Federal Reserve said Thursday - the question is who the banks will be lending to. Indeed, merely plying the banks with capital isn't certain to get them lending in a world in which businesses and consumers are trying to reduce their leverage after a long run of credit expansion.
William Cline, a senior fellow at the Peterson Institute for International Economics, notes that the decline of saving in the United States over the past two decades was accompanied by a sharp increase in the rate of bank lending, as consumers cashed in on the appreciating value of their houses.
Bank credit growth, after averaging around 6.5% in the 1990s, spiked to 12% in the four years ended in 2007, Cline says. Meanwhile the U.S. personal saving rate turned negative at the height of the housing bubble in 2005, down from around 7% in the early 1990s.
"We were already on course to have some return to saving," says Cline, who is the author of the 2005 book, "The United States as a Debtor Nation." With the credit crunch making consumer credit scarcer, he adds, and reduced house prices making Americans feel poorer, "We're going to see some more pressure on household spending."
For now, that will mean more pressure on companies that sell their goods to consumers. GM (GM, Fortune 500) and Ford (F, Fortune 500) have traded at multi-decade lows this month as U.S. auto sales slowed to a pace last seen in the early 1990s. Macy's (M, Fortune 500) dropped 12% Wednesday after the department store chain cut its profit forecast, prompting ratings agency Moody's to warn that further problems could prompt a costly credit downgrade.
The government interventions mean deleveraging can continue without the risk of an economic collapse, which is obviously "extremely positive" in the long run, says Ken Kamen, a financial adviser who is president of Mercadien Asset Management in Trenton, N.J. But that doesn't mean the short run is going to be particularly enjoyable, as Wednesday's 9% stock market decline suggests.
Kamen warns his clients that before they make any hasty decisions, they should decide how much stress they can tolerate in their portfolios.
"You don't want to be resetting your financial future while the compass needle is spinning," he says. "You may need to sell assets - but only to the point where you can sleep at night."
But as dark as the next three or four quarters could be, the U.S. economy appears to be undergoing a more lasting, and ultimately uplifting, shift.
Americans who for decades have spent an increasing share of their incomes and taken on more and more debt are now, for the first time in years, saving instead.
The personal savings rate, which measures the amount of disposable personal income that isn't spent, ticked up to almost 3% in the second quarter of 2008, after almost four years below 1%.
While Americans still aren't going to win any awards for thrift - consumers save more than 10% of their paychecks in creditor nations such as Germany and Japan, for instance - the return to saving carries big implications for U.S. economic health.
More saving is good over the long haul, because domestic savings create a pool of money from which companies can borrow to invest in new plants and equipment, creating the jobs that push living standards higher over time.
A growing domestic savings pool could also reduce America's need to borrow money overseas - which would make the U.S. less beholden to foreign creditors who now supply us with hundreds of billions of dollars in financing every year.
The trouble with virtue
Unfortunately, thrift will cost in the short run. Saving more means spending less - which translates into more hard times in retail and other consumer-driven businesses like the auto industry. The latest evidence of the shift came in Wednesday's steeper-than-expected pullback in retail sales. They dropped 1.2% in September, in their first year-on-year decline in six years and only their third drop in the past 16 years. Economists had been looking for a 0.7% drop.
Given that two-thirds of economic activity is consumer spending, today's thrift will exacerbate a general downturn and will weaken the impact of the massive interventions the government has made in the financial markets.
"The breadth of the decline shows a broad-based pullback in consumer spending that will not quickly turn around," writes PNC economist Stuart Hoffman, "even with the arsenal of federal firepower now aimed at the Great Financial Crisis of 2008."
Federal actions such as a $250 billion plan to buy preferred shares in banks, along with a public guarantee of bank deposits and bank debt, are aimed at unlocking credit markets and boosting economic activity. Policymakers have promised to get banks lending again, to restore economic growth that has clearly been ebbing even as government data chalked up modest gains in gross domestic product for the first half of the year.
"This plan is a means to an end," Hoffman says of the Treasury's agreement to make capital injections in banks such as Citi (C, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and Bank of America (BAC, Fortune 500). "The key concept is that reasonably prudent lending should be supported."
But as the economy shows further signs of deceleration - factory production and industrial capacity utilization fell sharply in September, the Federal Reserve said Thursday - the question is who the banks will be lending to. Indeed, merely plying the banks with capital isn't certain to get them lending in a world in which businesses and consumers are trying to reduce their leverage after a long run of credit expansion.
William Cline, a senior fellow at the Peterson Institute for International Economics, notes that the decline of saving in the United States over the past two decades was accompanied by a sharp increase in the rate of bank lending, as consumers cashed in on the appreciating value of their houses.
Bank credit growth, after averaging around 6.5% in the 1990s, spiked to 12% in the four years ended in 2007, Cline says. Meanwhile the U.S. personal saving rate turned negative at the height of the housing bubble in 2005, down from around 7% in the early 1990s.
"We were already on course to have some return to saving," says Cline, who is the author of the 2005 book, "The United States as a Debtor Nation." With the credit crunch making consumer credit scarcer, he adds, and reduced house prices making Americans feel poorer, "We're going to see some more pressure on household spending."
For now, that will mean more pressure on companies that sell their goods to consumers. GM (GM, Fortune 500) and Ford (F, Fortune 500) have traded at multi-decade lows this month as U.S. auto sales slowed to a pace last seen in the early 1990s. Macy's (M, Fortune 500) dropped 12% Wednesday after the department store chain cut its profit forecast, prompting ratings agency Moody's to warn that further problems could prompt a costly credit downgrade.
The government interventions mean deleveraging can continue without the risk of an economic collapse, which is obviously "extremely positive" in the long run, says Ken Kamen, a financial adviser who is president of Mercadien Asset Management in Trenton, N.J. But that doesn't mean the short run is going to be particularly enjoyable, as Wednesday's 9% stock market decline suggests.
Kamen warns his clients that before they make any hasty decisions, they should decide how much stress they can tolerate in their portfolios.
"You don't want to be resetting your financial future while the compass needle is spinning," he says. "You may need to sell assets - but only to the point where you can sleep at night."
Friday, October 17, 2008
Tense times in Hollywood's dream factory
Even in the land of make-believe, where the meltdown on Wall Street feels a million miles away, these are tense days. While no one can say for sure how the financial crisis will affect Hollywood, a prevailing view is that the film business is relatively protected for at least a year or two, but that the TV industry which was already impacted by last winter's writers' strike could be in for a rocky ride.
Surreal at the best of times - ok, all the time - sunny Tinseltown has avoided the sense of catastrophe that has enshrouded Wall Street and spooked Silicon Valley. But now its biggest players are trying to come to grips with exactly what the financial and economic meltdown is going to mean for them. One big-deal agent told me the other day that only projects involving major stars and producers are going forward right now. "Everybody's putting their tail between their legs," the agent said. "It's hard to get deals done." More worryingly, one senior TV executive posited to me: "I can almost guarantee that you're going to see major cuts across our businesses."
Well-timed funding boom
Broadly, there are in fact two early takes on how tough times are going to affect the entertainment industry. The first take is that the movie industry in particular is going to be just fine for the next couple of years. This is more by happenstance then design, although there is evidence that entertainment products are less impacted by economic downturns than other sources of consumer spending. (The conventional thinking that the box office actually goes up because people are taking fewer vacations and or holding off on big-ticket items).
Additionally, this time Hollywood has timing on its side. For one thing, Tinseltown has just gone through a boom in new outside sources of funding led by hedge funds and Wall Street sources. By the estimate of one finance executive who worked on several of these financings, between $10 and $15 billion was raised over the past few years to fund slates of studio films, as well as television projects.
What this means is that whatever films are already in the works don't have to worry about how they are going to be financed, and relatively few big Hollywood players are going to have an imminent need for cash. The only deal that has been held up by the crisis is the $700-million debt financing for the Dreamworks (DWA) studio's new venture with India's Reliance group, but no one has expressed fears that the financing is in doubt. (There are of course question marks on the horizon, such as $3.7 billion of MGM's debt coming due in 2012, and relentless chatter about the capital needs of smaller shops like the Weinstein Company.)
"Hollywood is pretty well financed in terms of enough money being there right now," says a finance chief at one of the studios. "What it looks like two years from now, I don't know."
Hollywood under pressure
Meanwhile, the impact of last winter's writer's strike - as well as uncertainty over whether there might yet be a strike from the Screen Actors Guild - led to a slowdown in the production of new films and TV shows that some have called a "de facto strike." But according to a recent report in Variety, after a period of being put on hold some 40 or more films are going to go into production between spring and summer of next year.
Layer on top of this the fact that many of the Hollywood majors, including Warner Bros. (owned by Fortune parent Time Warner), Fox and the Disney (DIS, Fortune 500) studio, have reduced the number of films they are releasing, while smaller studio divisions like Warner Independent, New Line and Paramount Vantage have been restructured or shuttered. In the first announcement of cost-cutting that was directly linked to the financial crisis, Paramount announced that it is slimming its release slate by 20% to 20 films a year to hit financial targets set by its parent, Viacom (VIA).
Which brings us to the second take, that the downturn is still going to hurt everyone, and more fallout in LaLa Land is inevitable. Television costs will be under immense pressure as advertising continues to weaken, and, if the fall TV season so far is any indication, viewers are not stampeding to watch all the new shows. (To be fair, part of this is still hangover from the strike plus the fact that the election and meltdown have been competing rather well for audiences' attentions.)
Also worrying: To the extent that Hollywood's growth is driven by the adoption of new technologies - a lot - a bleak outlook for selling new gizmos this holiday season could lead to further sluggishness in home video and ancillary revenues, a big cash engine for the studios from both film and TV.
Meanwhile, for all the Hollywood executives who are sadly watching their shareholdings in their media conglomerate parent companies diminish, we can only offer by way of a suggestion a recent statement made by the studios' trade association in the context of preventing another strike: "If ever there was a time when Americans wanted the diversions of movies and television, it is now."
Surreal at the best of times - ok, all the time - sunny Tinseltown has avoided the sense of catastrophe that has enshrouded Wall Street and spooked Silicon Valley. But now its biggest players are trying to come to grips with exactly what the financial and economic meltdown is going to mean for them. One big-deal agent told me the other day that only projects involving major stars and producers are going forward right now. "Everybody's putting their tail between their legs," the agent said. "It's hard to get deals done." More worryingly, one senior TV executive posited to me: "I can almost guarantee that you're going to see major cuts across our businesses."
Well-timed funding boom
Broadly, there are in fact two early takes on how tough times are going to affect the entertainment industry. The first take is that the movie industry in particular is going to be just fine for the next couple of years. This is more by happenstance then design, although there is evidence that entertainment products are less impacted by economic downturns than other sources of consumer spending. (The conventional thinking that the box office actually goes up because people are taking fewer vacations and or holding off on big-ticket items).
Additionally, this time Hollywood has timing on its side. For one thing, Tinseltown has just gone through a boom in new outside sources of funding led by hedge funds and Wall Street sources. By the estimate of one finance executive who worked on several of these financings, between $10 and $15 billion was raised over the past few years to fund slates of studio films, as well as television projects.
What this means is that whatever films are already in the works don't have to worry about how they are going to be financed, and relatively few big Hollywood players are going to have an imminent need for cash. The only deal that has been held up by the crisis is the $700-million debt financing for the Dreamworks (DWA) studio's new venture with India's Reliance group, but no one has expressed fears that the financing is in doubt. (There are of course question marks on the horizon, such as $3.7 billion of MGM's debt coming due in 2012, and relentless chatter about the capital needs of smaller shops like the Weinstein Company.)
"Hollywood is pretty well financed in terms of enough money being there right now," says a finance chief at one of the studios. "What it looks like two years from now, I don't know."
Hollywood under pressure
Meanwhile, the impact of last winter's writer's strike - as well as uncertainty over whether there might yet be a strike from the Screen Actors Guild - led to a slowdown in the production of new films and TV shows that some have called a "de facto strike." But according to a recent report in Variety, after a period of being put on hold some 40 or more films are going to go into production between spring and summer of next year.
Layer on top of this the fact that many of the Hollywood majors, including Warner Bros. (owned by Fortune parent Time Warner), Fox and the Disney (DIS, Fortune 500) studio, have reduced the number of films they are releasing, while smaller studio divisions like Warner Independent, New Line and Paramount Vantage have been restructured or shuttered. In the first announcement of cost-cutting that was directly linked to the financial crisis, Paramount announced that it is slimming its release slate by 20% to 20 films a year to hit financial targets set by its parent, Viacom (VIA).
Which brings us to the second take, that the downturn is still going to hurt everyone, and more fallout in LaLa Land is inevitable. Television costs will be under immense pressure as advertising continues to weaken, and, if the fall TV season so far is any indication, viewers are not stampeding to watch all the new shows. (To be fair, part of this is still hangover from the strike plus the fact that the election and meltdown have been competing rather well for audiences' attentions.)
Also worrying: To the extent that Hollywood's growth is driven by the adoption of new technologies - a lot - a bleak outlook for selling new gizmos this holiday season could lead to further sluggishness in home video and ancillary revenues, a big cash engine for the studios from both film and TV.
Meanwhile, for all the Hollywood executives who are sadly watching their shareholdings in their media conglomerate parent companies diminish, we can only offer by way of a suggestion a recent statement made by the studios' trade association in the context of preventing another strike: "If ever there was a time when Americans wanted the diversions of movies and television, it is now."
Monday, October 13, 2008
Europe to U.S.: You messed up the rescue, too
First you mess up the world's financial system. Then you blow the rescue of it. Now let's show you how to do it properly.
That, in a nutshell, is the less-than-flattering message European governments are sending to the U.S. as they mount their own gigantic bank bailout. The plans, announced Monday after two weeks of dithering, involve Britain, Germany, France and some others recapitalizing national banks that require help, and providing state guarantees and other measures to kick-start the stalled credit market. The details are strikingly different from the U.S. approach adopted by U.S. Treasury Secretary Hank Paulson and the Federal Reserve Board. And there's a big reason for that: The Europeans think Paulson got it badly wrong, and have watched aghast as he failed to restore confidence in the world's financial system.
In particular, they now think - and are openly saying - that it was a huge mistake to allow Lehman Brothers to fail. But they also believe that the $700 billion bailout plan was badly misdirected. Rather than buying up toxic assets, as the Paulson plan initially intended, they believe the role of government intervention should be to recapitalize the banks directly in exchange for some control of operations. That's at the core of the European plans announced Monday (and apparently the direction Treasury is now heading, too).
Much of the griping has been taking place anonymously, so as not to cause political ructions. But France's Finance Minister Christine Lagarde cast aside diplomatic niceties on the eve of last weekend's G-7 meetings in the U.S. when she told French radio: "as soon as you let one domino fall, the rest risk crashing down."
While not defending Lehman - "there were certainly bad decisions taken by that bank, bad management," she said, Lagarde nonetheless argued that allowing the investment bank to fail merely heightened anxiety in international banking and led to the seizing up of interbank lending. It's an argument that has now become conventional wisdom in Europe, where the mantra for this week's rescues is: Relax, no bank will be allowed to fail.
Too complex, too opaque
The second lesson from the U.S. handling of the crisis concerns the way government money is best used. Here the Europeans have a valuable precedent: Sweden's banking crisis in the early 1990s, which was resolved by the state forcing a consolidation and clean-up of the system even as it kept the banks afloat. Starting in Sept. 1992, the government in Stockholm announced a general guarantee for the whole of the banking system, encouraged the central bank to organize massive injections of liquidity, and created a state agency that essentially forced banks to give up any remnants of make-belief accounting and quickly write down the value of their assets to much more realistic levels. The strategy worked, and Urban Bäckström, the former Swedish central bank president who played a central role in the rescue, has said that "prompt and transparent handling" of the problems were a key to the success.
By contrast, the initial Paulson plan involved the U.S. government buying up the problem securities of banks in a procedure that risked being anything other than prompt and transparent. "It looks as complex as the credit derivatives that caused the problem in the first place," one top European finance official told me, on condition I didn't quote him by name.
Of course, this is not exactly a time to crow, and there are some big unanswered questions about the European solution, too. One is just how tough governments will be in imposing their conditions on national banks, including forcing mergers of stronger and weaker ones. That's particularly a concern for Germany, which has the most fragmented banking sector of any of the big European nations and has the biggest potential for discovering nasty surprises. Germany's problem is that any banking consolidation is likely to run into opposition from regional authorities, who have a say in the running of savings banks networks. And with national elections scheduled for next year, the fragile coalition government under Chancellor Angela Merkel doesn't have a very strong hand to play.
Her finance minister Peer Steinbrück, who could end up as her challenger in the election, has been among the most vocal European government official complaining about how the problems started in the U.S. sub-prime market - and how they will result in the erosion of American influence. "The U.S. will lose its superpower status in the world financial system," he has said, predicting that the dollar will also lose ground to the euro and the Japanese yen.
Stock markets for the moment are applauding the concerted European response. Only time will tell whether they're getting it right. It puts a huge onus on governments to fix the system, and the track record there is mixed. France nationalized its banks in the 1980s under President Francois Mitterrand for ideological reasons, but made such a mess of the job that it privatized them again. Still, after two weeks of conflicting and contradictory moves and statements in Europe, a bit of coordination certainly feels good - and if it looks like it stands a good chance of working, all the better.
That, in a nutshell, is the less-than-flattering message European governments are sending to the U.S. as they mount their own gigantic bank bailout. The plans, announced Monday after two weeks of dithering, involve Britain, Germany, France and some others recapitalizing national banks that require help, and providing state guarantees and other measures to kick-start the stalled credit market. The details are strikingly different from the U.S. approach adopted by U.S. Treasury Secretary Hank Paulson and the Federal Reserve Board. And there's a big reason for that: The Europeans think Paulson got it badly wrong, and have watched aghast as he failed to restore confidence in the world's financial system.
In particular, they now think - and are openly saying - that it was a huge mistake to allow Lehman Brothers to fail. But they also believe that the $700 billion bailout plan was badly misdirected. Rather than buying up toxic assets, as the Paulson plan initially intended, they believe the role of government intervention should be to recapitalize the banks directly in exchange for some control of operations. That's at the core of the European plans announced Monday (and apparently the direction Treasury is now heading, too).
Much of the griping has been taking place anonymously, so as not to cause political ructions. But France's Finance Minister Christine Lagarde cast aside diplomatic niceties on the eve of last weekend's G-7 meetings in the U.S. when she told French radio: "as soon as you let one domino fall, the rest risk crashing down."
While not defending Lehman - "there were certainly bad decisions taken by that bank, bad management," she said, Lagarde nonetheless argued that allowing the investment bank to fail merely heightened anxiety in international banking and led to the seizing up of interbank lending. It's an argument that has now become conventional wisdom in Europe, where the mantra for this week's rescues is: Relax, no bank will be allowed to fail.
Too complex, too opaque
The second lesson from the U.S. handling of the crisis concerns the way government money is best used. Here the Europeans have a valuable precedent: Sweden's banking crisis in the early 1990s, which was resolved by the state forcing a consolidation and clean-up of the system even as it kept the banks afloat. Starting in Sept. 1992, the government in Stockholm announced a general guarantee for the whole of the banking system, encouraged the central bank to organize massive injections of liquidity, and created a state agency that essentially forced banks to give up any remnants of make-belief accounting and quickly write down the value of their assets to much more realistic levels. The strategy worked, and Urban Bäckström, the former Swedish central bank president who played a central role in the rescue, has said that "prompt and transparent handling" of the problems were a key to the success.
By contrast, the initial Paulson plan involved the U.S. government buying up the problem securities of banks in a procedure that risked being anything other than prompt and transparent. "It looks as complex as the credit derivatives that caused the problem in the first place," one top European finance official told me, on condition I didn't quote him by name.
Of course, this is not exactly a time to crow, and there are some big unanswered questions about the European solution, too. One is just how tough governments will be in imposing their conditions on national banks, including forcing mergers of stronger and weaker ones. That's particularly a concern for Germany, which has the most fragmented banking sector of any of the big European nations and has the biggest potential for discovering nasty surprises. Germany's problem is that any banking consolidation is likely to run into opposition from regional authorities, who have a say in the running of savings banks networks. And with national elections scheduled for next year, the fragile coalition government under Chancellor Angela Merkel doesn't have a very strong hand to play.
Her finance minister Peer Steinbrück, who could end up as her challenger in the election, has been among the most vocal European government official complaining about how the problems started in the U.S. sub-prime market - and how they will result in the erosion of American influence. "The U.S. will lose its superpower status in the world financial system," he has said, predicting that the dollar will also lose ground to the euro and the Japanese yen.
Stock markets for the moment are applauding the concerted European response. Only time will tell whether they're getting it right. It puts a huge onus on governments to fix the system, and the track record there is mixed. France nationalized its banks in the 1980s under President Francois Mitterrand for ideological reasons, but made such a mess of the job that it privatized them again. Still, after two weeks of conflicting and contradictory moves and statements in Europe, a bit of coordination certainly feels good - and if it looks like it stands a good chance of working, all the better.
Sunday, October 12, 2008
GM needs cash before Chrysler
For General Motors Corp. to acquire Chrysler LLC and all of its warts, GM would have to get desperately needed cash. Lots of it, according to industry analysts.
With both automakers struggling to survive amid slumping sales, a slowing global economy and an unprecedented credit crunch, it's unclear whether Chrysler's majority owner, Cerberus Capital Management LP, would be willing to pay up, or whether the federal government might even get involved to save one or both struggling automakers.
"There's got to be more in it for GM than just Chrysler," said Erich Merkle, an auto industry analyst with Crowe Horwath LLP, an accounting and consulting firm. "If you put two auto companies together, both that are losing money, both that are losing market share, you've just got an auto company that's losing market share faster and losing more money."
GM and Cerberus, which owns 80.1% of Chrysler, have held preliminary talks about an acquisition or other combination of the two automakers, according to a person familiar with the discussions who did not want to be identified because the talks have not been made public.
A tie-up between the automotive giants would be historic for the industry and solidify GM's position as the global sales leader, which it has been in danger of losing to Toyota Motor Corp.
GM and Toyota finished 2007 essentially even in vehicles sold worldwide. GM and Chrysler already have a joint venture with BMW AG making a hybrid gas-electric powertrain.
While melding the companies could save money by combining management, engineering, manufacturing and administrative staffs, analysts say consolidation would bring more costs, and the rewards probably wouldn't come for several years.
That might be too late for both automakers. Auburn Hills-based Chrysler, a privately held company, doesn't have to open its books, but it lost at least $510 million in the first quarter and $1.6 billion last year. Its sales are down 25% so far this year, the worst drop of any major automaker.
Detroit-based GM is burning up more than $1 billion in cash per month, with several analysts predicting it will reach its minimum operating cash level of $14 billion sometime next year.
Sales are down 18%, and the company has lost $57.5 billion in the past 18 months, largely because of tax accounting changes.
Bad timing? All of this comes as U.S. sales have slowed to their lowest point in 15 years, making bankruptcy possible for all of the cash-strapped Detroit Three if things don't turn around soon enough.
Not exactly the prime scenario for a GM-Chrysler combination, said analyst Kevin Tynan of New York-based Argus Research Corp.
"Even though you're getting the rationalization of folding the two businesses together, it doesn't make sense at this time," he said. "There's got to be some sort of outside motivation for them to do that sort of deal, especially in this market."
That outside motive, analysts speculated, could be the federal government, which would inherit massive pension liabilities if either company went under.
In exchange for taking on Chrysler, analysts envisioned that GM could be given access to low-rate emergency borrowing from the Federal Reserve's discount window, used in normal times by banks.
GM, though, said it is not going to the Fed at present. "We're not actively pursuing anything at this time," said Greg Martin, GM's Washington spokesman.
What's in it for Cerberus? The Wall Street Journal reported late Friday that Cerberus might trade Chrysler for GM's 49% stake in GMAC Financial Services. Cerberus bought 51% of GM's former financial arm for $14 billion in 2006, but since then GMAC has suffered because of bad mortgage loans.
GMAC could look good to Cerberus now, Merkle said, because its insurance and auto businesses are profitable, and the federal government may take on its bad mortgages through the $700 billion financial bailout plan approved earlier this month.
If a merger were to go through, GM could move quickly to cut costs and save billions, said Van Conway, a mergers and acquisitions expert and partner with Birmingham, Mich.-based Conway & MacKenzie.
The company would have to calculate whether it has enough cash to stay alive and fund the deal, he said. If the numbers work, a lean, merged automaker would be in a strong position to make money once the U.S. market recovers and people start buying vehicles again, Conway said.
"You want to be the last man standing here because the car market is going to come back," he said.
Tynan estimated GM could save more than $5 billion a year by running the two companies as one, but said it could take years to realize the savings.
"Over the short term there's very little in the way of consolidation that could occur," said Michael Robinet, vice president of global forecast services for CSM Worldwide, an auto industry consulting company based in Northville, Mich.
Renault and Nissan are still completing their consolidation, even though the companies joined in 1999, he said.
A combined GM-Chrysler would have too much factory capacity, too many brands and too many dealers, the analysts said. "Adding three more brands (Chrysler, Dodge and Jeep) to their mix and another company that's very heavy in the area of truck production and sales, I don't know how that can be a good thing," Merkle said.
Neither GM nor Chrysler would confirm that they've talked, but each said discussions between automakers are routine.
There also were reports Saturday that Chrysler was in talks with Nissan-Renault, and The New York Times reported that GM had approached Ford Motor Co. about a merger earlier in the year, but Ford wanted to stay independent.
Merger talk among the Detroit Three is not new. GM talked with DaimlerChrysler AG in 2007 about acquiring Chrysler before Cerberus bought its stake in a $7.4 billion deal. The talks fell through when GM decided it should concentrate on cost savings and efficiencies by globalizing its own operations.
Cerberus and Daimler confirmed last month that they are in talks for the private equity firm to acquire Daimler's remaining 19.9% Chrysler stake.
The Journal said the talks between GM and Chrysler are on hold for now due to recent turmoil in the financial markets.
The auto industry has been hit hard in recent weeks by the effects of the credit crisis, prompting GM and Ford to issue statements Friday to dispel the notion that they might be headed for bankruptcy.
GM and Ford shares were battered with the rest of the stock market this week, falling to lows not seen in decades. GM (GM, Fortune 500) shares lost about half of their already-depressed value during the week, closing at $4.89 on Friday. Ford (F, Fortune 500) shares fell similarly, ending the week at $1.99.
GM said Friday, in response to the stock price, that it is nor considering a bankruptcy filing.
"Clearly we face unprecedented challenges related to uncertainties in the financial markets globally and weakening economic fundamentals in many key markets, but bankruptcy protection is not an option GM is considering," a company statement said.
With both automakers struggling to survive amid slumping sales, a slowing global economy and an unprecedented credit crunch, it's unclear whether Chrysler's majority owner, Cerberus Capital Management LP, would be willing to pay up, or whether the federal government might even get involved to save one or both struggling automakers.
"There's got to be more in it for GM than just Chrysler," said Erich Merkle, an auto industry analyst with Crowe Horwath LLP, an accounting and consulting firm. "If you put two auto companies together, both that are losing money, both that are losing market share, you've just got an auto company that's losing market share faster and losing more money."
GM and Cerberus, which owns 80.1% of Chrysler, have held preliminary talks about an acquisition or other combination of the two automakers, according to a person familiar with the discussions who did not want to be identified because the talks have not been made public.
A tie-up between the automotive giants would be historic for the industry and solidify GM's position as the global sales leader, which it has been in danger of losing to Toyota Motor Corp.
GM and Toyota finished 2007 essentially even in vehicles sold worldwide. GM and Chrysler already have a joint venture with BMW AG making a hybrid gas-electric powertrain.
While melding the companies could save money by combining management, engineering, manufacturing and administrative staffs, analysts say consolidation would bring more costs, and the rewards probably wouldn't come for several years.
That might be too late for both automakers. Auburn Hills-based Chrysler, a privately held company, doesn't have to open its books, but it lost at least $510 million in the first quarter and $1.6 billion last year. Its sales are down 25% so far this year, the worst drop of any major automaker.
Detroit-based GM is burning up more than $1 billion in cash per month, with several analysts predicting it will reach its minimum operating cash level of $14 billion sometime next year.
Sales are down 18%, and the company has lost $57.5 billion in the past 18 months, largely because of tax accounting changes.
Bad timing? All of this comes as U.S. sales have slowed to their lowest point in 15 years, making bankruptcy possible for all of the cash-strapped Detroit Three if things don't turn around soon enough.
Not exactly the prime scenario for a GM-Chrysler combination, said analyst Kevin Tynan of New York-based Argus Research Corp.
"Even though you're getting the rationalization of folding the two businesses together, it doesn't make sense at this time," he said. "There's got to be some sort of outside motivation for them to do that sort of deal, especially in this market."
That outside motive, analysts speculated, could be the federal government, which would inherit massive pension liabilities if either company went under.
In exchange for taking on Chrysler, analysts envisioned that GM could be given access to low-rate emergency borrowing from the Federal Reserve's discount window, used in normal times by banks.
GM, though, said it is not going to the Fed at present. "We're not actively pursuing anything at this time," said Greg Martin, GM's Washington spokesman.
What's in it for Cerberus? The Wall Street Journal reported late Friday that Cerberus might trade Chrysler for GM's 49% stake in GMAC Financial Services. Cerberus bought 51% of GM's former financial arm for $14 billion in 2006, but since then GMAC has suffered because of bad mortgage loans.
GMAC could look good to Cerberus now, Merkle said, because its insurance and auto businesses are profitable, and the federal government may take on its bad mortgages through the $700 billion financial bailout plan approved earlier this month.
If a merger were to go through, GM could move quickly to cut costs and save billions, said Van Conway, a mergers and acquisitions expert and partner with Birmingham, Mich.-based Conway & MacKenzie.
The company would have to calculate whether it has enough cash to stay alive and fund the deal, he said. If the numbers work, a lean, merged automaker would be in a strong position to make money once the U.S. market recovers and people start buying vehicles again, Conway said.
"You want to be the last man standing here because the car market is going to come back," he said.
Tynan estimated GM could save more than $5 billion a year by running the two companies as one, but said it could take years to realize the savings.
"Over the short term there's very little in the way of consolidation that could occur," said Michael Robinet, vice president of global forecast services for CSM Worldwide, an auto industry consulting company based in Northville, Mich.
Renault and Nissan are still completing their consolidation, even though the companies joined in 1999, he said.
A combined GM-Chrysler would have too much factory capacity, too many brands and too many dealers, the analysts said. "Adding three more brands (Chrysler, Dodge and Jeep) to their mix and another company that's very heavy in the area of truck production and sales, I don't know how that can be a good thing," Merkle said.
Neither GM nor Chrysler would confirm that they've talked, but each said discussions between automakers are routine.
There also were reports Saturday that Chrysler was in talks with Nissan-Renault, and The New York Times reported that GM had approached Ford Motor Co. about a merger earlier in the year, but Ford wanted to stay independent.
Merger talk among the Detroit Three is not new. GM talked with DaimlerChrysler AG in 2007 about acquiring Chrysler before Cerberus bought its stake in a $7.4 billion deal. The talks fell through when GM decided it should concentrate on cost savings and efficiencies by globalizing its own operations.
Cerberus and Daimler confirmed last month that they are in talks for the private equity firm to acquire Daimler's remaining 19.9% Chrysler stake.
The Journal said the talks between GM and Chrysler are on hold for now due to recent turmoil in the financial markets.
The auto industry has been hit hard in recent weeks by the effects of the credit crisis, prompting GM and Ford to issue statements Friday to dispel the notion that they might be headed for bankruptcy.
GM and Ford shares were battered with the rest of the stock market this week, falling to lows not seen in decades. GM (GM, Fortune 500) shares lost about half of their already-depressed value during the week, closing at $4.89 on Friday. Ford (F, Fortune 500) shares fell similarly, ending the week at $1.99.
GM said Friday, in response to the stock price, that it is nor considering a bankruptcy filing.
"Clearly we face unprecedented challenges related to uncertainties in the financial markets globally and weakening economic fundamentals in many key markets, but bankruptcy protection is not an option GM is considering," a company statement said.
Friday, October 10, 2008
Oil sheds more than $9 to hit 13-month low
Oil prices plunged to a 13-month low Friday, following steep stock market declines, as investors worried that the weakening global economy was driving down demand for fuel worldwide.
U.S. crude for November delivery sank as much as $9.50 to a low of $77.09 a barrel during Friday trading, its lowest level since Sept. 11, 2007, when crude hit an intraday low of $77.00.
Prices later recovered slightly to settle down $8.89 to $77.70 a barrel in New York, oil's lowest close since Sept. 10, 2007, when crude ended the day at $77.49.
Friday's plunge was the third largest dollar amount on record following a fall of $10.56 on Jan. 17, 1991, prompted by the launch of Operation Desert Storm, and $10.56 just over a week ago on Sept. 29 after the House made its first attempt to pass the $700 billion bailout plan to shore up the economy.
Investors remain concerned that a crumbling economy is causing businesses and consumers to cut back on fuel consumption.
During Friday trading the Dow Jones industrial average lost nearly 700 points before recovering to add about 150 points, or about 1.7%.
If oil ends the day below $80 a barrel, crude prices could slide even further in the coming weeks, according to James Cordier, founder of OptionSellers.com in Florida.
"People have to remember oil used to trade for the longest time at $35 to $40 a barrel," said Cordier, referring to prices not seen since 2004. "The consumption that we saw back then, we could see it again."
Worries about the economy have weighed heavily on the world markets this week. Stocks and commodities have all fallen in the United States since Monday as the euro sank to fresh lows against the dollar, and U.S. treasury bonds, often considered a safe haven in times of economic strife, were extremely volatile.
As the world economy weakens and money becomes tight, energy expenditures are often among the first to be cut, according to analysts.
"Factories are closing, jets are on the ground, a lot of the expansion in China and India are probably going to be curtailed," said Cordier.
In an effort to encourage banks to loosen their lending practices and get cash flowing again, the Federal Reserve and central banks in Europe simultaneously cut interest rates this week, on top of a host of other measures.
As energy prices fall, oil and natural gas companies will likely be forced to cut back production, according to Tom Orr, head of research with Weeden & Co. in Connecticut.
"Production starts to become un-economic because costs are rising," Orr said. "They just don't have any access to liquidity."
Falling demand: As the economic crisis worsened, the Energy Department registered a sharp drop in demand for gasoline.
On Wednesday the government reported a 5.3% decline in demand for motor gasoline over the four weeks ended Oct. 3, compared to a year earlier.
The government also said supplies of crude in the United States grew by 8.1 million barrels last week, an indicator that oil use is dropping.
Meanwhile the International Energy Agency, citing financial turmoil, slashed global demand growth forecasts for 2008 and 2009 to 0.5% and 0.8% respectively.
In the U.S., falling demand helped drive gas prices down from a national average of $4.114 a gallon in mid-July, according to motorist group AAA. Over that same period, crude oil prices have also fallen more than 40% from an all-time high of $147.27 a barrel.
By Friday, gas was selling at an average of $3.35 a gallon, AAA reported.
OPEC response: The rapid decline in crude prices has sent officials from the Organization of Petroleum Exporting Countries into crisis mode.
The organization that manages oil prices and production levels for major international oil producers, such as Saudi Arabia and Venezuela, called Thursday for an "extraordinary" meeting to be held Nov. 18 in Vienna to deal with the economic crisis's impact on crude prices.
Analysts believe the cartel intends to cut production in order to keep prices from plummeting. But unless they cut production dramatically, "the power of the global recession is going to greatly supercede what they can do," Orr said.
U.S. crude for November delivery sank as much as $9.50 to a low of $77.09 a barrel during Friday trading, its lowest level since Sept. 11, 2007, when crude hit an intraday low of $77.00.
Prices later recovered slightly to settle down $8.89 to $77.70 a barrel in New York, oil's lowest close since Sept. 10, 2007, when crude ended the day at $77.49.
Friday's plunge was the third largest dollar amount on record following a fall of $10.56 on Jan. 17, 1991, prompted by the launch of Operation Desert Storm, and $10.56 just over a week ago on Sept. 29 after the House made its first attempt to pass the $700 billion bailout plan to shore up the economy.
Investors remain concerned that a crumbling economy is causing businesses and consumers to cut back on fuel consumption.
During Friday trading the Dow Jones industrial average lost nearly 700 points before recovering to add about 150 points, or about 1.7%.
If oil ends the day below $80 a barrel, crude prices could slide even further in the coming weeks, according to James Cordier, founder of OptionSellers.com in Florida.
"People have to remember oil used to trade for the longest time at $35 to $40 a barrel," said Cordier, referring to prices not seen since 2004. "The consumption that we saw back then, we could see it again."
Worries about the economy have weighed heavily on the world markets this week. Stocks and commodities have all fallen in the United States since Monday as the euro sank to fresh lows against the dollar, and U.S. treasury bonds, often considered a safe haven in times of economic strife, were extremely volatile.
As the world economy weakens and money becomes tight, energy expenditures are often among the first to be cut, according to analysts.
"Factories are closing, jets are on the ground, a lot of the expansion in China and India are probably going to be curtailed," said Cordier.
In an effort to encourage banks to loosen their lending practices and get cash flowing again, the Federal Reserve and central banks in Europe simultaneously cut interest rates this week, on top of a host of other measures.
As energy prices fall, oil and natural gas companies will likely be forced to cut back production, according to Tom Orr, head of research with Weeden & Co. in Connecticut.
"Production starts to become un-economic because costs are rising," Orr said. "They just don't have any access to liquidity."
Falling demand: As the economic crisis worsened, the Energy Department registered a sharp drop in demand for gasoline.
On Wednesday the government reported a 5.3% decline in demand for motor gasoline over the four weeks ended Oct. 3, compared to a year earlier.
The government also said supplies of crude in the United States grew by 8.1 million barrels last week, an indicator that oil use is dropping.
Meanwhile the International Energy Agency, citing financial turmoil, slashed global demand growth forecasts for 2008 and 2009 to 0.5% and 0.8% respectively.
In the U.S., falling demand helped drive gas prices down from a national average of $4.114 a gallon in mid-July, according to motorist group AAA. Over that same period, crude oil prices have also fallen more than 40% from an all-time high of $147.27 a barrel.
By Friday, gas was selling at an average of $3.35 a gallon, AAA reported.
OPEC response: The rapid decline in crude prices has sent officials from the Organization of Petroleum Exporting Countries into crisis mode.
The organization that manages oil prices and production levels for major international oil producers, such as Saudi Arabia and Venezuela, called Thursday for an "extraordinary" meeting to be held Nov. 18 in Vienna to deal with the economic crisis's impact on crude prices.
Analysts believe the cartel intends to cut production in order to keep prices from plummeting. But unless they cut production dramatically, "the power of the global recession is going to greatly supercede what they can do," Orr said.
GE under siege
When Warren Buffett went to bed at his Omaha home on the evening of Tuesday, Sept. 30, he asked his wife, Astrid, to wake him in the morning at 6:55 a.m. He had an important call coming in. By 7:30 the call was over. Buffett walked into the kitchen, still wearing an old robe he likes, and announced to a breakfast visitor that he had agreed to send General Electric $3 billion of Berkshire Hathaway money in return for a new issue of preferred stock and warrants allowing Berkshire to buy an equal amount of common stock over the next five years.
It was the beginning of one of the more dramatic days in GE's 130-year history.
The deal was done, but the news wasn't yet out, and in the meantime GE's world was deteriorating fast. By 9:14 Eastern time, a GE spokesman had e-mailed the media with a message that Congress must act "urgently" on the pending financial bailout package. By 11 an analyst at Deutsche Bank had announced that he was sharply cutting his forecast for GE's 2008 profits - though only three months remained in 2008 - and the stock dropped 9% almost immediately. By 11:23 the price of credit default swaps - lenders' insurance - on the bonds of GE Capital had rocketed: The market was saying that the bonds of this great and storied company, one of only six corporations on planet Earth with a triple-A credit rating, were junk.
Finally, at 1:44 p.m., GE (GE, Fortune 500) announced its deal with Buffett and said it would sell $12 billion of common stock to the public the following day. The statement contained an important sentence from Buffett: "I am confident that GE will continue to be successful in the years to come." GE stock edged up - though by day's end it was still way down since the start of the year.
So here's what had just happened: General Electric had arranged to raise $15 billion on a few days' notice. For perspective, remember that in March, Visa had culminated months of preparation by staging the largest stock offering ever, raising $18 billion. In other words, GE needed a sudden, huge, and utterly unexpected emergency infusion of cash. Only six days before, when a Wall Street analyst had asked GE chief Jeff Immelt about the possibility of the company's selling new equity, Immelt had answered unequivocally: "We just don't see it right now. We feel very secure about how the funding looks."
The idea that GE might ever be desperate for cash would have seemed ludicrous a year ago and looked unworthy of concern even this past summer. After all, this is history's most famously well-managed company. But now the stock trades for less than half its price 12 months ago. More than $200 billion of value has vaporized.
In its most recent earnings announcement, on Oct. 10, GE said profits fell 22% in the third quarter, driven down by a 38% drop in earnings from financial services; profits there should continue to decline, the company said. GE remains highly profitable; analysts expect it to earn about $20 billion this year, but that's 10% less than last year, a sharp change from earlier forecasts of robust growth. And for the first time in memory, investors are pricing GE at a level that indicates that they expect it to shrink rather than grow, a surreal situation.
text
Managing this crisis is certainly the sternest test Immelt has faced in his seven years as chief, and it may well become the episode that defines his legacy. Says Tom Priore, who runs the credit hedge fund ICP Structured Investments: "If you thought AIG was important, GE is many times a multiple of AIG." And now GE's future, like the economy's, looks as if it could tip either way.
The source of GE's strength - and its problems
To see how GE got so badly beaten up, consider first what the company really is. Its strength and curse is that it looks a lot like the economy. Over the decades GE's well-known manufacturing businesses - jet engines, locomotives, appliances, light bulbs have shrunk as a proportion of the total. Like America, GE has long been mainly in the business of services. The most important and profitable services it offers are financial. In fact, though the average citizen probably thinks of GE as a great industrial company, its industry classification in the Fortune 500 is diversified financials. It is by far the largest company in that industry group. The next biggest - and here we begin to glimpse GE's troubles - are Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500).
The reality is that for years, about half of GE's prodigious profits have come from General Electric Capital, a 100%-owned affiliate that files its own reports with the SEC. GE Capital, headed by 29-year GE veteran Michael Neal, has ventured into practically every kind of financial service, from making car loans in Europe to investing in commercial real estate in Florida. If you have a credit card from Wal-Mart or Lowe's, it's really from GE Capital. The business owns almost 1,800 commercial airplanes and leases them to 225 airlines. Until last year it made subprime mortgages in the U.S.
But GE Capital is more than just a major profit contributor to GE. The relationship is symbiotic. GE Capital helps GE by financing the customers that buy GE power turbines, jet engines, windmills, locomotives, and other products, offering low interest rates that competitors can't match. In the other direction, GE helps GE Capital by furnishing the reliable earnings and tangible assets that enable the whole company to maintain that triple-A credit rating, which is overwhelmingly important to GE's success. Company managers call it "sacred" and the "gold standard." Immelt says it's "incredibly important."
That rating lets GE Capital borrow funds in world markets at lower cost than any pure financial company. For example, Morgan Stanley's cost of capital is about 10.6% (as calculated by the EVA Advisers consulting firm). Citigroup's is about 8.4%. Even Buffett's Berkshire Hathaway (BRKA, Fortune 500) has a capital cost of about 8%. But GE's cost is only 7.3%, and in businesses where hundredths of a percentage point make a big difference, that's an enormously valuable advantage. And thanks to the earnings strength of GE's industrial side, GE Capital can maintain its rating without holding much capital on its balance sheet.
GE Capital also performs another critical function: It helps GE manage earnings. Though earnings management is a no-no among good-governance types, the company has never denied doing it, and GE Capital is the perfect mechanism. Since financial assets are, under normal conditions, far more liquid than tangible assets, the company can buy or sell them in the final days of a quarter so that reported earnings rise with comforting smoothness, right in line with Wall Street expectations. Investors happily pay extra for companies whose profits rise steadily rather than erratically, so this function is valuable. Michael Lewitt, president of the hedge fund Harch Capital Management, says GE Capital "has become such a necessary part of GE's legendary earnings results that General Electric could not perform as well or consistently if anything happened to it."
The good times
For GE Capital, the business world from 2002 to 2006 was a nearly perfect environment. Executives Gary Wendt and Denis Nayden had aggressively globalized the business, and now all the major economies (and most of the minor ones) were growing simultaneously at healthy clips, an unprecedented occurrence. Interest rates were low. Every kind of asset seemed to be appreciating. For a big finance operation with low funding costs, opportunity was everywhere. During that period GE Capital levered up, growing its ratio of debt to equity from 6.6 to 8.1. Profits quadrupled to almost $11 billion, more than the profits of Procter & Gamble or Goldman Sachs.
Good times never last forever, but GE is known for seeing changes ahead of time - recognizing early, for example, that it had to go "green" - and responding to them faster and more creatively than the competition. Last year, however, signs began turning up that this admirable pattern wasn't holding at GE Capital. For example, the company had left the home mortgage business in 2000 but reentered it in 2004 when it was flying high, buying a subprime lender called WMC Mortgage from a private equity firm (the price was never announced). Home prices peaked in June 2006, yet it wasn't until a year later, with the subprime crisis on the front page of every newspaper, that GE Capital finally decided to bail out. WMC lost almost $1 billion in 2007 before GE dumped it in December. A Japanese consumer-lending company called Lake was another lousy business, but GE Capital again didn't face the music until it was too late. GE took a $1.2 billion loss on it last year after deciding in September to sell it - but by then consumer credit was deteriorating so fast that unloading it (to Shinsei Bank) took another year.
This emerging pattern of confronting problems only after they could no longer be fixed was disturbing, but Immelt remained confident in GE Capital coming into this year. Despite its stumbles, GE has a long history of strict financial discipline. Immelt told shareholders in February, and repeated to employees recently, that GE had no exposure to collateralized debt obligations (CDOs) or structured investment vehicles (SIVs). It uses derivatives for hedging, which is relatively safe, but prohibits speculating in them, which is dangerous. It subjects its financial positions to shock tests - for example, assuming that interest rates rise a full percentage point across the board and stay there for a year; if that happened in 2008, Immelt said at the beginning of the year, GE's positions were so well hedged that the effect on profits would be negligible. His upbeat conclusion in February: "Our financial businesses should do well in a year like 2008."
That was more than just talk. In late 2007 and early 2008, Immelt spent about $10 million of his own money buying GE stock at prices in the middle to upper 30s.
'Get a gun out'
Evidence that such optimism wasn't justified - and a hint of much bigger problems to come - finally arrived with a bang in April. That's when GE announced that first-quarter profits had fallen short of Wall Street's expectations by $700 million, a mammoth miss that by GE standards is historic. It's what prompted former CEO Jack Welch to rant on CNBC that he'd "get a gun out and shoot [Immelt] if he doesn't make what he promised now" for following quarters.
Making matters worse, Immelt had assured investors only 18 days before the quarter's end that everything was on track. GE's just-released annual report was titled "Invest and Deliver," significant because inside GE "deliver" is a special word. You deliver on commitments - always. As Welch said on CNBC, "Just deliver the earnings. Tell them you're going to grow 12% and deliver 12%."
So Immelt committed the ultimate GE sin and failed to deliver. How come? That's easy. He reassured investors on March 13, and the quarter ended on March 31. But something unimagined happened in between: Bear Stearns failed, causing credit markets nationwide to freeze up. GE had been counting on GE Capital to do its usual end-of-quarter rescue act, but this time it couldn't.
Result? Uproar and a further slide in the stock. Investors felt betrayed and disillusioned. Analyst Nicholas Heymann of Sterne Agee spoke for many when he wrote: "Investors now understand that GE uses the last couple weeks in the quarter to 'fine-tune' its financial service portfolios to ensure its earnings objectives are achieved. It turns out it really wasn't miracle management systems or risk-control systems or even innovative brilliance. It was the green curtain that allowed the magic to be consistently performed undetected."
It was the beginning of one of the more dramatic days in GE's 130-year history.
The deal was done, but the news wasn't yet out, and in the meantime GE's world was deteriorating fast. By 9:14 Eastern time, a GE spokesman had e-mailed the media with a message that Congress must act "urgently" on the pending financial bailout package. By 11 an analyst at Deutsche Bank had announced that he was sharply cutting his forecast for GE's 2008 profits - though only three months remained in 2008 - and the stock dropped 9% almost immediately. By 11:23 the price of credit default swaps - lenders' insurance - on the bonds of GE Capital had rocketed: The market was saying that the bonds of this great and storied company, one of only six corporations on planet Earth with a triple-A credit rating, were junk.
Finally, at 1:44 p.m., GE (GE, Fortune 500) announced its deal with Buffett and said it would sell $12 billion of common stock to the public the following day. The statement contained an important sentence from Buffett: "I am confident that GE will continue to be successful in the years to come." GE stock edged up - though by day's end it was still way down since the start of the year.
So here's what had just happened: General Electric had arranged to raise $15 billion on a few days' notice. For perspective, remember that in March, Visa had culminated months of preparation by staging the largest stock offering ever, raising $18 billion. In other words, GE needed a sudden, huge, and utterly unexpected emergency infusion of cash. Only six days before, when a Wall Street analyst had asked GE chief Jeff Immelt about the possibility of the company's selling new equity, Immelt had answered unequivocally: "We just don't see it right now. We feel very secure about how the funding looks."
The idea that GE might ever be desperate for cash would have seemed ludicrous a year ago and looked unworthy of concern even this past summer. After all, this is history's most famously well-managed company. But now the stock trades for less than half its price 12 months ago. More than $200 billion of value has vaporized.
In its most recent earnings announcement, on Oct. 10, GE said profits fell 22% in the third quarter, driven down by a 38% drop in earnings from financial services; profits there should continue to decline, the company said. GE remains highly profitable; analysts expect it to earn about $20 billion this year, but that's 10% less than last year, a sharp change from earlier forecasts of robust growth. And for the first time in memory, investors are pricing GE at a level that indicates that they expect it to shrink rather than grow, a surreal situation.
text
Managing this crisis is certainly the sternest test Immelt has faced in his seven years as chief, and it may well become the episode that defines his legacy. Says Tom Priore, who runs the credit hedge fund ICP Structured Investments: "If you thought AIG was important, GE is many times a multiple of AIG." And now GE's future, like the economy's, looks as if it could tip either way.
The source of GE's strength - and its problems
To see how GE got so badly beaten up, consider first what the company really is. Its strength and curse is that it looks a lot like the economy. Over the decades GE's well-known manufacturing businesses - jet engines, locomotives, appliances, light bulbs have shrunk as a proportion of the total. Like America, GE has long been mainly in the business of services. The most important and profitable services it offers are financial. In fact, though the average citizen probably thinks of GE as a great industrial company, its industry classification in the Fortune 500 is diversified financials. It is by far the largest company in that industry group. The next biggest - and here we begin to glimpse GE's troubles - are Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500).
The reality is that for years, about half of GE's prodigious profits have come from General Electric Capital, a 100%-owned affiliate that files its own reports with the SEC. GE Capital, headed by 29-year GE veteran Michael Neal, has ventured into practically every kind of financial service, from making car loans in Europe to investing in commercial real estate in Florida. If you have a credit card from Wal-Mart or Lowe's, it's really from GE Capital. The business owns almost 1,800 commercial airplanes and leases them to 225 airlines. Until last year it made subprime mortgages in the U.S.
But GE Capital is more than just a major profit contributor to GE. The relationship is symbiotic. GE Capital helps GE by financing the customers that buy GE power turbines, jet engines, windmills, locomotives, and other products, offering low interest rates that competitors can't match. In the other direction, GE helps GE Capital by furnishing the reliable earnings and tangible assets that enable the whole company to maintain that triple-A credit rating, which is overwhelmingly important to GE's success. Company managers call it "sacred" and the "gold standard." Immelt says it's "incredibly important."
That rating lets GE Capital borrow funds in world markets at lower cost than any pure financial company. For example, Morgan Stanley's cost of capital is about 10.6% (as calculated by the EVA Advisers consulting firm). Citigroup's is about 8.4%. Even Buffett's Berkshire Hathaway (BRKA, Fortune 500) has a capital cost of about 8%. But GE's cost is only 7.3%, and in businesses where hundredths of a percentage point make a big difference, that's an enormously valuable advantage. And thanks to the earnings strength of GE's industrial side, GE Capital can maintain its rating without holding much capital on its balance sheet.
GE Capital also performs another critical function: It helps GE manage earnings. Though earnings management is a no-no among good-governance types, the company has never denied doing it, and GE Capital is the perfect mechanism. Since financial assets are, under normal conditions, far more liquid than tangible assets, the company can buy or sell them in the final days of a quarter so that reported earnings rise with comforting smoothness, right in line with Wall Street expectations. Investors happily pay extra for companies whose profits rise steadily rather than erratically, so this function is valuable. Michael Lewitt, president of the hedge fund Harch Capital Management, says GE Capital "has become such a necessary part of GE's legendary earnings results that General Electric could not perform as well or consistently if anything happened to it."
The good times
For GE Capital, the business world from 2002 to 2006 was a nearly perfect environment. Executives Gary Wendt and Denis Nayden had aggressively globalized the business, and now all the major economies (and most of the minor ones) were growing simultaneously at healthy clips, an unprecedented occurrence. Interest rates were low. Every kind of asset seemed to be appreciating. For a big finance operation with low funding costs, opportunity was everywhere. During that period GE Capital levered up, growing its ratio of debt to equity from 6.6 to 8.1. Profits quadrupled to almost $11 billion, more than the profits of Procter & Gamble or Goldman Sachs.
Good times never last forever, but GE is known for seeing changes ahead of time - recognizing early, for example, that it had to go "green" - and responding to them faster and more creatively than the competition. Last year, however, signs began turning up that this admirable pattern wasn't holding at GE Capital. For example, the company had left the home mortgage business in 2000 but reentered it in 2004 when it was flying high, buying a subprime lender called WMC Mortgage from a private equity firm (the price was never announced). Home prices peaked in June 2006, yet it wasn't until a year later, with the subprime crisis on the front page of every newspaper, that GE Capital finally decided to bail out. WMC lost almost $1 billion in 2007 before GE dumped it in December. A Japanese consumer-lending company called Lake was another lousy business, but GE Capital again didn't face the music until it was too late. GE took a $1.2 billion loss on it last year after deciding in September to sell it - but by then consumer credit was deteriorating so fast that unloading it (to Shinsei Bank) took another year.
This emerging pattern of confronting problems only after they could no longer be fixed was disturbing, but Immelt remained confident in GE Capital coming into this year. Despite its stumbles, GE has a long history of strict financial discipline. Immelt told shareholders in February, and repeated to employees recently, that GE had no exposure to collateralized debt obligations (CDOs) or structured investment vehicles (SIVs). It uses derivatives for hedging, which is relatively safe, but prohibits speculating in them, which is dangerous. It subjects its financial positions to shock tests - for example, assuming that interest rates rise a full percentage point across the board and stay there for a year; if that happened in 2008, Immelt said at the beginning of the year, GE's positions were so well hedged that the effect on profits would be negligible. His upbeat conclusion in February: "Our financial businesses should do well in a year like 2008."
That was more than just talk. In late 2007 and early 2008, Immelt spent about $10 million of his own money buying GE stock at prices in the middle to upper 30s.
'Get a gun out'
Evidence that such optimism wasn't justified - and a hint of much bigger problems to come - finally arrived with a bang in April. That's when GE announced that first-quarter profits had fallen short of Wall Street's expectations by $700 million, a mammoth miss that by GE standards is historic. It's what prompted former CEO Jack Welch to rant on CNBC that he'd "get a gun out and shoot [Immelt] if he doesn't make what he promised now" for following quarters.
Making matters worse, Immelt had assured investors only 18 days before the quarter's end that everything was on track. GE's just-released annual report was titled "Invest and Deliver," significant because inside GE "deliver" is a special word. You deliver on commitments - always. As Welch said on CNBC, "Just deliver the earnings. Tell them you're going to grow 12% and deliver 12%."
So Immelt committed the ultimate GE sin and failed to deliver. How come? That's easy. He reassured investors on March 13, and the quarter ended on March 31. But something unimagined happened in between: Bear Stearns failed, causing credit markets nationwide to freeze up. GE had been counting on GE Capital to do its usual end-of-quarter rescue act, but this time it couldn't.
Result? Uproar and a further slide in the stock. Investors felt betrayed and disillusioned. Analyst Nicholas Heymann of Sterne Agee spoke for many when he wrote: "Investors now understand that GE uses the last couple weeks in the quarter to 'fine-tune' its financial service portfolios to ensure its earnings objectives are achieved. It turns out it really wasn't miracle management systems or risk-control systems or even innovative brilliance. It was the green curtain that allowed the magic to be consistently performed undetected."
Wednesday, October 8, 2008
World markets return to selloff
Global markets turned sharply lower Wednesday, despite emergency action by global central banks that had initially calmed skittish investors.
Stock markets worldwide had briefly recovered after the United States, Canada, England, the European Union, Sweden and Switzerland announced coordinated interest-rate cuts at 7 a.m. ET.
But sentiment turned, and investors sent stocks falling way down to the low levels seen in the hours before the joint cut was issued.
In Germany, a leading stock index had been trading flat just after the announcement, but fell 4.5% later on.
Stocks in Paris were down just 3.9%, after having been down just 0.2%.
Stocks in London were down 3.7% after rising slightly.
U.S. stock futures were mixed just before the market open after all pointing to a much higher open at 7:30 a.m.
Markets in Asia were already closed by the time the central banks moved. Investors in Japan suffered one of their worst days ever, with the Nikkei down more than 9%. Hong Kong's Hang Seng index plunged 8.2%, even as the Hong Kong Monetary Authority announced it would lower interest rates a full percentage point starting Thursday.
A Russian stock exchange was shut down after a huge decline at the open.
European governments step in
Three European central banks announced that they were pumping more money into the system to keep banks going.
The most dramatic move was in Great Britain, where the Treasury announced a plan to inject billions of dollars into the banking system.
British Finance Minister Alistair Darling announced the program shortly before markets opened in Britain.
"This is a major step," Darling told CNN affiliate ITN. "Never before have we been in a position where the government is actually saying to banks, 'You've agreed with us that you're going to raise more capital. If you can't do it in the normal way on the markets, we'll actually provide the funds to enable you to do that.'"
The goal of the effort, carried out in consultation with the nation's central bank and regulators, was to provide immediate relief and free up lending.
"In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity," according to a British government statement. "In its provision of short term liquidity the [central] bank will extend and widen its facilities in whatever way is necessary to ensure the stability of the system."
Under the British plan, the largest banks have agreed to increase their capital by $43.7 billion and the government "stands ready" to provide $43.7 billion if necessary.
Among the banks participating in the program are global financial leaders Barclays, HBOS and Royal Bank of Scotland.
The government also said it is increasing the amount of long-term funding it is providing to banks under a special liquidity plan announced in April. Since then, the British government has made more than $176 billion available to banks. Darling said that amount will now be increased to at least $350 billion.
"This is not a time for conventional thinking or outdated dogma, but for the fresh and innovative intervention that gets to the heart of the problem," British Prime Minister Gordon Brown said.
Brown and Darling said the plan would ensure the flow of money between banks and their customers. They said it would "unjam" any potential freeze by lenders jittery about global markets and liquidity.
Separately, the European Central Bank, the Bank of England and the Swiss National Bank offered $90 billion in overnight money to the financial sector, the Associated Press reported. The ECB offered up $70 billion, while the BoE and the Swiss bank each offered $10 billion
Stock markets worldwide had briefly recovered after the United States, Canada, England, the European Union, Sweden and Switzerland announced coordinated interest-rate cuts at 7 a.m. ET.
But sentiment turned, and investors sent stocks falling way down to the low levels seen in the hours before the joint cut was issued.
In Germany, a leading stock index had been trading flat just after the announcement, but fell 4.5% later on.
Stocks in Paris were down just 3.9%, after having been down just 0.2%.
Stocks in London were down 3.7% after rising slightly.
U.S. stock futures were mixed just before the market open after all pointing to a much higher open at 7:30 a.m.
Markets in Asia were already closed by the time the central banks moved. Investors in Japan suffered one of their worst days ever, with the Nikkei down more than 9%. Hong Kong's Hang Seng index plunged 8.2%, even as the Hong Kong Monetary Authority announced it would lower interest rates a full percentage point starting Thursday.
A Russian stock exchange was shut down after a huge decline at the open.
European governments step in
Three European central banks announced that they were pumping more money into the system to keep banks going.
The most dramatic move was in Great Britain, where the Treasury announced a plan to inject billions of dollars into the banking system.
British Finance Minister Alistair Darling announced the program shortly before markets opened in Britain.
"This is a major step," Darling told CNN affiliate ITN. "Never before have we been in a position where the government is actually saying to banks, 'You've agreed with us that you're going to raise more capital. If you can't do it in the normal way on the markets, we'll actually provide the funds to enable you to do that.'"
The goal of the effort, carried out in consultation with the nation's central bank and regulators, was to provide immediate relief and free up lending.
"In these extraordinary market conditions, the Bank of England will take all actions necessary to ensure that the banking system has access to sufficient liquidity," according to a British government statement. "In its provision of short term liquidity the [central] bank will extend and widen its facilities in whatever way is necessary to ensure the stability of the system."
Under the British plan, the largest banks have agreed to increase their capital by $43.7 billion and the government "stands ready" to provide $43.7 billion if necessary.
Among the banks participating in the program are global financial leaders Barclays, HBOS and Royal Bank of Scotland.
The government also said it is increasing the amount of long-term funding it is providing to banks under a special liquidity plan announced in April. Since then, the British government has made more than $176 billion available to banks. Darling said that amount will now be increased to at least $350 billion.
"This is not a time for conventional thinking or outdated dogma, but for the fresh and innovative intervention that gets to the heart of the problem," British Prime Minister Gordon Brown said.
Brown and Darling said the plan would ensure the flow of money between banks and their customers. They said it would "unjam" any potential freeze by lenders jittery about global markets and liquidity.
Separately, the European Central Bank, the Bank of England and the Swiss National Bank offered $90 billion in overnight money to the financial sector, the Associated Press reported. The ECB offered up $70 billion, while the BoE and the Swiss bank each offered $10 billion
Rate cut gives dollar a ride
The dollar was mostly lower against global currencies Wednesday after nations around the globe issued emergency interest rate cuts.
In a move to boost economic growth in the midst of a worsening global financial crisis, the Federal Reserve lowered its fed funds rate by half of a percentage point to 1.5%.
The Fed's move was part of a coordinated effort to lower rates by the central banks of the United States, Canada, England, the European Union, Sweden and Switzerland. The enactment was announced at 7 a.m. ET.
Investors at first cheered the move, taking out the funds they have been storing in dollar trading since July as a safe haven, and putting them in stocks. Foreign stock indexes recovered, oil prices rose, and U.S. stock futures soared immediately after the announcement.
But about an hour after the news, stocks and oil both fell sharply, as investors' mood changed. They put their funds back into the perceived safety of the dollar.
"The outlook is bad," said Tom Benfer, foreign exchange vice president at the Bank of Montreal. "There is a fair amount of doubt in the marketplace that this is going to work."
Risk aversion hurts European currencies
The euro bought $1.3635, up 0.3% from Tuesday's close of $1.3589. The 15-nation euro was as much as 1.1% higher after the announcement before selling off.
The British pound traded at $1.7434, down 0.1% from Tuesday's $1.7456. The U.K. currency traded up as much as 1.2% after the banks' joint rate cut.
With an ever-worsening economic situation in Europe, investors have been selling off pounds and euros and buying up U.S. dollars. Just two days ago, the euro traded at a 14-month low, and the pound hit a more than 2-year low.
"The dollar has been trading up since July broadly on increasing risk aversion," said Dustin Reid, senior currency strategist at ABN AMRO. "The dollar has seen a lot of safe haven flows recently."
Traders tend to think that the U.S. economy will bounce back before those in Europe because of the U.S. government's recovery efforts.
"We got the ball rolling earlier than the other countries," said Benfer. "Even now there's disagreement in Europe about how to proceed."
Yen boosted by fear factor
On the other hand, the dollar continued its enormous plunge against the Japanese yen. The dollar fell 1.1% against the yen to ¥100.34 from ¥101.47 the day before. Monday, the dollar suffered an historic collapse, falling by as much as 4.8% - the biggest one-day drop ever. The dollar fell another 0.6% Tuesday.
The yen typically increases when investors show aversion to risk.
"When you make capital and money cheaper, it's a good step theoretically," said Benfer of the rate cuts. "But we all know if the credit markets still won't lend money out, we'll be stuck in the same situation for a long time."
Benfer said that if the dollar starts to sink below ¥100, which it did momentarily Wednesday, the stock markets could remain in their recent funk.
In a move to boost economic growth in the midst of a worsening global financial crisis, the Federal Reserve lowered its fed funds rate by half of a percentage point to 1.5%.
The Fed's move was part of a coordinated effort to lower rates by the central banks of the United States, Canada, England, the European Union, Sweden and Switzerland. The enactment was announced at 7 a.m. ET.
Investors at first cheered the move, taking out the funds they have been storing in dollar trading since July as a safe haven, and putting them in stocks. Foreign stock indexes recovered, oil prices rose, and U.S. stock futures soared immediately after the announcement.
But about an hour after the news, stocks and oil both fell sharply, as investors' mood changed. They put their funds back into the perceived safety of the dollar.
"The outlook is bad," said Tom Benfer, foreign exchange vice president at the Bank of Montreal. "There is a fair amount of doubt in the marketplace that this is going to work."
Risk aversion hurts European currencies
The euro bought $1.3635, up 0.3% from Tuesday's close of $1.3589. The 15-nation euro was as much as 1.1% higher after the announcement before selling off.
The British pound traded at $1.7434, down 0.1% from Tuesday's $1.7456. The U.K. currency traded up as much as 1.2% after the banks' joint rate cut.
With an ever-worsening economic situation in Europe, investors have been selling off pounds and euros and buying up U.S. dollars. Just two days ago, the euro traded at a 14-month low, and the pound hit a more than 2-year low.
"The dollar has been trading up since July broadly on increasing risk aversion," said Dustin Reid, senior currency strategist at ABN AMRO. "The dollar has seen a lot of safe haven flows recently."
Traders tend to think that the U.S. economy will bounce back before those in Europe because of the U.S. government's recovery efforts.
"We got the ball rolling earlier than the other countries," said Benfer. "Even now there's disagreement in Europe about how to proceed."
Yen boosted by fear factor
On the other hand, the dollar continued its enormous plunge against the Japanese yen. The dollar fell 1.1% against the yen to ¥100.34 from ¥101.47 the day before. Monday, the dollar suffered an historic collapse, falling by as much as 4.8% - the biggest one-day drop ever. The dollar fell another 0.6% Tuesday.
The yen typically increases when investors show aversion to risk.
"When you make capital and money cheaper, it's a good step theoretically," said Benfer of the rate cuts. "But we all know if the credit markets still won't lend money out, we'll be stuck in the same situation for a long time."
Benfer said that if the dollar starts to sink below ¥100, which it did momentarily Wednesday, the stock markets could remain in their recent funk.
Tuesday, October 7, 2008
Business loan bailout
The Federal Reserve announced a new program to help the battered market for short-term business loans - taking its closest step yet to lending directly to businesses.
The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations.
Commercial paper is sold by major corporations and most of the nation's leading financial institutions. They use the proceeds to fund day-to-day business operations. It is bought primarily by money market fund managers and other institutional investors.
Before the current credit crisis, there was nearly $2 trillion of commercial paper outstanding and was mostly issued for short terms - never more than nine months - and thus had to be renewed frequently.
For investors, it was considered a very safe investment to purchase and one that could be easily resold to other investors.
In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to a seasonally adjusted $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10.
The decline in available funding indicates only part of the market's problems, however. Investors have also become unwilling to buy longer-term paper - beyond a week or two - from even companies and financial institutions with top-flight credit ratings.
Federal Reserve officials speaking on background to reporters said that the overwhelming majority of the paper outstanding is coming up for renewal in the next several days and companies needing to use the money could face trouble when they try to renew it.
Experts in the field say the market really fell apart after Lehman Brothers, the nation's No. 4 Wall Street firm at the time, filed for bankruptcy on Sept. 15. The firm's collapse essentially wiped out the value of its commercial paper and scared money market managers out of the commercial paper market and into Treasurys.
Federal Reserve officials say they hope that the Fed's entry into the market will give money markets and other investors confidence to reenter the market because they know they will be able to sell that paper to the Fed as a backstop. So they hope the central bank will not have to actually buy much of the commercial paper in order to restore confidence in the market.
Fed officials said there is no limit to the amount of commercial paper it could buy. They said that market conditions - and the decisions of investors - will determine the extent to which the government will have to step in.
Many of the details of the program, including when it will be open for business, had not yet been settled as of Tuesday's announcement.
The Fed will buy only top-rated commercial paper, of which there was about $1.3 trillion outstanding in August. About $100 billion of that was in the form of unsecured loans to non-financial firms, and about $600 billion was to financial firms. The other approximately $600 billion is backed by assets at the firms issuing the paper, although that is generally considered unsecured lending as well.
Much of the commercial paper outstanding at the start of the credit crisis is now coming up for renewal, As a result, fears have grown that the market could drop even more sharply without some drastic improvement in the market.
Under the program announced Tuesday morning, the Fed will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The program is slated to expire in April 2009 and will have financial support from taxpayers.
"The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility," said the Fed's statement.
The new program comes as the Treasury Department scrambles to put in place a $700 billion bailout of the financial system enacted on Friday. Under that program, the Treasury is expected to purchase troubled assets from banks and financial institutions in an effort to spur more lending.
The program addresses commercial paper, a form of short-term funding that is crucial to many businesses operations.
Commercial paper is sold by major corporations and most of the nation's leading financial institutions. They use the proceeds to fund day-to-day business operations. It is bought primarily by money market fund managers and other institutional investors.
Before the current credit crisis, there was nearly $2 trillion of commercial paper outstanding and was mostly issued for short terms - never more than nine months - and thus had to be renewed frequently.
For investors, it was considered a very safe investment to purchase and one that could be easily resold to other investors.
In the past month, the amount of money outstanding in commercial paper loans has fallen 11% to a seasonally adjusted $1.6 trillion on Oct. 1 from $1.82 trillion on Sept. 10.
The decline in available funding indicates only part of the market's problems, however. Investors have also become unwilling to buy longer-term paper - beyond a week or two - from even companies and financial institutions with top-flight credit ratings.
Federal Reserve officials speaking on background to reporters said that the overwhelming majority of the paper outstanding is coming up for renewal in the next several days and companies needing to use the money could face trouble when they try to renew it.
Experts in the field say the market really fell apart after Lehman Brothers, the nation's No. 4 Wall Street firm at the time, filed for bankruptcy on Sept. 15. The firm's collapse essentially wiped out the value of its commercial paper and scared money market managers out of the commercial paper market and into Treasurys.
Federal Reserve officials say they hope that the Fed's entry into the market will give money markets and other investors confidence to reenter the market because they know they will be able to sell that paper to the Fed as a backstop. So they hope the central bank will not have to actually buy much of the commercial paper in order to restore confidence in the market.
Fed officials said there is no limit to the amount of commercial paper it could buy. They said that market conditions - and the decisions of investors - will determine the extent to which the government will have to step in.
Many of the details of the program, including when it will be open for business, had not yet been settled as of Tuesday's announcement.
The Fed will buy only top-rated commercial paper, of which there was about $1.3 trillion outstanding in August. About $100 billion of that was in the form of unsecured loans to non-financial firms, and about $600 billion was to financial firms. The other approximately $600 billion is backed by assets at the firms issuing the paper, although that is generally considered unsecured lending as well.
Much of the commercial paper outstanding at the start of the credit crisis is now coming up for renewal, As a result, fears have grown that the market could drop even more sharply without some drastic improvement in the market.
Under the program announced Tuesday morning, the Fed will purchase three-month unsecured and asset-backed commercial paper directly from eligible issuers. The program is slated to expire in April 2009 and will have financial support from taxpayers.
"The Treasury believes this facility is necessary to prevent substantial disruptions to the financial markets and the economy and will make a special deposit at the Federal Reserve Bank of New York in support of this facility," said the Fed's statement.
The new program comes as the Treasury Department scrambles to put in place a $700 billion bailout of the financial system enacted on Friday. Under that program, the Treasury is expected to purchase troubled assets from banks and financial institutions in an effort to spur more lending.
Pensions lose $2 trillion
The top congressional budget analyst says pension plans have lost as much as $2 trillion in the past 15 months.
Peter Orszag told a House panel on Tuesday that the losses are likely to force many workers to hold off on major purchases and delay their retirements.
The panel was investigating how the housing, credit and financial troubles battering the economy have affected retirement savings.
More than half the people surveyed in a recent Associated Press-GfK poll said they worry that they will have to work longer because the value of their retirement savings has declined.
Peter Orszag told a House panel on Tuesday that the losses are likely to force many workers to hold off on major purchases and delay their retirements.
The panel was investigating how the housing, credit and financial troubles battering the economy have affected retirement savings.
More than half the people surveyed in a recent Associated Press-GfK poll said they worry that they will have to work longer because the value of their retirement savings has declined.
Monday, October 6, 2008
eBay to trim global workforce by 10%
The world's largest auction Web site, eBay Inc., announced Monday that it will cut 10% of its global workforce, or about 1,000 employees, citing efforts to streamline its business.
Separately, eBay announced its was acquiring the online payment business Bill Me Later for about $820 million and $125 million in outstanding options, as well as Denmark's leading online classifieds site dba.dk for about $390 million in cash.
The job cuts, which will also affect several hundred temporary workers, are expected to result in pretax restructuring charges of approximately $70 million to $80 million, with the charges predominantly recorded in the fourth quarter of 2008, eBay (EBAY, Fortune 500) said.
"While never an easy decision to make, these reductions will help improve our operations and strengthen our ability to continue investing in growth," John Donahoe, eBay's president and chief executive officer, said in a statement.
The company also said it expects to hit the low-end of its third-quarter revenue guidance and exceed its GAAP and non-GAAP earnings-per-share forecast.
Third-quarter revenue for eBay was forecast in the range of $2.1 billion to $2.15 billion, with GAAP earnings per diluted share seen in the range of 30 to 32 cents a share and non-GAAP earnings per diluted share in the range of 39 to 41 cents a share.
Analysts expect the company to earn 41 cents a share on sales of $2.16 billion, according to Thomson Financial.
Quarterly earnings from eBay are expected Oct. 15.
Shares of eBay were down slightly in premarket trading
Separately, eBay announced its was acquiring the online payment business Bill Me Later for about $820 million and $125 million in outstanding options, as well as Denmark's leading online classifieds site dba.dk for about $390 million in cash.
The job cuts, which will also affect several hundred temporary workers, are expected to result in pretax restructuring charges of approximately $70 million to $80 million, with the charges predominantly recorded in the fourth quarter of 2008, eBay (EBAY, Fortune 500) said.
"While never an easy decision to make, these reductions will help improve our operations and strengthen our ability to continue investing in growth," John Donahoe, eBay's president and chief executive officer, said in a statement.
The company also said it expects to hit the low-end of its third-quarter revenue guidance and exceed its GAAP and non-GAAP earnings-per-share forecast.
Third-quarter revenue for eBay was forecast in the range of $2.1 billion to $2.15 billion, with GAAP earnings per diluted share seen in the range of 30 to 32 cents a share and non-GAAP earnings per diluted share in the range of 39 to 41 cents a share.
Analysts expect the company to earn 41 cents a share on sales of $2.16 billion, according to Thomson Financial.
Quarterly earnings from eBay are expected Oct. 15.
Shares of eBay were down slightly in premarket trading
Eli Lilly pays $6B for ImClone
The drugmaker Eli Lilly & Co. said Monday it has agreed to buy biotechnology company ImClone Systems Inc. for more than $6 billion in a deal that would expand its pipeline of cancer treatments.
New York-based ImClone (IMC) had previously rejected as too low two lower-priced takeover offers from Bristol-Myers Squibb Co (BMY, Fortune 500)., its marketing partner for the cancer drug Erbitux.
A price jump
Indianapolis-based Lilly (LLY, Fortune 500) said it will pay $70 per share in cash for ImClone (IMCL), up 7.7% from Friday's close and more than 50% higher than its price in July before Bristol-Myers made its first bid.
With about 87 million shares outstanding as of Aug. 1, that would amount to nearly $6.1 billion. Lilly said in its news release that the transaction is worth $6.5 billion. Both boards have approved and recommended that ImClone stockholders tender their shares.
Bristol-Myers had previously offered $60 a share and later $62 per share for ImClone. Bristol-Myers Squibb had no immediate comment on the Lilly offer Monday.
ImClone said its chairman, Carl Icahn, who owns about 14% of ImClone stock, has agreed to vote in favor of the Lilly deal.
Billionaire investor
In a press release, Icahn said the move "vindicated" his opposition to a 2006 buyout offer that was worth $36 per share. The billionaire investor became ImClone's chairman in late October of that year after replacing several of the company's directors, which he termed "the old regime" on Monday.
At the time Icahn became chairman, ImClone had recently turned down a buyout offer worth $36 per share from an undisclosed pharmaceutical buyer.
Lilly's cancer drugs include Erbitux, a treatment for colorectal and head and neck cancers, the lung cancer and mesothelioma treatment Alimta, and chemotherapy agent Gemzar. The company identified three ImClone drug candidates as particularly promising: IMC-112B, IMC-A12 and IMC-11F8.
The 112B drug is designed to kill tumors by preventing the growth of the blood vessels that feed them, similar to Genentech Inc.'s cancer drug Avastin.
ImClone shares rise
The 11F8 drug is an antibody that targets production of a protein found on the surface of many cancer cells. That protein, epidermal growth factor receptor, is also targeted by Erbitux.
The 112B drug is in late-stage testing as a treatment for metastastatic breast cancer. Late-stage trials of the other drug candidates in a variety of indications could start in 2009.
In premarket electronic trading, ImClone shares rose $3.74, or 5.8%, to $68.70. The stock finished at $64.96 Friday, and traded at $46.44 before Bristol-Myers Squibb made its initial offer in late July.
New York-based ImClone (IMC) had previously rejected as too low two lower-priced takeover offers from Bristol-Myers Squibb Co (BMY, Fortune 500)., its marketing partner for the cancer drug Erbitux.
A price jump
Indianapolis-based Lilly (LLY, Fortune 500) said it will pay $70 per share in cash for ImClone (IMCL), up 7.7% from Friday's close and more than 50% higher than its price in July before Bristol-Myers made its first bid.
With about 87 million shares outstanding as of Aug. 1, that would amount to nearly $6.1 billion. Lilly said in its news release that the transaction is worth $6.5 billion. Both boards have approved and recommended that ImClone stockholders tender their shares.
Bristol-Myers had previously offered $60 a share and later $62 per share for ImClone. Bristol-Myers Squibb had no immediate comment on the Lilly offer Monday.
ImClone said its chairman, Carl Icahn, who owns about 14% of ImClone stock, has agreed to vote in favor of the Lilly deal.
Billionaire investor
In a press release, Icahn said the move "vindicated" his opposition to a 2006 buyout offer that was worth $36 per share. The billionaire investor became ImClone's chairman in late October of that year after replacing several of the company's directors, which he termed "the old regime" on Monday.
At the time Icahn became chairman, ImClone had recently turned down a buyout offer worth $36 per share from an undisclosed pharmaceutical buyer.
Lilly's cancer drugs include Erbitux, a treatment for colorectal and head and neck cancers, the lung cancer and mesothelioma treatment Alimta, and chemotherapy agent Gemzar. The company identified three ImClone drug candidates as particularly promising: IMC-112B, IMC-A12 and IMC-11F8.
The 112B drug is designed to kill tumors by preventing the growth of the blood vessels that feed them, similar to Genentech Inc.'s cancer drug Avastin.
ImClone shares rise
The 11F8 drug is an antibody that targets production of a protein found on the surface of many cancer cells. That protein, epidermal growth factor receptor, is also targeted by Erbitux.
The 112B drug is in late-stage testing as a treatment for metastastatic breast cancer. Late-stage trials of the other drug candidates in a variety of indications could start in 2009.
In premarket electronic trading, ImClone shares rose $3.74, or 5.8%, to $68.70. The stock finished at $64.96 Friday, and traded at $46.44 before Bristol-Myers Squibb made its initial offer in late July.
Sunday, October 5, 2008
Bailout for major German lender
Germany on Sunday guaranteed all private bank accounts and negotiated a 50 billion euro ($69 billion) bailout deal for Hypo Real Estate AG as Europe's second-largest economy sought to ward off financial crisis.
The Finance Ministry and private banks reached a deal late Sunday to infuse an additional line of credit worth up to 15 billion euros ($21 billion) into the embattled real estate giant, expanding on an earlier 35 billion euro ($48 billion) bailout plan that would have found the government and private banks splitting the bill.
The earlier deal fell apart Saturday when Hypo announced that a consortium of unnamed financial institutions had backed out. That prompted banking executives and lawmakers to convene in the capital for feverish talks toward the new deal they unveiled late Sunday.
The new package includes the original 35 billion euro (48.4 billion) plan with the government paying up to 27 billion euros ($37 billion) of that sum and banks funding the remainder as a line of credit.
New is an additional 15 billion euro ($21 billion) line of insured credit from the banks.
The ministry said in a statement that the new deal would "strengthen the financial community of Germany in difficult times."
Guaranteeing deposits
Earlier Sunday, Germany joined Ireland and Greece in taking drastic independent measures to protect its private citizens by guaranteeing all private bank and savings accounts as well as time deposits, or CDs.
Finance Ministry spokesman Torsten Albig said the unlimited guarantee covered some 568 billion euros ($785 billion) in investments.
Chancellor Angela Merkel vowed that she would not let the failure of any company disrupt the German economy.
"We will not allow the distress of one financial institution to distress the entire system," she told reporters.
Merkel said the plan would ensure that anyone who made reckless market decisions would be made to answer for their actions.
Hypo was the first German blue chip to seek a government rescue. It ran into trouble in mid-September as credit froze on international markets after its Dublin-based unit, Depfa Bank PLC, failed to attract needed short-term funding amid the widening credit crunch.
A spokesman for Ireland's department of finance said the government would not help Germany bail out Hypo or its subsidiary.
Sunday's emergency meeting came a day after Europe's four major economic powers called for tighter regulation in a bid to stop the fiscal bleeding wrought by turmoil on Wall Street - though Germany, France, Britain and Italy shied away from advocating a massive bailout akin to that in the United States, where Congress approved a $700 billion plan last week.
European governments have pumped billions of euros into banks to keep them afloat over the last week, trying to assure savers their money was safe and avert a panic that has frozen lending across the world.
The Finance Ministry and private banks reached a deal late Sunday to infuse an additional line of credit worth up to 15 billion euros ($21 billion) into the embattled real estate giant, expanding on an earlier 35 billion euro ($48 billion) bailout plan that would have found the government and private banks splitting the bill.
The earlier deal fell apart Saturday when Hypo announced that a consortium of unnamed financial institutions had backed out. That prompted banking executives and lawmakers to convene in the capital for feverish talks toward the new deal they unveiled late Sunday.
The new package includes the original 35 billion euro (48.4 billion) plan with the government paying up to 27 billion euros ($37 billion) of that sum and banks funding the remainder as a line of credit.
New is an additional 15 billion euro ($21 billion) line of insured credit from the banks.
The ministry said in a statement that the new deal would "strengthen the financial community of Germany in difficult times."
Guaranteeing deposits
Earlier Sunday, Germany joined Ireland and Greece in taking drastic independent measures to protect its private citizens by guaranteeing all private bank and savings accounts as well as time deposits, or CDs.
Finance Ministry spokesman Torsten Albig said the unlimited guarantee covered some 568 billion euros ($785 billion) in investments.
Chancellor Angela Merkel vowed that she would not let the failure of any company disrupt the German economy.
"We will not allow the distress of one financial institution to distress the entire system," she told reporters.
Merkel said the plan would ensure that anyone who made reckless market decisions would be made to answer for their actions.
Hypo was the first German blue chip to seek a government rescue. It ran into trouble in mid-September as credit froze on international markets after its Dublin-based unit, Depfa Bank PLC, failed to attract needed short-term funding amid the widening credit crunch.
A spokesman for Ireland's department of finance said the government would not help Germany bail out Hypo or its subsidiary.
Sunday's emergency meeting came a day after Europe's four major economic powers called for tighter regulation in a bid to stop the fiscal bleeding wrought by turmoil on Wall Street - though Germany, France, Britain and Italy shied away from advocating a massive bailout akin to that in the United States, where Congress approved a $700 billion plan last week.
European governments have pumped billions of euros into banks to keep them afloat over the last week, trying to assure savers their money was safe and avert a panic that has frozen lending across the world.
The first jobs to go
With jobless claims and unemployment climbing, employees across the country are holding their breath, hoping to hang on to their positions and paychecks.
But widespread layoffs are all too common in an economic downturn. The economy has already lost over 600,000 jobs this year, and experts agree that there will be many more jobs lost in the months ahead.
When credit freezes up, businesses find it tougher to secure financing needed for daily operations, including payroll. That means that more companies will have to take a careful look at business operations in the current climate - and make some tough decisions.
That will likely involve cutting human capital. But which employees will be the first to go?
"From a job standpoint, we're in a recession. When the economy is in recession the chance of being laid off goes up," says John Challenger, chief executive of global outplacement firm Challenger, Gray & Christmas.
Employees with less time at the company are likely to feel more insecure than those who have many years under their belts. But experts say companies are more likely to target layoffs based on things like individual performance and salary.
In the midst of the current financial crisis, here are a few factors that can determine who gets laid off first:
Job performance: Gone are the days of last hired, first fired, Challenger said. Employers now are more focused on building a better and more efficient team.
When a workforce must be cut, "employers need to keep their best talent," Challenger said. "You want to keep the people that you think are your A-players."
Instead of cutting those that have been at the company for the least amount of time, companies now have sophisticated methods for evaluating performance. Management teams can better pinpoint the employees that are the most productive and do the highest quality of work, Challenger said, and retain those that help the business succeed.
And that doesn't just mean showing up on time and completing each task. In order to avoid a pink slip, "everybody who is employed should remind themselves how important it is to make themselves as valuable as possible," cautioned Bob Eubank, executive director of the Northeast Human Resources Association.
Salary: Productivity alone cannot necessarily keep you safe from the next round of layoffs. Employees at every level of an operation usually fall within a defined salary range, and those at the upper end could also be targeted.
"When companies cut back, they certainly look hard at people at the high end of the salary range," Challenger said.
In an effort to cut costs, highly paid individuals are more at risk simply because they are more expensive. "They really have to justify that they are worth that money," Challenger added.
Business need: Employers will also take a hard look at each division or department, to find areas that can be cut without sacrificing successful business operations. "As [companies] look to cut costs, they look to see where the expensive items are," according to John Dooney, manager of employment and HR strategy for The Society for Human Resource Management.
In tough times, it is not unusual to see companies slashing entire departments if they are not cost effective, or dismantling divisions that are costing more money than they're bringing in.
In many of those cases, all or most employees in the department will get pink slips, regardless of their length of service or loyalty, performance or salary. If possible, some companies will try to redeploy some workers to other areas within the company to maintain employee confidence and retain the top performers.
But widespread layoffs are all too common in an economic downturn. The economy has already lost over 600,000 jobs this year, and experts agree that there will be many more jobs lost in the months ahead.
When credit freezes up, businesses find it tougher to secure financing needed for daily operations, including payroll. That means that more companies will have to take a careful look at business operations in the current climate - and make some tough decisions.
That will likely involve cutting human capital. But which employees will be the first to go?
"From a job standpoint, we're in a recession. When the economy is in recession the chance of being laid off goes up," says John Challenger, chief executive of global outplacement firm Challenger, Gray & Christmas.
Employees with less time at the company are likely to feel more insecure than those who have many years under their belts. But experts say companies are more likely to target layoffs based on things like individual performance and salary.
In the midst of the current financial crisis, here are a few factors that can determine who gets laid off first:
Job performance: Gone are the days of last hired, first fired, Challenger said. Employers now are more focused on building a better and more efficient team.
When a workforce must be cut, "employers need to keep their best talent," Challenger said. "You want to keep the people that you think are your A-players."
Instead of cutting those that have been at the company for the least amount of time, companies now have sophisticated methods for evaluating performance. Management teams can better pinpoint the employees that are the most productive and do the highest quality of work, Challenger said, and retain those that help the business succeed.
And that doesn't just mean showing up on time and completing each task. In order to avoid a pink slip, "everybody who is employed should remind themselves how important it is to make themselves as valuable as possible," cautioned Bob Eubank, executive director of the Northeast Human Resources Association.
Salary: Productivity alone cannot necessarily keep you safe from the next round of layoffs. Employees at every level of an operation usually fall within a defined salary range, and those at the upper end could also be targeted.
"When companies cut back, they certainly look hard at people at the high end of the salary range," Challenger said.
In an effort to cut costs, highly paid individuals are more at risk simply because they are more expensive. "They really have to justify that they are worth that money," Challenger added.
Business need: Employers will also take a hard look at each division or department, to find areas that can be cut without sacrificing successful business operations. "As [companies] look to cut costs, they look to see where the expensive items are," according to John Dooney, manager of employment and HR strategy for The Society for Human Resource Management.
In tough times, it is not unusual to see companies slashing entire departments if they are not cost effective, or dismantling divisions that are costing more money than they're bringing in.
In many of those cases, all or most employees in the department will get pink slips, regardless of their length of service or loyalty, performance or salary. If possible, some companies will try to redeploy some workers to other areas within the company to maintain employee confidence and retain the top performers.
Foreclosure crisis: The $4 billion fix
City officials and community activists can't wait to get their hands on nearly $4 billion the federal government is about to inject into blighted neighborhoods suffering from record foreclosures.
Opponents of the measure say the paltry sum won't do much good considering the number of vacant homes on the market - one million families are expected to lose their homes this year - and will more likely turn into a political boondoggle.
It remains to be seen which side is right. But the program - part of the massive housing rescue bill Bush enacted last month despite his own misgivings - will serve as one test of Washington's ability to mitigate the foreclosure crisis.
The U.S. Department of Housing and Urban Development is expected in late September to come up with a formula for how to distribute $3.92 billion to states and cities nationwide to turn foreclosed property to affordable housing for sale or rent.
The funds are intended to help communities deal with the flood of vacant homes, which drain public resources and drag down property values of neighboring houses.
"This money will help get neighborhoods hard hit by foreclosures back on their feet again," said Jeff Falcusan, policy advisor for the National Association of Housing and Redevelopment Officials, a trade group.
Congress mandated that the money be allocated based on the number and percentage of foreclosures, homes financed with subprime loans and homes in default or delinquency in the community. Once the formula is set, HUD has 30 days to dole out the funds. Government officials then have 18 months to put the money to use in their neighborhoods.
In addition to buying and fixing up homes, municipalities can use the money to demolish blighted structures and redevelop vacant land. The foreclosed property must be bought at a discount from its current appraised value to avoid bailing out the lenders.
Local governments could rehab the properties on their own or with the help of public housing authorities. They could also partner with community groups.
The program is also designed to increase the affordable housing stock in the community. The law mandates that the homes be sold or rented to families at or below 120% of the area median income, with one-quarter of the funds set aside for families at or below 50% of median income.
Communities "will have the opportunity to put these houses back into productive use," said Steve Adamske, communications director for the House Committee of Financial Services.
Vacant homes = trouble
Vacant properties can cause big problems for municipalities. As the number of abandoned homes multiplies, property tax revenues fall. Yet, the vacant houses often require more public resources, including frequent visits by police, health department and code enforcement officials. And they hurt property values of surrounding houses.
In Tucson, Ariz., which has been hit hard in the housing slump, abandoned pools have been a particular concern because they attract West Nile-carrying mosquitoes, said Emily Nottingham, the city's community services director. Neighbors also complain about dilapidated houses and overgrown gardens.
"It can really become an eyesore for a neighborhood," she said. Vacant houses "can attract squatters and if the weeds are overgrown, it's harder for adjoining houses to be sold. Pools turn green and attract mosquitoes."
Foreclosures are a widespread problem in Tucson. It already has 4,000 foreclosed properties on the market and is expecting the number to grow. The city is projecting 8,000 homes to enter foreclosure this year - some of which are already up for sale - and another 8,000 in 2009.
The key to using the federal funds most effectively is concentrating efforts in particular neighborhoods rather than scattering the money around town, experts said.
"Target neighborhoods where it can make a difference," said Buzz Roberts, senior vice president for policy at Local Initiatives Support Corp., a national non-profit group which focuses on rebuilding low-income communities.
Local rehab efforts
Rehabbing blighted communities is nothing new for many municipalities and community groups, experts said. Numerous efforts are underway to address the mess left behind in the foreclosure crisis, said Ali Solis, vice president for public policy and industry relations at Enterprise Community Partners, a non-profit group that develops and finances affordable housing.
For instance, Living Cities, a collaboration of corporations and philanthropies, is doling out $10 million in grants to renovate foreclosed properties. The initial recipients include Dallas, Detroit, New York and Washington, D.C.
In Cincinnati, local officials are hoping to use the federal funds to augment a $1.25 million revitalization effort already in the works, said Michael Cervay, director of community development.
The funds should allow the city to demolish or fix up hundreds of vacant homes. The city has about half of the 5,600 homes that went into foreclosure in Hamilton County in 2007. Even more foreclosures are expected this year.
"It will make a significant impact on the problem in Cincinnati," he said.
A drop in the bucket
Some foreclosure experts, however, said that the funding is too little to have any real effect, especially in the hardest hit areas. California, for example, had 209,000 homes go into foreclosure over the past year, said Sean O'Toole, founder of foreclosureradar.com, a foreclosed properties website for real estate professionals.
"$4 billion is kind of a meaningless sum," O'Toole said. "It can't possibly make a difference. You've brought a pistol to a nuclear war."
Converting foreclosed houses into livable homes may prove a big challenge for many municipalities, said David John, senior research fellow at the Heritage Foundation, a conservative think tank. He foresees a lot of the funding going to waste in poor planning or fraud.
Also, because of the weak housing market, local officials might find themselves unable to unload the houses once they are renovated at a price the recoups the repair costs, he said.
"The money could be better used for other purposes," John said. "State and local government have a rather bad record of managing this kind of activity. They don't really have much expertise in retail housing."
Opponents of the measure say the paltry sum won't do much good considering the number of vacant homes on the market - one million families are expected to lose their homes this year - and will more likely turn into a political boondoggle.
It remains to be seen which side is right. But the program - part of the massive housing rescue bill Bush enacted last month despite his own misgivings - will serve as one test of Washington's ability to mitigate the foreclosure crisis.
The U.S. Department of Housing and Urban Development is expected in late September to come up with a formula for how to distribute $3.92 billion to states and cities nationwide to turn foreclosed property to affordable housing for sale or rent.
The funds are intended to help communities deal with the flood of vacant homes, which drain public resources and drag down property values of neighboring houses.
"This money will help get neighborhoods hard hit by foreclosures back on their feet again," said Jeff Falcusan, policy advisor for the National Association of Housing and Redevelopment Officials, a trade group.
Congress mandated that the money be allocated based on the number and percentage of foreclosures, homes financed with subprime loans and homes in default or delinquency in the community. Once the formula is set, HUD has 30 days to dole out the funds. Government officials then have 18 months to put the money to use in their neighborhoods.
In addition to buying and fixing up homes, municipalities can use the money to demolish blighted structures and redevelop vacant land. The foreclosed property must be bought at a discount from its current appraised value to avoid bailing out the lenders.
Local governments could rehab the properties on their own or with the help of public housing authorities. They could also partner with community groups.
The program is also designed to increase the affordable housing stock in the community. The law mandates that the homes be sold or rented to families at or below 120% of the area median income, with one-quarter of the funds set aside for families at or below 50% of median income.
Communities "will have the opportunity to put these houses back into productive use," said Steve Adamske, communications director for the House Committee of Financial Services.
Vacant homes = trouble
Vacant properties can cause big problems for municipalities. As the number of abandoned homes multiplies, property tax revenues fall. Yet, the vacant houses often require more public resources, including frequent visits by police, health department and code enforcement officials. And they hurt property values of surrounding houses.
In Tucson, Ariz., which has been hit hard in the housing slump, abandoned pools have been a particular concern because they attract West Nile-carrying mosquitoes, said Emily Nottingham, the city's community services director. Neighbors also complain about dilapidated houses and overgrown gardens.
"It can really become an eyesore for a neighborhood," she said. Vacant houses "can attract squatters and if the weeds are overgrown, it's harder for adjoining houses to be sold. Pools turn green and attract mosquitoes."
Foreclosures are a widespread problem in Tucson. It already has 4,000 foreclosed properties on the market and is expecting the number to grow. The city is projecting 8,000 homes to enter foreclosure this year - some of which are already up for sale - and another 8,000 in 2009.
The key to using the federal funds most effectively is concentrating efforts in particular neighborhoods rather than scattering the money around town, experts said.
"Target neighborhoods where it can make a difference," said Buzz Roberts, senior vice president for policy at Local Initiatives Support Corp., a national non-profit group which focuses on rebuilding low-income communities.
Local rehab efforts
Rehabbing blighted communities is nothing new for many municipalities and community groups, experts said. Numerous efforts are underway to address the mess left behind in the foreclosure crisis, said Ali Solis, vice president for public policy and industry relations at Enterprise Community Partners, a non-profit group that develops and finances affordable housing.
For instance, Living Cities, a collaboration of corporations and philanthropies, is doling out $10 million in grants to renovate foreclosed properties. The initial recipients include Dallas, Detroit, New York and Washington, D.C.
In Cincinnati, local officials are hoping to use the federal funds to augment a $1.25 million revitalization effort already in the works, said Michael Cervay, director of community development.
The funds should allow the city to demolish or fix up hundreds of vacant homes. The city has about half of the 5,600 homes that went into foreclosure in Hamilton County in 2007. Even more foreclosures are expected this year.
"It will make a significant impact on the problem in Cincinnati," he said.
A drop in the bucket
Some foreclosure experts, however, said that the funding is too little to have any real effect, especially in the hardest hit areas. California, for example, had 209,000 homes go into foreclosure over the past year, said Sean O'Toole, founder of foreclosureradar.com, a foreclosed properties website for real estate professionals.
"$4 billion is kind of a meaningless sum," O'Toole said. "It can't possibly make a difference. You've brought a pistol to a nuclear war."
Converting foreclosed houses into livable homes may prove a big challenge for many municipalities, said David John, senior research fellow at the Heritage Foundation, a conservative think tank. He foresees a lot of the funding going to waste in poor planning or fraud.
Also, because of the weak housing market, local officials might find themselves unable to unload the houses once they are renovated at a price the recoups the repair costs, he said.
"The money could be better used for other purposes," John said. "State and local government have a rather bad record of managing this kind of activity. They don't really have much expertise in retail housing."
The new math of lending
Forget oil and gold. Credit might be the commodity that's in the scarcest supply these days.
Saddled by soaring loan losses, banks have been drastically tightening their lending standards, effectively putting credit out of reach for many consumers in search of mortgages, credit cards or car loans.
"Like the tide, credit goes in and out," said Jeff Davis, a bank analyst and managing director at FTN Midwest. "And right now it's headed out."
Raising the bar
According to the Federal Reserve's first-quarter survey of senior loan officers at some of the nation's largest financial institutions, banks were turning away an increasing number of consumers because of credit fears.
The Fed is likely to report that this trend continued in the second quarter when it releases its latest senior loan officer survey later this month.
Banks endured rising loan losses in the quarter as the housing market deteriorated further and the economy sputtered.
Hoping to preserve capital and rid themselves of these troubled loans, financial companies have, as a result, held borrowers to a much higher standard.
Auto loan providers, for example, have increasingly favored borrowers with higher income levels and have pushed for shorter lending terms.
Hoping to clear out all the toxic mortgages from their books, banks and other lenders are also raising the bar for potential homebuyers, demanding bigger down payments and additional up-front fees, effectively pricing some shoppers out of the market.
And unlike in years past, fewer consumers are finding they can tap their home for cash via a home equity loan, notes Davis - unless you happen to be a prime borrower with a property where there is no pre-existing lien.
But by raising the bar, some would-be borrowers have fallen by the wayside.
"Once you start raising the standards, there will be that group of people that were on the borderline as far as underwriting criteria that may fall out," said Hugh Queener, chief administrative officer of Pinnacle Financial Partners (PNFP), a Nashville, Tenn.-based bank.
Credit, but at a cost
In addition to being tougher to get, credit is also a lot more expensive these days.
While the rates on various loans hinge on a variety of factors, such as the 10-year Treasury note and the prime rate, banks tend to have some leeway when it comes to setting lending rates. And some institutions are certainly taking advantage of this fact.
Some banks, for example, are boosting rates sharply on risky loans in order to avoid attracting any new business.
"They just don't want them," said Adam Schneider, a principal at Deloitte Consulting who deals with clients in the financial services industry. "They are pricing their way out of the problem."
Others are upping rates simply to make a few extra bucks.
"They are finding they are still able to grow their balance sheet and gain market share even with higher pricing," said Jefferson Harralson, an analyst with Keefe Bruyette & Woods.
"But my sense is that they are tiptoeing into it since they so unfamiliar with the lack of price competition," Harralson added.
Not without risks
But banks must also walk a fine line when it comes to credit.
Some beleaguered lenders, for example, may see the value in turning away new loans in order to preserve capital and to live on for another day.
While banks and investors are justifiably concerned about lending, it is also possible that by making credit standards too difficult, institutions are effectively turning away business and ultimately sacrificing earnings growth.
At the same, they run the risk of driving both existing and potential customers into the arms of their competitors - a risky proposition as borrowers can often be a repeat source of business.
Loan pricing can also be tricky.
Sky-high rates can ultimately scare away would-be borrowers to competitors. But even when a bank is able to get a borrower to take a high-interest loan, it has to be careful not to put themselves at risk.
If a banks sets rates too high and a borrower is unable to keep up with payments, the bank only has itself to blame when defaults happen.
"There is no amount of interest you can charge on a bad loan that will make up for it," said Queener.
Saddled by soaring loan losses, banks have been drastically tightening their lending standards, effectively putting credit out of reach for many consumers in search of mortgages, credit cards or car loans.
"Like the tide, credit goes in and out," said Jeff Davis, a bank analyst and managing director at FTN Midwest. "And right now it's headed out."
Raising the bar
According to the Federal Reserve's first-quarter survey of senior loan officers at some of the nation's largest financial institutions, banks were turning away an increasing number of consumers because of credit fears.
The Fed is likely to report that this trend continued in the second quarter when it releases its latest senior loan officer survey later this month.
Banks endured rising loan losses in the quarter as the housing market deteriorated further and the economy sputtered.
Hoping to preserve capital and rid themselves of these troubled loans, financial companies have, as a result, held borrowers to a much higher standard.
Auto loan providers, for example, have increasingly favored borrowers with higher income levels and have pushed for shorter lending terms.
Hoping to clear out all the toxic mortgages from their books, banks and other lenders are also raising the bar for potential homebuyers, demanding bigger down payments and additional up-front fees, effectively pricing some shoppers out of the market.
And unlike in years past, fewer consumers are finding they can tap their home for cash via a home equity loan, notes Davis - unless you happen to be a prime borrower with a property where there is no pre-existing lien.
But by raising the bar, some would-be borrowers have fallen by the wayside.
"Once you start raising the standards, there will be that group of people that were on the borderline as far as underwriting criteria that may fall out," said Hugh Queener, chief administrative officer of Pinnacle Financial Partners (PNFP), a Nashville, Tenn.-based bank.
Credit, but at a cost
In addition to being tougher to get, credit is also a lot more expensive these days.
While the rates on various loans hinge on a variety of factors, such as the 10-year Treasury note and the prime rate, banks tend to have some leeway when it comes to setting lending rates. And some institutions are certainly taking advantage of this fact.
Some banks, for example, are boosting rates sharply on risky loans in order to avoid attracting any new business.
"They just don't want them," said Adam Schneider, a principal at Deloitte Consulting who deals with clients in the financial services industry. "They are pricing their way out of the problem."
Others are upping rates simply to make a few extra bucks.
"They are finding they are still able to grow their balance sheet and gain market share even with higher pricing," said Jefferson Harralson, an analyst with Keefe Bruyette & Woods.
"But my sense is that they are tiptoeing into it since they so unfamiliar with the lack of price competition," Harralson added.
Not without risks
But banks must also walk a fine line when it comes to credit.
Some beleaguered lenders, for example, may see the value in turning away new loans in order to preserve capital and to live on for another day.
While banks and investors are justifiably concerned about lending, it is also possible that by making credit standards too difficult, institutions are effectively turning away business and ultimately sacrificing earnings growth.
At the same, they run the risk of driving both existing and potential customers into the arms of their competitors - a risky proposition as borrowers can often be a repeat source of business.
Loan pricing can also be tricky.
Sky-high rates can ultimately scare away would-be borrowers to competitors. But even when a bank is able to get a borrower to take a high-interest loan, it has to be careful not to put themselves at risk.
If a banks sets rates too high and a borrower is unable to keep up with payments, the bank only has itself to blame when defaults happen.
"There is no amount of interest you can charge on a bad loan that will make up for it," said Queener.
Breakfast price break on the table
Beth Bastian, a Web site project designer and mother of three in Los Angeles, is facing down soaring food costs and finding creative ways to put breakfast on the table.
Bastian said she headed to her local Vons grocery chain, which temporarily doubled the buying power of all coupons. Armed with a fistful of $1 coupons, she said she was able to get 45 boxes of $2 cereal for free.
"My opinion is that if you really look out for good deals, you can combat this, unlike the price of gas," said Bastian. "I was able to get all my cereal for free."
Bastian and other consumers could soon see some inflation relief including a drop in sky-high prices for some of the more notoriously inflated items, such as cereal and other grain products.
The U.S. Department of Agriculture expects food prices to increase by 4.5% to 5.5% this year, said spokesman Keith Williams, which is a decrease from the current rate. The price of food and beverages increased 6.7% in the first six months of 2008, according to the Bureau of Labor Statistics' Consumer Price Index.
iReport.com: How are food prices affecting you?
The price of cereals and bakery products jumped 15.9% during the first six months of the year, according to the CPI. The price of flour and prepared flour mix has soared 33.8% during the first half, while the price of rice, pasta and cornmeal has surged 40.6%.
Ethanol production has been blamed for food-price inflation, but Williams said high oil prices are the biggest culprit, because of the costs of shipping. But the cost of crude has declined dramatically in recent weeks, plummeting more than $30 a barrel after hitting a peak of $147.27 on July 11.
John Norris, a food price analyst and director of wealth management for Oakworth Capital Bank in Birmingham, Ala., said grain and cereal prices are "unsustainable" at their current levels, and he expects them to "moderate or fall by the end of the year."
"If we haven't reached the top already, we'll reach it soon," he said. "Once commodities have stabilized and started to fall, food prices will start to fall as well."
Some milk for their corn flakes
"Milk is easing a little, but milk prices have been going up so high, for the average consumer they're still expensive," she said.
Scott Mushkin, a grocery retail analyst for Jefferies & Co., believes dairy prices will continue to be "flat or slightly down" in the near future. He added that egg inflation, which has already slowed down to 6.1% in the first half of 2008 from 43.6% in the second half of 2007, will "flatten out."
Meat of the matter
"The consumers have not seen the impact of what has happened back at the farm," he said. "The pricing of meat has not reflected inflation in grain prices."
On Thursday, the government will release CPI figures for July after reporting food and beverage prices edged up 0.7% in June. Every month this year, food prices have increased by a fraction of a percentage point. "I don't foresee any radical changes," for July said Mogelonsky.
While food prices are high, she noted, the nation is not going hungry. "We're still a well-fed country," she said.
Correction: An earlier version of this story misspelled the name of the Vons grocery chain
Bastian said she headed to her local Vons grocery chain, which temporarily doubled the buying power of all coupons. Armed with a fistful of $1 coupons, she said she was able to get 45 boxes of $2 cereal for free.
"My opinion is that if you really look out for good deals, you can combat this, unlike the price of gas," said Bastian. "I was able to get all my cereal for free."
Bastian and other consumers could soon see some inflation relief including a drop in sky-high prices for some of the more notoriously inflated items, such as cereal and other grain products.
The U.S. Department of Agriculture expects food prices to increase by 4.5% to 5.5% this year, said spokesman Keith Williams, which is a decrease from the current rate. The price of food and beverages increased 6.7% in the first six months of 2008, according to the Bureau of Labor Statistics' Consumer Price Index.
iReport.com: How are food prices affecting you?
The price of cereals and bakery products jumped 15.9% during the first six months of the year, according to the CPI. The price of flour and prepared flour mix has soared 33.8% during the first half, while the price of rice, pasta and cornmeal has surged 40.6%.
Ethanol production has been blamed for food-price inflation, but Williams said high oil prices are the biggest culprit, because of the costs of shipping. But the cost of crude has declined dramatically in recent weeks, plummeting more than $30 a barrel after hitting a peak of $147.27 on July 11.
John Norris, a food price analyst and director of wealth management for Oakworth Capital Bank in Birmingham, Ala., said grain and cereal prices are "unsustainable" at their current levels, and he expects them to "moderate or fall by the end of the year."
"If we haven't reached the top already, we'll reach it soon," he said. "Once commodities have stabilized and started to fall, food prices will start to fall as well."
Some milk for their corn flakes
"Milk is easing a little, but milk prices have been going up so high, for the average consumer they're still expensive," she said.
Scott Mushkin, a grocery retail analyst for Jefferies & Co., believes dairy prices will continue to be "flat or slightly down" in the near future. He added that egg inflation, which has already slowed down to 6.1% in the first half of 2008 from 43.6% in the second half of 2007, will "flatten out."
Meat of the matter
"The consumers have not seen the impact of what has happened back at the farm," he said. "The pricing of meat has not reflected inflation in grain prices."
On Thursday, the government will release CPI figures for July after reporting food and beverage prices edged up 0.7% in June. Every month this year, food prices have increased by a fraction of a percentage point. "I don't foresee any radical changes," for July said Mogelonsky.
While food prices are high, she noted, the nation is not going hungry. "We're still a well-fed country," she said.
Correction: An earlier version of this story misspelled the name of the Vons grocery chain
Saturday, October 4, 2008
Why the bailout may not be enough
After much ado, the government appears ready to toss a lifeline to Wall Street. But with policymakers frantically battling to keep the economy out of a deep slump, it won't be the only one needed.
The House of Representatives is expected to approve a $700 billion rescue package Friday. The so-called Troubled Asset Relief Program would allow Treasury Secretary Henry Paulson to buy bad mortgage assets, in hopes of getting bank loans flowing through the economy again.
But using TARP to slim the bloated balance sheets of U.S. financial institutions may not be enough to restore the investor confidence that began ebbing last year - confidence that's necessary if banks are going to be able to raise the capital they need to stand behind their loans, and engage in the borrowing they need to keep their operations running on a daily basis.
The key is to vanquish the fear that has left banks hoarding cash - and potentially strangling growth by withholding the credit consumers and businesses need. That means recapitalizing troubled banks via purchases of preferred stock, and guaranteeing the senior debt of financial companies.
"Nationalization works because it creates confidence," said John Hempton, an investor and financial analyst based in Australia. Investors around the globe lost faith in American finance when it became clear that Wall Street had spent the boom years earlier this decade peddling bad debt, Hempton says.
But for the banks, restoring trust isn't merely a matter of saving face. Financial institutions borrow to finance their operations. Because Americans have been loath to save money in recent years, banks in the United States tend to have much smaller deposit bases than those in, say, Japan, where a high savings rate has given banks a surplus of deposits.
In America, by contrast, deposit-light financial firms have funded themselves in the short-term debt markets. That was a profitable strategy for years, because the wholesale funding markets generally offered low rates and abundant liquidity.
But since Wall Street's perfidy came to light in August of 2007, short-term lending rates have risen, squeezing firms that depended on market funding. The squeeze continued even as the Fed and other central banks created all sorts of new methods to lend to financial institutions.
And the vise has tightened in earnest in the past month, with the failure of Lehman Brothers and Washington Mutual and the forced sale or nationalization of five other firms.
The collapse of short-term funding markets recently forced two blue-chip U.S. companies, Goldman Sachs (GS, Fortune 500) and General Electric (GE, Fortune 500), to sell some $8 billion in preferred stock to billionaire investor Warren Buffett's Berkshire Hathaway (BRKB). Those sales will cost the companies dearly: the terms call for Berkshire to get a rich 10% dividend in each case.
But then, when credit isn't available, everyone pays, as policymakers are well aware.
Stop the bleeding
"A continued correction in credit supply, fiscal receipts, investment, employment and consumer balance sheets is inevitable," wrote Lena Komileva, an economist at Tullett Prebon in London, a broker that facilitates business between other brokers. "The question is about the slope and duration of the downturn, not about the direction of the economic cycle."
That's why Hempton says that however the next stage of the bailout unfolds, it's imperative that the government stand behind the senior debts of financial companies in a bid to restore the confidence of the lenders who supply the bulk of financing for U.S. banks.
Hempton cites last month's takeover of mortgage giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) as proof that a government backstop can work, even in a market as large as the one for mortgage-backed securities. By signaling that the Treasury would stand behind the debt the agencies have issued, the Fannie-Freddie takeover brought the foreign central banks that have been the big buyers of Fannie and Freddie securities back into the market, reducing U.S. mortgage rates.
By contrast, the failures of Lehman Brothers and Washington Mutual left senior creditors with substantial losses - potentially discouraging investors from putting their money into other financial firms that need funding as well.
The government may also need to take a more direct role in providing new capital. One question about the TARP is whether the government's purchases of illiquid mortgage-related assets would help banks boost their capital cushions, which have been depleted by mortgage-related losses.
Paulson and Federal Reserve chief Ben Bernanke have indicated a preference for paying prices above the fire sale values quoted in the markets - which could, by forestalling further writedowns, help the banks' capital positions.
Don't overpay
But overpaying for assets may leave taxpayers exposed to big losses and may simply drag out the time it will take for the real estate market to finish making the painful correction that comes when a bubble is popped.
Even TARP backers such as Buffett have suggested the plan is workable only if the purchases are made at market prices.
So why not have the government recapitalize firms directly by buying senior preferred shares? It's a more straightforward, honest approach and, says David Merkel, chief economist at broker-dealer FinaCorp Securities, it puts taxpayers first in line to reap the benefits of any recovery down the road.
Yes, a government stake will dilute the ownership stakes of existing shareholders. But combined with backstopping the banks' debt, it will send a clear message that the U.S. is serious about restoring banks' capital and creditors' confidence before economic conditions worsen.
"As the rapid deterioration of market conditions following Lehman's collapse revealed," Komileva wrote, "a government move today is worth two tomorrow."
The House of Representatives is expected to approve a $700 billion rescue package Friday. The so-called Troubled Asset Relief Program would allow Treasury Secretary Henry Paulson to buy bad mortgage assets, in hopes of getting bank loans flowing through the economy again.
But using TARP to slim the bloated balance sheets of U.S. financial institutions may not be enough to restore the investor confidence that began ebbing last year - confidence that's necessary if banks are going to be able to raise the capital they need to stand behind their loans, and engage in the borrowing they need to keep their operations running on a daily basis.
The key is to vanquish the fear that has left banks hoarding cash - and potentially strangling growth by withholding the credit consumers and businesses need. That means recapitalizing troubled banks via purchases of preferred stock, and guaranteeing the senior debt of financial companies.
"Nationalization works because it creates confidence," said John Hempton, an investor and financial analyst based in Australia. Investors around the globe lost faith in American finance when it became clear that Wall Street had spent the boom years earlier this decade peddling bad debt, Hempton says.
But for the banks, restoring trust isn't merely a matter of saving face. Financial institutions borrow to finance their operations. Because Americans have been loath to save money in recent years, banks in the United States tend to have much smaller deposit bases than those in, say, Japan, where a high savings rate has given banks a surplus of deposits.
In America, by contrast, deposit-light financial firms have funded themselves in the short-term debt markets. That was a profitable strategy for years, because the wholesale funding markets generally offered low rates and abundant liquidity.
But since Wall Street's perfidy came to light in August of 2007, short-term lending rates have risen, squeezing firms that depended on market funding. The squeeze continued even as the Fed and other central banks created all sorts of new methods to lend to financial institutions.
And the vise has tightened in earnest in the past month, with the failure of Lehman Brothers and Washington Mutual and the forced sale or nationalization of five other firms.
The collapse of short-term funding markets recently forced two blue-chip U.S. companies, Goldman Sachs (GS, Fortune 500) and General Electric (GE, Fortune 500), to sell some $8 billion in preferred stock to billionaire investor Warren Buffett's Berkshire Hathaway (BRKB). Those sales will cost the companies dearly: the terms call for Berkshire to get a rich 10% dividend in each case.
But then, when credit isn't available, everyone pays, as policymakers are well aware.
Stop the bleeding
"A continued correction in credit supply, fiscal receipts, investment, employment and consumer balance sheets is inevitable," wrote Lena Komileva, an economist at Tullett Prebon in London, a broker that facilitates business between other brokers. "The question is about the slope and duration of the downturn, not about the direction of the economic cycle."
That's why Hempton says that however the next stage of the bailout unfolds, it's imperative that the government stand behind the senior debts of financial companies in a bid to restore the confidence of the lenders who supply the bulk of financing for U.S. banks.
Hempton cites last month's takeover of mortgage giants Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) as proof that a government backstop can work, even in a market as large as the one for mortgage-backed securities. By signaling that the Treasury would stand behind the debt the agencies have issued, the Fannie-Freddie takeover brought the foreign central banks that have been the big buyers of Fannie and Freddie securities back into the market, reducing U.S. mortgage rates.
By contrast, the failures of Lehman Brothers and Washington Mutual left senior creditors with substantial losses - potentially discouraging investors from putting their money into other financial firms that need funding as well.
The government may also need to take a more direct role in providing new capital. One question about the TARP is whether the government's purchases of illiquid mortgage-related assets would help banks boost their capital cushions, which have been depleted by mortgage-related losses.
Paulson and Federal Reserve chief Ben Bernanke have indicated a preference for paying prices above the fire sale values quoted in the markets - which could, by forestalling further writedowns, help the banks' capital positions.
Don't overpay
But overpaying for assets may leave taxpayers exposed to big losses and may simply drag out the time it will take for the real estate market to finish making the painful correction that comes when a bubble is popped.
Even TARP backers such as Buffett have suggested the plan is workable only if the purchases are made at market prices.
So why not have the government recapitalize firms directly by buying senior preferred shares? It's a more straightforward, honest approach and, says David Merkel, chief economist at broker-dealer FinaCorp Securities, it puts taxpayers first in line to reap the benefits of any recovery down the road.
Yes, a government stake will dilute the ownership stakes of existing shareholders. But combined with backstopping the banks' debt, it will send a clear message that the U.S. is serious about restoring banks' capital and creditors' confidence before economic conditions worsen.
"As the rapid deterioration of market conditions following Lehman's collapse revealed," Komileva wrote, "a government move today is worth two tomorrow."
Offshore oil: What's really out there?
President Bush intensified pressure on Congressional Democrats this weekend to end a 26-year-old offshore drilling moratorium, saying lawmakers have closed off "vast" oil reserves that could be tapped to lower record gasoline prices.
There are just two problems with that critique:
First, it'll be at least five years - and more like 10 - before any significant amount of new oil starts flowing.
Second, no one really knows how much oil is out there to begin with.
Congress banned offshore drilling in most federal waters in 1982, citing environmental concerns. And with few exceptions, oil companies have largely given up the fight to start drilling off the coasts of California and Florida, where the most reserves are believed to be.
But with oil hovering around $130 a barrel and an American public increasingly antsy about rising gas prices, the idea - like the one involving opening up the Arctic National Wildlife Refuge to exploration - is once again open for debate.
McCain, Obama disagree
Some Republicans argue that the United States could easily produce an extra 3 million barrels of oil a day - a 35% increase in daily domestic production - if the oil companies were allowed to explore in American waters again.
Democrats counter that the further opening of federal waters to drilling could damage the environment while failing to lower prices in the near term. The issue has divided the presidential candidates, with Democrat Barack Obama opposing an end to the moratorium, and Republican John McCain supporting more drilling with the consent of states.
So who's right?
If the bans were lifted tomorrow, government agencies would spend a year or two conducting environmental and economic reviews of any lease applications. Even then, when ExxonMobil (XOM, Fortune 500), say, obtained a lease, the company would take another five years to explore, drill wells, build production platforms and lay pipelines so that commercial production could begin. And that doesn't include the potential delays caused by lawsuits from states, environmentalists and fishermen.
So lifting the ban won't get a lot more oil flowing quickly. On the other hand, says Anadarko Petroleum chairman and CEO James Hackett, any significant new find could bring down prices simply because the market would know the oil would be available eventually.
"So lets say we discover something within two years of getting the lease," says Hackett, whose company is a leading oil-exploration firm. "We may not produce it for another two years, but the price impact may actually be felt during that period. But you'll never find any new discoveries without actually going and looking."
Tell us what you think: To drill or not to drill?
Which leads back to the second point, above. No one, Hackett concedes, can quantify how much oil is off the coasts.
With the exception of the Gulf of Mexico and Alaska, America's coastlines are largely unexplored. There have been only about 350 exploration wells ever drilled in federal waters along the Pacific Coast. Along the Atlantic, it's closer to 50. That compares with more than 40,000 wells in the Gulf of Mexico.
"Could America pump three million more barrels a day?" asks Harold Syms, who heads up the resource evaluation division of the U.S. Mineral Management Service. "It's certainly possible - optimistic but possible."
By broad government estimates that often rely on decades-old data, there are 86 billion barrels of oil in federal waters, with about 18 billion located in areas now off-limits. The greatest prize based on sheer volume probably lies off the coast of Southern California, which is estimated to hold 5.6 billion barrels of oil and 10 trillion cubic feet of natural gas.
The eastern and central Gulf of Mexico are believed to hold 3.7 billion barrels of oil and 21.5 trillion cubic feet of gas. MMS analysts say there are also smaller caches off the Atlantic seaboard and further up the Pacific Coast.
If the ban were lifted, oil companies would probably rush into places they know, like off the coast of Los Angeles and Santa Barbara. There are already 26 million barrels a year produced there from platforms built before the offshore moratorium on new wells went into effect.
The Gulf Coast of Florida would take longer to get going quickly because of the lack of necessary infrastructure - pipelines and refineries - nearby.
It would be even more difficult on the Atlantic. There, the oil-reserve estimates are so out of date that the MMS has had to draw on well data from Nova Scotia and even from North Africa - which 200 million years ago, after all, was all but bumping up against the southern coast of North America.
There are just two problems with that critique:
First, it'll be at least five years - and more like 10 - before any significant amount of new oil starts flowing.
Second, no one really knows how much oil is out there to begin with.
Congress banned offshore drilling in most federal waters in 1982, citing environmental concerns. And with few exceptions, oil companies have largely given up the fight to start drilling off the coasts of California and Florida, where the most reserves are believed to be.
But with oil hovering around $130 a barrel and an American public increasingly antsy about rising gas prices, the idea - like the one involving opening up the Arctic National Wildlife Refuge to exploration - is once again open for debate.
McCain, Obama disagree
Some Republicans argue that the United States could easily produce an extra 3 million barrels of oil a day - a 35% increase in daily domestic production - if the oil companies were allowed to explore in American waters again.
Democrats counter that the further opening of federal waters to drilling could damage the environment while failing to lower prices in the near term. The issue has divided the presidential candidates, with Democrat Barack Obama opposing an end to the moratorium, and Republican John McCain supporting more drilling with the consent of states.
So who's right?
If the bans were lifted tomorrow, government agencies would spend a year or two conducting environmental and economic reviews of any lease applications. Even then, when ExxonMobil (XOM, Fortune 500), say, obtained a lease, the company would take another five years to explore, drill wells, build production platforms and lay pipelines so that commercial production could begin. And that doesn't include the potential delays caused by lawsuits from states, environmentalists and fishermen.
So lifting the ban won't get a lot more oil flowing quickly. On the other hand, says Anadarko Petroleum chairman and CEO James Hackett, any significant new find could bring down prices simply because the market would know the oil would be available eventually.
"So lets say we discover something within two years of getting the lease," says Hackett, whose company is a leading oil-exploration firm. "We may not produce it for another two years, but the price impact may actually be felt during that period. But you'll never find any new discoveries without actually going and looking."
Tell us what you think: To drill or not to drill?
Which leads back to the second point, above. No one, Hackett concedes, can quantify how much oil is off the coasts.
With the exception of the Gulf of Mexico and Alaska, America's coastlines are largely unexplored. There have been only about 350 exploration wells ever drilled in federal waters along the Pacific Coast. Along the Atlantic, it's closer to 50. That compares with more than 40,000 wells in the Gulf of Mexico.
"Could America pump three million more barrels a day?" asks Harold Syms, who heads up the resource evaluation division of the U.S. Mineral Management Service. "It's certainly possible - optimistic but possible."
By broad government estimates that often rely on decades-old data, there are 86 billion barrels of oil in federal waters, with about 18 billion located in areas now off-limits. The greatest prize based on sheer volume probably lies off the coast of Southern California, which is estimated to hold 5.6 billion barrels of oil and 10 trillion cubic feet of natural gas.
The eastern and central Gulf of Mexico are believed to hold 3.7 billion barrels of oil and 21.5 trillion cubic feet of gas. MMS analysts say there are also smaller caches off the Atlantic seaboard and further up the Pacific Coast.
If the ban were lifted, oil companies would probably rush into places they know, like off the coast of Los Angeles and Santa Barbara. There are already 26 million barrels a year produced there from platforms built before the offshore moratorium on new wells went into effect.
The Gulf Coast of Florida would take longer to get going quickly because of the lack of necessary infrastructure - pipelines and refineries - nearby.
It would be even more difficult on the Atlantic. There, the oil-reserve estimates are so out of date that the MMS has had to draw on well data from Nova Scotia and even from North Africa - which 200 million years ago, after all, was all but bumping up against the southern coast of North America.
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