Posted by: Ben Steverman on December 24
1. A promise that stocks will move higher in January.
The Stock Trader’s Almanac argues for the importance of its January Barometer:
…the most crucial indicator will be the full-month January Barometer, which states as the S&P 500 goes in January, so goes the year. Devised in 1972 by Yale Hirsch, this gauge has provided an accuracy ratio of 91.4%. It will be especially indicative with the market reacting to the agendas and priorities being set by the new Obama administration and a new Congress convening in addition to regular slew of economic data releases, earnings announcements and market forecasts.
The barometer was correct in 2008, when stocks tumbled almost 8% in January, then dropped more than 40% the whole year.
2. An end to crazy volatility.
Since the start of the financial crisis — and particularly since the collapse of Lehman Brothers — we’ve gotten used to wild swings in the stock market. These moves occur not just from day to day, but from hour to hour, often apparently in reaction to no news at all.
It’s all a sign of investors’ confusion about where the market (and the economy and financial system) are headed. Volatility also has scared away investors who might otherwise have jumped into this market. Why buy now if later this afternoon stocks might be down another 3%?
3. More confidence for executives and analysts about where earnings are headed.
Lately, corporate executives have sounded as confused as everyone else about the state of the economy and their own businesses. Analysts are predicting S&P 500 earnings fall 8.5% in the first quarter of 2009, but analysts have been rapidly adjusting their estimates all year. Few investors take them seriously anymore. If investors could have more confidence analysts’ and executives’ predictions are right, they could consider buying stocks based on their fundamentals. But with the future so fuzzy, it’s hard to be sure that stocks are indeed priced cheaply.
4. Unemployment that stays near 7%.
It seems likely that the jobless rate is going up (from 6.7% in November), as demonstrated by news that initial jobless claims rose 30,000 to 586,000 for the week ending Dec. 20. More job cuts may be planned for the New Year as well. However, the unemployment rate can’t jump too high or consumer spending will plunge and prospects for a 2009 economic recovery become bleak.
5. An end to scandals, collapses and other confidence-shaking events.
The Bernard Madoff debacle is the latest of the big financial headlines to shock investors this year. It started with the collapse of Bear Stearns, continued with the demise of Lehman Brothers, the trouble at AIG and the Bush Administration’s request for a $750 billion bailout.
All these big headlines have rattled investors. It’s important to the stock market’s psychological health that conditions quiet down for a bit.
But if the bad news won’t stop, perhaps investors would settle for a more aggressive Securities and Exchange Commission. An aggressive federal regulator could help assure people their money is safe from the unscrupulous investment managers.
If you put together an investing wish list, what would be on it?
Monday, December 29, 2008
Wednesday, December 24, 2008
Stocks: Five Trends to Watch in 2009 (3)
Some people might argue that this is the worst time to go into annuities because the market has already suffered most of its downside. But if you're a retail investor sitting on sidelines, paralyzed between your logical and emotional inclinations, for an extra fee an annuity can offer peace of mind without having to sacrifice higher returns from riskier bets, he says.
Many insurance firms that offer these structures are starting to recognize they should be charging more, given the losses they're taking in the current market environment. Marshall doubts that the insurance companies will make annuities so prohibitively expensive as to kill demand for them, but they may eliminate some of the riskier mutual fund options and require investors to invest in some sort of balanced portfolio, he adds.
Emerging Markets
Most economists believe the recession will be less severe for the U.S. than for other developed economies, especially those in Europe. The sharp drop in values for assets in emerging markets in 2008 has scared off many investors, but Peirce at State Street sees the decline as more of a correction to the outsized gains made in 2007. "They didn't really underperform that badly relative to past episodes. It reflects that they've come a long way. They've learned to handle their finances more effectively," he says.
Developed international markets may face fundamental challenges that are more daunting than those in emerging markets in the years ahead, he warns. Not only does the population growth and increase in consumer demand in emerging markets bear watching, but many of these economies have an advantage by being much less indebted than most developed countries, says Peirce.
China continues to be very export-oriented and the huge fiscal and monetary stimulus programs it has announced should enable its economy to keep growing at a reasonably fast pace. The process of moving its culture from one based on savings to one geared more toward consumption is a long one but it is happening, he says. As for the rest of Asia, the watershed financial crisis experienced by those countries a decade ago "prevented them from engaging in some of the excesses that we've spent our time doing in the last 10 years," he says.
For the broadest exposure, ETFs that track the MSCI Emerging Markets Index are worth considering.
Geopolitical Risks
One might wish that a global recession of enormous proportion was the only concern over the the next year or so, but unfortunately geopolitical risks continue to simmer. From tensions between Pakistan and India to a looming nuclear threat from Iran and other assorted minefields, the incoming Obama Administration won't have much room to make mistakes, warns Bob Andres, president of Andres Capital Management outside Philadelphia.
Expectations that President-elect Barack Obama will be able to lead the U.S. economy out of its current financial woes are running so high that if he fails to do so it's likely to diminish his international clout to broker geopolitical solutions, says Andres. He cites Vice President-elect Joe Biden's recent comment that the new President is sure to be tested on the diplomatic front.
Anything that damages Obama's ability to handle overseas threats will reduce confidence and would have a negative impact on the stock market, warns Andres. It seems that investors will have to read the international section of the paper as carefully as the business pages in 2009.
Bogoslaw is a reporter for BusinessWeek's Investing channel.
Many insurance firms that offer these structures are starting to recognize they should be charging more, given the losses they're taking in the current market environment. Marshall doubts that the insurance companies will make annuities so prohibitively expensive as to kill demand for them, but they may eliminate some of the riskier mutual fund options and require investors to invest in some sort of balanced portfolio, he adds.
Emerging Markets
Most economists believe the recession will be less severe for the U.S. than for other developed economies, especially those in Europe. The sharp drop in values for assets in emerging markets in 2008 has scared off many investors, but Peirce at State Street sees the decline as more of a correction to the outsized gains made in 2007. "They didn't really underperform that badly relative to past episodes. It reflects that they've come a long way. They've learned to handle their finances more effectively," he says.
Developed international markets may face fundamental challenges that are more daunting than those in emerging markets in the years ahead, he warns. Not only does the population growth and increase in consumer demand in emerging markets bear watching, but many of these economies have an advantage by being much less indebted than most developed countries, says Peirce.
China continues to be very export-oriented and the huge fiscal and monetary stimulus programs it has announced should enable its economy to keep growing at a reasonably fast pace. The process of moving its culture from one based on savings to one geared more toward consumption is a long one but it is happening, he says. As for the rest of Asia, the watershed financial crisis experienced by those countries a decade ago "prevented them from engaging in some of the excesses that we've spent our time doing in the last 10 years," he says.
For the broadest exposure, ETFs that track the MSCI Emerging Markets Index are worth considering.
Geopolitical Risks
One might wish that a global recession of enormous proportion was the only concern over the the next year or so, but unfortunately geopolitical risks continue to simmer. From tensions between Pakistan and India to a looming nuclear threat from Iran and other assorted minefields, the incoming Obama Administration won't have much room to make mistakes, warns Bob Andres, president of Andres Capital Management outside Philadelphia.
Expectations that President-elect Barack Obama will be able to lead the U.S. economy out of its current financial woes are running so high that if he fails to do so it's likely to diminish his international clout to broker geopolitical solutions, says Andres. He cites Vice President-elect Joe Biden's recent comment that the new President is sure to be tested on the diplomatic front.
Anything that damages Obama's ability to handle overseas threats will reduce confidence and would have a negative impact on the stock market, warns Andres. It seems that investors will have to read the international section of the paper as carefully as the business pages in 2009.
Bogoslaw is a reporter for BusinessWeek's Investing channel.
Stocks: Five Trends to Watch in 2009 (2)
Government Stimulus
Another trend to watch is what form the government stimulus package takes and how quickly it works its way through the economy. There's been talk of a stimulus as big as $1 trillion but clearly the focus will be using the money in a way that gets the biggest bang for the buck.
The best results will come from "anything that allows the private sector to be more efficient and more productive," says Laufenberg at Ameriprise. That would include a large-scale effort to computerize medical records and wire schools and libraries for Internet access. And if the Obama Administration wants to preserve jobs, the answer isn't to bail out troubled companies since part of the package is likely to be requiring downsizing and job cuts farther in the future, he says.
Spending on public infrastructure projects that many states say are already in the planning stages would produce results more quickly than tax cuts, and would also be more likely to boost tax revenue over the long term than cutting taxes would, Laufenberg says.
Others, like Herrmann at Waddell & Reed, argue that tax cuts are quicker to stimulate the economy as long as they are permanent, not temporary. He believes a reduction in payroll taxes will come first and will result in higher consumer spending, which would benefit discount retailers such as Wal-Mart (WMT) more so than more expensive ones. A tax cut to corporations that accelerates the depreciation schedule on plants, property, and equipment could jump-start capital spending on technology and industrial machinery, he says.
If the stimulus package helps the economy recover faster than people currently expect, that would cause energy prices and stocks to rally, which argues for increased bets on energy and natural resources mutual funds, says Herrmann.
Laufenberg says that a sustainable expansion will depend not only on government stimulus but on some adjustment in prices, too. Lower interest rates and narrowing credit spreads are part of that process. While the market generally anticipates recovery about six months in advance, there will continue to be a lot of volatility around the economy, especially with a big drop in fourth-quarter gross domestic product and higher unemployment still to come, he says.
There will be plenty of opportunity to play sectors in the longer term, but in the meantime, Laufenberg recommends an index fund that tracks the broader market, as represented by the Standard & Poor's 500-stock index. "I don't know if you'll make money on that trade in the next week or month, but I can tell you that you will make money on that trade in the next two to three years," he says.
Continued Flight to Safety
The internal conflict for investors whose brains tell them it's time to take advantage of low valuations and start buying equities but whose emotions resist any type of risk is likely to continue in 2009, says John Marshall, co-founding partner of the Resource Group, a wealth management firm in Glendale, Calif.
For those investors, annuities could be the perfect way to get through the volatile times ahead, he says. Annuities allow you to take risk in sub-accounts through a broad menu of mutual funds while having your principal guaranteed by an insurance company in return for a fee. "I liken it to an automobile where it's going to cost you a small premium to put in extra safety features," says Marshall. "An annuity in some ways is like putting air bags on your portfolio. Even if you get into a fender-bender, you may not need the air bags, but it may be worth that expense in case you get into a major collision later on."
Another trend to watch is what form the government stimulus package takes and how quickly it works its way through the economy. There's been talk of a stimulus as big as $1 trillion but clearly the focus will be using the money in a way that gets the biggest bang for the buck.
The best results will come from "anything that allows the private sector to be more efficient and more productive," says Laufenberg at Ameriprise. That would include a large-scale effort to computerize medical records and wire schools and libraries for Internet access. And if the Obama Administration wants to preserve jobs, the answer isn't to bail out troubled companies since part of the package is likely to be requiring downsizing and job cuts farther in the future, he says.
Spending on public infrastructure projects that many states say are already in the planning stages would produce results more quickly than tax cuts, and would also be more likely to boost tax revenue over the long term than cutting taxes would, Laufenberg says.
Others, like Herrmann at Waddell & Reed, argue that tax cuts are quicker to stimulate the economy as long as they are permanent, not temporary. He believes a reduction in payroll taxes will come first and will result in higher consumer spending, which would benefit discount retailers such as Wal-Mart (WMT) more so than more expensive ones. A tax cut to corporations that accelerates the depreciation schedule on plants, property, and equipment could jump-start capital spending on technology and industrial machinery, he says.
If the stimulus package helps the economy recover faster than people currently expect, that would cause energy prices and stocks to rally, which argues for increased bets on energy and natural resources mutual funds, says Herrmann.
Laufenberg says that a sustainable expansion will depend not only on government stimulus but on some adjustment in prices, too. Lower interest rates and narrowing credit spreads are part of that process. While the market generally anticipates recovery about six months in advance, there will continue to be a lot of volatility around the economy, especially with a big drop in fourth-quarter gross domestic product and higher unemployment still to come, he says.
There will be plenty of opportunity to play sectors in the longer term, but in the meantime, Laufenberg recommends an index fund that tracks the broader market, as represented by the Standard & Poor's 500-stock index. "I don't know if you'll make money on that trade in the next week or month, but I can tell you that you will make money on that trade in the next two to three years," he says.
Continued Flight to Safety
The internal conflict for investors whose brains tell them it's time to take advantage of low valuations and start buying equities but whose emotions resist any type of risk is likely to continue in 2009, says John Marshall, co-founding partner of the Resource Group, a wealth management firm in Glendale, Calif.
For those investors, annuities could be the perfect way to get through the volatile times ahead, he says. Annuities allow you to take risk in sub-accounts through a broad menu of mutual funds while having your principal guaranteed by an insurance company in return for a fee. "I liken it to an automobile where it's going to cost you a small premium to put in extra safety features," says Marshall. "An annuity in some ways is like putting air bags on your portfolio. Even if you get into a fender-bender, you may not need the air bags, but it may be worth that expense in case you get into a major collision later on."
Stocks: Five Trends to Watch in 2009 (1)
By David Bogoslaw
With the U.S. government determined to throw virtually everything in its toolbox at the recession in hopes of minimizing the economic pain, it may be all but impossible to single out any one policy element that started the recovery rolling. Indeed, there are so many moving parts right now in the economy—though the public perception may be that Bernanke, Paulson & Co. are spinning their wheels instead of moving the wagon forward—that it's tempting for investors to throw up their hands and find a nice quiet place to hole up until the recovery comes.
But you might be missing some opportunities to protect your portfolio or make some money. And that requires keeping your ear to the ground. BusinessWeek asked economists and investment strategists to identify five trends that bear watching in 2009 and that could provide clues about how to position your investment portfolio.
Deflation vs. Inflation
Deflation clearly has the upper hand over inflation for the foreseeable future, and the Federal Reserve's decision on Dec. 16 to knock down the Fed funds rate to a record low of zero to 0.25% drives home that fighting deflation is now the central bank's priority.
What few people mention, however, is the potential benefits of deflation for U.S. consumers, starting with the plunge in energy costs and a discernible easing in interest rates. That may hurt people who thrive on investment income but it's more likely to spell relief for individuals who still have jobs and companies looking to borrow or who want to refinance existing mortgages or other debt, says Dan Peirce , portfolio manager in the global asset allocation group at State Street Global Advisors (STT) in Boston.
That suggests some of the battered sectors in the equities market such as retailers, restaurants, and apparel chains may be able to beat market expectations in 2009, he says. If that's your belief, Peirce points toward sector-oriented exchange-traded funds or mutual funds that focus on consumer staples or even consumer discretionary stocks. Peirce says investors should not be dissuaded by all the front-page headlines about the auto manufacturers, which are part of consumer discretionary group but account for a much smaller portion of the sector than they once did. Even some of the more diversified media companies that focus on advertising and broadcast operations may be good bets in light of the beating they have taken, he adds.
Some strategists will tell you that as long as the deflation risk outweighs the potential for serious inflation, the bond market offers more attractive returns than equities. The real (inflation-adjusted) yields on 10- and 20-year Treasury Inflation-Protected Securities, or TIPS, compared with the nominal yields of regular Treasury notes of comparable maturity suggest that inflation will be extraordinarily low over the next 10 to 20 years, says Peirce. While the TIPS market has already priced in expectations of hugely negative inflation over the next two years, Peirce says his group doubts it will be that severe.
Although inflation probably won't be a credible threat again until at least 2010, it will become a concern much sooner in the next expansion than it had been in each of the last three expansions, Dan Laufenberg, chief economist at Ameriprise Financial (AMP) in Minneapolis, predicted in a report published Dec. 19.
If inflation returns sooner than expected, the place to be is in equities with exposure to rising commodity or asset prices, including energy and steel producers, says Hank Herrmann, chief executive at Waddell & Reed (WDR). Reducing your portfolio's allocation to fixed income would also be a good idea since inflation would push yields higher and bond prices lower, he says.
With the U.S. government determined to throw virtually everything in its toolbox at the recession in hopes of minimizing the economic pain, it may be all but impossible to single out any one policy element that started the recovery rolling. Indeed, there are so many moving parts right now in the economy—though the public perception may be that Bernanke, Paulson & Co. are spinning their wheels instead of moving the wagon forward—that it's tempting for investors to throw up their hands and find a nice quiet place to hole up until the recovery comes.
But you might be missing some opportunities to protect your portfolio or make some money. And that requires keeping your ear to the ground. BusinessWeek asked economists and investment strategists to identify five trends that bear watching in 2009 and that could provide clues about how to position your investment portfolio.
Deflation vs. Inflation
Deflation clearly has the upper hand over inflation for the foreseeable future, and the Federal Reserve's decision on Dec. 16 to knock down the Fed funds rate to a record low of zero to 0.25% drives home that fighting deflation is now the central bank's priority.
What few people mention, however, is the potential benefits of deflation for U.S. consumers, starting with the plunge in energy costs and a discernible easing in interest rates. That may hurt people who thrive on investment income but it's more likely to spell relief for individuals who still have jobs and companies looking to borrow or who want to refinance existing mortgages or other debt, says Dan Peirce , portfolio manager in the global asset allocation group at State Street Global Advisors (STT) in Boston.
That suggests some of the battered sectors in the equities market such as retailers, restaurants, and apparel chains may be able to beat market expectations in 2009, he says. If that's your belief, Peirce points toward sector-oriented exchange-traded funds or mutual funds that focus on consumer staples or even consumer discretionary stocks. Peirce says investors should not be dissuaded by all the front-page headlines about the auto manufacturers, which are part of consumer discretionary group but account for a much smaller portion of the sector than they once did. Even some of the more diversified media companies that focus on advertising and broadcast operations may be good bets in light of the beating they have taken, he adds.
Some strategists will tell you that as long as the deflation risk outweighs the potential for serious inflation, the bond market offers more attractive returns than equities. The real (inflation-adjusted) yields on 10- and 20-year Treasury Inflation-Protected Securities, or TIPS, compared with the nominal yields of regular Treasury notes of comparable maturity suggest that inflation will be extraordinarily low over the next 10 to 20 years, says Peirce. While the TIPS market has already priced in expectations of hugely negative inflation over the next two years, Peirce says his group doubts it will be that severe.
Although inflation probably won't be a credible threat again until at least 2010, it will become a concern much sooner in the next expansion than it had been in each of the last three expansions, Dan Laufenberg, chief economist at Ameriprise Financial (AMP) in Minneapolis, predicted in a report published Dec. 19.
If inflation returns sooner than expected, the place to be is in equities with exposure to rising commodity or asset prices, including energy and steel producers, says Hank Herrmann, chief executive at Waddell & Reed (WDR). Reducing your portfolio's allocation to fixed income would also be a good idea since inflation would push yields higher and bond prices lower, he says.
Thursday, December 18, 2008
Crisis at Chrysler 2
Worse, insiders at DaimlerChrysler say Chrysler is likely to post a loss in 2007 as well—an event that could seriously dent Daimler's share price and rekindle ire among institutional investors about the alliance, prompting calls for a spin-off. "If we don't see a visible improvement in 2007 at Chrysler, it's really bad news," says JP Morgan analyst Philippe Houchois.
Uebber and LaSorda, who also participated in the conference call, declined to forecast a recovery for Chrysler in 2007, noting that eight new models in the second half of 2006, and more in 2007 should help rekindle sales. By cutting production, LaSorda aims to bring unsold inventory down to around 500,000 vehicles by yearend. By the end of September, Chrysler's excess inventories were down to 534,000 from a 2006 peak of 580,000.
More Than Muddling
Beyond cutting inventory, management has launched a new initiative dubbed the "Chrysler Group Optimization Program" to study everything from product strategy and fixed costs to manufacturing capacity and quality. Seven corporate S.W.A.T. teams, which aim to slash $1,000 from the cost of building each Chrysler car, are headed by Chrysler executives but receive frequent visits from a group led by Mercedes Chief Operating Officer and restructuring ace Rainer Schmueckle.
"I don't want anyone to think we are sitting here and muddling through," said LaSorda. We are aggressively analyzing the business, including future break-even points if the market goes down."
Chrysler's third-quarter loss implies a loss of $2,600 per vehicle, Morgan Stanley analyst Adam Jonas calculated in a recent report—far greater than the per-unit loss posted at Chrysler in the depth of its crisis in 2000 and 2001. Jones now expects Chrysler to post a loss of more than $1 billion in 2007. "We cannot rule out the risk of even greater losses in 2007," Jonas says.
Guilty of Optimism
If market conditions in the U.S. remain unfavorable and Chrysler suffers another large loss in 2007, Zetsche could be forced to consider a spin-off as early as 2008, insiders say. Chrysler's double profit warning this year is an especially tough blow for Zetsche, who was hailed a year ago as the turnaround ace who fixed Chrysler when he returned from Auburn Hills to take charge of Mercedes Car Group.
A much chastened Zetsche admitted Sept. 19 to the major management blunder this year and took the blame for Chrysler's overly optimistic sales forecasts, which should have been corrected far sooner. Zetsche became CEO of the $190 billion-revenue DaimlerChrysler group on Jan. 1.
At the Paris Auto Show in September, Zetsche reiterated that the target for Chrysler's operating margin remains 5%. "When we can achieve that target is the right question," he said. "More than that, it has to be sustainable."
Back in Action
Zetsche gave the first hint of more radical solutions for Chrysler on Sept. 19 when he said he did not rule out long-term changes to DaimlerChrysler's structure. Uebber's comments on Oct. 25 seemed to confirm that a spin-off is one possible future option (see BusinessWeek.com, 9/19/06, "Turnaround Time at Chrysler—Again?").
As Chrysler veers off track, Mercedes is regaining traction. Zetsche has presided over a recovery at the $63 billion Mercedes Car Group following years of quality problems and a crisis at Smart that triggered large write-downs. Mercedes' operating profit rose 127% to $1.2 billion in the third quarter.
One-third of the profit gains came from increasing sales and higher-priced cars in the mix and two-thirds from cost-cutting. Mercedes is expected to achieve an operating profit of 7% in 2007—returning to its historic role as profit engine. Powerful profits at Mercedes could help Zetsche buy time in pondering Chrysler's future.
Edmondson is a senior correspondent in BusinessWeek's Frankfurt bureau. Welch is BusinessWeek's Detroit bureau chief.
Uebber and LaSorda, who also participated in the conference call, declined to forecast a recovery for Chrysler in 2007, noting that eight new models in the second half of 2006, and more in 2007 should help rekindle sales. By cutting production, LaSorda aims to bring unsold inventory down to around 500,000 vehicles by yearend. By the end of September, Chrysler's excess inventories were down to 534,000 from a 2006 peak of 580,000.
More Than Muddling
Beyond cutting inventory, management has launched a new initiative dubbed the "Chrysler Group Optimization Program" to study everything from product strategy and fixed costs to manufacturing capacity and quality. Seven corporate S.W.A.T. teams, which aim to slash $1,000 from the cost of building each Chrysler car, are headed by Chrysler executives but receive frequent visits from a group led by Mercedes Chief Operating Officer and restructuring ace Rainer Schmueckle.
"I don't want anyone to think we are sitting here and muddling through," said LaSorda. We are aggressively analyzing the business, including future break-even points if the market goes down."
Chrysler's third-quarter loss implies a loss of $2,600 per vehicle, Morgan Stanley analyst Adam Jonas calculated in a recent report—far greater than the per-unit loss posted at Chrysler in the depth of its crisis in 2000 and 2001. Jones now expects Chrysler to post a loss of more than $1 billion in 2007. "We cannot rule out the risk of even greater losses in 2007," Jonas says.
Guilty of Optimism
If market conditions in the U.S. remain unfavorable and Chrysler suffers another large loss in 2007, Zetsche could be forced to consider a spin-off as early as 2008, insiders say. Chrysler's double profit warning this year is an especially tough blow for Zetsche, who was hailed a year ago as the turnaround ace who fixed Chrysler when he returned from Auburn Hills to take charge of Mercedes Car Group.
A much chastened Zetsche admitted Sept. 19 to the major management blunder this year and took the blame for Chrysler's overly optimistic sales forecasts, which should have been corrected far sooner. Zetsche became CEO of the $190 billion-revenue DaimlerChrysler group on Jan. 1.
At the Paris Auto Show in September, Zetsche reiterated that the target for Chrysler's operating margin remains 5%. "When we can achieve that target is the right question," he said. "More than that, it has to be sustainable."
Back in Action
Zetsche gave the first hint of more radical solutions for Chrysler on Sept. 19 when he said he did not rule out long-term changes to DaimlerChrysler's structure. Uebber's comments on Oct. 25 seemed to confirm that a spin-off is one possible future option (see BusinessWeek.com, 9/19/06, "Turnaround Time at Chrysler—Again?").
As Chrysler veers off track, Mercedes is regaining traction. Zetsche has presided over a recovery at the $63 billion Mercedes Car Group following years of quality problems and a crisis at Smart that triggered large write-downs. Mercedes' operating profit rose 127% to $1.2 billion in the third quarter.
One-third of the profit gains came from increasing sales and higher-priced cars in the mix and two-thirds from cost-cutting. Mercedes is expected to achieve an operating profit of 7% in 2007—returning to its historic role as profit engine. Powerful profits at Mercedes could help Zetsche buy time in pondering Chrysler's future.
Edmondson is a senior correspondent in BusinessWeek's Frankfurt bureau. Welch is BusinessWeek's Detroit bureau chief.
Crisis at Chrysler I
by Gail Edmondson and David Welch
The news is grim enough for Chrysler. A massive pileup of unsold vehicles this year prompted a $1.5 billion third-quarter loss—the third huge earnings bloodbath at Chrysler in six years (see BusinessWeek.com, 10/18/06, "Detroit's Oversupply Problem").
Once again German troubleshooters from parent company DaimlerChrysler's (DCX) headquarters in Stuttgart are shuttling to Auburn Hills, Mich., to analyze its ailing U.S. division. But, unlike in the past, this time there are no assurances by the Germans that Chrysler can be fixed.
Chrysler's swift decline has even raised the possibility that it could be spun off, an option top executives haven't publicly discussed but also did not dismiss. Asked at an Oct. 25 conference call with analysts and reporters whether a spin-off of Chrysler was among possible future options, chief financial officer Bodo Uebber replied, "We won't exclude anything. We are looking at structural changes. We are first doing our analysis. Then we will draw our conclusions."
Future Still Unclear
DaimlerChrysler's revenues for the third quarter declined 8% to $44 billion and its operating profit plunged 50% to $1.1 billion. Losses at Chrysler and aerospace unit EADS will outweigh gains this year at Mercedes and the truck division, forcing group profit down in 2006, Uebber said.
Nearly nine years since the merger of Daimler-Benz and Chrysler, Chrysler has become a chronic source of distress for the group's German top management. Despite billions spent to restructure Chrysler and some modest gains over the past two years, its future prospects remain murky.
The U.S. automaker continues to suffer from anemic sales—down 24% this quarter—an inability to anticipate major market trends such as the shift to fuel-efficient cars, production overcapacity, and erosion of market share. Only 16% of Chrysler's vehicles are fuel-efficient four-cylinder models, compared with an industry average of 37%.
The Cost of Conscience
Chrysler has a raft of passenger cars coming, for instance the just-released Jeep Compass crossover SUV, and soon, the new Chrysler Sebring and Dodge Avenger mid-sized sedans. But with more than 70% of its business in trucks, SUVs, and minivans, Chrysler will have to work hard to establish brand credibility among passenger car buyers, many of whom flock to Japanese and Korean models.
The company suffers from another common Detroit malady: retiree costs. Like rivals General Motors (GM) and Ford (F), Chrysler is paying for legions of retirees who rely on the corporation for their pension and medical benefits. Chrysler pays about $1,400 per vehicle in health-care costs, and the United Auto Workers union has frustrated Daimler CEO Dieter Zetsche and Chrysler chief Tom LaSorda by so far refusing to give them the same concessions on retiree benefits that saved GM $1 billion a year.
Chrysler also has a $22.3 billion pension plan that is underfunded by $1.7 billion. If Chrysler can't make up the shortfall by investing the pension fund's proceeds, it will have to spend more cash to get the plan flush.
"Really Bad News"
Auto industry analysts increasingly question whether Chrysler can escape a troubling pattern of swinging between modest profits in its best years and gushing losses in the worst ones. And that scenario makes it difficult to justify hanging on to Chrysler. "It's early to say the whole thing has to be unraveled, but they cannot keep throwing good money down the drain," says Garel Rhys, professor of automotive economics at the University of Cardiff in Wales.
Chrysler is now expected to lose $1.2 billion in 2006, dragging down group earnings and casting a shadow over a recovery under way at Mercedes Car Group.
The news is grim enough for Chrysler. A massive pileup of unsold vehicles this year prompted a $1.5 billion third-quarter loss—the third huge earnings bloodbath at Chrysler in six years (see BusinessWeek.com, 10/18/06, "Detroit's Oversupply Problem").
Once again German troubleshooters from parent company DaimlerChrysler's (DCX) headquarters in Stuttgart are shuttling to Auburn Hills, Mich., to analyze its ailing U.S. division. But, unlike in the past, this time there are no assurances by the Germans that Chrysler can be fixed.
Chrysler's swift decline has even raised the possibility that it could be spun off, an option top executives haven't publicly discussed but also did not dismiss. Asked at an Oct. 25 conference call with analysts and reporters whether a spin-off of Chrysler was among possible future options, chief financial officer Bodo Uebber replied, "We won't exclude anything. We are looking at structural changes. We are first doing our analysis. Then we will draw our conclusions."
Future Still Unclear
DaimlerChrysler's revenues for the third quarter declined 8% to $44 billion and its operating profit plunged 50% to $1.1 billion. Losses at Chrysler and aerospace unit EADS will outweigh gains this year at Mercedes and the truck division, forcing group profit down in 2006, Uebber said.
Nearly nine years since the merger of Daimler-Benz and Chrysler, Chrysler has become a chronic source of distress for the group's German top management. Despite billions spent to restructure Chrysler and some modest gains over the past two years, its future prospects remain murky.
The U.S. automaker continues to suffer from anemic sales—down 24% this quarter—an inability to anticipate major market trends such as the shift to fuel-efficient cars, production overcapacity, and erosion of market share. Only 16% of Chrysler's vehicles are fuel-efficient four-cylinder models, compared with an industry average of 37%.
The Cost of Conscience
Chrysler has a raft of passenger cars coming, for instance the just-released Jeep Compass crossover SUV, and soon, the new Chrysler Sebring and Dodge Avenger mid-sized sedans. But with more than 70% of its business in trucks, SUVs, and minivans, Chrysler will have to work hard to establish brand credibility among passenger car buyers, many of whom flock to Japanese and Korean models.
The company suffers from another common Detroit malady: retiree costs. Like rivals General Motors (GM) and Ford (F), Chrysler is paying for legions of retirees who rely on the corporation for their pension and medical benefits. Chrysler pays about $1,400 per vehicle in health-care costs, and the United Auto Workers union has frustrated Daimler CEO Dieter Zetsche and Chrysler chief Tom LaSorda by so far refusing to give them the same concessions on retiree benefits that saved GM $1 billion a year.
Chrysler also has a $22.3 billion pension plan that is underfunded by $1.7 billion. If Chrysler can't make up the shortfall by investing the pension fund's proceeds, it will have to spend more cash to get the plan flush.
"Really Bad News"
Auto industry analysts increasingly question whether Chrysler can escape a troubling pattern of swinging between modest profits in its best years and gushing losses in the worst ones. And that scenario makes it difficult to justify hanging on to Chrysler. "It's early to say the whole thing has to be unraveled, but they cannot keep throwing good money down the drain," says Garel Rhys, professor of automotive economics at the University of Cardiff in Wales.
Chrysler is now expected to lose $1.2 billion in 2006, dragging down group earnings and casting a shadow over a recovery under way at Mercedes Car Group.
Microsoft in Europe: The Real Stakes 2
Slow-Moving Regulators
In recent years, the European Union increasingly has taken on the role of global regulator for the tech industry, filling the vacuum left behind as the U.S. Justice Dept., under the Bush Administration, took a much less active role in pursuing antitrust cases. The EU push continues under Competition Commissioner Neelie Kroes, who replaced Monti in 2004. Analysts say the outcome of this case will determine if the Commission's Competition Directorate has the legal toolkit to enforce antitrust law in the complex and fast-changing technology business.
Indeed, many observers complain that regulators and courts are far too slow ever to be effective at shaping tech competition. During the years Microsoft has squared off with the EU, its market share in server operating software has grown to more than 70%, while Windows still holds a 93% share of desktop operating systems and Microsoft Office commands a 97% share of personal productivity applications.
That's why rivals are prodding the EC to go after Microsoft again. They argue that Vista and Office 2007 demonstrate a longstanding strategy by Microsoft to eliminate alternative platforms that threaten its market control. "Microsoft continues to protect and extend its monopolies through bundling and selective denial of interoperability information," says attorney Vinje, who represents the group of tech companies going after the software giant in the latest protest. Besides IBM, Oracle, and Nokia, the coalition, which filed its complaint as the European Committee for Interoperable Systems, or ECIS, includes Sun Microsystems (JAVA), Adobe Systems (ADBE), RealNetworks (RNWK), and open-source software maker Red Hat (RHT).
Antitrust Decision's Weaknesses
The ECIS argues that the European Commission should take action to restore competition in the server market and preserve the open-source operating system Linux and the Internet as alternative computing platforms. If it doesn't, the risk is that much of the world will be locked into using Microsoft software for the next 10 years, says Carlo Piana, a partner at Milan law firm Tamos Piana & Partners who represents the Free Software Foundation Europe, an industry group that champions open-source software.
Brussels antitrust lawyers say it is possible the new complaint will go forward even if the Commission loses on several counts on Sept. 17. The EC's 2004 decision does have some potential weaknesses, say antitrust lawyers. The remedy to fix Microsoft's Media Player monopoly failed miserably, for instance: The EC forced Microsoft to sell a version of its Windows operating system without Media Player software bundled in—but only a few thousand copies of the stripped-down version were ever sold. And RealNetworks, despite the ruling, became irrelevant in the media player market.
Another problem is Microsoft has negotiated private settlements with five of the major rivals who supported the original European case: Time Warner (TWX), Sun Microsystems, Novell (NOVL), the Computer & Communications Industry Assn., and RealNetworks. That means all the evidence submitted by companies such as RealNetworks was stripped from the record before being submitted to the Court of First Instance.
Appeal Possible from Either Side
The court could, in fact, rule against the Commission on procedure, fact, or remedy. What is essential for the Commission is that the legal grounds for its decision are upheld. Without that, it may lack the legal precedent—and gumption—to proceed with new cases.
Microsoft is hoping for victory, of course, though it couches its ambitions in diplomatic language. "This isn't really a question of win or lose," says spokesman Tom Brookes. "Microsoft hopes it will get clarity on some of the big questions regarding what its responsibilities are, and hopes that will form a basis for a constructive conversation with the regulators and with the industry so we can all move forward."
Either side has two months and 10 days to appeal the judgment of the Court of First Instance to the European Court of Justice. If that happens, it is likely to take at least another 18 months for a final decision to be reached.
Schenker is a BusinessWeek correspondent in Paris.
In recent years, the European Union increasingly has taken on the role of global regulator for the tech industry, filling the vacuum left behind as the U.S. Justice Dept., under the Bush Administration, took a much less active role in pursuing antitrust cases. The EU push continues under Competition Commissioner Neelie Kroes, who replaced Monti in 2004. Analysts say the outcome of this case will determine if the Commission's Competition Directorate has the legal toolkit to enforce antitrust law in the complex and fast-changing technology business.
Indeed, many observers complain that regulators and courts are far too slow ever to be effective at shaping tech competition. During the years Microsoft has squared off with the EU, its market share in server operating software has grown to more than 70%, while Windows still holds a 93% share of desktop operating systems and Microsoft Office commands a 97% share of personal productivity applications.
That's why rivals are prodding the EC to go after Microsoft again. They argue that Vista and Office 2007 demonstrate a longstanding strategy by Microsoft to eliminate alternative platforms that threaten its market control. "Microsoft continues to protect and extend its monopolies through bundling and selective denial of interoperability information," says attorney Vinje, who represents the group of tech companies going after the software giant in the latest protest. Besides IBM, Oracle, and Nokia, the coalition, which filed its complaint as the European Committee for Interoperable Systems, or ECIS, includes Sun Microsystems (JAVA), Adobe Systems (ADBE), RealNetworks (RNWK), and open-source software maker Red Hat (RHT).
Antitrust Decision's Weaknesses
The ECIS argues that the European Commission should take action to restore competition in the server market and preserve the open-source operating system Linux and the Internet as alternative computing platforms. If it doesn't, the risk is that much of the world will be locked into using Microsoft software for the next 10 years, says Carlo Piana, a partner at Milan law firm Tamos Piana & Partners who represents the Free Software Foundation Europe, an industry group that champions open-source software.
Brussels antitrust lawyers say it is possible the new complaint will go forward even if the Commission loses on several counts on Sept. 17. The EC's 2004 decision does have some potential weaknesses, say antitrust lawyers. The remedy to fix Microsoft's Media Player monopoly failed miserably, for instance: The EC forced Microsoft to sell a version of its Windows operating system without Media Player software bundled in—but only a few thousand copies of the stripped-down version were ever sold. And RealNetworks, despite the ruling, became irrelevant in the media player market.
Another problem is Microsoft has negotiated private settlements with five of the major rivals who supported the original European case: Time Warner (TWX), Sun Microsystems, Novell (NOVL), the Computer & Communications Industry Assn., and RealNetworks. That means all the evidence submitted by companies such as RealNetworks was stripped from the record before being submitted to the Court of First Instance.
Appeal Possible from Either Side
The court could, in fact, rule against the Commission on procedure, fact, or remedy. What is essential for the Commission is that the legal grounds for its decision are upheld. Without that, it may lack the legal precedent—and gumption—to proceed with new cases.
Microsoft is hoping for victory, of course, though it couches its ambitions in diplomatic language. "This isn't really a question of win or lose," says spokesman Tom Brookes. "Microsoft hopes it will get clarity on some of the big questions regarding what its responsibilities are, and hopes that will form a basis for a constructive conversation with the regulators and with the industry so we can all move forward."
Either side has two months and 10 days to appeal the judgment of the Court of First Instance to the European Court of Justice. If that happens, it is likely to take at least another 18 months for a final decision to be reached.
Schenker is a BusinessWeek correspondent in Paris.
Microsoft in Europe: The Real Stakes 1
By Jennifer L. Schenker
Microsoft's legal battle with Europe's competition regulator will reach a climax on Sept. 17, when Europe's second-highest court, the Luxembourg-based Court of First Instance, hands down a judgment that could determine the future of antitrust policy in the technology sector, as well as the commercial and legal strategy of the U.S software behemoth.
The immediate issue before the court is whether to uphold the European Commission's landmark 2004 antitrust decision against Microsoft (MSFT) or to side with Microsoft in its appeal. But the stakes are much higher than just one case. If the Luxembourg court validates the Commission's order, Microsoft could face a future in which its product design decisions and licensing policies are subject to scrutiny by governments around the world. If the court sides with Microsoft, it could signal the death knell for any serious attempt by policymakers anywhere to rein in the software giant.
The issue is of vital importance in Europe and beyond. Even as both sides have waited for a ruling from the appeals court, a group representing Microsoft rivals, including IBM (IBM), Oracle (ORCL), and Nokia (NOK), filed yet another complaint against Microsoft with the Commission last year. They argue that with the new Vista version of Windows and Office 2007, Microsoft is trying to extend its dominance into even more areas of the market—and threatening the open nature of the Internet.
If the court overturns the Commission's 2004 decision, it would eviscerate Europe's antitrust effort—and likely stop movement on the new complaint. But if the justices affirm that Microsoft employed unlawful business tactics in the past, "the Commission will be empowered to prohibit their use in the future," says Thomas Vinje, a partner at the law firm Clifford Chance in Brussels who represents a coalition of tech companies behind the latest complaint. Microsoft almost certainly will press on, even if it loses: The company is expected to appeal a negative ruling to the European Court of Justice, the highest body in the bloc and final arbiter.
Moment of Truth
Microsoft has been in the crosshairs of European antitrust officials since 1998. In March, 2004, the EU's Competition Directorate, under the leadership of Mario Monti, ordered the company to offer a version of Windows without a built-in, or "bundled," digital Media Player. Microsoft also had to share proprietary technical information to help rival software products communicate better with Windows desktops and servers. And the EC ordered the company to pay a $613 million fine, imposing an additional $390 million penalty in July, 2006, for Microsoft's failure to comply with the technical disclosure remedy.
Microsoft appealed, and now, at last, the moment of truth has arrived. Legal experts familiar with the Microsoft case—as well as with the Court of First Instance and Europe's skimpy collection of antitrust precedents—are deeply divided on the likely outcome. Some predict a split decision, with Microsoft winning on the media player (bundling) component of the case but losing on the interoperability (disclosure) part. One way or another, the Sept. 17 ruling will determine how effectively the European Commission can go forward with legal challenges to companies such as Microsoft and Intel (INTC).
That's critical because even while waiting for the appeal ruling, the Commission has launched an antitrust investigation against Intel (BusinessWeek.com, 7/27/07). On July 27, it issued a "statement of objections" that alleges Intel broke European Union law with the aim of excluding its main rival, AMD (AMD), from the market for the widely used x86 computer chip.
Microsoft's legal battle with Europe's competition regulator will reach a climax on Sept. 17, when Europe's second-highest court, the Luxembourg-based Court of First Instance, hands down a judgment that could determine the future of antitrust policy in the technology sector, as well as the commercial and legal strategy of the U.S software behemoth.
The immediate issue before the court is whether to uphold the European Commission's landmark 2004 antitrust decision against Microsoft (MSFT) or to side with Microsoft in its appeal. But the stakes are much higher than just one case. If the Luxembourg court validates the Commission's order, Microsoft could face a future in which its product design decisions and licensing policies are subject to scrutiny by governments around the world. If the court sides with Microsoft, it could signal the death knell for any serious attempt by policymakers anywhere to rein in the software giant.
The issue is of vital importance in Europe and beyond. Even as both sides have waited for a ruling from the appeals court, a group representing Microsoft rivals, including IBM (IBM), Oracle (ORCL), and Nokia (NOK), filed yet another complaint against Microsoft with the Commission last year. They argue that with the new Vista version of Windows and Office 2007, Microsoft is trying to extend its dominance into even more areas of the market—and threatening the open nature of the Internet.
If the court overturns the Commission's 2004 decision, it would eviscerate Europe's antitrust effort—and likely stop movement on the new complaint. But if the justices affirm that Microsoft employed unlawful business tactics in the past, "the Commission will be empowered to prohibit their use in the future," says Thomas Vinje, a partner at the law firm Clifford Chance in Brussels who represents a coalition of tech companies behind the latest complaint. Microsoft almost certainly will press on, even if it loses: The company is expected to appeal a negative ruling to the European Court of Justice, the highest body in the bloc and final arbiter.
Moment of Truth
Microsoft has been in the crosshairs of European antitrust officials since 1998. In March, 2004, the EU's Competition Directorate, under the leadership of Mario Monti, ordered the company to offer a version of Windows without a built-in, or "bundled," digital Media Player. Microsoft also had to share proprietary technical information to help rival software products communicate better with Windows desktops and servers. And the EC ordered the company to pay a $613 million fine, imposing an additional $390 million penalty in July, 2006, for Microsoft's failure to comply with the technical disclosure remedy.
Microsoft appealed, and now, at last, the moment of truth has arrived. Legal experts familiar with the Microsoft case—as well as with the Court of First Instance and Europe's skimpy collection of antitrust precedents—are deeply divided on the likely outcome. Some predict a split decision, with Microsoft winning on the media player (bundling) component of the case but losing on the interoperability (disclosure) part. One way or another, the Sept. 17 ruling will determine how effectively the European Commission can go forward with legal challenges to companies such as Microsoft and Intel (INTC).
That's critical because even while waiting for the appeal ruling, the Commission has launched an antitrust investigation against Intel (BusinessWeek.com, 7/27/07). On July 27, it issued a "statement of objections" that alleges Intel broke European Union law with the aim of excluding its main rival, AMD (AMD), from the market for the widely used x86 computer chip.
Nokia: High Profits in Low-End Phones 2
"We have been able with our volumes and marketing money to make it very difficult for competitors to match what we can offer," says Simonson. "And in the markets where we are also selling other products with heavy advertising behind the Nokia brand, there is a big overflow of marketing money in the sub-€30 segment."
Low-End Bonanza
Take India, one of the most promising and lucrative new markets for handset makers. The Finnish phonemaker's brand is now "what Kleenex is to tissue," says Piper Jaffray's Walker. Over 50% of all of the handsets sold by Nokia in the country are under €50, or $70.91. Sales of phones for less than €30 are growing fast and are expected to represent as much as 20% of the total device market in 2007.
While rivals are leery of following Nokia into the low end, the company has plenty of competition elsewhere. During an Oct. 18 conference call with investors, Chief Executive Olli-Pekka Kallasvuo singled out Apple (AAPL) and Research In Motion (RIMM) as competitors he's keeping an eye on.
Nokia holds 50% of the world market for smartphones, the pricey devices that let people handle e-mail, Web surfing, and more. But competition is expected to intensify as RIM continues to introduce devices and Apple's iPhone goes on sale in Britain, France, and Germany. "We are investing more money so that we can not only match that competition, but beat that competition," says Kallasvuo.
Allaying Some Worries
The U.S. is one of the company's few weak spots. Its market share is well behind what it holds overall in the world, in part because of technology issues and also because powerful wireless operators such as AT&T (T) and Verizon Communications (VZ) have chosen to use more malleable handset suppliers. Kallasvuo acknowledges the challenges, but says Nokia is determined to improve its overall position in the North American market. "We are not home and dry," he says. Next year "will be a critical year."
Kallasvuo also tried to allay a few fears about the company's future. In particular, he addressed concerns that Nokia's push into services could damage its relationship with wireless operators, by putting the company into competition with its own customers. On Oct. 1 the company made its biggest acquisition ever, agreeing to spend $8.1 billion on Navteq (NVT) (BusinessWeek.com, 10/1/07), a Chicago company that provides the digital mapping information underlying navigation devices and Internet services. Nokia already offers its own music service, similar to what companies such as Verizon offer.
In the third-quarter conference call, Kallasvuo pointed to an Oct. 9 deal with Spain's Telefónica as an example of the opportunities ahead. The two said they will work together to accelerate the adoption of new Internet services on mobile devices by giving Telefónica customers easy access to Net services developed by both companies. "We have ongoing discussions with many other operators across the world, and you will hear much more about that going forward," says Kallasvuo. "We can bring a lot to the table when it comes to services."
Who says Nokia can't find opportunities to cooperate where others see only competition? Its success in low-end phones shows the Finnish phone giant is able to pull off what few others can.
Schenker is a BusinessWeek correspondent in Paris.
Low-End Bonanza
Take India, one of the most promising and lucrative new markets for handset makers. The Finnish phonemaker's brand is now "what Kleenex is to tissue," says Piper Jaffray's Walker. Over 50% of all of the handsets sold by Nokia in the country are under €50, or $70.91. Sales of phones for less than €30 are growing fast and are expected to represent as much as 20% of the total device market in 2007.
While rivals are leery of following Nokia into the low end, the company has plenty of competition elsewhere. During an Oct. 18 conference call with investors, Chief Executive Olli-Pekka Kallasvuo singled out Apple (AAPL) and Research In Motion (RIMM) as competitors he's keeping an eye on.
Nokia holds 50% of the world market for smartphones, the pricey devices that let people handle e-mail, Web surfing, and more. But competition is expected to intensify as RIM continues to introduce devices and Apple's iPhone goes on sale in Britain, France, and Germany. "We are investing more money so that we can not only match that competition, but beat that competition," says Kallasvuo.
Allaying Some Worries
The U.S. is one of the company's few weak spots. Its market share is well behind what it holds overall in the world, in part because of technology issues and also because powerful wireless operators such as AT&T (T) and Verizon Communications (VZ) have chosen to use more malleable handset suppliers. Kallasvuo acknowledges the challenges, but says Nokia is determined to improve its overall position in the North American market. "We are not home and dry," he says. Next year "will be a critical year."
Kallasvuo also tried to allay a few fears about the company's future. In particular, he addressed concerns that Nokia's push into services could damage its relationship with wireless operators, by putting the company into competition with its own customers. On Oct. 1 the company made its biggest acquisition ever, agreeing to spend $8.1 billion on Navteq (NVT) (BusinessWeek.com, 10/1/07), a Chicago company that provides the digital mapping information underlying navigation devices and Internet services. Nokia already offers its own music service, similar to what companies such as Verizon offer.
In the third-quarter conference call, Kallasvuo pointed to an Oct. 9 deal with Spain's Telefónica as an example of the opportunities ahead. The two said they will work together to accelerate the adoption of new Internet services on mobile devices by giving Telefónica customers easy access to Net services developed by both companies. "We have ongoing discussions with many other operators across the world, and you will hear much more about that going forward," says Kallasvuo. "We can bring a lot to the table when it comes to services."
Who says Nokia can't find opportunities to cooperate where others see only competition? Its success in low-end phones shows the Finnish phone giant is able to pull off what few others can.
Schenker is a BusinessWeek correspondent in Paris.
Nokia: High Profits in Low-End Phones 1
By Jennifer L. Schenker
Maybe there is high profit potential in low-end phones. On Oct. 18, Nokia (NOK) announced that third-quarter profit soared 85%, to $2.2 billion, handily beating analysts' estimates and sending its stock surging.
The strong showing is something of a surprise, not only because it comes just as telecom equipment makers Ericsson (ERIC) and Alcatel-Lucent (ALU) are struggling, but also because Nokia is the first mobile-phone company to show it can make healthy operating margins on entry-level phones. "The profitability is stunning considering the sales in the low end of the market," says Richard Windsor, a financial analyst who tracks Nokia for Nomura Securities (NMR).
Nokia reported that third-quarter revenues rose 28%, to €12.9 billion, or $18.3 billion. Net income increased to €1.6 billion, or $2.2 billion, which works out to 40 eurocents, 6 cents more than analysts had been predicting. The report came just two days after Ericsson reported third-quarter earnings that fell far short of expectations (BusinessWeek.com, 10/16/07), wiping out some $17.5 billion in market capitalization.
Helping Nokia is the continuing strong demand for mobile phones. The company shipped 112 million units for the quarter, a record for the industry. Nokia now predicts that 1.1 billion mobile devices will be sold this year, up from 978 million in 2006. The company's results follow strong profit reports from mobile-phone rivals LG, Samsung, and Sony Ericsson in the third quarter. Michael Walkley, a wireless technology analyst at Piper Jaffray (PJC), says the fact that so many of the handset makers are doing well underscores the robust demand for mobile phones, even in a relatively benign pricing environment. Motorola (MOT), another top rival, is slated to report results on Oct. 25.
Healthy Margins
But Nokia is the only manufacturer that's managing to do well even as it pushes aggressively into the low end of the market. The company impressed financial analysts by reporting healthy operating margins, despite a sharp drop in the average selling price of its phones. The average price dropped to €82, or $116, in the third quarter, from €90, or $127, in the previous quarter. Nevertheless, the company's operating margins in its mobile-phone business increased to 22.6% in the third quarter, up from 21.2% in the second quarter. The decrease in average selling price was the result of a sharp uptick in the number of phones it sells for less than €30, or $42.54.
With the widest range of phones of any handset maker, Nokia is managing to do well in low-end phones, top-of-the-line, and pretty much everything in between. "We can make money on a €300 phone, a €150 phone, or a €30 phone, and nobody else has been able to do that last part," says Rick Simonson, Nokia's chief financial officer in an interview. "Even when we are selling a €30 device, we are making gross margins in the high 20% range," he says.
Nokia now holds 39% of the mobile-phone market globally, more than all three of its closest rivals—Samsung, Motorola, and Sony Ericsson—combined. The company predicts it will be able to match that market share in the fourth quarter, which would boost its share for the year from last year.
Maybe there is high profit potential in low-end phones. On Oct. 18, Nokia (NOK) announced that third-quarter profit soared 85%, to $2.2 billion, handily beating analysts' estimates and sending its stock surging.
The strong showing is something of a surprise, not only because it comes just as telecom equipment makers Ericsson (ERIC) and Alcatel-Lucent (ALU) are struggling, but also because Nokia is the first mobile-phone company to show it can make healthy operating margins on entry-level phones. "The profitability is stunning considering the sales in the low end of the market," says Richard Windsor, a financial analyst who tracks Nokia for Nomura Securities (NMR).
Nokia reported that third-quarter revenues rose 28%, to €12.9 billion, or $18.3 billion. Net income increased to €1.6 billion, or $2.2 billion, which works out to 40 eurocents, 6 cents more than analysts had been predicting. The report came just two days after Ericsson reported third-quarter earnings that fell far short of expectations (BusinessWeek.com, 10/16/07), wiping out some $17.5 billion in market capitalization.
Helping Nokia is the continuing strong demand for mobile phones. The company shipped 112 million units for the quarter, a record for the industry. Nokia now predicts that 1.1 billion mobile devices will be sold this year, up from 978 million in 2006. The company's results follow strong profit reports from mobile-phone rivals LG, Samsung, and Sony Ericsson in the third quarter. Michael Walkley, a wireless technology analyst at Piper Jaffray (PJC), says the fact that so many of the handset makers are doing well underscores the robust demand for mobile phones, even in a relatively benign pricing environment. Motorola (MOT), another top rival, is slated to report results on Oct. 25.
Healthy Margins
But Nokia is the only manufacturer that's managing to do well even as it pushes aggressively into the low end of the market. The company impressed financial analysts by reporting healthy operating margins, despite a sharp drop in the average selling price of its phones. The average price dropped to €82, or $116, in the third quarter, from €90, or $127, in the previous quarter. Nevertheless, the company's operating margins in its mobile-phone business increased to 22.6% in the third quarter, up from 21.2% in the second quarter. The decrease in average selling price was the result of a sharp uptick in the number of phones it sells for less than €30, or $42.54.
With the widest range of phones of any handset maker, Nokia is managing to do well in low-end phones, top-of-the-line, and pretty much everything in between. "We can make money on a €300 phone, a €150 phone, or a €30 phone, and nobody else has been able to do that last part," says Rick Simonson, Nokia's chief financial officer in an interview. "Even when we are selling a €30 device, we are making gross margins in the high 20% range," he says.
Nokia now holds 39% of the mobile-phone market globally, more than all three of its closest rivals—Samsung, Motorola, and Sony Ericsson—combined. The company predicts it will be able to match that market share in the fourth quarter, which would boost its share for the year from last year.
HSBC, Credit Suisse Swing the Axe
By Sean Farrell
Another 1,150 redundancies in Britain's banking industry were announced yesterday as Credit Suisse (CS) cut 10 per cent of its UK workforce and HSBC (HBC)said it was axing 500 jobs.
Credit Suisse, which has offices in London, Birmingham and Manchester, said it would cut 650 jobs. A spokesman for the Swiss bank blamed "market conditions and projected staffing levels required to meet client needs".
HSBC also said it was making cuts because of the tough economic climate and in order to cut duplication. Most of the jobs will go from support functions such as legal and finance at the bank's London headquarters at Canary Wharf, where about 8,000 of its 58,000 employees work. The rest will be cut from HSBC's business banking operations around the country.
The bank said the cuts would affect fewer than 500 people because some would be redeployed. But Unite, Britain's biggest trade union, reacted with fury to HSBC's decision, accusing the bank of using the economic slowdown as an excuse to axe jobs at a time when staff are vulnerable. The union pledged to oppose compulsory redundancies.
Derek Simpson, Unite's joint general secretary, said: "The decision by HSBC to make 500 job cuts is a disgrace. Unite is appalled that this news has been delivered so close to Christmas. The union has seen no business rationale for these job losses. The bank has again reported an increase in half-yearly profit and continues to do well."
HSBC has had frosty relations with unions in recent years. The job cuts come soon after the bank watered down proposals to reduce benefits of its final-salary pension scheme after Unite threatened to strike over the plan.
HSBC's UK managing director, Paul Thurston, said of the cuts: "We deeply regret this step, but consider it essential to ensure our business is operating as efficiently as possible and we are best placed to deal with the downturn."
Provided by The Independent—from London, for Independent minds
Another 1,150 redundancies in Britain's banking industry were announced yesterday as Credit Suisse (CS) cut 10 per cent of its UK workforce and HSBC (HBC)said it was axing 500 jobs.
Credit Suisse, which has offices in London, Birmingham and Manchester, said it would cut 650 jobs. A spokesman for the Swiss bank blamed "market conditions and projected staffing levels required to meet client needs".
HSBC also said it was making cuts because of the tough economic climate and in order to cut duplication. Most of the jobs will go from support functions such as legal and finance at the bank's London headquarters at Canary Wharf, where about 8,000 of its 58,000 employees work. The rest will be cut from HSBC's business banking operations around the country.
The bank said the cuts would affect fewer than 500 people because some would be redeployed. But Unite, Britain's biggest trade union, reacted with fury to HSBC's decision, accusing the bank of using the economic slowdown as an excuse to axe jobs at a time when staff are vulnerable. The union pledged to oppose compulsory redundancies.
Derek Simpson, Unite's joint general secretary, said: "The decision by HSBC to make 500 job cuts is a disgrace. Unite is appalled that this news has been delivered so close to Christmas. The union has seen no business rationale for these job losses. The bank has again reported an increase in half-yearly profit and continues to do well."
HSBC has had frosty relations with unions in recent years. The job cuts come soon after the bank watered down proposals to reduce benefits of its final-salary pension scheme after Unite threatened to strike over the plan.
HSBC's UK managing director, Paul Thurston, said of the cuts: "We deeply regret this step, but consider it essential to ensure our business is operating as efficiently as possible and we are best placed to deal with the downturn."
Provided by The Independent—from London, for Independent minds
European Economic Recession Ahead? 2
On a trade-weighted basis, the exchange rate of the euro against the zone’s major trading partners strengthened since the beginning of 2007 to reach its highest level since 1999 in April 2008. At a time when foreign demand for Eurozone products, particularly from the United States but also from the weakening United Kingdom economy, is sliding, a strong currency is an obvious impediment.
That said, more positive factors should also be considered. One is that Eurozone exporters have benefited significantly from the rising import demand from oil-exporting countries. Export revenues of major oil-exporting countries rose to $1.3 trillion in 2007 from about $412 billion in 2002, on the back of the sustained rise in oil prices.
A study in the July 2008 issue of the European Central Bank’s (ECB) monthly bulletin showed that despite the growing share of Asian exports in these markets, Eurozone exporters have been able to maintain a high and stable market share in recent years, averaging 25% in 2007. This positive outcome must be nuanced, however, as it has been driven mainly by Russia, as Eurozone exports’ market share in other oil-exporting countries (mainly OPEC) declined slightly to 21% in 2007 from 25% in 2002.
But over that same period, the U.S. market share in total imports of oil-exporting countries (Russia included) decreased to 7.5% from 12.0%. In other words, Eurozone exporters were able to maintain or even increase (in Russia) their market share despite the handicap of a strong currency. Between 2002 and 2007 the annual growth in export volumes of goods to OPEC and Russia was on average 7% and 17%, respectively, significantly above the average growth in extra-Eurozone exports of around 5%. Strong demand from those economies will continue to boost Eurozone exports in 2008 and 2009.
The second mitigating factor comes from the outlook for the euro exchange rate itself. Our baseline forecast expects the euro exchange rate to peak against the U.S. dollar in the third quarter of 2008 near 1.60. Then, the rate should slowly decline, as the fundamentals begin to turn in favor of the U.S. currency, with weaker growth prospects in the Eurozone and an increased probability of an interest rate hike in 2009 in the United States. We expect the euro to retreat toward 1.45 in the fourth quarter of 2008 and to 1.40 by mid-2009.
Overall, Eurozone export growth should drop to 4% in 2008 (6% in 2007) and 3% in 2009. German exports are likely to follow a similar trend, rising 4.7% in 2008 (8.0% last year) and 3.0% in 2009. French exports, after an upbeat performance in the first quarter of this year, should experience a very modest rise in the second half of the year, leading to an average increase in 2008 of 3.9% (3.6% in 2007). French export growth in 2009 is likely to ease further to 3.0%.
That said, more positive factors should also be considered. One is that Eurozone exporters have benefited significantly from the rising import demand from oil-exporting countries. Export revenues of major oil-exporting countries rose to $1.3 trillion in 2007 from about $412 billion in 2002, on the back of the sustained rise in oil prices.
A study in the July 2008 issue of the European Central Bank’s (ECB) monthly bulletin showed that despite the growing share of Asian exports in these markets, Eurozone exporters have been able to maintain a high and stable market share in recent years, averaging 25% in 2007. This positive outcome must be nuanced, however, as it has been driven mainly by Russia, as Eurozone exports’ market share in other oil-exporting countries (mainly OPEC) declined slightly to 21% in 2007 from 25% in 2002.
But over that same period, the U.S. market share in total imports of oil-exporting countries (Russia included) decreased to 7.5% from 12.0%. In other words, Eurozone exporters were able to maintain or even increase (in Russia) their market share despite the handicap of a strong currency. Between 2002 and 2007 the annual growth in export volumes of goods to OPEC and Russia was on average 7% and 17%, respectively, significantly above the average growth in extra-Eurozone exports of around 5%. Strong demand from those economies will continue to boost Eurozone exports in 2008 and 2009.
The second mitigating factor comes from the outlook for the euro exchange rate itself. Our baseline forecast expects the euro exchange rate to peak against the U.S. dollar in the third quarter of 2008 near 1.60. Then, the rate should slowly decline, as the fundamentals begin to turn in favor of the U.S. currency, with weaker growth prospects in the Eurozone and an increased probability of an interest rate hike in 2009 in the United States. We expect the euro to retreat toward 1.45 in the fourth quarter of 2008 and to 1.40 by mid-2009.
Overall, Eurozone export growth should drop to 4% in 2008 (6% in 2007) and 3% in 2009. German exports are likely to follow a similar trend, rising 4.7% in 2008 (8.0% last year) and 3.0% in 2009. French exports, after an upbeat performance in the first quarter of this year, should experience a very modest rise in the second half of the year, leading to an average increase in 2008 of 3.9% (3.6% in 2007). French export growth in 2009 is likely to ease further to 3.0%.
European Economic Recession Ahead? 1
By Jean-Michel Six, Standard & Poor's
From Standard & Poor's Equity Research
Results for the first quarter of 2008 could have made us believe that Europe would remain relatively immune from the U.S. slowdown and the disruptions in financial markets. Since then, however, a flurry of data from across the region consistently suggests that such views were overly optimistic, and a major slowdown is about to occur in the second half of this year.
Gross domestic product (GDP) in the Eurozone contracted at a 0.8% annual rate in the second quarter. Additionally, the July survey of purchasing managers in manufacturing and services dropped to its lowest level since 2001.
Meanwhile, consumer price inflation in the Eurozone accelerated to 4.1% in the 12 months to July, its highest level since the introduction of the single currency in 1999. Inflation also accelerated in the United Kingdom to 4.4% year-on-year (3.8% in June). We consider the outlook for inflation in the next 12 months to be the most critical variable for Europe’s economies. Indeed, we think a deceleration on the back of lower oil prices would create a very different environment for monetary policies and provide a relief for hard-squeezed consumers. Until then, however, Europe should brace itself for a period of stagflation.
Economic storm gains strength
Economic reports published recently painted a bleak picture. The data are indicative that European economies are currently in the middle of a storm. Its components include:
A downturn in world trade induced by the weakening U.S. economy and whose effects are compounded by the strong euro exchange rate; the unwinding of the housing bubbles in key economies such as the United Kingdom, Spain, and Ireland, now extending to other countries such as France, Denmark, and Portugal; and accelerating retail price inflation on the back of surging commodity prices. This curtails consumers’ purchasing power and prevents central banks from adopting more supportive policies, while lenders clamp down on credit growth as wholesale funding dried up.
In the face of this slew of negative data, business and consumer sentiment is heading south. In July, the Eurozone purchasing managers index (PMI) tumbled to its lowest level in the 10-year history of the series (except for October-November 2001). The PMI decline was mirrored in the national business surveys. The August Ifo business confidence survey for Germany showed a marked decline in business leaders’ expectations of future conditions, comparable to what was seen in early 2004, when the German economy began to slow. The July ZEW indicator of economic sentiment, which focuses more on investors’ expectations in that same country, showed a similar deterioration.
Consumer surveys are similarly bleak, reporting a sharp deterioration on the back of worsening conditions in labor markets, as weak domestic demand and margin compression lead companies to curtail hiring. The biggest drop in confidence took place in Spain in June, which is hardly surprising given the fast deceleration in economic growth taking place at the moment in that country, although French sentiment also plummeted to levels not seen since early 2005 when Europe as a whole was experiencing anemic growth.
In the United Kingdom, the number of benefit claimants rose by 15,500 in June, the highest single-month increase since December 1992, highlighting a weakening labor market.
European car sales contracted by 7.9% in the month of June, according to ACEA, the European Association of Car Manufacturers. The breakdown of the ACEA numbers shows, however, that the economic slowdown is uneven across the region: In France (+1.5%) and Germany (+1.0%), the number of registrations increased, while the markets in the United Kingdom (-6.1%), Italy (-19.5%), and Spain (-30.8%) deteriorated.
All these negative signals point to the same question: Is the European economy about to enter into a period of recession, with several consecutive quarters of negative growth?
The strong euro is weighing on the performance of Eurozone exports.
From Standard & Poor's Equity Research
Results for the first quarter of 2008 could have made us believe that Europe would remain relatively immune from the U.S. slowdown and the disruptions in financial markets. Since then, however, a flurry of data from across the region consistently suggests that such views were overly optimistic, and a major slowdown is about to occur in the second half of this year.
Gross domestic product (GDP) in the Eurozone contracted at a 0.8% annual rate in the second quarter. Additionally, the July survey of purchasing managers in manufacturing and services dropped to its lowest level since 2001.
Meanwhile, consumer price inflation in the Eurozone accelerated to 4.1% in the 12 months to July, its highest level since the introduction of the single currency in 1999. Inflation also accelerated in the United Kingdom to 4.4% year-on-year (3.8% in June). We consider the outlook for inflation in the next 12 months to be the most critical variable for Europe’s economies. Indeed, we think a deceleration on the back of lower oil prices would create a very different environment for monetary policies and provide a relief for hard-squeezed consumers. Until then, however, Europe should brace itself for a period of stagflation.
Economic storm gains strength
Economic reports published recently painted a bleak picture. The data are indicative that European economies are currently in the middle of a storm. Its components include:
A downturn in world trade induced by the weakening U.S. economy and whose effects are compounded by the strong euro exchange rate; the unwinding of the housing bubbles in key economies such as the United Kingdom, Spain, and Ireland, now extending to other countries such as France, Denmark, and Portugal; and accelerating retail price inflation on the back of surging commodity prices. This curtails consumers’ purchasing power and prevents central banks from adopting more supportive policies, while lenders clamp down on credit growth as wholesale funding dried up.
In the face of this slew of negative data, business and consumer sentiment is heading south. In July, the Eurozone purchasing managers index (PMI) tumbled to its lowest level in the 10-year history of the series (except for October-November 2001). The PMI decline was mirrored in the national business surveys. The August Ifo business confidence survey for Germany showed a marked decline in business leaders’ expectations of future conditions, comparable to what was seen in early 2004, when the German economy began to slow. The July ZEW indicator of economic sentiment, which focuses more on investors’ expectations in that same country, showed a similar deterioration.
Consumer surveys are similarly bleak, reporting a sharp deterioration on the back of worsening conditions in labor markets, as weak domestic demand and margin compression lead companies to curtail hiring. The biggest drop in confidence took place in Spain in June, which is hardly surprising given the fast deceleration in economic growth taking place at the moment in that country, although French sentiment also plummeted to levels not seen since early 2005 when Europe as a whole was experiencing anemic growth.
In the United Kingdom, the number of benefit claimants rose by 15,500 in June, the highest single-month increase since December 1992, highlighting a weakening labor market.
European car sales contracted by 7.9% in the month of June, according to ACEA, the European Association of Car Manufacturers. The breakdown of the ACEA numbers shows, however, that the economic slowdown is uneven across the region: In France (+1.5%) and Germany (+1.0%), the number of registrations increased, while the markets in the United Kingdom (-6.1%), Italy (-19.5%), and Spain (-30.8%) deteriorated.
All these negative signals point to the same question: Is the European economy about to enter into a period of recession, with several consecutive quarters of negative growth?
The strong euro is weighing on the performance of Eurozone exports.
How Many Countries Will Need IMF Help?
By S. Adam Cardais
It's now clear that the global financial crisis has not only crossed the Atlantic into Europe, it has spanned the entire continent.
Just weeks ago the vulnerability that emerged in the United Kingdom and flashed before the world as Iceland's banking sector imploded looked confined to Western Europe. After all, many analysts said, Central and Eastern European economies are little exposed to the mortgage-backed securities behind the meltdown, and for most, their fundamentals and growth are strong.
Then came news at the end of October that the International Monetary Fund was negotiating multibillion dollar bailout packages for Ukraine and Hungary, the latter of which had already received a nearly $7 billion credit line from the European Central Bank. Suddenly, there were murmurs of an Iceland sequel in the east.
The IMF, which has now reached loan deals with both countries, seems committed to restoring confidence in battered economies, so that probably won't happen. But with regional currencies and stock markets from Riga to Budapest to Prague cratering – many down more than 50 percent this year – as panic spreads, it's not unreasonable to start talking about the "Eastern European predicament."
Economically, Central and Eastern Europe is diverse, so the individual symptoms behind the region's larger sickness are many, as are the prognoses for each country. But, ultimately, it's fairly simple: for many years, like U.S. homeowners who took out mortgages they couldn't afford, many of these economies have lived beyond their means on credit.
EAGER BORROWERS
Countries throughout the region used capital inflows from lenders, investors, and foreign governments to build up their economies after the fall of the Soviet Union and, in some cases, in preparation for European Union membership. This was a largely healthy process, but as economies matured and living standards improved, consumption ballooned. In the Baltics, Romania, Bulgaria, or Ukraine, for example, consumption became the main driver of robust economic growth, not manufacturing or exporting, according to Vasily Astrov of the Vienna Institute for International Economic Studies.
This, in turn, led to huge demand for imports. But this was not met – or, ideally, exceeded – by revenues from exports.
"So they had to borrow," Astrov says. "And they became heavily indebted."
Technically, this borrowing was tenable as long as the global financial system was flush with cash. Now it's not; credit, capital, and investors are becoming scarce; and these economies are foundering as panic spreads through stock and currency markets. The Hungarian forint, for example, is down around 30 percent against the U.S. dollar since August.
Economists call this a "sudden stop." It's as if the global economy is saying, "Hey, you know all that money we've been lending you guys? Yeah, we've got cash flow problems at the moment, so you're on your own."
Further exposing many countries are high foreign exchange loan volumes. In recent years many Hungarian homeowners and businesses, for instance, have taken loans from Western banks in foreign currencies at lower interest rates than would be offered domestically, betting that the forint would remain strong.
But with the forint tumbling, repaying those loans has become a lot more expensive – and they account for 90 percent of new mortgages since 2006, according to figures published 23 October in The Economist. This has fomented a nascent currency crisis that has many Western lenders worried about defaults and questioning whether they should roll over loans, even to sound debtors.
That's a major reason the IMF rushed to help Ukraine and Hungary. It's loaning the former $16 billion and, together with the EU and the World Bank, Hungary $25.1 billion, the largest international economic rescue package for an emerging economy since the start of the crisis.
The IMF has also created a $100 billion fund to aid other economies. The question now is, how many East European countries will need similar help?
Romania and Bulgaria likely will, but a lot will depend on whether Western banks, which own much of Eastern Europe's banking sector, keep lending, as The Economist recently pointed out.
Astrov says those economies saturated by large Western banks, such as the Czech Republic, will at least in the short term have fewer liquidity problems than countries with a lower penetration.
"In countries where the presence of foreign banks is more limited, then local banks have to borrow abroad," he says. "If there's a crisis of confidence, [foreign banks] might not lend money to someone who doesn't belong to them."
It's also true that more advanced economies such as the Czech Republic, Slovakia, and Poland appear better positioned to ride this out. The Czech Republic, for instance, has seen the Prague bourse drop around 50 percent this year and the crown lose 20 percent against the dollar since August. But its economy is export-, not consumption-based, and debt and inflation are low relative to many of its eastern neighbors.
Poland and Slovakia appear relatively safe as well, though both Slovakia and the Czech Republic – each car manufacturing hubs and large exporters to Western Europe – should be concerned about the automotive industry's decline and winnowing demand as Old Europe suffers.
After all, this crisis is collapsing on Europe – and no country, no matter how fundamentally sound, will be invulnerable.
Provided by Transitions Online—Intelligent Eastern Europe
It's now clear that the global financial crisis has not only crossed the Atlantic into Europe, it has spanned the entire continent.
Just weeks ago the vulnerability that emerged in the United Kingdom and flashed before the world as Iceland's banking sector imploded looked confined to Western Europe. After all, many analysts said, Central and Eastern European economies are little exposed to the mortgage-backed securities behind the meltdown, and for most, their fundamentals and growth are strong.
Then came news at the end of October that the International Monetary Fund was negotiating multibillion dollar bailout packages for Ukraine and Hungary, the latter of which had already received a nearly $7 billion credit line from the European Central Bank. Suddenly, there were murmurs of an Iceland sequel in the east.
The IMF, which has now reached loan deals with both countries, seems committed to restoring confidence in battered economies, so that probably won't happen. But with regional currencies and stock markets from Riga to Budapest to Prague cratering – many down more than 50 percent this year – as panic spreads, it's not unreasonable to start talking about the "Eastern European predicament."
Economically, Central and Eastern Europe is diverse, so the individual symptoms behind the region's larger sickness are many, as are the prognoses for each country. But, ultimately, it's fairly simple: for many years, like U.S. homeowners who took out mortgages they couldn't afford, many of these economies have lived beyond their means on credit.
EAGER BORROWERS
Countries throughout the region used capital inflows from lenders, investors, and foreign governments to build up their economies after the fall of the Soviet Union and, in some cases, in preparation for European Union membership. This was a largely healthy process, but as economies matured and living standards improved, consumption ballooned. In the Baltics, Romania, Bulgaria, or Ukraine, for example, consumption became the main driver of robust economic growth, not manufacturing or exporting, according to Vasily Astrov of the Vienna Institute for International Economic Studies.
This, in turn, led to huge demand for imports. But this was not met – or, ideally, exceeded – by revenues from exports.
"So they had to borrow," Astrov says. "And they became heavily indebted."
Technically, this borrowing was tenable as long as the global financial system was flush with cash. Now it's not; credit, capital, and investors are becoming scarce; and these economies are foundering as panic spreads through stock and currency markets. The Hungarian forint, for example, is down around 30 percent against the U.S. dollar since August.
Economists call this a "sudden stop." It's as if the global economy is saying, "Hey, you know all that money we've been lending you guys? Yeah, we've got cash flow problems at the moment, so you're on your own."
Further exposing many countries are high foreign exchange loan volumes. In recent years many Hungarian homeowners and businesses, for instance, have taken loans from Western banks in foreign currencies at lower interest rates than would be offered domestically, betting that the forint would remain strong.
But with the forint tumbling, repaying those loans has become a lot more expensive – and they account for 90 percent of new mortgages since 2006, according to figures published 23 October in The Economist. This has fomented a nascent currency crisis that has many Western lenders worried about defaults and questioning whether they should roll over loans, even to sound debtors.
That's a major reason the IMF rushed to help Ukraine and Hungary. It's loaning the former $16 billion and, together with the EU and the World Bank, Hungary $25.1 billion, the largest international economic rescue package for an emerging economy since the start of the crisis.
The IMF has also created a $100 billion fund to aid other economies. The question now is, how many East European countries will need similar help?
Romania and Bulgaria likely will, but a lot will depend on whether Western banks, which own much of Eastern Europe's banking sector, keep lending, as The Economist recently pointed out.
Astrov says those economies saturated by large Western banks, such as the Czech Republic, will at least in the short term have fewer liquidity problems than countries with a lower penetration.
"In countries where the presence of foreign banks is more limited, then local banks have to borrow abroad," he says. "If there's a crisis of confidence, [foreign banks] might not lend money to someone who doesn't belong to them."
It's also true that more advanced economies such as the Czech Republic, Slovakia, and Poland appear better positioned to ride this out. The Czech Republic, for instance, has seen the Prague bourse drop around 50 percent this year and the crown lose 20 percent against the dollar since August. But its economy is export-, not consumption-based, and debt and inflation are low relative to many of its eastern neighbors.
Poland and Slovakia appear relatively safe as well, though both Slovakia and the Czech Republic – each car manufacturing hubs and large exporters to Western Europe – should be concerned about the automotive industry's decline and winnowing demand as Old Europe suffers.
After all, this crisis is collapsing on Europe – and no country, no matter how fundamentally sound, will be invulnerable.
Provided by Transitions Online—Intelligent Eastern Europe
Will Credit Crunch Destroy the Euro Zone? (part 2)
Some readers will recall a time in 1988 when it was claimed that the value of a few square kilometres of real estate in Tokyo exceeded the assets of the US state of California.
The bursting of the Japanese property bubble brought with it a similar credit crunch, and fearing the worst, Japanese households cut their spending thus sending the economy deeper into recession. The Bank of Japan initially did the right thing, flooding the market with liquidity and holding nominal interest rates close to zero. But in the early 1990s, price levels started to fall—causing consumers' nominal debt to rise in real terms and leading them to postpone consumption even more. The result was nearly two decades of stagnation. As Keynes recognised, there comes a point when the use of monetary policy alone is as ineffective as 'pushing on a string'.
The fourth point—following logically from the third—is that Keynesian fiscal policy is very relevant today. Ultimately, when nobody else is willing to spend and when credit is tight, it is government which must spent its way out of the crisis. This was the lesson of the 1930s and 40s, the lesson in Europe of Marshall and the the trente glorieuses, the lesson of Japan, and it is still the lesson today. But Europe has been vulnerable to stagnation for the past decade.
Why Europe is vulnerable
Lest Europeans should think themselves smugly superior to America in terms of economics (we after all have not engaged in sub-prime lending), the reader might ponder the ECB's current obsession with inflation.
True, oil prices are rising and food is dearer (particularly in the world's poorest countries), but to raise interest rates in the face of impending recession as the ECB has recently done is little short of economic madness. Oil prices are high because of growing uncertainty about the future of the Middle East; food prices are high in good measure because of switching agricultural land to biofuel crops. Tighter money in Europe may squeeze household demand, but it will not help resolve the underlying causes of inflation.
More ominously, the Eurozone is vulnerable to crisis because of the lop-sided nature of its economic governance—a powerful central bank, but a tiny, non-adjustable EU budget, with fiscal spending at member-state level constrained by the SGP.
In this sense, the US is far better equipped to combat recession; its Central Bank is required to treat inflation as only one of three criteria, while Congress has discretionary power to use the federal budget counter-cyclically; eg, it accepted George Bush's reflationary package worth 1% of GDP, however poorly targeted the package may have been. The EU has no such discretion, but instead is bound by rules-driven automatic stabilisers inspired by bankers' notions of 'sound money'.
True, when the downswing really starts to hurt the ECB still retains plenty of scope to cut interest rates. But what happens when monetary policy becomes ineffective. In truth, Brussels will need to reconsider Keynes and the Eurozone's economic architecture will need to alter drastically, or else the very existence of the Eurozone will be in peril. For pro-Europeans like myself, that is the harshest lesson of the present crisis.
Provided by EUobserver—For the latest EU related news
The bursting of the Japanese property bubble brought with it a similar credit crunch, and fearing the worst, Japanese households cut their spending thus sending the economy deeper into recession. The Bank of Japan initially did the right thing, flooding the market with liquidity and holding nominal interest rates close to zero. But in the early 1990s, price levels started to fall—causing consumers' nominal debt to rise in real terms and leading them to postpone consumption even more. The result was nearly two decades of stagnation. As Keynes recognised, there comes a point when the use of monetary policy alone is as ineffective as 'pushing on a string'.
The fourth point—following logically from the third—is that Keynesian fiscal policy is very relevant today. Ultimately, when nobody else is willing to spend and when credit is tight, it is government which must spent its way out of the crisis. This was the lesson of the 1930s and 40s, the lesson in Europe of Marshall and the the trente glorieuses, the lesson of Japan, and it is still the lesson today. But Europe has been vulnerable to stagnation for the past decade.
Why Europe is vulnerable
Lest Europeans should think themselves smugly superior to America in terms of economics (we after all have not engaged in sub-prime lending), the reader might ponder the ECB's current obsession with inflation.
True, oil prices are rising and food is dearer (particularly in the world's poorest countries), but to raise interest rates in the face of impending recession as the ECB has recently done is little short of economic madness. Oil prices are high because of growing uncertainty about the future of the Middle East; food prices are high in good measure because of switching agricultural land to biofuel crops. Tighter money in Europe may squeeze household demand, but it will not help resolve the underlying causes of inflation.
More ominously, the Eurozone is vulnerable to crisis because of the lop-sided nature of its economic governance—a powerful central bank, but a tiny, non-adjustable EU budget, with fiscal spending at member-state level constrained by the SGP.
In this sense, the US is far better equipped to combat recession; its Central Bank is required to treat inflation as only one of three criteria, while Congress has discretionary power to use the federal budget counter-cyclically; eg, it accepted George Bush's reflationary package worth 1% of GDP, however poorly targeted the package may have been. The EU has no such discretion, but instead is bound by rules-driven automatic stabilisers inspired by bankers' notions of 'sound money'.
True, when the downswing really starts to hurt the ECB still retains plenty of scope to cut interest rates. But what happens when monetary policy becomes ineffective. In truth, Brussels will need to reconsider Keynes and the Eurozone's economic architecture will need to alter drastically, or else the very existence of the Eurozone will be in peril. For pro-Europeans like myself, that is the harshest lesson of the present crisis.
Provided by EUobserver—For the latest EU related news
Will Credit Crunch Destroy the Euro Zone? (part 1)
By George Irvin
Anybody who believes the Eurozone is immune to the havoc created in the Anglo-Saxon economies by the credit crunch would do well to look again. Recent figures suggest the outlook for the EU-15 is poor—and if one factors in weakness of the Eurozone's economic governance, the outlook is positively grim.
This week marks the first anniversary of the credit crunch, the moment when it dawned on bankers that the US$12 trillion mortgage market was in meltdown and that an unknown fraction of the securitised mortgage bonds held by banks and funds was toxic.
Since nobody knew quite how much toxicity was in the system, banks started writing off bad debts and calling in loans while highly leveraged hedge funds found themselves in dire straits: last August, two of Bear Stearns hedge funds collapsed, America's largest mortgage bank (Countrywide) announced itself in distress while in France, BNB Paribas blocked withdrawals of US$2.2 billion in funds.
The US Fed and the European ECB quickly (and correctly) poured massive amounts of liquidity into the markets to prevent them seizing up altogether: US$70bn and US$ 140bn respectively. Moreover, the Fed cut interest rates drastically: whereas its rate stood at 5.25% in early 2007, it is now down to 2 percent. Still, the crunch has deepened in 2008. In the US this week, mortgage approvals hit a record low while the fall in US house prices continued to accelerate. In Britain, retailers were reporting that sales in July 2008 were at their lowest level in a quarter of a century. Both Britain and the US are headed towards recession, and there is no end in sight.
While it is widely recognised that property markets in Spain and Ireland are tumbling and that in France the market has softened dramatically, what is less known is that business sentiment is deteriorating everywhere in the Eurozone. Last week's Purchasing Managers Survey of the EU-15 revealed the worse outlook since November 2001.
In Germany, until recently thought to be bouncing back, corporate sentiment surveyed by Munich's Ifo Institute for Economic Research is at its lowest in three years, while the recent INSEE survey in France suggests the outlook there is worse. To add to the gloom, the IMF's latest Global Financial Stability Report says there is no sign of recovery from the credit crunch. In the words of Jaime Caruana, one of the IMF directors, 'As economies slow, credit deterioration is widening and deepening, and as banks deleverage [cease lending] and rebuild capital, lending is beginning to be squeezed, restricting household spending and clouding the outlook for the real economy.'
Key lessons from the crunch
Until early 2008, the orthodox view in the financial community was that the crunch was a short term affair; the real economy would soon bounce back, all the healthier for having purged the bad debt from the books.
But there were many possible triggers for recession besides toxic mortgages; one had merely to look at America's treble deficit—on current, government and household accounts—to realise that the US economy was in for a great unravelling, almost certainly taking the EU with it. As the financial journalist Larry Elliot has argued, coming to grips with the crisis requires at least four things.
First, the denial has to stop—this is not a short term crisis, nor even the beginning of a 2001 style recession—it is far more serious. Secondly, the financial system needs regulating. It is in deep trouble, largely of its own making. Yes, governments will need to pour billions of taxpayers' dollars and euros into the system if confidence is to be restored, but the quid pro quo is that the financial services sector must accept serious government intervention, minimally of the sort which existed prior to Reagan-Thatcher style 'deregulation'. Franklin Roosevelt saw this clearly in the 1930s when he pledged that government must become an effective counterweight to Wall Street's financial oligarchy.
Thirdly, the historical precedent is not the Great Crash of 1929. Rather, it is the Japanese property bubble of 1989 and the deflation and long-term stagnation which followed.
Anybody who believes the Eurozone is immune to the havoc created in the Anglo-Saxon economies by the credit crunch would do well to look again. Recent figures suggest the outlook for the EU-15 is poor—and if one factors in weakness of the Eurozone's economic governance, the outlook is positively grim.
This week marks the first anniversary of the credit crunch, the moment when it dawned on bankers that the US$12 trillion mortgage market was in meltdown and that an unknown fraction of the securitised mortgage bonds held by banks and funds was toxic.
Since nobody knew quite how much toxicity was in the system, banks started writing off bad debts and calling in loans while highly leveraged hedge funds found themselves in dire straits: last August, two of Bear Stearns hedge funds collapsed, America's largest mortgage bank (Countrywide) announced itself in distress while in France, BNB Paribas blocked withdrawals of US$2.2 billion in funds.
The US Fed and the European ECB quickly (and correctly) poured massive amounts of liquidity into the markets to prevent them seizing up altogether: US$70bn and US$ 140bn respectively. Moreover, the Fed cut interest rates drastically: whereas its rate stood at 5.25% in early 2007, it is now down to 2 percent. Still, the crunch has deepened in 2008. In the US this week, mortgage approvals hit a record low while the fall in US house prices continued to accelerate. In Britain, retailers were reporting that sales in July 2008 were at their lowest level in a quarter of a century. Both Britain and the US are headed towards recession, and there is no end in sight.
While it is widely recognised that property markets in Spain and Ireland are tumbling and that in France the market has softened dramatically, what is less known is that business sentiment is deteriorating everywhere in the Eurozone. Last week's Purchasing Managers Survey of the EU-15 revealed the worse outlook since November 2001.
In Germany, until recently thought to be bouncing back, corporate sentiment surveyed by Munich's Ifo Institute for Economic Research is at its lowest in three years, while the recent INSEE survey in France suggests the outlook there is worse. To add to the gloom, the IMF's latest Global Financial Stability Report says there is no sign of recovery from the credit crunch. In the words of Jaime Caruana, one of the IMF directors, 'As economies slow, credit deterioration is widening and deepening, and as banks deleverage [cease lending] and rebuild capital, lending is beginning to be squeezed, restricting household spending and clouding the outlook for the real economy.'
Key lessons from the crunch
Until early 2008, the orthodox view in the financial community was that the crunch was a short term affair; the real economy would soon bounce back, all the healthier for having purged the bad debt from the books.
But there were many possible triggers for recession besides toxic mortgages; one had merely to look at America's treble deficit—on current, government and household accounts—to realise that the US economy was in for a great unravelling, almost certainly taking the EU with it. As the financial journalist Larry Elliot has argued, coming to grips with the crisis requires at least four things.
First, the denial has to stop—this is not a short term crisis, nor even the beginning of a 2001 style recession—it is far more serious. Secondly, the financial system needs regulating. It is in deep trouble, largely of its own making. Yes, governments will need to pour billions of taxpayers' dollars and euros into the system if confidence is to be restored, but the quid pro quo is that the financial services sector must accept serious government intervention, minimally of the sort which existed prior to Reagan-Thatcher style 'deregulation'. Franklin Roosevelt saw this clearly in the 1930s when he pledged that government must become an effective counterweight to Wall Street's financial oligarchy.
Thirdly, the historical precedent is not the Great Crash of 1929. Rather, it is the Japanese property bubble of 1989 and the deflation and long-term stagnation which followed.
Why the ECB Can't Fix Europe 2
"The history of these kinds of crises in Europe is that governments typically do disagree, they rarely come to coordinated agreements and you get this fairly inefficient solution," said Perkins at ABN Amro.
"There are very different philosophies in Europe about how you deal with these problems. You're never going to get the kind of coordinated policy response that you have in the US."
Scott Livermore, director of international macro forecasting at Oxford Economics, a leading economic consultancy in Britain, said: "Where Europe has been lacking is that they have no contingency plan at the moment and we're adopting this piecemeal."
"The problem is that if Europe is hit as hard as the US was there is no contingency plan in place, and in such a crisis you need to have a rapid response. You can say what you like about the US rescue package, it may or not be the best approach but it is there and something is happening."
Part 2: U-Turns and Vague Pledges
The actions by Europe's governments over the last week have failed to inspire confidence, as slumping equity markets show.
First the leaders of Europe's top four economies Germany, France, Britain and Italy failed to agree on a common plan at a mini-summit in Paris at the weekend.
Then German Chancellor Angela Merkel made a surprise policy U-turn by announcing an unlimited state guarantee for all private German bank deposits on Sunday, a move that sparked confusion and put governments across Europe under pressure to follow suit to prevent their nation's banks from suffering a competitive disadvantage.
On Tuesday, EU finance ministers issued a vague pledge that EU governments would not allow "system relevant" financial institutions to fail, a statement that seemed aimed at masking the absence of a pan-European approach.
"It's very important when one makes announcements such as issuing a bank deposit guarantee to be precise. Vague ad hoc announcements can sow confusion," said Polleit at Barclays Capital.
"I think it's important that politicians do more to consult people who operate in financial markets and who know how expectations gets translated into market prices. I think the crisis management now requires not just bureaucrats but experts."
Everyone for Himself
Despite all European pledges to take joint action, the underlying message this week has been that every EU nation will sort out its own mess itself. Fresh evidence of that approach emerged on Wednesday when Britain announced plans to inject up to £50 billion ($87.2 billion) into its biggest retail banks.
The country's top banks suffered a share slump this week in which some lost nearly half their market value amid investor fears they could collapse. "Extraordinary times call for bold and far-reaching solutions," British Prime Minister Gordon Brown said.
Holger Schmieding, chief economist for Europe at Bank of America, said Europe was likely to come up with effective answers to the crisis, but that it would take time.
"I'd say it's a bit more difficult for Europe to get out of the crisis than it is for the US because there are different national responses to the crisis. It takes longer in Europe but things are going in the right direction. The measures taken won't end up differing much from country to country."
"There is a certain convergence process, almost everyone is thinking about deposit guarantees and almost everyone is pledging to bail out domestic banks with government support."
Schmieding said Europe didn't need a pan-European fund to tackle the crisis, and that such a move would be difficult to implement anyway. "Taxes are a very national affair, the top prerogative of national parliaments. That makes it very difficult in practical terms and politically to set up a European fund."
Provided by Spiegel Online—Read the latest from Europe's largest newsmagazine
"There are very different philosophies in Europe about how you deal with these problems. You're never going to get the kind of coordinated policy response that you have in the US."
Scott Livermore, director of international macro forecasting at Oxford Economics, a leading economic consultancy in Britain, said: "Where Europe has been lacking is that they have no contingency plan at the moment and we're adopting this piecemeal."
"The problem is that if Europe is hit as hard as the US was there is no contingency plan in place, and in such a crisis you need to have a rapid response. You can say what you like about the US rescue package, it may or not be the best approach but it is there and something is happening."
Part 2: U-Turns and Vague Pledges
The actions by Europe's governments over the last week have failed to inspire confidence, as slumping equity markets show.
First the leaders of Europe's top four economies Germany, France, Britain and Italy failed to agree on a common plan at a mini-summit in Paris at the weekend.
Then German Chancellor Angela Merkel made a surprise policy U-turn by announcing an unlimited state guarantee for all private German bank deposits on Sunday, a move that sparked confusion and put governments across Europe under pressure to follow suit to prevent their nation's banks from suffering a competitive disadvantage.
On Tuesday, EU finance ministers issued a vague pledge that EU governments would not allow "system relevant" financial institutions to fail, a statement that seemed aimed at masking the absence of a pan-European approach.
"It's very important when one makes announcements such as issuing a bank deposit guarantee to be precise. Vague ad hoc announcements can sow confusion," said Polleit at Barclays Capital.
"I think it's important that politicians do more to consult people who operate in financial markets and who know how expectations gets translated into market prices. I think the crisis management now requires not just bureaucrats but experts."
Everyone for Himself
Despite all European pledges to take joint action, the underlying message this week has been that every EU nation will sort out its own mess itself. Fresh evidence of that approach emerged on Wednesday when Britain announced plans to inject up to £50 billion ($87.2 billion) into its biggest retail banks.
The country's top banks suffered a share slump this week in which some lost nearly half their market value amid investor fears they could collapse. "Extraordinary times call for bold and far-reaching solutions," British Prime Minister Gordon Brown said.
Holger Schmieding, chief economist for Europe at Bank of America, said Europe was likely to come up with effective answers to the crisis, but that it would take time.
"I'd say it's a bit more difficult for Europe to get out of the crisis than it is for the US because there are different national responses to the crisis. It takes longer in Europe but things are going in the right direction. The measures taken won't end up differing much from country to country."
"There is a certain convergence process, almost everyone is thinking about deposit guarantees and almost everyone is pledging to bail out domestic banks with government support."
Schmieding said Europe didn't need a pan-European fund to tackle the crisis, and that such a move would be difficult to implement anyway. "Taxes are a very national affair, the top prerogative of national parliaments. That makes it very difficult in practical terms and politically to set up a European fund."
Provided by Spiegel Online—Read the latest from Europe's largest newsmagazine
Why the ECB Can't Fix Europe 1
by David Crossland
The European Central Bank joined the United States Federal Reserve and other major central banks in cutting key interest rates by half a point on Wednesday in a concerted move to stabilize financial markets and avert recession, but the ECB's power to stem the financial crisis in Europe is limited, economists say.
The cut brought key interest rates down to 3.75 percent in the euro zone and to 1.5 percent in the United States, the banks said in a surprise announcement that followed a dramatic slump in world financial markets this week. The Bank of England also cut its key rate by half a point.
It was the ECB's first rate cut in more than five years and the move echoed the coordinated rate cuts on Sept. 17, 2001 in the aftermath of the 9/11 attacks.
The cooperation among central banks contrasted with a divided response to the crisis from European governments this week which has undermined investor confidence and highlighted chronic weaknesses in Europe's financial architecture.
The Frankfurt-based ECB, guardian of the euro and responsible for setting interest rates for the 15-nation euro area, has been keeping the continent's financial system afloat with cash injections into the money market which has been at risk of drying up because banks are increasingly unwilling to lend each other money.
"The confidence is out of the system and you can quite clearly see that in money market interest rates and in turnover in the money market. The banks no longer trust each other," said Thorsten Polleit, chief German economist at Barclays Capital in Frankfurt.
Economists say the ECB has effectively replaced the money market, where banks trade money in overnight and other short-term loans to remain liquid.
It has been supplying tens of billions of euros via so-called "quick tenders" for money. And banks have been parking any surplus funds with the ECB rather than lending it to each other.
The reluctance of banks to lend each other money is reflected in an increase in interest rates for interbank loans—the key three-month Euribor, the euro inter-bank-offered rate, reached 5.377 percent on Tuesday, the highest level since late 1994.
Taxpayers' Money Is Key
Technically, the ECB can go on propping up the money market in this way indefinitely, and there's nothing to stop it continuing to cut interest rates aggressively. But the general loss of investor confidence that is causing the dramatic slump in share prices and putting banks in trouble can only be solved by pledging taxpayers' money to rescue major banks, economists say.
"The ECB is effectively the money market now," said Dario Perkins, senior European economist at ABN Amro in London. "Banks can get as much money as they need from the ECB so that in itself isn't the problem. In theory it can do that as long as necessary."
"The question is whether that's enough to stop these broader problems in financial markets. Clearly the evidence is that it isn't if you look at what's happening to bank share prices and broader equity markets."
Europe's chaotic response to the escalation of the crisis over the last week has highlighted an inherent weakness in the continent's financial system that central bankers have warned about ever since the launch of the ECB in 1999.
The independent ECB can dictate monetary policy by determining the price and supply of money for 320 million citizens, but it has no say over the disposal of taxpayers' money, which is in the hands of individual nation states and is the key to solving the crisis.
Central bankers never tire of exhorting EU governments to rein in their budget deficits and coordinate their fiscal policies to avoid imbalances in the system.
But despite decades of integration, the EU remains a bloc of sovereign states with separate tax and spending regimes that make it very hard to reach pan-European agreements.
Europe Less Well-Equipped than US to Fight Crisis
As a result, Europe is inevitably less well-equipped than the United States to tackle the financial crisis, economists say. The US last week agreed a $700 billion package to bail out America's banks.
The European Central Bank joined the United States Federal Reserve and other major central banks in cutting key interest rates by half a point on Wednesday in a concerted move to stabilize financial markets and avert recession, but the ECB's power to stem the financial crisis in Europe is limited, economists say.
The cut brought key interest rates down to 3.75 percent in the euro zone and to 1.5 percent in the United States, the banks said in a surprise announcement that followed a dramatic slump in world financial markets this week. The Bank of England also cut its key rate by half a point.
It was the ECB's first rate cut in more than five years and the move echoed the coordinated rate cuts on Sept. 17, 2001 in the aftermath of the 9/11 attacks.
The cooperation among central banks contrasted with a divided response to the crisis from European governments this week which has undermined investor confidence and highlighted chronic weaknesses in Europe's financial architecture.
The Frankfurt-based ECB, guardian of the euro and responsible for setting interest rates for the 15-nation euro area, has been keeping the continent's financial system afloat with cash injections into the money market which has been at risk of drying up because banks are increasingly unwilling to lend each other money.
"The confidence is out of the system and you can quite clearly see that in money market interest rates and in turnover in the money market. The banks no longer trust each other," said Thorsten Polleit, chief German economist at Barclays Capital in Frankfurt.
Economists say the ECB has effectively replaced the money market, where banks trade money in overnight and other short-term loans to remain liquid.
It has been supplying tens of billions of euros via so-called "quick tenders" for money. And banks have been parking any surplus funds with the ECB rather than lending it to each other.
The reluctance of banks to lend each other money is reflected in an increase in interest rates for interbank loans—the key three-month Euribor, the euro inter-bank-offered rate, reached 5.377 percent on Tuesday, the highest level since late 1994.
Taxpayers' Money Is Key
Technically, the ECB can go on propping up the money market in this way indefinitely, and there's nothing to stop it continuing to cut interest rates aggressively. But the general loss of investor confidence that is causing the dramatic slump in share prices and putting banks in trouble can only be solved by pledging taxpayers' money to rescue major banks, economists say.
"The ECB is effectively the money market now," said Dario Perkins, senior European economist at ABN Amro in London. "Banks can get as much money as they need from the ECB so that in itself isn't the problem. In theory it can do that as long as necessary."
"The question is whether that's enough to stop these broader problems in financial markets. Clearly the evidence is that it isn't if you look at what's happening to bank share prices and broader equity markets."
Europe's chaotic response to the escalation of the crisis over the last week has highlighted an inherent weakness in the continent's financial system that central bankers have warned about ever since the launch of the ECB in 1999.
The independent ECB can dictate monetary policy by determining the price and supply of money for 320 million citizens, but it has no say over the disposal of taxpayers' money, which is in the hands of individual nation states and is the key to solving the crisis.
Central bankers never tire of exhorting EU governments to rein in their budget deficits and coordinate their fiscal policies to avoid imbalances in the system.
But despite decades of integration, the EU remains a bloc of sovereign states with separate tax and spending regimes that make it very hard to reach pan-European agreements.
Europe Less Well-Equipped than US to Fight Crisis
As a result, Europe is inevitably less well-equipped than the United States to tackle the financial crisis, economists say. The US last week agreed a $700 billion package to bail out America's banks.
Japan's SMFG to Raise $5.8 Billion in Share Sale 2
Fitch adds that the unrealised gains of the eight major banks disappear completely when the TOPIX index hits 900 points. At this point, tier-1 capital starts to crumble. As of Thursday, the simple moving average of the TOPIX over the past 50 days was 878 points, and 1,052 points over the past 100 days.
Fitch estimates that the major banks' tier-1 capital would be dragged down to the minimum permissible 4% if the TOPIX slid to 600 points. SMFG's capital raising therefore makes good sense, as does that of its peers. In fact, a total of $30 billion in capital raisings have been announced this year by the Japanese banking sector.
According to the Fitch report, SMFG had a tier-1 capital ratio of 7.08% in September, compared to 7.36% for Mitsubishi UFJ Financial Group and 7.36% for Mizuho. SMFG was the only bank that saw its tier-1 capital adequacy ratio improve somewhat between March and September. SMFG had a total (including tier-2) capital ratio of 10.25% in September, down from 10.56% in March. This is not high by international standards, says Fitch.
The ratings agency welcomes additional capital, whatever the form, but notes that the quality of the mega banks' capital will not be improved by such moves. Indeed, core capital is related to shareholder equity, and is supposed to reflect the concentrated value of the company based on the original shareholders' equity and retained earnings. Using hybrid capital to complement the former shows that net earnings may not be growing at a healthy pace. SMFG's net income of ¥83 billion in the six months to September 2008 was down over 50% on the ¥171 billion it earned in the same period last year.
SMFG and the other banks are not just facing market risk via their dangerous shareholdings, they are also facing credit risk as the Japanese economy slides into recession. Credit costs for the first half of the 2009 financial year (ending March 2009) doubled for the eight major banks. SMFG has the highest net non-performing loans to tier-1 capital ratio among the major banks, at 11.5%. Problem loans appear to have risen as a result of the weakening of the real estate sector, defaults among small businesses, and losses on the exposure to Lehman Brothers, which Fitch computes at about ¥150 billion for the major banks.
SMFG is no doubt regretting the $1 billion it spent on its passive (voting rights are 2%) stake in Barclays PLC in June, whose share price has fallen precipitously in the interim. Its only comfort is that its rival MUFG's $9 billion investment in Morgan Stanley hasn't performed well either.
Fitch estimates that the major banks' tier-1 capital would be dragged down to the minimum permissible 4% if the TOPIX slid to 600 points. SMFG's capital raising therefore makes good sense, as does that of its peers. In fact, a total of $30 billion in capital raisings have been announced this year by the Japanese banking sector.
According to the Fitch report, SMFG had a tier-1 capital ratio of 7.08% in September, compared to 7.36% for Mitsubishi UFJ Financial Group and 7.36% for Mizuho. SMFG was the only bank that saw its tier-1 capital adequacy ratio improve somewhat between March and September. SMFG had a total (including tier-2) capital ratio of 10.25% in September, down from 10.56% in March. This is not high by international standards, says Fitch.
The ratings agency welcomes additional capital, whatever the form, but notes that the quality of the mega banks' capital will not be improved by such moves. Indeed, core capital is related to shareholder equity, and is supposed to reflect the concentrated value of the company based on the original shareholders' equity and retained earnings. Using hybrid capital to complement the former shows that net earnings may not be growing at a healthy pace. SMFG's net income of ¥83 billion in the six months to September 2008 was down over 50% on the ¥171 billion it earned in the same period last year.
SMFG and the other banks are not just facing market risk via their dangerous shareholdings, they are also facing credit risk as the Japanese economy slides into recession. Credit costs for the first half of the 2009 financial year (ending March 2009) doubled for the eight major banks. SMFG has the highest net non-performing loans to tier-1 capital ratio among the major banks, at 11.5%. Problem loans appear to have risen as a result of the weakening of the real estate sector, defaults among small businesses, and losses on the exposure to Lehman Brothers, which Fitch computes at about ¥150 billion for the major banks.
SMFG is no doubt regretting the $1 billion it spent on its passive (voting rights are 2%) stake in Barclays PLC in June, whose share price has fallen precipitously in the interim. Its only comfort is that its rival MUFG's $9 billion investment in Morgan Stanley hasn't performed well either.
Japan's SMFG to Raise $5.8 Billion in Share Sale 1
By Dan Slater
The latest capital raising exercise by Sumitomo Mitsui Financial Group (SMFG) shows that Japanese banks are weak, although for different reasons than their Western counterparts who have been hurt by their exposure to the subprime crisis. Japanese banks are suffering from a slowing economy, narrow interest margins and excessive exposure to the stockmarket. So, like Western banks, they are busy raising capital.
The ¥538.2 billion ($5.84 billion) worth of perpetual preference shares SMFG plans to issue through a private placement on December 18 should take some of the pressure off the company's capital adequacy ratios, which have become increasingly thin. An unconfirmed rumour that SMFG, the smallest of Japan's mega-banks by assets, could add an extra ¥260 billion to the sum already announced gave the market further reason to cheer, and helped push SMFG's share price 9.6% higher to ¥342,000 in Thursday's trading. (The counter reached a high of ¥1.36 million in 2006.)
According to Reuters, the preference shares will be taken up by a collection of around 20 Japanese institutional investors, including real estate and insurance companies.
SMFG's announcement on Thursday follows a decision made public on November 19 to set up a wholly owned overseas special purpose subsidiary in the Cayman Islands to issue perpetual preference shares. The proceeds will partly be used to redeem an existing series of bonds maturing on January 26, 2009, which amounts to ¥283 billion. The remaining ¥255 billion will be added to the existing tier-1 capital of ¥4.5 trillion, an increase of under 6%. That means the extra capital raising if it materialises will be welcome, since it could roughly double the percentage increase.
The structure for issuing the non-cumulative preference shares is complex but has advantages. Under the terms of the deal, the offshore group vehicle will issue the shares, and then make what is essentially an intra-company loan with the proceeds. This combines tax benefits with a boost to the tier-1 capital cushion, points out Peter Kilner, managing partner at Clifford Chance in Tokyo.
"One of the reasons for the structure is that interest paid on the loan should be deductible by Sumitomo Mitsuin Banking Corporation (SMBC) for tax purposes, which would not be the case if SMBC were to pay dividends on the preference shares direct," he explains.
SMBC is the actual bank and the main asset within the SMFG group.
The preference shares will be issued in four tranches of ¥113 billion, ¥140 billion, ¥140 billion, ¥145.2 billion, with coupons of 4.57%, 5.07%, 4.87% and 4.76% respectively. The tranches all come with fixed rates until various dates, including 2014, 2016 or 2019, before switching to a floating rate. One of the tranches comes with a step-up clause.
Even prior to the announcement earlier this month that Japan has entered a recession, SMFG was being hit by the steeply declining stockmarket. The TOPIX index has dropped by almost one-third since March this year. Reductions in unrealised stock gains initially hurt tier-2 capital, but once the gains turn to losses, essential tier-1 capital also begins to get eaten away. The decline in Japan's stockmarket over the past months has been so fast that it has raised the alarm about Japanese banks.
Observers say the fact that Japanese banks as a group own some 15% of the listed Japanese market cap is a sign that the banking sector is not yet 'normalised'. The ownership is down substantially from its peak, but still leaves the banks vulnerable to swings in the equity market. The shareholdings are part of the elaborate cross-shareholding arrangement that originally arose to protect Japanese companies from hostile often defined as 'foreign' takeovers.
Fitch Ratings writes in a recent report that SMFG's unrealised gains on stocks had fallen from ¥936 billion in March to ¥786 billion in September, while losses on bonds amounted to ¥60 billion. The cost of these figures to tier-1 capital amounted to almost half of tier-1 equity.
The latest capital raising exercise by Sumitomo Mitsui Financial Group (SMFG) shows that Japanese banks are weak, although for different reasons than their Western counterparts who have been hurt by their exposure to the subprime crisis. Japanese banks are suffering from a slowing economy, narrow interest margins and excessive exposure to the stockmarket. So, like Western banks, they are busy raising capital.
The ¥538.2 billion ($5.84 billion) worth of perpetual preference shares SMFG plans to issue through a private placement on December 18 should take some of the pressure off the company's capital adequacy ratios, which have become increasingly thin. An unconfirmed rumour that SMFG, the smallest of Japan's mega-banks by assets, could add an extra ¥260 billion to the sum already announced gave the market further reason to cheer, and helped push SMFG's share price 9.6% higher to ¥342,000 in Thursday's trading. (The counter reached a high of ¥1.36 million in 2006.)
According to Reuters, the preference shares will be taken up by a collection of around 20 Japanese institutional investors, including real estate and insurance companies.
SMFG's announcement on Thursday follows a decision made public on November 19 to set up a wholly owned overseas special purpose subsidiary in the Cayman Islands to issue perpetual preference shares. The proceeds will partly be used to redeem an existing series of bonds maturing on January 26, 2009, which amounts to ¥283 billion. The remaining ¥255 billion will be added to the existing tier-1 capital of ¥4.5 trillion, an increase of under 6%. That means the extra capital raising if it materialises will be welcome, since it could roughly double the percentage increase.
The structure for issuing the non-cumulative preference shares is complex but has advantages. Under the terms of the deal, the offshore group vehicle will issue the shares, and then make what is essentially an intra-company loan with the proceeds. This combines tax benefits with a boost to the tier-1 capital cushion, points out Peter Kilner, managing partner at Clifford Chance in Tokyo.
"One of the reasons for the structure is that interest paid on the loan should be deductible by Sumitomo Mitsuin Banking Corporation (SMBC) for tax purposes, which would not be the case if SMBC were to pay dividends on the preference shares direct," he explains.
SMBC is the actual bank and the main asset within the SMFG group.
The preference shares will be issued in four tranches of ¥113 billion, ¥140 billion, ¥140 billion, ¥145.2 billion, with coupons of 4.57%, 5.07%, 4.87% and 4.76% respectively. The tranches all come with fixed rates until various dates, including 2014, 2016 or 2019, before switching to a floating rate. One of the tranches comes with a step-up clause.
Even prior to the announcement earlier this month that Japan has entered a recession, SMFG was being hit by the steeply declining stockmarket. The TOPIX index has dropped by almost one-third since March this year. Reductions in unrealised stock gains initially hurt tier-2 capital, but once the gains turn to losses, essential tier-1 capital also begins to get eaten away. The decline in Japan's stockmarket over the past months has been so fast that it has raised the alarm about Japanese banks.
Observers say the fact that Japanese banks as a group own some 15% of the listed Japanese market cap is a sign that the banking sector is not yet 'normalised'. The ownership is down substantially from its peak, but still leaves the banks vulnerable to swings in the equity market. The shareholdings are part of the elaborate cross-shareholding arrangement that originally arose to protect Japanese companies from hostile often defined as 'foreign' takeovers.
Fitch Ratings writes in a recent report that SMFG's unrealised gains on stocks had fallen from ¥936 billion in March to ¥786 billion in September, while losses on bonds amounted to ¥60 billion. The cost of these figures to tier-1 capital amounted to almost half of tier-1 equity.
China's Economy is Still Heading Downward
By Daniel Inman
A further slowdown in GDP growth in China and high levels of unemployment will affect the population's propensity to spend, meaning domestic consumption is unlikely to make up for falling exports.
As soon as it became apparent that the financial crisis was no temporary matter, the Chinese government was quick to put forward Rmb4 trillion ($585 billion) to bolster its economy. The latest data confirms that this support was necessary, but observers say it will take some time for the medicine to have an effect.
November was another bad month. Industrial production growth declined to 5.4% year-on-year, which is the lowest since early 2002, and the purchasing managers' index fell to 38.8%—a big reduction from October's 44.6%.
To some extent, much of this was expected as diminishing global demand was putting pressure on manufacturers. What is possibly more worrying is the slowdown in retail sales, because domestic consumption is generally seen to be a major factor that could make up for falling exports. In November, retail sales grew at 20.8% year-on-year, down from 22% in October. The growth in urban sales, which accounts for two-thirds of all retail sales in China, slowed by 1.8 percentage points to 20.3% month-on-month.
At the same time, November saw a slight decrease in fixed asset investment growth—26.8% in the period between January and November, compared to 27.2% in January to October.
In a recent note, Citi economists predict a further slowdown in GDP growth and high levels of unemployment in the cities, which will affect the income of individuals and their propensity to spend. The same note singles out department stores as a retailing area that is "likely to disappoint", while favouring an overweight position on supermarkets. "Falling food inflation could impart some downside risk to top line growth, but we believe supermarket operators are enjoying better earnings visibility into 2009."
Things are going to get worse before they get better, says Morgan Stanley in its 2009 China economics outlook. A drop in exports is only part of what the report describes as a "triple whammy"—there is also the depressed property sector, brought down by tough government policies introduced last year, and the massive levels of destocking.
Although the Morgan Stanley report says that this triumvirate of ills has most likely reached its peak, it will continue to be felt through the first half of next year, which will in turn lay the foundations for a strong recovery in 2010. The US investment bank's baseline scenario is for GDP to grow at 7.5% next year (versus 11.4% in 2007), on the assumption that declines in property sales and lower levels of exports will be balanced by infrastructure investment provoked by the stimulus package.
The downside risks relate to property. "If... real estate investment were to collapse and contract by 30% in 2009, the impact would be so big that even the fiscal stimulus package in its current form and size would not be able to make up for the growth shortfall, in our view," says the report. Under such circumstances, GDP growth could drop to 5%. Any potential upside depends very much on external factors. A growth rate of 9% is possible if the recession in China's key export markets turns out to be less bad than expected.
In the meantime, all we can do is wait until the stimulus package, much of which will be allocated towards infrastructure, starts stimulating. Jing Ulrich, head of China equities at J.P. Morgan, in a note predicts the package to start having an effect in the second quarter of 2009. Between now and then, expect more bad news to come, especially around Chinese New Year, when a poor set of corporate earnings is anticipated.
Copyright FinanceAsia.com Ltd., a subsidiary of Haymarket Media Ltd
A further slowdown in GDP growth in China and high levels of unemployment will affect the population's propensity to spend, meaning domestic consumption is unlikely to make up for falling exports.
As soon as it became apparent that the financial crisis was no temporary matter, the Chinese government was quick to put forward Rmb4 trillion ($585 billion) to bolster its economy. The latest data confirms that this support was necessary, but observers say it will take some time for the medicine to have an effect.
November was another bad month. Industrial production growth declined to 5.4% year-on-year, which is the lowest since early 2002, and the purchasing managers' index fell to 38.8%—a big reduction from October's 44.6%.
To some extent, much of this was expected as diminishing global demand was putting pressure on manufacturers. What is possibly more worrying is the slowdown in retail sales, because domestic consumption is generally seen to be a major factor that could make up for falling exports. In November, retail sales grew at 20.8% year-on-year, down from 22% in October. The growth in urban sales, which accounts for two-thirds of all retail sales in China, slowed by 1.8 percentage points to 20.3% month-on-month.
At the same time, November saw a slight decrease in fixed asset investment growth—26.8% in the period between January and November, compared to 27.2% in January to October.
In a recent note, Citi economists predict a further slowdown in GDP growth and high levels of unemployment in the cities, which will affect the income of individuals and their propensity to spend. The same note singles out department stores as a retailing area that is "likely to disappoint", while favouring an overweight position on supermarkets. "Falling food inflation could impart some downside risk to top line growth, but we believe supermarket operators are enjoying better earnings visibility into 2009."
Things are going to get worse before they get better, says Morgan Stanley in its 2009 China economics outlook. A drop in exports is only part of what the report describes as a "triple whammy"—there is also the depressed property sector, brought down by tough government policies introduced last year, and the massive levels of destocking.
Although the Morgan Stanley report says that this triumvirate of ills has most likely reached its peak, it will continue to be felt through the first half of next year, which will in turn lay the foundations for a strong recovery in 2010. The US investment bank's baseline scenario is for GDP to grow at 7.5% next year (versus 11.4% in 2007), on the assumption that declines in property sales and lower levels of exports will be balanced by infrastructure investment provoked by the stimulus package.
The downside risks relate to property. "If... real estate investment were to collapse and contract by 30% in 2009, the impact would be so big that even the fiscal stimulus package in its current form and size would not be able to make up for the growth shortfall, in our view," says the report. Under such circumstances, GDP growth could drop to 5%. Any potential upside depends very much on external factors. A growth rate of 9% is possible if the recession in China's key export markets turns out to be less bad than expected.
In the meantime, all we can do is wait until the stimulus package, much of which will be allocated towards infrastructure, starts stimulating. Jing Ulrich, head of China equities at J.P. Morgan, in a note predicts the package to start having an effect in the second quarter of 2009. Between now and then, expect more bad news to come, especially around Chinese New Year, when a poor set of corporate earnings is anticipated.
Copyright FinanceAsia.com Ltd., a subsidiary of Haymarket Media Ltd
OPEC's Big Move: Less Than Meets the Eye
By Stanley Reed
OPEC's announcement at its meeting on Dec. 17 in Oran, Algeria, that it would cut 4.2 million barrels per day from September production levels sounds like a big deal. But it is less than meets the eye. That number includes 2 million barrels of previously announced cuts. If implemented, the measure would amount to around an 8% cut from current levels. Markets were not impressed, even though this represents the most serious OPEC tightening effort since the late 1990s. Prices for U.S. light, sweet crude fell $3.54 per barrel, to $40.06 per barrel.
OPEC itself has modest expectations. The idea is to begin soaking up excess oil. One delegate said it was highly unlikely that prices would move above $55 per barrel through the first half of 2009. Delegates think OPEC may well have to cut more next year.
OPEC is scrambling to catch up with a radically changed world. Thanks to an imploding world economy, demand for oil is expected by many analysts to fall this year for the first time in a quarter-century. Oil production is easily outpacing consumption as evidenced by the growing fleet of supertankers being used for floating storage. One industry source estimated there are roughly 21 such tankers carrying about 40 million barrels of crude steaming the world's seas today as opposed to just four or five at the end of October.
Plenty of Worries
OPEC is fearful the imbalance of supply over demand will accelerate next year if nothing is done. The oil ministers well remember that prices dipped below $10 per barrel as recently as the late 1990s. The organization is also worried about its almost complete lack of sway over the markets. Prices have fallen close to $100 per barrel since mid-July, even though OPEC held four meetings to manage the markets.
OPEC was clearly determined to make a big show of unity at its meeting, which was held in Algeria to honor Chekib Khelil, the Algerian minister of energy, who has served as OPEC's president this year. Even non-OPEC producers were invited to participate. Russian Vice Premier Igor Sechin brought a heavyweight delegation of the country's top oil chiefs. He promised that Russia would cut 320,000 barrels per day in 2009 if market conditions demanded such a move.
OPEC meetings are closed to journalists, but delegates wandering in and out of the meeting at the Oran Sheraton, a massive building perched on a hill above the faded port city, shared their views of the proceedings. The main issue was not whether to make a big cut. Even the Saudis, the most moderate player and leader, called for 2 million barrels a day of cutbacks from the beginning. Instead, there was disagreement over how to describe the cuts and where to draw the baseline. Venezuela, in particular, says it is producing more than most analysts estimate. Calling for cuts from September levels was a way of fudging the issue. But that obfuscation raises questions about the degree to which OPEC members will comply with the decision. Through November, OPEC had dropped production by about 1.2 million barrels per day from September levels. Nearly all of this came from Saudi Arabia, which has eased back production to about 8.5 million barrels per day, since reaching close to 9.7 million barrels per day last summer.
Market participants will now closely monitor compliance with the latest promised cuts. Having reduced production by 1.2 million barrels per day, the Saudis are unlikely to cut another 2 million barrels per day on their own. With several hundred billion dollars in the bank and a relatively small population, they can tolerate prices at today's levels much longer than big-spending Venezuela and Iran. The Saudis want to see those countries, which are the two largest OPEC producers after the kingdom, take more of the pain. The new agreement "reflects a de facto reallocation of quotas," says David Kirsch, an analyst at PFC Energy in Washington. "In September several members were underproducing their formal quotas, so they are looking for real cuts from these members," he adds. If those cuts don't materialize, dissension in the producers' club will increase, putting more downward pressure on prices.
Reed is London bureau chief for BusinessWeek.
OPEC's announcement at its meeting on Dec. 17 in Oran, Algeria, that it would cut 4.2 million barrels per day from September production levels sounds like a big deal. But it is less than meets the eye. That number includes 2 million barrels of previously announced cuts. If implemented, the measure would amount to around an 8% cut from current levels. Markets were not impressed, even though this represents the most serious OPEC tightening effort since the late 1990s. Prices for U.S. light, sweet crude fell $3.54 per barrel, to $40.06 per barrel.
OPEC itself has modest expectations. The idea is to begin soaking up excess oil. One delegate said it was highly unlikely that prices would move above $55 per barrel through the first half of 2009. Delegates think OPEC may well have to cut more next year.
OPEC is scrambling to catch up with a radically changed world. Thanks to an imploding world economy, demand for oil is expected by many analysts to fall this year for the first time in a quarter-century. Oil production is easily outpacing consumption as evidenced by the growing fleet of supertankers being used for floating storage. One industry source estimated there are roughly 21 such tankers carrying about 40 million barrels of crude steaming the world's seas today as opposed to just four or five at the end of October.
Plenty of Worries
OPEC is fearful the imbalance of supply over demand will accelerate next year if nothing is done. The oil ministers well remember that prices dipped below $10 per barrel as recently as the late 1990s. The organization is also worried about its almost complete lack of sway over the markets. Prices have fallen close to $100 per barrel since mid-July, even though OPEC held four meetings to manage the markets.
OPEC was clearly determined to make a big show of unity at its meeting, which was held in Algeria to honor Chekib Khelil, the Algerian minister of energy, who has served as OPEC's president this year. Even non-OPEC producers were invited to participate. Russian Vice Premier Igor Sechin brought a heavyweight delegation of the country's top oil chiefs. He promised that Russia would cut 320,000 barrels per day in 2009 if market conditions demanded such a move.
OPEC meetings are closed to journalists, but delegates wandering in and out of the meeting at the Oran Sheraton, a massive building perched on a hill above the faded port city, shared their views of the proceedings. The main issue was not whether to make a big cut. Even the Saudis, the most moderate player and leader, called for 2 million barrels a day of cutbacks from the beginning. Instead, there was disagreement over how to describe the cuts and where to draw the baseline. Venezuela, in particular, says it is producing more than most analysts estimate. Calling for cuts from September levels was a way of fudging the issue. But that obfuscation raises questions about the degree to which OPEC members will comply with the decision. Through November, OPEC had dropped production by about 1.2 million barrels per day from September levels. Nearly all of this came from Saudi Arabia, which has eased back production to about 8.5 million barrels per day, since reaching close to 9.7 million barrels per day last summer.
Market participants will now closely monitor compliance with the latest promised cuts. Having reduced production by 1.2 million barrels per day, the Saudis are unlikely to cut another 2 million barrels per day on their own. With several hundred billion dollars in the bank and a relatively small population, they can tolerate prices at today's levels much longer than big-spending Venezuela and Iran. The Saudis want to see those countries, which are the two largest OPEC producers after the kingdom, take more of the pain. The new agreement "reflects a de facto reallocation of quotas," says David Kirsch, an analyst at PFC Energy in Washington. "In September several members were underproducing their formal quotas, so they are looking for real cuts from these members," he adds. If those cuts don't materialize, dissension in the producers' club will increase, putting more downward pressure on prices.
Reed is London bureau chief for BusinessWeek.
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