Oil Falls Below $79 a Barrel

Crude-oil futures were lower Tuesday, slumping at one point below $79 a barrel as Gulf of Mexico producers continued to restore output that was shut in last week by an approaching storm system.

The front-month November light, sweet crude contract on the New York Mercantile Exchange was recently down $1.50 at $79.45 a barrel after falling as low as $78.96. Front-month prices reached an all-time intraday record of $83.90 on Sept. 20. Brent crude on the ICE futures exchange fell $1.41 to $77.50 a barrel.

Questions over whether oil prices are sustainable at more than the psychologically important $80 level and profit-taking after a sharp run-up in prices lately are also weighing on prices. Once prices were unable to hold $80, they dropped quickly, dropping below $79.

"I think the market was a little overvalued when it was trading above $83," said Tony Rosado of IAG Energy Brokers in Fort Lauderdale. He said the market turned downwards overnight after producers continued to bring back production in the Gulf after a tropical depression passed through the region over the weekend, causing little damage to infrastructure. Prices "could easily drop another dollar," he said.

The equivalent of 251,285 barrels a day of Gulf oil production remained shut in Monday morning, the U.S. Minerals Management Service said, down from 814,578 barrels a day that had been shut as of Friday.

The threat of Gulf of Mexico hurricanes will still play on traders' minds, however, after a tropical depression in the Atlantic Ocean was upgraded to Tropical Storm Karen Tuesday morning. The National Hurricane Center said it posed no immediate threat to land.

Traders will also be looking ahead to Wednesday's weekly U.S. inventory statistics put out by the Department of Energy. Analysts are expecting a fifth straight decline in crude oil stockpiles in the data, according to a Dow Jones Newswires survey of analysts.

Crude stocks are seen falling by 1.8 million barrels in the report, according to the average of the analysts' forecasts. Gasoline stocks are seen building by 200,000 barrels, and distillate inventories, which include heating oil and diesel fuel, are expected to gain by 1.1 million barrels. Refinery use is seen dropping by 0.6 percentage point to 89% of capacity.

"The market is awaiting the weekly DOE stats tomorrow to get some sort of market direction," said Nauman Barakat, senior vice president at Macquarie Futures USA. "I feel the downside is limited -- we will see big draws in crude in the stats due to storm disruptions."

Front-month October reformulated gasoline blendstock, or RBOB, fell 3.84 cents, or 1.8%, to $2.045 a gallon. October heating oil fell 4.78 cents, or 2.1%, to $2.1828 a gallon.
Source : http://online.wsj.com

Microsoft Said to Consider a Stake in Facebook

Some people laughed at Mark E. Zuckerberg when he reportedly turned down a $900 million offer last year for Facebook, the social networking Web site he founded three and a half years ago.

Now, it may be Mr. Zuckerberg’s turn to laugh — all the way to the bank. Microsoft, Google and several funds are considering investments in the fast-growing site that could give the start-up a value of more than $10 billion, according to news reports.

While discussions are said to be in the early stages, Microsoft is reportedly considering an investment of $300 million to $500 million for a 5 percent stake of the company. And, according to The New York Times, Google is also interested in an investment.

Facebook’s valuation could go even higher as the two rivals create the kind of competitive bidding situation that has recently driven the acquisition prices of other start-ups into the stratosphere.

The Times said that Facebook is seeking a minimum valuation of $10 billion but interested bidders have apparently expressed a willingness to value it as high as $13 billion, on the assumption that, in the future, Facebook will become a powerful player in the online world.

But these numbers might have little basis in actual revenue or profit. Facebook is a private company and does not reveal its income. Earlier this year, a Pali Research analyst, Richard Greenfield, estimated that the company brought in $60 million to $96 million in annual revenue, with no real profit. Much of that revenue comes from a year-old advertising relationship with Microsoft, which places display advertisements on the site.

The Financial Times’s Lex column suggests that Microsoft is in a “serious quandary.” The software giant is under intense pressure to catch up with competitors in the online realm, and so it could end up paying an exorbitant price to preserve its ties with Facebook.

DealBook colleague Saul Hansell argues in The Times’ Bits blog that, for Microsoft, there seems to be little upside.

Facebook is only worth all that money if it becomes a significant platform for content and communications and that means it would rival Microsoft’s MSN/Windows Live platform, Yahoo and Google. If Mr. Zuckerberg succeeds, he will be free to ignore Microsoft, and sell Facebook to the public or to any Microsoft rival for that matter.

If he fails at building the company, Microsoft’s investment will look overpriced.

Breakingviews was also skeptical, saying that “even by the wacky metrics of Web 2.0, there’s no way the software giant can justify such profligacy.”

The amount, the publication noted, would amount to more than $200 per Facebook user — well above the $70 that Google put on YouTube’s individual eyeballs or $50 that Ebay paid for each of Skype’s earlobes.

But Mr. Greenfield told The Times the investment price that Microsoft was considering might have more to do with keeping the prize out of the hands of its powerful rivals. “There may be competitive reasons to be connected to this asset beyond what the specific valuation is today,” he told The Times. “You may be paying a premium to keep others out.”

The lack of a track record for Facebook might actually be driving the price up. “Trying to delineate a value today of what was a new industry five years ago is challenging right now,” Mr. Greenfield said.

The Times noted that there may also be be personal reasons that Facebook would align itself with Microsoft, according to The Times. Mr. Zuckerberg has a personal friendship with Ray Ozzie, Microsoft’s chief software architect and one of the people stepping in for Bill Gates, the co-founder who is giving up his day-to-day responsibilities at the company.

Also, Jim Breyer, a managing partner at the venture capital firm of Accel Partners and one of three Facebook board members, was an investor in Groove Networks, Mr. Ozzie’s company, which Microsoft purchased in 2005.

The investment discussions by Facebook are part of its effort to raise an additional round of capital to further the company’s growth and build on its current momentum. The company has solicited interest not only from Internet companies but also from a handful of financial players including venture capitalists, hedge funds and private equity firms, according to people with knowledge of its plans.

Last September, Yahoo was in acquisition talks with Facebook. It reportedly offered $900 million to buy the site outright and was rebuffed by Mr. Zuckerberg, the 23-year-old chief executive, who has said that he was determined to keep the company independent and take it public through an initial public offering.

Now, Google and Microsoft are jockeying for a stake in a social networking site that is said to be creating a new way for Internet users to meet people and interact with friends on the Web.

In May, Facebook redefined itself as a platform, allowing other companies to create features like games, photo-sharing tools and music players that run in Facebook.

That strategy, just four months old, has unleashed a flood of interest in the company, with thousands of independent software developers creating a range of programs for the service.

“We have this situation where every developer worth his salt here in Silicon Valley seems to be working on a Facebook application,” Charlene Li, an analyst at Forrester Research, told The Times.

Facebook is full of activities, from the goofy, like “biting” friends with a virtual vampire, to the more utilitarian, like seeing what parties and events Facebook friends are attending. There are more than 4,000 third-party applications on Facebook, the company said.

The strategy has drawn plenty of attention and new users to the site. Facebook has more than 40 million members, up from 9 million last year.
Source : http://dealbook.blogs.nytimes.com

EchoStar May Split Into 2 Companies

EchoStar Communications Corp. said Tuesday that it may split into two publicly traded companies, one to operate the Dish satellite TV service and the other to focus on technology development.

The news came one day after EchoStar said it would acquire Sling Media Inc., a privately held video technology company, for $380 million.

Sling's products include the Sling Box, which allows users to watch television that's streamed from their homes to a computer or other Internet-connected device. The gadget has caused concerns among some program providers.

EchoStar's CEO Charlie Ergen said in a statement that any split in the company wouldn't affect Dish network's 13.6 million customers.

Ergen said the separation of the company's consumer and wholesale technology businesses would allow both to pursue their respective goals and unlock additional value.

Investors embraced the announcements, sending EchoStar's shares up $2.72 or 6.6 percent to $44.04 in morning trading Tuesday. The shares have traded between $31.40 and $49.69 over the past year.

EchoStar said it has asked the Internal Revenue Service to say whether the split-up could be done in a tax-free manner to EchoStar and its shareholders, who would receive shares in each new company.

The technology company to be spun off from EchoStar would include a set-top box design and manufacturing business, businesses that provide satellite service to other companies, and several international assets.

Ergen would continue to serve as chairman and CEO of Dish Network and fill the same roles with the spun-off company. The board of directors would have to approve splitting the company and confirm that the spin-off would qualify as tax-free.

Final terms and timing of the transaction have not yet been determined.
Source : http://www.foxnews.com

GM, UAW Resumption of Talks May Signal Short Strike

The United Auto Workers' return to bargaining with General Motors Corp. within hours of calling the first national strike against the automaker in 37 years may signal the union's desire for a quick end to the walkout.

``I'm looking for a short strike, possibly three days to an eight- or nine-day time frame,'' Craig Fitzgerald, an auto analyst at Plante & Moran PLC in Southfield, Michigan, said in an interview today.

Talks resumed today in Detroit after an overnight break. The strike that began at 11 a.m. yesterday followed almost 25 hours of continuous bargaining. By early afternoon, negotiators returned for a session that lasted until about 8 p.m.

The showdown between GM and the UAW, while pivotal to the automaker's future profit and the union's dwindling membership, may not match their battles of the 1930s. Neither side can afford a long strike that cuts GM profit or gives Toyota Motor Corp. a chance to win more U.S. buyers and force the closing of even more UAW plants.

``If it goes more than a couple of weeks, I would get very worried about it extracting a price that will be hard to recover from for either side,'' Fitzgerald said.

In other strikes, some unions have cut off talks before returning to negotiations, extending the walkout, said Jules Crystal, a labor lawyer at Bryan Cave LLP in Chicago, who has negotiated more than 260 contracts with the UAW and other unions for auto-parts suppliers.

`Call Us When You're Ready'

The immediate return to bargaining ``shows that the union leadership does in fact want to reach an agreement,'' Crystal said. ``In many cases, the union would walk out in a huff and say, `Call us when you're ready to talk.'''

GM fell 6 cents to $34.68 at 11:07 a.m. in New York Stock Exchange composite trading. The shares rose 13 percent this year before today.

The strike idled GM workers at more than 80 GM auto- assembly and parts operations in the U.S. and may cause shutdowns throughout Canada and Mexico as well. A prolonged walkout threatens supplies of such vehicles as the Buick Enclave, the automaker's hopes for ending seven straight years of U.S. sales declines.

``Toyota is probably just waiting to pounce, to take more market share,'' said Crystal, referring to Toyota's claim to 16.2 percent of the U.S. market so far this year, from 9.3 percent in 2000. GM's share in that span fell to 23.6 percent from 28.1 percent.

Cost Estimate

The strike may cost GM $880 million a week, Rod Lache, a Deutsche Bank analyst in New York, wrote in a report to investors today.

The dispute highlighted the conflicting goals of GM's Rick Wagoner, 54, in his eighth year as chief executive officer, and the UAW's Ron Gettelfinger, 63, in his second term as president.

Wagoner is using the negotiations to cut labor and health- care costs that contributed to $12.4 billion in losses in 2005 and 2006. Gettelfinger seeks to preserve pay, benefits and jobs, while U.S. automakers GM, Ford Motor Co. and Chrysler LLC shed sales and market share to Toyota and other Japanese rivals.

The expectations that the union established in the 1950s under President Walter Reuther -- such as pensions, health care and regular wage increases -- may need to be satisfied in different ways, said Paul Gerhart, a professor at Case Western Reserve University in Cleveland.

Reuther's Legacy

``It's not really Reuther's underlying goals that are on the table; what's on the table is, `How do you achieve them?''' Gerhart said. ``Reuther himself said a contract is not a dead piece of paper; it's a living document.''

Gettelfinger yesterday said the union supports the central idea of the talks, a plan to transfer an estimated $50 billion in future UAW retiree health-care costs to the union in exchange for a one-time payment from GM to set up a trust fund. Future health-care payments would come from income earned off the investments.

In an interview today on WJR-AM radio in Detroit, Gettelfinger said that plan is ``off the table,'' without saying whether the proposal was tabled permanently or temporarily.

``We want to get it done as quickly as we can,'' Gettelfinger said, referring to the contract negotiations. ``We realize there's risk here. We were pushed into a strike'' by GM, he said. ``I'm very puzzled why we were not able to drive this to an agreement.''

Traditional Issues

The strike is about job security and other traditional issues, not the health-care plan, he told reporters yesterday. Gettelfinger accused GM of being ``one way'' and not serious about reaching an agreement during his midday press conference before saying the UAW negotiating team planned to return to the table after the media briefing.

GM, in a statement yesterday, said it sought an agreement ``as soon as possible.''

``There is the possibility that the union will fight to the death because no offer is acceptable, but I don't think it operates that way,'' said John Casesa, managing partner of New York-based consulting firm Casesa Strategic Advisors LLC. ``The UAW is well informed, and they will work something out.''

The automaker's 8.375 percent bond due July 2033 fell .75 cent to 86.75 cents on the dollar, according to Trace, the bond- price reporting system of the NASD. The yield rose to 9.8 percent.

Investor Confidence

Credit-default swaps tied to GM's bonds rose 10 basis points to 560 basis points, according to Credit Suisse Group, signaling deterioration in investor confidence. The price means it costs $560,000 a year for five years to protect $10 million of GM's bonds.

Practical issues may affect the length of the strike, said Crystal. Many workers will have mortgages and other bills coming due on Oct. 1 and may begin to run out of cash.

Striking workers receive about $200 a week from the union while serving on the picket line, less than one fifth of a traditional weekly paycheck for a UAW assembly worker.

``I was really surprised,'' said Scott Ferguson, 53, a quality inspector at GM's Cadillac plant in Hamtramck, Michigan, with 34 years seniority. ``Unlike some people in there, I'm not living check to check. I've got some money in the bank, but nobody wants to spend it. All you can do is pray on it, and hope the leadership does the right thing for you.''

The stakes rise as the strike drags on. GM will lose output of about 12,200 cars a day for the first 36 hours, and the toll will increase to 18,100 cars daily after 72 hours as plants in Mexico and Canada run out of U.S.-made parts, CSM Worldwide Inc. analyst Michael Robinet said yesterday. GM could withstand a strike of two or three weeks before dealers face any shortages, he said.

``As long as they're talking there's hope,'' said Sean McAlinden, an analyst at the Center for Automotive Research in Ann Arbor, Michigan. ``If they stop negotiating, things could slip out of control.''
Source :

London set for three days of Tube misery as workers start strike

Londoners were once again battling to work this morning through travel chaos caused by a 72-hour strike by workers from the Tube line maintenance firm Metronet.

All but three of the capital’s Tube lines ground to a halt yesterday afternoon, and Transport for London (TfL) cautioned last night that normal service would not resume until Friday morning.

The Jubilee, Northern and Picadilly lines, which are managed by a separate maintenance company, continue to operate, but TfL said that these would be extremely crowded.

A spokesman for the RMT Union, which organised the strike in a dispute over job security and pensions after Metronet went into administration, predicted that the remaining lines would prove harder to run as the strike progressed.

“These lines share some tracks and signal services with Metronet lines,” he said. “If anything goes wrong there won’t be any way to repair them.”

Ken Livingstone, the Mayor of London, had made a last-minute attempt to halt the strike. He called it one of the most “purposeless” actions mounted to date and said that all issues raised by the unions over jobs, transfers and pensions had been settled.

These assurances had appeared to pacify the two other unions involved in the dispute, Unite and the Transport Salaried Staffs Association (TSSA), both of which called off their strikes hours before the planned 6pm walkout.

However, the TSSA will hold further talks on pensions this week and has given warning that its members could join a second 72-hour strike planned by the RMT for next week if its demands are not satisfied.

Analysts estimated that the strike would cost London’s economy up to £50 million a day, while business groups gave warning of a severe impact on tourism and industry.

The 3.2 million passengers who travel by Tube each day have been advised to make alternative arrangements or refrain from travelling altogether. Last night long queues formed at bus stops. A spokesman for Transport for London told The Times: “As many buses will be on the network as possible.” However, TfL is unable to increase significantly the number of buses running through the capital.

“We are asking operators to put out as many extra services as possible but it will have a limited impact,” he said. “We haven’t got a huge supply of buses that are not normally in use and we are to a certain extent limited by staffing issues. We have a finite number of licensed drivers, and there are resilience issues. This is a 72-hour strike.”

Commuters who were considering climbing into their cars were warned that the congestion charge would continue to operate as normal.

Last night Eva Coleman, 47, a legal secretary from Walthamstow who had been stranded at King’s Cross by the strike, said: “The Tube [union] bosses think they can just call a strike whenever they feel like it, without taking into account the pain and suffering they cause. I have had to take half a day off just so I can make it home. Tomorrow is going to be even worse.”

Explaining the action, Bob Crow, the general secretary of the RMT, said: “We have been seeking simple, unqualified guarantees from Metronet and its administrator that there will be no job losses, forced transfers or pension cuts and we have not had them.

“The problem for all of us remains that Metronet and its administrator are the employer and the qualified assurances they have given cover only the period of administration.”

Yesterday 2,300 of their members began picketing Tube depots: today they will lobby the Department for Transport for Tube maintenance work to be brought back in-house.

Tim Toole, managing director of London Underground, said that the RMT had received a letter from Metronet and the administrator last Friday stating that there would be “no job losses, no transfers and no loss of pensions as a result of the collapse of Metronet”. He said the strike would cause “the lives of millions of Londoners to be disrupted . . . RMT members will lose hundreds of pounds”.

Service disruption

— The Jubilee, Northern and Piccadilly lines are scheduled to run as normal, except on the Piccadilly Line between Hyde Park Corner and Northfields/Uxbridge, where service is suspended. TfL advises that all three lines will be very crowded

— Passengers are advised to use alternative routes where possible, including the DLR, National Rail and bus services. Tube tickets may be used on bus services

— Anyone who can cycle or walk is advised to do so: a spokesman said that 10,000 parking spaces for bikes had been introduced in recent years, along with a larger network of cycle lanes

— Commuter riverboat services operate between Putney and Blackfriars, from Hilton Docklands in Rotherhithe to Canary Wharf, and from Greenwich to Blackfriars and The Savoy hotel

— Anyone who can defer their journey until Friday morning is urged to do so
Source : http://business.timesonline.co.uk

Housing, Housing Finance, and Monetary Policy

Over the years, Tom Hoenig and his colleagues at the Federal Reserve Bank of Kansas City have done an excellent job of selecting interesting and relevant topics for this annual symposium. I think I can safely say that this year they have outdone themselves. Recently, the subject of housing finance has preoccupied financial-market participants and observers in the United States and around the world. The financial turbulence we have seen had its immediate origins in the problems in the subprime mortgage market, but the effects have been felt in the broader mortgage market and in financial markets more generally, with potential consequences for the performance of the overall economy.

In my remarks this morning, I will begin with some observations about recent market developments and their economic implications. I will then try to place recent events in a broader historical context by discussing the evolution of housing markets and housing finance in the United States. In particular, I will argue that, over the years, institutional changes in U.S. housing and mortgage markets have significantly influenced both the transmission of monetary policy and the economy's cyclical dynamics. As our system of housing finance continues to evolve, understanding these linkages not only provides useful insights into the past but also holds the promise of helping us better cope with the implications of future developments.

Recent Developments in Financial Markets and the Economy
I will begin my review of recent developments by discussing the housing situation. As you know, the downturn in the housing market, which began in the summer of 2005, has been sharp. Sales of new and existing homes have declined significantly from their mid-2005 peaks and have remained slow in recent months. As demand has weakened, house prices have decelerated or even declined by some measures, and homebuilders have scaled back their construction of new homes. The cutback in residential construction has directly reduced the annual rate of U.S. economic growth about 3/4 percentage point on average over the past year and a half. Despite the slowdown in construction, the stock of unsold new homes remains quite elevated relative to sales, suggesting that further declines in homebuilding are likely.

The outlook for home sales and construction will also depend on unfolding developments in mortgage markets. A substantial increase in lending to nonprime borrowers contributed to the bulge in residential investment in 2004 and 2005, and the tightening of credit conditions for these borrowers likely accounts for some of the continued softening in demand we have seen this year. As I will discuss, recent market developments have resulted in additional tightening of rates and terms for nonprime borrowers as well as for potential borrowers through "jumbo" mortgages. Obviously, if current conditions persist in mortgage markets, the demand for homes could weaken further, with possible implications for the broader economy. We are following these developments closely.

As house prices have softened, and as interest rates have risen from the low levels of a couple of years ago, we have seen a marked deterioration in the performance of nonprime mortgages. The problems have been most severe for subprime mortgages with adjustable rates: the proportion of those loans with serious delinquencies rose to about 13-1/2 percent in June, more than double the recent low seen in mid-2005. 1 The adjustable-rate subprime mortgages originated in late 2005 and in 2006 have performed the worst, in part because of slippage in underwriting standards, reflected for example in high loan-to-value ratios and incomplete documentation. With many of these borrowers facing their first interest rate resets in coming quarters, and with softness in house prices expected to continue to impede refinancing, delinquencies among this class of mortgages are likely to rise further. Apart from adjustable-rate subprime mortgages, however, the deterioration in performance has been less pronounced, at least to this point. For subprime mortgages with fixed rather than variable rates, for example, serious delinquencies have been fairly stable at about 5-1/2 percent. The rate of serious delinquencies on alt-A securitized pools rose to nearly 3 percent in June, from a low of less than 1 percent in mid-2005. Delinquency rates on prime jumbo mortgages have also risen, though they are lower than those for prime conforming loans, and both rates are below 1 percent.

Investors' concerns about mortgage credit performance have intensified sharply in recent weeks, reflecting, among other factors, worries about the housing market and the effects of impending interest-rate resets on borrowers' ability to remain current. Credit spreads on new securities backed by subprime mortgages, which had jumped earlier this year, rose significantly more in July. Issuance of such securities has been negligible since then, as dealers have faced difficulties placing even the AAA-rated tranches. Issuance of securities backed by alt-A and prime jumbo mortgages also has fallen sharply, as investors have evidently become concerned that the losses associated with these types of mortgages may be higher than had been expected.

With securitization impaired, some major lenders have announced the cancellation of their adjustable-rate subprime lending programs. A number of others that specialize in nontraditional mortgages have been forced by funding pressures to scale back or close down. Some lenders that sponsor asset-backed commercial paper conduits as bridge financing for their mortgage originations have been unable to "roll" the maturing paper, forcing them to draw on back-up liquidity facilities or to exercise options to extend the maturity of their paper. As a result of these developments, borrowers face noticeably tighter terms and standards for all but conforming mortgages.

As you know, the financial stress has not been confined to mortgage markets. The markets for asset-backed commercial paper and for lower-rated unsecured commercial paper market also have suffered from pronounced declines in investor demand, and the associated flight to quality has contributed to surges in the demand for short-dated Treasury bills, pushing T-bill rates down sharply on some days. Swings in stock prices have been sharp, with implied price volatilities rising to about twice the levels seen in the spring. Credit spreads for a range of financial instruments have widened, notably for lower-rated corporate credits. Diminished demand for loans and bonds to finance highly leveraged transactions has increased some banks' concerns that they may have to bring significant quantities of these instruments onto their balance sheets. These banks, as well as those that have committed to serve as back-up facilities to commercial paper programs, have become more protective of their liquidity and balance-sheet capacity.

Although this episode appears to have been triggered largely by heightened concerns about subprime mortgages, global financial losses have far exceeded even the most pessimistic projections of credit losses on those loans. In part, these wider losses likely reflect concerns that weakness in U.S. housing will restrain overall economic growth. But other factors are also at work. Investor uncertainty has increased significantly, as the difficulty of evaluating the risks of structured products that can be opaque or have complex payoffs has become more evident. Also, as in many episodes of financial stress, uncertainty about possible forced sales by leveraged participants and a higher cost of risk capital seem to have made investors hesitant to take advantage of possible buying opportunities. More generally, investors may have become less willing to assume risk. Some increase in the premiums that investors require to take risk is probably a healthy development on the whole, as these premiums have been exceptionally low for some time. However, in this episode, the shift in risk attitudes has interacted with heightened concerns about credit risks and uncertainty about how to evaluate those risks to create significant market stress. On the positive side of the ledger, we should recognize that past efforts to strengthen capital positions and the financial infrastructure place the global financial system in a relatively strong position to work through this process.

In the statement following its August 7 meeting, the Federal Open Market Committee (FOMC) recognized that the rise in financial volatility and the tightening of credit conditions for some households and businesses had increased the downside risks to growth somewhat but reiterated that inflation risks remained its predominant policy concern. In subsequent days, however, following several events that led investors to believe that credit risks might be larger and more pervasive than previously thought, the functioning of financial markets became increasingly impaired. Liquidity dried up and spreads widened as many market participants sought to retreat from certain types of asset exposures altogether.

Well-functioning financial markets are essential for a prosperous economy. As the nation's central bank, the Federal Reserve seeks to promote general financial stability and to help to ensure that financial markets function in an orderly manner. In response to the developments in the financial markets in the period following the FOMC meeting, the Federal Reserve provided reserves to address unusual strains in money markets. On August 17, the Federal Reserve Board announced a cut in the discount rate of 50 basis points and adjustments in the Reserve Banks' usual discount window practices to facilitate the provision of term financing for as long as thirty days, renewable by the borrower. The Federal Reserve also took a number of supplemental actions, such as cutting the fee charged for lending Treasury securities. The purpose of the discount window actions was to assure depositories of the ready availability of a backstop source of liquidity. Even if banks find that borrowing from the discount window is not immediately necessary, the knowledge that liquidity is available should help alleviate concerns about funding that might otherwise constrain depositories from extending credit or making markets. The Federal Reserve stands ready to take additional actions as needed to provide liquidity and promote the orderly functioning of markets.

It is not the responsibility of the Federal Reserve--nor would it be appropriate--to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy. In a statement issued simultaneously with the discount window announcement, the FOMC indicated that the deterioration in financial market conditions and the tightening of credit since its August 7 meeting had appreciably increased the downside risks to growth. In particular, the further tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.

The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector. However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country. Inevitably, the uncertainty surrounding the outlook will be greater than normal, presenting a challenge to policymakers to manage the risks to their growth and price stability objectives. The Committee continues to monitor the situation and will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.

Beginnings: Mortgage Markets in the Early Twentieth Century
Like us, our predecessors grappled with the economic and policy implications of innovations and institutional changes in housing finance. In the remainder of my remarks, I will try to set the stage for this weekend's conference by discussing the historical evolution of the mortgage market and some of the implications of that evolution for monetary policy and the economy.

The early decades of the twentieth century are a good starting point for this review, as urbanization and the exceptionally rapid population growth of that period created a strong demand for new housing. Between 1890 and 1930, the number of housing units in the United States grew from about 10 million to about 30 million; the pace of homebuilding was particularly brisk during the economic boom of the 1920s.

Remarkably, this rapid expansion of the housing stock took place despite limited sources of mortgage financing and typical lending terms that were far less attractive than those to which we are accustomed today. Required down payments, usually about half of the home's purchase price, excluded many households from the market. Also, by comparison with today's standards, the duration of mortgage loans was short, usually ten years or less. A "balloon" payment at the end of the loan often created problems for borrowers. 2

High interest rates on loans reflected the illiquidity and the essentially unhedgeable interest rate risk and default risk associated with mortgages. Nationwide, the average spread between mortgage rates and high-grade corporate bond yields during the 1920s was about 200 basis points, compared with about 50 basis points on average since the mid-1980s. The absence of a national capital market also produced significant regional disparities in borrowing costs. Hard as it may be to conceive today, rates on mortgage loans before World War I were at times as much as 2 to 4 percentage points higher in some parts of the country than in others, and even in 1930, regional differences in rates could be more than a full percentage point. 3

Despite the underdevelopment of the mortgage market, homeownership rates rose steadily after the turn of the century. As would often be the case in the future, government policy provided some inducement for homebuilding. When the federal income tax was introduced in 1913, it included an exemption for mortgage interest payments, a provision that is a powerful stimulus to housing demand even today. By 1930, about 46 percent of nonfarm households owned their own homes, up from about 37 percent in 1890.

The limited availability of data prior to 1929 makes it hard to quantify the role of housing in the monetary policy transmission mechanism during the early twentieth century. Comparisons are also complicated by great differences between then and now in monetary policy frameworks and tools. Still, then as now, periods of tight money were reflected in higher interest rates and a greater reluctance of banks to lend, which affected conditions in mortgage markets. Moreover, students of the business cycle, such as Arthur Burns and Wesley Mitchell, have observed that residential construction was highly cyclical and contributed significantly to fluctuations in the overall economy (Burns and Mitchell, 1946). Indeed, if we take the somewhat less reliable data for 1901 to 1929 at face value, real housing investment was about three times as volatile during that era as it has been over the past half-century.

During the past century we have seen two great sea changes in the market for housing finance. The first of these was the product of the New Deal. The second arose from financial innovation and a series of crises from the 1960s to the mid-1980s in depository funding of mortgages. I will turn first to the New Deal period.

The New Deal and the Housing Market
The housing sector, like the rest of the economy, was profoundly affected by the Great Depression. When Franklin Roosevelt took office in 1933, almost 10 percent of all homes were in foreclosure (Green and Wachter, 2005), construction employment had fallen by half from its late 1920s peak, and a banking system near collapse was providing little new credit. As in other sectors, New Deal reforms in housing and housing finance aimed to foster economic revival through government programs that either provided financing directly or strengthened the institutional and regulatory structure of private credit markets.

Actually, one of the first steps in this direction was taken not by Roosevelt but by his predecessor, Herbert Hoover, who oversaw the creation of the Federal Home Loan Banking System in 1932. This measure reorganized the thrift industry (savings and loans and mutual savings banks) under federally chartered associations and established a credit reserve system modeled after the Federal Reserve. The Roosevelt administration pushed this and other programs affecting housing finance much further. In 1934, his administration oversaw the creation of the Federal Housing Administration (FHA). By providing a federally backed insurance system for mortgage lenders, the FHA was designed to encourage lenders to offer mortgages on more attractive terms. This intervention appears to have worked in that, by the 1950s, most new mortgages were for thirty years at fixed rates, and down payment requirements had fallen to about 20 percent. In 1938, the Congress chartered the Federal National Mortgage Association, or Fannie Mae, as it came to be known. The new institution was authorized to issue bonds and use the proceeds to purchase FHA mortgages from lenders, with the objectives of increasing the supply of mortgage credit and reducing variations in the terms and supply of credit across regions. 4

Shaped to a considerable extent by New Deal reforms and regulations, the postwar mortgage market took on the form that would last for several decades. The market had two main sectors. One, the descendant of the pre-Depression market sector, consisted of savings and loan associations, mutual savings banks, and, to a lesser extent, commercial banks. With financing from short-term deposits, these institutions made conventional fixed-rate long-term loans to homebuyers. Notably, federal and state regulations limited geographical diversification for these lenders, restricting interstate banking and obliging thrifts to make mortgage loans in small local areas--within 50 miles of the home office until 1964, and within 100 miles after that. In the other sector, the product of New Deal programs, private mortgage brokers and other lenders originated standardized loans backed by the FHA and the Veterans' Administration (VA). These guaranteed loans could be held in portfolio or sold to institutional investors through a nationwide secondary market.

No discussion of the New Deal's effect on the housing market and the monetary transmission mechanism would be complete without reference to Regulation Q--which was eventually to exemplify the law of unintended consequences. The Banking Acts of 1933 and 1935 gave the Federal Reserve the authority to impose deposit-rate ceilings on banks, an authority that was later expanded to cover thrift institutions. The Fed used this authority in establishing its Regulation Q. The so-called Reg Q ceilings remained in place in one form or another until the mid-1980s. 5

The original rationale for deposit ceilings was to reduce "excessive" competition for bank deposits, which some blamed as a cause of bank failures in the early 1930s. In retrospect, of course, this was a dubious bit of economic analysis. In any case, the principal effects of the ceilings were not on bank competition but on the supply of credit. With the ceilings in place, banks and thrifts experienced what came to be known as disintermediation--an outflow of funds from depositories that occurred whenever short-term money-market rates rose above the maximum that these institutions could pay. In the absence of alternative funding sources, the loss of deposits prevented banks and thrifts from extending mortgage credit to new customers.

The Transmission Mechanism and the New Deal Reforms
Under the New Deal system, housing construction soared after World War II, driven by the removal of wartime building restrictions, the need to replace an aging housing stock, rapid family formation that accompanied the beginning of the baby boom, and large-scale internal migration. The stock of housing units grew 20 percent between 1940 and 1950, with most of the new construction occurring after 1945.

In 1951, the Treasury-Federal Reserve Accord freed the Fed from the obligation to support Treasury bond prices. Monetary policy began to focus on influencing short-term money markets as a means of affecting economic activity and inflation, foreshadowing the Federal Reserve's current use of the federal funds rate as a policy instrument. Over the next few decades, housing assumed a leading role in the monetary transmission mechanism, largely for two reasons: Reg Q and the advent of high inflation.

The Reg Q ceilings were seldom binding before the mid-1960s, but disintermediation induced by the ceilings occurred episodically from the mid-1960s until Reg Q began to be phased out aggressively in the early 1980s. The impact of disintermediation on the housing market could be quite significant; for example, a moderate tightening of monetary policy in 1966 contributed to a 23 percent decline in residential construction between the first quarter of 1966 and the first quarter of 1967. State usury laws and branching restrictions worsened the episodes of disintermediation by placing ceilings on lending rates and limiting the flow of funds between local markets. For the period 1960 to 1982, when Reg Q assumed its greatest importance, statistical analysis shows a high correlation between single-family housing starts and the growth of small time deposits at thrifts, suggesting that disintermediation effects were powerful; in contrast, since 1983 this correlation is essentially zero. 6

Economists at the time were well aware of the importance of the disintermediation phenomenon for monetary policy. Frank de Leeuw and Edward Gramlich highlighted this particular channel in their description of an early version of the MPS macroeconometric model, a joint product of researchers at the Federal Reserve, MIT, and the University of Pennsylvania (de Leeuw and Gramlich, 1969). The model attributed almost one-half of the direct first-year effects of monetary policy on the real economy--which were estimated to be substantial--to disintermediation and other housing-related factors, despite the fact that residential construction accounted for only 4 percent of nominal gross domestic product (GDP) at the time.

As time went on, however, monetary policy mistakes and weaknesses in the structure of the mortgage market combined to create deeper economic problems. For reasons that have been much analyzed, in the late 1960s and the 1970s the Federal Reserve allowed inflation to rise, which led to corresponding increases in nominal interest rates. Increases in short-term nominal rates not matched by contractually set rates on existing mortgages exposed a fundamental weakness in the system of housing finance, namely, the maturity mismatch between long-term mortgage credit and the short-term deposits that commercial banks and thrifts used to finance mortgage lending. This mismatch led to a series of liquidity crises and, ultimately, to a rash of insolvencies among mortgage lenders. High inflation was also ultimately reflected in high nominal long-term rates on new mortgages, which had the effect of "front loading" the real payments made by holders of long-term, fixed-rate mortgages. This front-loading reduced affordability and further limited the extension of mortgage credit, thereby restraining construction activity. Reflecting these factors, housing construction experienced a series of pronounced boom and bust cycles from the early 1960s through the mid-1980s, which contributed in turn to substantial swings in overall economic growth.

The Emergence of Capital Markets as a Source of Housing Finance
The manifest problems associated with relying on short-term deposits to fund long-term mortgage lending set in train major changes in financial markets and financial instruments, which collectively served to link mortgage lending more closely to the broader capital markets. The shift from reliance on specialized portfolio lenders financed by deposits to a greater use of capital markets represented the second great sea change in mortgage finance, equaled in importance only by the events of the New Deal.

Government actions had considerable influence in shaping this second revolution. In 1968, Fannie Mae was split into two agencies: the Government National Mortgage Association (Ginnie Mae) and the re-chartered Fannie Mae, which became a privately owned government-sponsored enterprise (GSE), authorized to operate in the secondary market for conventional as well as guaranteed mortgage loans. In 1970, to compete with Fannie Mae in the secondary market, another GSE was created--the Federal Home Loan Mortgage Corporation, or Freddie Mac. Also in 1970, Ginnie Mae issued the first mortgage pass-through security, followed soon after by Freddie Mac. In the early 1980s, Freddie Mac introduced collateralized mortgage obligations (CMOs), which separated the payments from a pooled set of mortgages into "strips" carrying different effective maturities and credit risks. Since 1980, the outstanding volume of GSE mortgage-backed securities has risen from less than $200 billion to more than $4 trillion today. Alongside these developments came the establishment of private mortgage insurers, which competed with the FHA, and private mortgage pools, which bundled loans not handled by the GSEs, including loans that did not meet GSE eligibility criteria--so-called nonconforming loans. Today, these private pools account for around $2 trillion in residential mortgage debt.

These developments did not occur in time to prevent a large fraction of the thrift industry from becoming effectively insolvent by the early 1980s in the wake of the late-1970s surge in inflation. 7 In this instance, the government abandoned attempts to patch up the system and instead undertook sweeping deregulation. Reg Q was phased out during the 1980s; state usury laws capping mortgage rates were abolished; restrictions on interstate banking were lifted by the mid-1990s; and lenders were permitted to offer adjustable-rate mortgages as well as mortgages that did not fully amortize and which therefore involved balloon payments at the end of the loan period. Critically, the savings and loan crisis of the late 1980s ended the dominance of deposit-taking portfolio lenders in the mortgage market. By the 1990s, increased reliance on securitization led to a greater separation between mortgage lending and mortgage investing even as the mortgage and capital markets became more closely integrated. About 56 percent of the home mortgage market is now securitized, compared with only 10 percent in 1980 and less than 1 percent in 1970.

In some ways, the new mortgage market came to look more like a textbook financial market, with fewer institutional "frictions" to impede trading and pricing of event-contingent securities. Securitization and the development of deep and liquid derivatives markets eased the spreading and trading of risk. New types of mortgage products were created. Recent developments notwithstanding, mortgages became more liquid instruments, for both lenders and borrowers. Technological advances facilitated these changes; for example, computerization and innovations such as credit scores reduced the costs of making loans and led to a "commoditization" of mortgages. Access to mortgage credit also widened; notably, loans to subprime borrowers accounted for about 13 percent of outstanding mortgages in 2006.

I suggested that the mortgage market has become more like the frictionless financial market of the textbook, with fewer institutional or regulatory barriers to efficient operation. In one important respect, however, that characterization is not entirely accurate. A key function of efficient capital markets is to overcome problems of information and incentives in the extension of credit. The traditional model of mortgage markets, based on portfolio lending, solved these problems in a straightforward way: Because banks and thrifts kept the loans they made on their own books, they had strong incentives to underwrite carefully and to invest in gathering information about borrowers and communities. In contrast, when most loans are securitized and originators have little financial or reputational capital at risk, the danger exists that the originators of loans will be less diligent. In securitization markets, therefore, monitoring the originators and ensuring that they have incentives to make good loans is critical. I have argued elsewhere that, in some cases, the failure of investors to provide adequate oversight of originators and to ensure that originators' incentives were properly aligned was a major cause of the problems that we see today in the subprime mortgage market (Bernanke, 2007). In recent months we have seen a reassessment of the problems of maintaining adequate monitoring and incentives in the lending process, with investors insisting on tighter underwriting standards and some large lenders pulling back from the use of brokers and other agents. We will not return to the days in which all mortgage lending was portfolio lending, but clearly the originate-to-distribute model will be modified--is already being modified--to provide stronger protection for investors and better incentives for originators to underwrite prudently.

The Monetary Transmission Mechanism Since the Mid-1980s
The dramatic changes in mortgage finance that I have described appear to have significantly affected the role of housing in the monetary transmission mechanism. Importantly, the easing of some traditional institutional and regulatory frictions seems to have reduced the sensitivity of residential construction to monetary policy, so that housing is no longer so central to monetary transmission as it was. 8 In particular, in the absence of Reg Q ceilings on deposit rates and with a much-reduced role for deposits as a source of housing finance, the availability of mortgage credit today is generally less dependent on conditions in short-term money markets, where the central bank operates most directly.

Most estimates suggest that, because of the reduced sensitivity of housing to short-term interest rates, the response of the economy to a given change in the federal funds rate is modestly smaller and more balanced across sectors than in the past. 9 These results are embodied in the Federal Reserve's large econometric model of the economy, which implies that only about 14 percent of the overall response of output to monetary policy is now attributable to movements in residential investment, in contrast to the model's estimate of 25 percent or so under what I have called the New Deal system.

The econometric findings seem consistent with the reduced synchronization of the housing cycle and the business cycle during the present decade. In all but one recession during the period from 1960 to 1999, declines in residential investment accounted for at least 40 percent of the decline in overall real GDP, and the sole exception--the 1970 recession--was preceded by a substantial decline in housing activity before the official start of the downturn. In contrast, residential investment boosted overall real GDP growth during the 2001 recession. More recently, the sharp slowdown in housing has been accompanied, at least thus far, by relatively good performance in other sectors. That said, the current episode demonstrates that pronounced housing cycles are not a thing of the past.

My discussion so far has focused primarily on the role of variations in housing finance and residential construction in monetary transmission. But, of course, housing may have indirect effects on economic activity, most notably by influencing consumer spending. With regard to household consumption, perhaps the most significant effect of recent developments in mortgage finance is that home equity, which was once a highly illiquid asset, has become instead quite liquid, the result of the development of home equity lines of credit and the relatively low cost of cash-out refinancing. Economic theory suggests that the greater liquidity of home equity should allow households to better smooth consumption over time. This smoothing in turn should reduce the dependence of their spending on current income, which, by limiting the power of conventional multiplier effects, should tend to increase macroeconomic stability and reduce the effects of a given change in the short-term interest rate. These inferences are supported by some empirical evidence. 10

On the other hand, the increased liquidity of home equity may lead consumer spending to respond more than in past years to changes in the values of their homes; some evidence does suggest that the correlation of consumption and house prices is higher in countries, like the United States, that have more sophisticated mortgage markets (Calza, Monacelli, and Stracca, 2007). Whether the development of home equity loans and easier mortgage refinancing has increased the magnitude of the real estate wealth effect--and if so, by how much--is a much-debated question that I will leave to another occasion.

Conclusion
I hope this exploration of the history of housing finance has persuaded you that institutional factors can matter quite a bit in determining the influence of monetary policy on housing and the role of housing in the business cycle. Certainly, recent developments have added yet further evidence in support of that proposition. The interaction of housing, housing finance, and economic activity has for years been of central importance for understanding the behavior of the economy, and it will continue to be central to our thinking as we try to anticipate economic and financial developments.

In closing, I would like to express my particular appreciation for an individual whom I count as a friend, as I know many of you do: Edward Gramlich. Ned was scheduled to be on the program but his illness prevented him from making the trip. As many of you know, Ned has been a research leader in the topics we are discussing this weekend, and he has just finished a very interesting book on subprime mortgage markets. We will miss not only Ned's insights over the course of this conference but his warmth and wit as well. Ned and his wife Ruth will be in the thoughts of all of us.

References

Benito, A., J. Thompson, M. Waldron, and R. Wood (2006). "House Prices and Consumer Spending" (420 KB PDF) , Bank of England Quarterly Bulletin, vol. 46 (Summer), 142-54.

Bennett, P., R. Peach, and S. Peristiani (2001). "Structural Change in the Mortgage Market and the Propensity to Refinance," Journal of Money, Credit and Banking, vol. 33 (no. 4), pp. 955-75.

Bernanke, Ben S. (2007). "The Subprime Mortgage Market," speech delivered at the Federal Reserve Bank of Chicago's 43rd Annual Conference on Bank Structure and Competition, Chicago, May 17.

Burns, Arthur F., and Wesley C. Mitchell (1946). Measuring Business Cycles (New York: National Bureau of Economic Research).

Calza, A., T. Monacelli, and L. Stracca (2007). "Mortgage Markets, Collateral Constraints, and Monetary Policy: Do Institutional Factors Matter?" CFS Working Paper Series No. 2007/10 (Frankfurt: Center for Financial Studies).

de Leeuw, Frank, and Edward M. Gramlich (1969). "The Channels of Monetary Policy: A Further Report on the Federal Reserve-MIT Model," Journal of Finance, vol. 24 (May, Papers and Proceedings of the American Finance Association), pp. 265-90.

Dynan, Karen E., Douglas W. Elmendorf, and Daniel E. Sichel (2005). "Can Financial Innovation Help to Explain the Reduced Volatility of Economic Activity?" (424 KB PDF) , Journal of Monetary Economics, vol. 53 (January), pp. 123-50.

Estrella, Arturo (2002). "Securitization and the Efficacy of Monetary Policy" (568 KB PDF) , Federal Reserve Bank of New York, Economic Policy Review, vol. 9 (May), pp. 243-55.

Green, Richard K., and Susan M. Wachter (2005). "The American Mortgage in Historical and International Context" (190 KB PDF) , Journal of Economic Perspectives, vol. 19 (no. 4), pp. 93-114.

Hurst, E., and F. Stafford (2004). "Home is Where the Equity Is: Mortgage Refinancing and Household Consumption," Journal of Money, Credit and Banking, vol. 36 (no. 6), pp. 985-1014.

Mahoney, Patrick I., and Alice P. White (1985). "The Thrift Industry in Transition," Federal Reserve Bulletin, vol. 71 (March), pp. 137-56.

McCarthy, J., and R. Peach (2002). "Monetary Policy Transmission to Residential Investment," Federal Reserve Bank of New York, Economic Policy Review, vol. 8 (no. 1), pp. 139-58.

Snowden, Kenneth A. (1987). "Mortgage Rates and American Capital Market Development in the Late Nineteenth Century," Journal of Economic History, vol. 47 (no. 3), pp. 671-91.

U.S. Department of Commerce (1937). Financial Survey of Urban Housing (Washington: Government Printing Office).

Weiss, Marc A. (1989). "Marketing and Financing Home Ownership: Mortgage Lending and Public Policy in the United States, 1918-1989" (617 KB PDF) , in Business and Economic History,series 2, vol. 18, William J. Hausman, ed., Wilmington, Del.: Business History Conference, pp. 109-18.

Footnotes

1. Estimates of delinquencies are based on data from First American Loan Performance. Return to text

2. Weiss (1989) provides an overview of the evolution of mortgage lending over the past 100 years.

3. Snowden (1987) discusses regional variations in home mortgage rates at the end of the nineteenth century. In addition, the U.S. Department of Commerce (1937) provides information on mortgage rates for various U.S. cities for the 1920s and early 1930s.

4. Later, in anticipation of the end of World War II, the Congress created the Veterans' Administration Home Loan Guarantee Program, which supported mortgage lending to returning GIs on attractive terms, often including little or no down-payment requirement. In 1948, the Congress authorized Fannie Mae to purchase these VA loans as well.

5. Regulation Q provisions that still exist restrict banks' ability to pay interest on some deposits, but these remaining provisions have little effect on the ability of depository institutions to raise funds.

6. In detrended data, the correlation between quarterly single-family housing starts and the growth of small time deposits at thrifts during the preceding quarter was 0.53 for the 1960-1982 period; since 1983, this correlation has fallen to -0.02. Return to text

7. Mahoney and White (1985) reported that the net worth of 156 thrift institutions was less than 1 percent of assets in 1984; when reported net worth was adjusted to exclude regulatory additions that did not represent true capital, this figure swelled to 253.

8. Institutional factors can still be relevant, however, as can be seen by international comparisons. For example, in the United Kingdom, where the predominance of adjustable-rate mortgages makes changes in short-term interest rates quite visible to borrowers and homeowners, housing has a significant role in the monetary transmission mechanism through cash-flow effects on consumption, among other channels (Benito, Thompson, Waldron and Wood, 2006). Although adjustable-rate mortgages have become more important in the United States and now account for about 40 percent of the market, most adjustable-rate mortgages here are actually hybrids in that they bear a fixed rate for the first several years of the loan.

9. For example, McCarthy and Peach (2002) report a substantial decline in the short-run, though not long-run, interest elasticity of residential investment and real GDP after the early 1980s. Work by Dynan, Elmendorf, and Sichel (2006) supports this conclusion as does other work at the Federal Reserve on models for forecasting residential investment. Modeling work at the Fed also shows that the short-run sensitivity of residential investment to nominal mortgage rates fell by more than half after the end of the New Deal system, but, in line with the findings of McCarthy and Peach, remained largely static after 1982. Estrella (2002) finds that secular changes in mortgage securitization have reduced the interest sensitivity of housing to short-term interest rates and the response of real output to an unanticipated change in monetary policy.

10. Dynan, Elmendorf and Sichel (2006) argue that financial innovation has made it easier for households to use the equity in their homes to buffer their spending against income shocks, thereby reducing the volatility of aggregate consumption. Studies by Hurst and Stafford (2004) and Bennett, Peach and Peristiani (2001) provide indirect evidence supporting this argument.
Source : http://foodconsumer.org

FTSE up as credit fears ease; rate verdicts eyed

The FTSE 100 .FTSE index of Britain's leading shares edged up on Monday after U.S. President George W. Bush and Federal Reserve Chairman Ben Bernanke talked about tackling the credit problem that has hit financial markets.

Investors interpreted Bernanke's remarks at a meeting of central bankers on Friday as a sign the bank would cut rates at its September meeting, sparking a 1 percent rally on Wall Street.

Meanwhile U.S. President George W. Bush proposed measures to help homeowners avoid defaulting on risky mortgages.

At 0744 GMT the index was up 8.4 points, or 0.1 percent, at 6,311.7.

But with little on the corporate or economic calendar this session and with U.S. markets closed for the Labor Day holiday, UK investors may struggle to find direction.

"It's going to be obviously quiet because of the U.S. (holiday)," said Lawrence Peterman, investment director at Eden Financial. "We've had a good bounce off the lows in the last week and I think there might be some consolidation now to take stock as to what has really happened out there in the last few weeks."

"(The Bernanke/Bush comments) always helps. Everyone is now expecting a rate cut in the U.S., that's factored into the market." Traders are also looking ahead to interest rate verdicts from both the European Central Bank (ECB) and Bank of England (BoE) on Thursday.
Source : http://today.reuters.com

French energy giants merge as world No 4

FRENCH utility groups Suez and Gaz de France (GDF) have agreed to merge to create the world's fourth-largest energy firm worth 90 billion (£61bn) - a deal hotly opposed by unions, which fear it will cause job losses.

The French government will hold more than 35 per cent of the new firm, to be called GDF Suez. It currently owns 80 per cent of GDF, and was keen to prevent Suez from merging with the Italian energy company Enel.

The new combined business will have annual revenues of 72bn and a workforce of 200,000.

Suez's water and environment business, valued at up to 20bn, will be spun off as a separate business, with its existing shareholders handed a 65 per cent stake. This business runs SITA in the UK, a waste management and recycling firm that runs joint ventures with Surrey County Council and seven north London borough councils.

GDF Suez will be the fourth-largest energy player in the world, behind Russia's Gazprom, Electricite de France and E.ON of Germany. The group will also be the number one buyer and seller of gas in Europe, and the fifth-biggest power producer in Europe.

GDF is already one of the biggest suppliers of gas to the UK and one of the most active explorers in the North Sea.

• HSBC, which has been trying to secure a landmark deal in Korea for eight years, has agreed to pay the investment group Lone Star about $6.3bn in cash to acquire a majority stake in Korea Exchange Bank.

But Europe's largest bank by assets said completion was contingent on a raft of conditions being met by next April, which include all government and regulatory approvals.
Source :http://business.scotsman.com

Mexico trucks to roll on U.S. highways

The Bush administration can proceed with a plan to open the U.S. border to long haul Mexican trucks as early as next week after an appeals court rejected a bid by labor, consumer and environmental interests to block the initiative.

The 9th Circuit Court of Appeals in San Francisco late on Friday denied an emergency petition sought by the Teamsters union, the Sierra Club and consumer group Public Citizen to halt the start of a one-year pilot program that was approved by Congress after years of legal and political wrangling.

The Transportation Department welcomed the decision and said in a statement that allowing more direct shipments from Mexico will benefit U.S. consumers.

The 1994 North American Free Trade Agreement approved broader access for ground shipments from both countries but the Clinton administration never complied with the trucking provision. A special tribunal ordered the Bush administration to do so in 2001.

"This is the wrong decision for working men and women," Jim Hoffa, president of the Teamsters, said in a statement after the court ruling. "We believe this program clearly breaks the law." The Teamsters represents truckers that would be affected by the change.

The emergency stay was sought on grounds the administration's pilot program had not satisfied the U.S. Congress' requirements on safety and other issues. But the appeals court ruled otherwise.

SAFETY ASPECTS

The administration plans to start the program on September 6. Transportation Department officials hope to receive final clearance early next week from the department's inspector general's office, which is reviewing its safety aspects, and finalize details with Mexican authorities.

The Mexican government must grant reciprocal access to U.S. trucks under NAFTA. That provision is not expected to be a problem, regulators said.
Source : http://www.reuters.com

Telkom says in talks with Vodafone and MTN

South Africa's Telkom (TKGJ.J: Quote, Profile , Research) said on Monday it was in talks with Britain's Vodafone (VOD.L: Quote, Profile , Research) and MTN (MTNJ.J: Quote, Profile , Research), sparking talk it wants to sell its fixed-line business and its stake in mobile phone operator Vodacom.

Telkom gave no further details. Vodafone and MTN -- sub-Saharan Africa's biggest mobile phone operator -- said separately the talks were at a "very preliminary stage".

"We've said before that we are interested in increasing our stake in Vodacom," Vodafone spokesman Mark Percy said. Vodafone and Telkom jointly own Vodacom, South Africa's top mobile phone operator.

Telkom shares rose as much as 10.68 percent, before closing 8.39 percent firmer at 190.99 rand. MTN fell 2.57 percent to 106 rand.

The Sunday Times reported at the weekend Telkom was close to selling its 50 percent stake in Vodacom to Vodafone. It also said MTN and a private consortium were bidding to acquire Telkom's fixed-line assets.

"We view the news positively and await the outcome of the discussions eagerly," said Brian Molefe, the chief executive of Public Investment Corporation, which owns close to 15.7 percent of Telkom.
Source : http://today.reuters.co.uk

HSBC pays $6.3bn for KEB stake

HSBC, the world’s fourth-largest lender, has signed a contract to buy a 51 per cent stake in Korea Exchange Bank for $6.3bn. The deal, if completed, will catapult HSBC into the top ranks of Asia’s third-largest banking market.

The agreed price is significantly higher than the markets were expecting – discussions were understood to be in the range of $5bn-$5.5bn – and underscores HSBC’s belief that KEB is its last chance to snap up a Korean bank.

However, the deal faces numerous hurdles, not least that the regulator has declared the sale can not take place while court cases involving Lone Star, the current majority owner of KEB, continue.

Under the deal signed on Monday, HSBC offered Won18,400 per share for Lone Star’s 51 per cent stake in KEB, valuing the acquisition at $6.3bn.

The price will rise by Won380 per share, or $133m, if the deal is not completed by January 31 next year, but the whole agreement will expire on April 30 if the sale has not taken place.

HSBC will now commence 40 days of due diligence on KEB, followed by a further five-day period during which time either side can terminate the agreement.

Stephen Green, HSBC group chairman, said: “Our stated strategy is to focus on expanding HSBC’s presence in important growth economies, particularly in Asia, Latin America and the Middle East and to maintain our capital strength to allow us to take advantage of strategic opportunities. This prospective acquisition reflects that strategy.”

The deal would also “reinforce our position as Asia's number one international bank,” Mr Green said.

The sale is based on conditions including regulatory approval from Korea’s Financial Supervisory Commission and the Fair Trade Commission; no adverse changes to KEB; and no deviation in KEB’s agreed management strategies.

However, Kim Dae-pyung, deputy governor of the Financial Supervisory Service, last month said that Lone Star would not be able to sell its controlling stake in KEB until all court cases involving the US private equity fund’s 2003 acquisition of the lender are resolved.

Lone Star was investigated for alleged involvement in artificially lowering the price at which it bought KEB in 2003, but was cleared by the state Board of Audit and Inspection of any wrongdoing. Former KEB and government officials remain under investigation for their role in pricing the 2003 deal.

Lawyers say there is no legal reason the fund should be prohibited from selling its stake in the bank as Lone Star has been cleared. The FSS does not appear to have the ability to block the deal, only to delay regulatory approval, they say.

But the KEB sale remains a highly political issue – ordinary Koreans were shocked that a foreign “vulture fund” will walk away with $4bn in tax-free profits, thanks to a double-taxation treaty between Korea and Belgium, where Lone Star’s investment vehicle is registered.

With presidential elections looming in December, many analysts say the cases will remain on hold until next year.
Source : http://www.ft.com

Oil continues higher on worries over hurricane Felix, OPEC output

Oil continued higher on ongoing worries hurricane Felix might disrupt supplies in Mexico, and continued speculation OPEC will not raise production when it meets in September.

Twenty-one out of 23 analysts polled by Thomson Financial said the cartel was likely to keep production levels unchanged at its Sept 11 meeting on worries that the current market turmoil might crimp oil demand.

'OPEC is like everyone else. It is going to wait for more clarity before they make any decisions on policy,' said Alaron analyst and trader Phil Flynn.

Meanwhile, traders were tracking hurricane Felix, which developed into a potentially catastrophic category 5 storm overnight, as it swept through the southern Caribbean towards Mexico's Yucatan peninsula and the Bay of Campeche.

'Oil production operations in the region have not been affected yet, but companies will remain alert and precautionary shut-downs could occur in the next few days,' said analysts at Barclays (nyse: BCS - news - people ) Capital.

At 2.49 pm, London's benchmark Brent crude contracts for October delivery were up 67 cents at 73.36 usd per barrel.

Meanwhile, New York crude contracts for October delivery were up 43 cents at 74.47 usd per barrel in electronic trades. The New York Mercantile Exchange was closed Monday for the Labor Day holiday.

Oil prices rallied a couple of weeks ago when hurricane Dean, the first hurricane of the Atlantic season, struck Mexico's Yucatan Peninsula before crossing into the southern Gulf of Mexico and shutting down Mexican output.

Although forecasters do not expect Felix to veer as far north as Dean, and therefore miss US oil installations in the Gulf of Mexico, there is always the risk that the hurricane will change course.

Even if it does not, Petromatrix analyst Olivier Jakob says oil operators in the region will still need to make decisions on precautionary evacuation of oil fields, just as they did with hurricane Dean.

Atlantic storms aside, analysts say oil is still benefiting from a new plan announced Friday by US President George Bush to help borrowers hit by the recent mortgage crisis.

The plan, which came alongside reassuring comments from Fed chairman Ben Bernanke, have helped ease market concerns that oil demand might wane if the US mortgage crisis and related global lending crunch ends up crimping growth.

Deutsche Bank (nyse: DB - news - people ) analyst Joel Crane said traders have taken the comments by top US government officials as indicating the country is intent on dealing 'forcefully with the mortgage situation... and the global credit crunch'.

The credit crunch, which has helped take oil off an all-time record of 78.77 usd a barrel hit on Aug 1 in New York, is affecting all commodity markets at present.

As regards oil, fears that consuming countries will cut back on crude purchases if the credit crunch worsens are making OPEC members ever more intent on leaving output levels unchanged at their September meeting.

As a result, US crude stocks are starting to decline rapidly from relatively high overall levels.

The US Energy Department said last week that crude stocks fell by almost 3.5 mln barrels in the week ending Aug 24, in part because of a large decline in imports.

The agency also reported that gasoline inventories fell by 3.6 mln barrels on the week, leaving overall stocks well below the lower end of the average range for the time of year.
Source : http://www.forbes.com

The Fed to the rescue II: Waiting for the other shoe to drop

In my column two weeks ago, “The Fed to the rescue,” I discussed the US Federal Reserve Bank’s cutting of the discount rate, the rate it charges for giving direct loans to banks, from 6.25 percent to 5.75 percent.

The Fed’s action was directed at the turmoil in financial markets that resulted from the sub prime mortgage crisis (see my column “The emergence of the Turkish mortgage market.”) However the financial markets, regarding the discount rate cut as temporary relief, have been expecting the Fed to drop the other shoe by cutting the target federal-funds rate -- the interest rate banks charge each other for overnight loans to meet reserve requirements -- by at least 0.25 percent from 5.00 percent, to complete its rescue mission. The target federal-funds rate has a much more important effect on the US economy than the discount rate, by determining the prime lending rate US banks charge their preferred customers, which in turn becomes the benchmark interest rate for all other consumer and business loans. That rate, in turn, can have an effect on short-term interest rates and exchange rates globally.

The Fed has not yet dropped the other shoe, despite persistent global financial instability driven by increasing risk aversion and uncertainty about the damage caused by the sub prime mortgage debacle. But it has implicitly signaled its pragmatic position and addressed again the concerns of financial markets through a much-anticipated speech Fed Chairman Ben Bernanke gave last Friday morning, at the Federal Reserve Bank of Kansas City’s annual economic symposium in Jackson Hole, Wyoming, during a high-level international meeting of central bankers and economists to discuss recent developments in the housing and housing finance markets. Bernanke devoted most of his speech, titled “Housing, Housing Finance, and Monetary Policy” -- his first public statement in six weeks -- to reviewing the causes of the US housing market crisis and its sub prime-mortgage-securitization based, contagiously destabilizing effects on global financial markets within the historical context of the US housing and housing-finance markets. What most people really cared about, however, was not the former economics professor’s lecture (with 15 references and 10 footnotes) on the evolution of the US housing and housing-finance markets. It was his explanation of the rationale behind the Fed’s recent actions to ease turbulence in financial markets and his hinting at what follow-up actions it might take, especially the cutting of the federal-funds target rate soon.

Bernanke acknowledged that financial market stability was one of the Fed’s major objectives: “Well-functioning financial markets are essential for a prosperous economy. As the nation’s central bank, the Federal Reserve seeks to promote general financial stability and to help to ensure that financial markets function in an orderly manner.” He also warned, “It is not the responsibility of the Federal Reserve -- nor would it be appropriate -- to protect lenders and investors from the consequences of their financial decisions.” He also told the financial markets not to expect a “Bernanke put,” similar to the “Greenspan put,” which refers to former Fed Chairman Alan Greenspan’s lowering of short-term interest rates in previous financial crises. (A put is an option that gives the holder of the option the right, for a premium, to sell a security at a predetermined price within a given period.) Bernanke weakened his stern position, however, with the following statement: “But developments in financial markets can have broad economic effects felt by many outside the markets and the Federal Reserve must take those effects into account when determining policy.”

So, please give us a clue, Mr. Chairman, as to under what conditions, if not when, the Fed would cut the target federal-funds rate. Well, the Fed would look at the condition of the real economy, which was doing reasonably well: “The incoming data indicate that the economy continued to expand at a moderate pace into the summer, despite the sharp correction in the housing sector.” Given the extraordinary turbulence and uncertainty in financial markets, however, the Fed would not be bound by its business-as-usual methods of following and correcting the course of the real economy: “However, in light of recent financial developments, economic data bearing on past months or quarters may be less useful than usual for our forecasts of economic activity and inflation. Consequently, we will pay particularly close attention to the timeliest indicators, as well as information gleaned from our business and banking contacts around the country.” In plain words, the Fed would be flexible and pragmatic and might cut the target federal-funds rate just to be on the safe side -- for the sake of the real economy (the Main Street) but not Wall Street -- when its Federal Open Market Committee, which decides the target, meets on Sept. 18.

US financial markets acknowledged this hopeful message with across-the-board rallies on the day of Bernanke’s speech. On Friday US stock prices went up and bond prices went down by amounts revealing traders’ cautious optimism, but not giddy exuberance. The markets also factored in the Bush administration’s encouraging announcement, also made on Friday, that the Federal Housing Administration would help ameliorate the sub prime mortgage crisis by limiting the number of foreclosures and helping borrowers with adjustable interest rates to refinance their mortgages.

The most recent monthly data show US core consumer inflation to be under control, well within the Fed’s one to two percent implicit target, and US consumer confidence to be slightly weakening, conditions reinforcing the chances of a federal-funds target rate cut next month. Although futures contracts traded on the Chicago Board of Trade -- through which traders bet on the expected monthly average effective federal-funds rate -- have already priced in a quarter percent target rate cut for next month, economists disagree on whether the Fed would actually cut its target. I still do not expect the “Bernanke put” to follow in the steps of the “Greenspan put,” if conditions in financial markets do not drastically worsen and the US real economic growth does not slow down suddenly, for the following reasons: (1) The most recent quarterly data on US economic growth show surprisingly robust performance. (2) The Bush administration has begun to address the sub prime mortgage crisis from the viewpoint of borrowers. (3) The fact that banks have significantly reduced their borrowing last week from the Fed’s discount window, after the Fed made its loans more available and attractive two weeks ago, indicates that credit markets have already calmed down considerably. If necessary, the Fed could cut the discount rate again, bringing it down closer to the current target federal-funds rate, to ease credit tightening. (4) Dr. Bernanke has to live down his early unsavory reputation as “Helicopter Bernanke,” for having suggested as a professor that the Fed could drop money from a helicopter to help prevent a potential deflation. (5) He must also rectify the Fed’s impaired rectitude arising from his predecessor’s laxness in easing credit for too long -- which is blamed for many of the present credit market problems -- to contain earlier financial crises. Bernanke, who has been at the helm of the Fed for less than two years, has to secure his reputation as an inflation hawk by embracing the financial markets with tough love. I hope that he will not be a clone of Greenspan, whose indulgent love for the financial markets left behind an increasingly questionable legacy after being adulated by some hyperbolically as “the greatest central banker of all time.”
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