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List of Madoff’s Assets Won’t Be Released, SEC Says (Update2)

By David Scheer and Allan Dodds Frank

Dec. 31 (Bloomberg) — A list of Bernard Madoff’s assets filed today with the U.S. Securities and Exchange Commission won’t be made public, said the regulator, which sued him earlier this month for allegedly directing a $50 billion fraud.

A federal judge ordered Madoff to provide the SEC an accounting of all investments, loans, lines of credit, business interests, brokerage accounts and other holdings. The court hasn’t authorized its public disclosure, said SEC enforcement official Andrew Calamari, who confirmed receipt of the list.

“I think one of the fears here is that much of this money may be in offshore funds,” Columbia Law School Professor John Coffee told Bloomberg Television, adding that the SEC wants to keep the assets secret to protect them. “There is the danger that foreign regulators and foreign creditors may seek to seize that money if the names and sources are made public.”

Madoff, 70, was charged earlier this month by federal prosecutors for directing an alleged Ponzi scheme through his New York investment firm. Defense lawyer Ira Sorkin has said Madoff’s company is cooperating with the government. His client met with prosecutors earlier this month, according to people familiar with the case.

Shortly before he was arrested, Madoff allegedly told employees that he had $200-$300 million left, according to an FBI complaint. Sorkin declined to comment today on the amount of Madoff’s remaining assets.

Arrested Dec. 11

Madoff’s firm collapsed after he was arrested Dec. 11. He told his sons that he directed the Ponzi scheme, in which old investors are paid off with money from new ones, according to a lawyer for the brothers. The firm is liquidating under the Securities Investor Protection Corp., whose funds cover securities and cash claims of as much as $500,000 per customer, including as much as $100,000 in cash.

The Dec. 18 court order that Madoff disclose his assets required the list be given directly to the regulator, Calamari said. It “does not authorize public release of materials related to the SEC’s ongoing investigation,” he said. The effort “seeks to preserve and recover money for investors and hold wrongdoers accountable.”

The catalog of Madoff’s assets may be attractive to angry investors including hedge funds, universities and charities as they sue to recoup lost money. Madoff’s investment advisory business may have had more than 4,000 customers, people familiar with investigation said earlier this month.

Inflated Losses

Losses disclosed by some clients may have been inflated by purported gains in their accounts with Madoff. Yeshiva University, which had previously valued its holdings with Madoff at $110 million, yesterday said its net investment was about $14.5 million before inflation by “fictitious” profits.

“Madoff may very well have given money to other persons or other entities,” said Fred Longer, a lawyer suing hedge fund operator Tremont Group Holdings Inc. over Madoff-related losses. He said the SEC list will be useful primarily to investors suing Madoff directly. “Those are the rabbit trails. They’ll need to trace all of them to find the cash and it will take a lot of forensic efforts.”

Longer filed a lawsuit in Manhattan federal court today against Tremont Group Holdings Inc., a hedge-fund firm owned by Massachusetts Mutual Life Insurance Co. The complaint seeks the recovery of losses suffered through the hedge fund firm’s investments with Madoff.

New Jersey Investor

The lawyer represents Group Defined Pension Plan & Trust, a Jersey City, New Jersey-based investor. Also sued was Tremont’s auditor, Ernst & Young LLP. Longer claims the accounting firm missed warnings about the alleged scheme. The complaint seeks class-action, or group, status.

Congress is set to hold hearings next week on the Madoff scandal. Witnesses scheduled to appear before the House Financial Services Committee on Jan. 5 include David Kotz, the SEC’s inspector general, Stephen Harbeck, president of the SIPC, and Harry Markopolos, a former investment firm employee who flagged suspicions about the alleged Ponzi scheme.

Madoff’s firm was the 23rd-largest market maker on Nasdaq in October, handling an average of about 50 million shares a day, according to exchange data. It took orders from online brokers for some of the largest U.S. companies, including General Electric Co. and Citigroup Inc.

Fraud Charge

Madoff, who hasn’t formally responded to the securities fraud charge, may have to appear in Manhattan federal court by Jan. 12 unless he is indicted before then.

Yesterday, the trustee now in charge of Bernard L. Madoff Investment Securities LLC obtained court approval to use $28.1 million out of its accounts as it unwinds the firm.

“The estate requires the funding to get to the sale of certain assets,” said Richard Bernard, an attorney representing Irving Picard, the trustee appointed by the SIPC to supervise Madoff’s company.

The SIPC said that the use of some of the Madoff firm’s funds won’t diminish customer returns, according to a statement from the agency and Picard.

Picard reached a deal with Bank of New York Mellon Corp., which holds the funds, to have them released. U.S. Bankruptcy Judge Burton Lifland in Manhattan said the court papers outlining the agreement were very basic and asked the lawyer for more information on the accounts.

More Funds

Bernard said there are more funds and accounts, without being specific. Bank of New York is holding some funds because it may have “set-off rights” on certain claims, he said, adding he was limited in what he could say in open court because of ongoing criminal investigations.

Picard is tasked with maximizing assets for the firm as investors that had about $36 billion with Madoff seek the return of their money.

Lifland last week gave him authority to share confidential information, such as proprietary trading programs, with potential buyers of the Madoff firm’s market-maker unit.

Picard will mail claim forms to customers and creditors of Madoff Securities by Jan. 9, the SIPC said.

The case is Securities and Exchange Commission v. Madoff, 08-cv-10791, U.S. District Court, Southern District of New York (Manhattan).

To contact the reporter on this story: David Scheer in New York at dscheer@bloomberg.net and; Allan Dodds Frank in New York at allanfrank@bloomberg.net.

Last Updated: December 31, 2008 17:53 EST

Journal of a Plague Year: Faith in Markets Cracks Under Losses

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By James Sterngold

Dec. 31 (Bloomberg) — It has been a year of record misery: the largest bankruptcy, bank failure and Ponzi scheme in U.S. history; $720 billion in writedowns and losses by financial institutions; $30.1 trillion in market valuation wiped out.

The biggest loss and the hardest thing to recover, though, may be something that can’t be precisely measured — confidence in the markets and the firms that rely on them.

“The wholesale funding model lost its credibility,” said David Hendler, senior analyst at New York-based CreditSights Inc. “That started the semi-nationalization of funding in the financial markets. It’s a real chink in the armor of capitalism as supposedly the best process for allocating capital. The government is now deciding who gets access to capital.”

For Paul DeRosa, a principal of Mount Lucas Management Corp., a $1 billion hedge fund in Princeton, New Jersey, most unnerving was that the credit crisis revived something that, like the bubonic plague, was supposed to be a relic of the past.

“We had what was for all intents and purposes a systemic bank run for the first time in 70 years,” said DeRosa, whose fund is up 25 percent this year. “This ended our belief that financial panics were a thing of the past. That’s why this is a transcendent event.”

The price tag has been transcendent, too. Global stock markets lost about half of their value in 2008, or $30.1 trillion dollars. In the U.S., $7.2 trillion of shareholder value was wiped off the books, as the Standard & Poor’s 500 Index fell 39 percent through Dec. 30 and the Nasdaq Composite Index dropped 42 percent.

Madoff Swindle

And if market losses weren’t bad enough, as much as $50 billion went up in smoke when New York money manager Bernard L. Madoff confessed to authorities this month to what may be the biggest swindle in history — an alleged Ponzi scheme that spanned the globe, claiming victims from Alicia Koplowitz, one of Spain’s richest women, to filmmaker Steven Spielberg.

Institutions that seemed as solid as their Manhattan headquarters buildings crumbled. Lehman Brothers Holdings Inc., with assets of $639 billion, filed the largest bankruptcy in U.S. history on Sept. 15. Its creditors may have lost as much $75 billion, the firm’s chief restructuring officer said.

Bear Stearns Cos. was taken over by JPMorgan Chase & Co. in March after a funding crisis triggered by losses from subprime- mortgage investments. Merrill Lynch & Co., facing a crisis of its own, sold itself to Charlotte, North Carolina-based Bank of America Corp. And the last two major investment banks, Goldman Sachs Group Inc. and Morgan Stanley, converted to bank holding companies and got capital injections from the U.S. government.

Bank Failures

In the largest U.S. bank failure, Seattle-based Washington Mutual Inc. collapsed in September with $307 billion in assets.

There were 25 bank failures in 2008, the most in 15 years, according to the Federal Deposit Insurance Corp. The combined assets of lenders that failed in 2008 exceeds the total of those that collapsed in the preceding six years.

New York-based Citigroup Inc., whose shares lost 78 percent of their value this year, needed $20 billion in U.S. bailout funds in November on top of an earlier $25 billion infusion of capital. The government also guaranteed $306 billion of the bank’s troubled assets.

The wave of writedowns and losses that swamped financial institutions around the world reached $720 billion this year. It also eroded employment: 221,360 job cuts in the financial- services industry were announced.

Wall Street bonuses became so rich in recent years that $1 million was referred to as “a buck.” This year, chief executive officers including Lloyd Blankfein of Goldman Sachs and John Mack of Morgan Stanley have said they will get no bonuses at all.

The Amex Securities Brokers/Dealers Index hit a high of 267.69 on June 1, 2007; as of Dec. 30, it stood at 74.26.

AIG, GM

The U.S. government was forced to rescue the world’s largest insurance company, American International Group Inc., with a $152.5 billion package of investments, loans and capital infusions. It had to start purchasing corporate commercial paper to give companies the capital they needed to meet payrolls and conduct routine business.

Overall, the federal government has committed $8.5 trillion in trying to jumpstart a shrinking economy. General Motors Corp. and Chrysler LLC will get $13.4 billion in federal loans to stay afloat until President-elect Barack Obama’s administration can devise a rescue plan of its own.

The paralysis of credit markets sent ripples through many of the businesses that had flooded Wall Street with profits over the past decade. U.S. corporations raised $4.54 trillion issuing securities in 2008, down from $5.14 trillion in 2007. Global merger activity fell to $2.5 trillion in deals announced from a record $4.1 trillion the previous year.

Loss of Faith

Hedge funds lost 18 percent of their value for the year through November, the worst year since record-keeping began in 1990, according to Chicago-based Hedge Fund Research Inc. Morgan Stanley estimated that, by year end, at least 620 hedge funds will have closed.

At bottom, the debacle amounted to a loss of faith, especially for individual investors. They pulled $215.7 billion from stock mutual funds in the first 11 months of the year, according to Investment Company Institute, a Washington-based association. That compares with a $91 billion inflow of funds for the same period of 2007.

As a result of those withdrawals and market losses, the total net assets in all types of mutual funds fell by $2.67 trillion in the first 11 months of 2008, the institute reported.

While the fear may pass, it will leave permanent changes in its wake. Few believe Wall Street will emerge as anything like the freewheeling industry it was over the past few decades.

“I see this as a Darwinian event,” said Mount Lucas Management’s DeRosa. “You find out which specimens of the species are genetically fit. I’m reasonably sure that things in 2009 will get better, but they’ll get materially worse before they start to look up.”

To contact the reporter on this story: James Sterngold in Los Angeles at jsterngold2@bloomberg.net

Last Updated: December 31, 2008 00:01 EST

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Journal of a Plague Year: Faith in Markets Cracks Under $30 Trillion Loss It has been a year of record misery: the largest bankruptcy, bank failure and Ponzi scheme in U.S. history; $720 billion in writedowns and losses by financial institutions; $30.1 trillion in market valuation wiped out.

Americans Under 70 May Find Economy Made 2008 Their Least Favorite Year This wasn’t just a bad year for the economy. By some measures, it was the worst year any American under age 70 has ever seen.

`Original Sin’ Returns to Emerging Markets Requiring Sales of Dollar Bonds Developing nations plan to sell the most dollar-denominated bonds since 2005, reversing a shift into local debt, as commodities prices fall, foreign reserves diminish and emerging-market currencies weaken.

‘Original Sin’ Returns as Emerging Markets Plan Bonds (Update3)

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By Lester Pimentel

Dec. 31 (Bloomberg) — Developing nations plan to sell the most dollar-denominated bonds since 2005, reversing a shift into local debt, as commodities prices fall, foreign reserves diminish and emerging-market currencies weaken.

International sales may rise 68 percent to $65 billion next year, according to estimates by ING Groep NV. Mexico raised $2 billion in a Dec. 18 offering. Peru’s Finance Minister Luis Valdivieso met with investors in New York, Boston, London and Madrid this month to drum up interest for the country’s first foreign sale in almost two years.

Governments are growing more dependent on international markets after the six-month drop in raw materials reduced earnings from exports and caused budget deficits to widen. Dollar borrowing will increase foreign-exchange risk, a pattern that led countries across Latin America to default in the 1980s, said Ricardo Hausmann, director of the Center for International Development at Harvard University in Cambridge, Massachusetts.

“Countries will be forced to issue in dollars,” said Hausmann, a former Venezuelan planning minister who called developing nations’ reliance on foreign markets the “original sin” in a 1998 article in Foreign Policy magazine. “Debt structures will deteriorate again.”

Dollar bond sales fell 43 percent in the past three years from $68 billion in 2005 as a 134 percent surge in commodities, as measured by the UBS Bloomberg CMCI Index, helped countries repay foreign obligations, according to Amsterdam-based ING. Local-currency debt offerings rose 23 percent annually since 2005, according to the Bank for International Settlements in Basel, Switzerland.

Declining Reserves

Colombia moved 71 percent of its debt into peso-based securities, up from 48 percent in 2002, according to Finance Ministry data. Eighty percent of Mexico’s obligations were in pesos in 2007, up from 55 percent seven years earlier, according to government figures.

The combination of slumping commodity prices since July and the worldwide credit crunch dried up dollar inflows, pushing down emerging-market currencies and draining foreign reserves. Oil, the biggest export from Mexico, Russia and Venezuela, plunged 71 percent from a record $147.27 a barrel.

Russia’s central bank used a quarter of its $598 billion of reserves in less than five months to limit the ruble’s slide against the dollar, according to Bank Rossii. Mexico’s $2 billion sale of 10-year bonds came after its central bank used $15.2 billion, or 18 percent, of foreign reserves to prop up the peso when it fell to a record low in October.

Twin Deficits

Budget needs are swelling. Russia will post its first deficit in a decade next year, Finance Minister Alexei Kudrin said Dec. 27. Mexico forecasts a shortfall equal to 1.8 percent of gross domestic product next year, a gap that UBS AG says would be the biggest since 1990. The forecast is based on an oil price estimate of $70 a barrel, 63 percent higher than today’s $42.90.

Venezuela, which gets about 90 percent of export receipts from oil, may have a deficit in the current account, the broadest measure of trade, equal to 4.3 percent of GDP in 2009 after posting a surplus of 12.5 percent of GDP this year, according to Standard & Poor’s.

“Pressures are mounting,” said David Spegel, head of emerging-market strategy at ING in New York. “Most budgets will be in deficit. They’re going to have to be financed.”

Borrowing costs in dollars rose this year as the credit squeeze triggered by $1 trillion in losses and writedowns at the world’s biggest financial companies eroded demand for all but the safest securities. Investors demanded an average 12 percent yield on emerging-market dollar bonds on Oct. 24, up from 6.92 percent on Aug. 29, according to data compiled by New York-based JPMorgan Chase & Co.

Bond Rebound

Yields on Argentine bonds due in 2033 have soared to over 22 percent from 11.2 percent four months ago after the government seized private pension funds, a move analysts said was aimed at cobbling together financing. Ukraine, Hungary and Pakistan, strapped for cash amid the crisis, reached loan agreements with the International Monetary Fund in November. Ecuador’s President Rafael Correa defaulted this month on $3.9 billion of foreign bonds, calling the debt “illegal.”

The average emerging-market yield fell back to 8.96 percent as the Federal Reserve took unprecedented steps to support the U.S. economy. The Fed cut its target interest rate for overnight loans between banks as low as zero, helping push yields on Treasuries, the benchmark for emerging-market rates, to a five- decade low.

‘Window of Opportunity’

Emerging-market local bonds have also rebounded, posting a 8.3 percent gain in dollar terms this month, as investors anticipate interest-rate cuts in Brazil, Indonesia and India, according to Merrill Lynch & Co.’s LDM Plus Index.

Gerardo Rodriguez, head of public credit at Mexico’s Finance Ministry, said in an interview Dec. 18 that he used a “window of opportunity” to sell the $2 billion of 10-year bonds at a yield of 5.98 percent.

Valdivieso, Peru’s finance minister, said Dec. 22 in Lima that meetings with investors suggested there’s demand for at least $600 million of notes. Russia is also considering an international sale, Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, said in a Dec. 24 telephone interview.

The increase in dollar bonds is unlikely to lead to a wave of defaults like those in the 1980s because developing nations have reduced spending and curbed inflation, Spegel said.

Currency Rallies

Brazil trimmed its budget deficit to the equivalent of 1.2 percent of gross domestic product from 8.8 percent a decade earlier. Inflation fell to 6.4 percent from a high of 6,821 percent in 1990.

“They are coming into the crisis in better shape,” said Igor Arsenin, an emerging-market strategist at Credit Suisse Group in New York. “Increased dollar issuance only poses a risk if we see a protracted period of global slowdown.”

This month’s rebound in emerging-market local-currency bonds left them up 1.2 percent for the year, according to Merrill’s LDM Plus index.

The bonds returned 13.9 percent in 2007 and 12.7 percent in 2006 as currencies rallied. Brazil’s real strengthened 62 percent against the dollar in the four years through 2007, the best performance among the 16 most-traded currencies, while Poland’s zloty rose 52 percent and Colombia’s peso climbed 38 percent.

‘Double Whammy’

Currency gains combined with yields of more than 10 percent in countries including Brazil, Turkey and Philippines proved irresistible to investors, said Jonathan Binder, who manages more than $2 billion of emerging-market assets at INTL Consilium LLC in Fort Lauderdale, Florida.

“It was a double whammy that was highly lucrative,” Binder said. “But it took a short time to reverse” gains, he said.

The real weakened 33 percent from a record high in August. Turkey’s lira slid 24 percent against the dollar over the same period while Hungary’s forint dropped 22 percent.

“You’ll see investor reluctance to fund locally,” said Michael Atkin, who helps oversee $12 billion of fixed-income assets as head of sovereign research at Putnam Investments in Boston. Countries may “find it much more difficult to issue locally and might find it more attractive to issue internationally,” he said.

To contact the reporter on this story: Lester Pimentel in New York at lpimentel1@bloomberg.net

Last Updated: December 31, 2008 16:13 EST

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Breaking Views

31 Dec 2008 11:09

The Greater Depression

By Martin Hutchinson

Globalisation:  Absent huge policy mistakes, the current downturn won’t rival the Great Depression, when US GDP dropped by 27% and the unemployment rate reached 25%. Even the worst pessimists don’t expect a double-digit percentage point GDP decline. But there’s a chance of a sort of quasi-depression – which could lead to a multi-decade decline in living standards in rich countries.

The gap between developing and developed world living standards is still huge. GDP per person in the US is 4.6 times higher than the world average, according to CIA World Factbook. But globalization – in trade, communications and knowledge – is narrowing the difference.

As yet, this great equalisation has been pleasing for the poor and largely painless for the rich. Both poor and rich have got richer, but the poor have got richer faster. That could change. The growth of the poor might start to come at the expense of the rich.

Consider the numbers. Suppose the 4.6-times income gap between rich and poor halves in the next 15 years while the whole world’s GDP keeps growing at the same 2.6% rate it did between 1960 and 2000. If that happens, US per capita GDP would mathematically be 27% lower in 2022 than in 2007 – the same fall experienced in the Great Depression, just spread out over many more years.

Statistical projections are not economic destiny, but rich countries can actually get poorer. The average Argentine was 9% poorer in 1945 than in 1929. It took heroic doses of wasteful macroeconomic policy to get that result. But the current rich-country policies of huge government deficits and tiny interest rates aren’t growth-friendly over the long term.

Unless reversed quickly, this mix tends to lead to larger governments, troublesome budget deficits and – when the debts can’t be paid off – increasingly dangerous inflation. Populist policies could make a bad situation worse. In the US and other wealthy countries, the result could be a downward sloping saw-tooth pattern of output. Each recovery is feebler than the preceding downturn.

As it stands, the poor are closely tied to the rich, so China and its peers are suffering from the troubles in their big export markets. That could change, though, if poorer countries learn to rely less on low-value exports. Instead, they could create a self-sustaining upward spiral of useful investments, improved productivity and rising incomes. Such a decoupling would be highly advisable if rich countries turn to the economic equivalent of self-harming behaviour.

Even if the rich get a third poorer, they will be much richer than their ancestors were in 1929, before the Great Depression started. But the psychological effect of losing income for so many years could be just as great. Talk about depressing.martin.hutchinson@breakingviews.com

Context News

According to Bureau of Economic Analysis’ statistics, US Gross Domestic Product declined 26.6% between 1929 and 1933 while real personal income declined 25.7%. Real personal consumption expenditures declined 18.2%. Per capita, real personal income declined 30% and consumption 23%.

US GDP per capita at purchasing power parity was $45,800 in 2007, thus 4.58 times the $10,000 average GDP per capita of the world as a whole. World GDP per capita grew by 2.58% in 1960-2000. If world per capita GDP grows at 2.58% per annum, it will equal current US GDP per capita of $45,600 in 60 years.

If global growth continues at 2.58% annually and globalization’s acceleration is sufficient to reduce the gap in global living standards by half in 15 years, the world’s average GDP per capita in 2022 will be $14,653, while 2022’s US per capita GDP, at 2.29 times global per capita GDP would be $33,556, a 26.8% drop from today.

Copyright © breakingviews 2008

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In 2008, 6 Years of Market Gains Are Lost

Richard Drew/Associated Press

The Dow industrials fell as much as 705 points on Sept. 29 after the House rejected the government’s financial bailout plan.

By VIKAS BAJAJ

Published: December 31, 2008

There was almost no place to hide from the crash of 2008.

The Year in Markets

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Times Topics: Credit Crisis

By the time the New York Stock Exchange closed Wednesday to end the year, virtually anyone with money in stocks had felt the punishing drop in the market.

Shares ended higher on Wednesday, but overall, it was a very bad year to own stocks, any stocks — indeed, one of the worst ever.

The Dow Jones industrial average ended the year down more than 33 percent, the worst year for the index since 1931, and the broader Standard & Poor’s 500-stock index more than 38 percent. Blue-chips like Bank of America, Citigroup and Alcoa lost more than 60 percent of their value.

All told, about $7 trillion of shareholders’ wealth — the gains of the last six years — will be wiped out in a year marked by violent market swings.

But what is striking is not just the magnitude of the declines, staggering as they are, but also their breadth. All but 2 of the 30 Dow industrials, Wal-Mart and McDonalds, fell by more than 10 percent. Almost no industry was spared as the crisis that emerged in the subprime mortgage market metastasized and the economy sank into what could be a long, gray recession.

As the new year dawns, Wall Street is looking to Washington, where the balance of financial power has tipped in recent months. Analysts and investors are focusing on what the incoming Obama administration and the Federal Reserve will do to revive the economy and the financial system.

It is a remarkable turnabout from the mid-1990s, when Wall Street traders helped drive economic policy. Back then, bond investors flexed their financial muscle and prodded the Clinton administration and a Republican Congress to reduce the federal budget deficit.

These days, the market in ultra-safe United States Treasury securities seems like a refuge, even as the deficit balloons from the cost of bailing out banks, insurers and the Detroit auto companies. Many investors, having lost stocks and other investments, are buying Treasuries that offer little or no return. They are content simply to get their money back.

“The only willing risk taker is the government,” said William H. Gross, the chief investment officer of the Pacific Investment Management Company, or Pimco, the giant bond trading firm. Speaking of the epicenter of the financial world, he added: “It is no longer New York, it’s Washington.”

Like many money managers, Mr. Gross is a conservative — he describes himself as a “Reagan fan from way back” — who generally prefers limited government involvement in the markets. But he and others say that the government’s sweeping intervention into private industry and in the markets, though sometimes flawed, was necessary to prevent a collapse of the financial system. They are hoping that policy makers do even more to stimulate the economy and revive moribund financial markets.

Given the damage in the markets, however, policy makers face daunting challenges.

“When we have bear markets, they usually take twice as long to get down this far,” said Robert C. Doll, vice chairman of BlackRock, the investment firm.

The markets have become incredibly volatile, especially since Lehman Brothers sank into bankruptcy in September. Since late September, there have been 18 days when the S.& P. moved more than 5 percent in either direction. In the previous 53 years, there were only 17 such days, according to calculations by Howard Silverblatt, an index analyst at S.& P.

Diversification — the idea that it is unwise to put all your eggs in one basket — did not pay off for investors in 2008, casting doubt over this cornerstone of modern investing. The American market was far from the worst hit in 2008. Stocks have fallen 55 percent to 72 percent in Brazil, Russia, India and China — the so-called BRIC economies that were darlings of the late, great boom. Stocks in developed European and Asian markets also fell sharply, though less than their emerging counterparts. Many commodities like oil and copper crashed.

Losses in the credit markets, which are at the heart of this financial crisis, appear small relative to the devastation in other markets. The International Monetary Fund estimated in October that banks and other investors would suffer $1.4 trillion in losses on loans and securities, a loss of just 6 percent. Financial institutions globally have already reported $1 trillion in write-downs, according to Bloomberg.

The I.M.F.’s estimate, however, does not count losses on derivatives, those complex instruments that derive their value from other assets. Losses on these instruments could outstrip those in the so-called cash markets because they are much bigger than their underlying assets.

A spokeswoman for the I.M.F. said the fund’s estimates do not include those losses because they are transfers of wealth from one party of a transaction to another. For example, when the insurance giant, American International Group, losses $1 billion on a credit default swap, a type of derivative, it makes payments to customers like investment banks.

These complex financial instruments will pose one of the biggest challenges to policy makers in the year ahead. Many investors have lost confidence in banks, insurers and other financial intermediaries, in part, because they do not know whether these companies are valuing opaque instruments properly. Some firms may be carrying enough toxic sludge to sink them, while others may be relatively unscathed.

“Until those assets can be removed from the balance sheets of the bank, or until the owners get a better understanding of what these assets are worth, we will have uncertainty,” said Douglas Peta, an independent market analyst.

A broader focus for policy makers will be reviving the economy. Most financial and political analysts expect the Obama administration to enact a stimulus package that could approach $1 trillion. The effort will aim to create three million jobs by spending money on infrastructure, green energy technology, aid to states and other initiatives.

Many analysts say such an effort would help revive the economy, but they warn that it will not have immediate results. Infrastructure spending, for instance, can have a powerful impact by stimulating demand and creating jobs but, like much else in the economy, it often takes time to work.

Some are looking to efforts by the Treasury and Fed to jump start lending by lowering mortgage rates and improving the market for bonds backed by small business, auto and credit card loans. A recent drop in mortgage rates has already sparked a refinance boom, but analysts say home prices in many parts of the country are still too high for many would-be home buyers. Furthermore, employment and household savings, which began to rise sharply in the spring of last year, will likely have climb for some time before consumers have enough confidence to buy homes and money for down payments.

“Across the board, they can potentially prevent a further slide, and they deserve a lot of credit if they achieve that,” Martin S. Fridson, chief executive of Fridson Investment Advisors, a bond-trading firm, said about policy makers. “I just don’t think that they can push a button and have the economy and the stock market turn around.”

Thomas J. Lee, the chief equity strategist at J.P. Morgan Chase, said a recovery early in the year could give way to another sell-off before the stock market finally bottoms later in the year. He said his forecast reflects “how unconventional the current recession is.” Unlike in the past, policy makers cannot rely on consumers to push the economy ahead by borrowing and spending, he said.

“This is a recession where households are net debtors,” he said. “They have lost money on houses and equities. That has rarely happened, at least since the 1950s.”

Mr. Doll of BlackRock agreed that consumers will not “run back and power the economy ahead.” But he nonetheless contends that several important markets, including stocks, may be close to their bottom. The Fed, he argued, has taken on a more activist role in the markets and the new administration is likely push through a massive stimulus.

Such sentiments have probably helped drive the S.& P. 500 index up by 20 percent since Nov. 20 and investment-grade corporate bonds up by nearly 9 percent since October.

“Perhaps we have seen a bottom,” Mr. Doll said. But he added that like the economy, “the stock market recovery will be more muted as well.”

http://www.nytimes.com/2009/01/01/business/economy/01markets.html?ref=business&pagewanted=all

In 2008, 6 Years of Market Gains Are Lost

Richard Drew/Associated Press

The Dow industrials fell as much as 705 points on Sept. 29 after the House rejected the government’s financial bailout plan.

By VIKAS BAJAJ

Published: December 31, 2008

There was almost no place to hide from the crash of 2008.

By the time the New York Stock Exchange closed Wednesday to end the year, virtually anyone with money in stocks had felt the punishing drop in the market.

Shares ended higher on Wednesday, but overall, it was a very bad year to own stocks, any stocks — indeed, one of the worst ever.

The Dow Jones industrial average ended the year down more than 33 percent, the worst year for the index since 1931, and the broader Standard & Poor’s 500-stock index more than 38 percent. Blue-chips like Bank of America, Citigroup and Alcoa lost more than 60 percent of their value.

All told, about $7 trillion of shareholders’ wealth — the gains of the last six years — will be wiped out in a year marked by violent market swings.

But what is striking is not just the magnitude of the declines, staggering as they are, but also their breadth. All but 2 of the 30 Dow industrials, Wal-Mart and McDonalds, fell by more than 10 percent. Almost no industry was spared as the crisis that emerged in the subprime mortgage market metastasized and the economy sank into what could be a long, gray recession.

As the new year dawns, Wall Street is looking to Washington, where the balance of financial power has tipped in recent months. Analysts and investors are focusing on what the incoming Obama administration and the Federal Reserve will do to revive the economy and the financial system.

It is a remarkable turnabout from the mid-1990s, when Wall Street traders helped drive economic policy. Back then, bond investors flexed their financial muscle and prodded the Clinton administration and a Republican Congress to reduce the federal budget deficit.

These days, the market in ultra-safe United States Treasury securities seems like a refuge, even as the deficit balloons from the cost of bailing out banks, insurers and the Detroit auto companies. Many investors, having lost stocks and other investments, are buying Treasuries that offer little or no return. They are content simply to get their money back.

“The only willing risk taker is the government,” said William H. Gross, the chief investment officer of the Pacific Investment Management Company, or Pimco, the giant bond trading firm. Speaking of the epicenter of the financial world, he added: “It is no longer New York, it’s Washington.”

Like many money managers, Mr. Gross is a conservative — he describes himself as a “Reagan fan from way back” — who generally prefers limited government involvement in the markets. But he and others say that the government’s sweeping intervention into private industry and in the markets, though sometimes flawed, was necessary to prevent a collapse of the financial system. They are hoping that policy makers do even more to stimulate the economy and revive moribund financial markets.

Given the damage in the markets, however, policy makers face daunting challenges.

“When we have bear markets, they usually take twice as long to get down this far,” said Robert C. Doll, vice chairman of BlackRock, the investment firm.

The markets have become incredibly volatile, especially since Lehman Brothers sank into bankruptcy in September. Since late September, there have been 18 days when the S.& P. moved more than 5 percent in either direction. In the previous 53 years, there were only 17 such days, according to calculations by Howard Silverblatt, an index analyst at S.& P.

Diversification — the idea that it is unwise to put all your eggs in one basket — did not pay off for investors in 2008, casting doubt over this cornerstone of modern investing. The American market was far from the worst hit in 2008. Stocks have fallen 55 percent to 72 percent in Brazil, Russia, India and China — the so-called BRIC economies that were darlings of the late, great boom. Stocks in developed European and Asian markets also fell sharply, though less than their emerging counterparts. Many commodities like oil and copper crashed.

Losses in the credit markets, which are at the heart of this financial crisis, appear small relative to the devastation in other markets. The International Monetary Fund estimated in October that banks and other investors would suffer $1.4 trillion in losses on loans and securities, a loss of just 6 percent. Financial institutions globally have already reported $1 trillion in write-downs, according to Bloomberg.

The I.M.F.’s estimate, however, does not count losses on derivatives, those complex instruments that derive their value from other assets. Losses on these instruments could outstrip those in the so-called cash markets because they are much bigger than their underlying assets.

A spokeswoman for the I.M.F. said the fund’s estimates do not include those losses because they are transfers of wealth from one party of a transaction to another. For example, when the insurance giant, American International Group, losses $1 billion on a credit default swap, a type of derivative, it makes payments to customers like investment banks.

These complex financial instruments will pose one of the biggest challenges to policy makers in the year ahead. Many investors have lost confidence in banks, insurers and other financial intermediaries, in part, because they do not know whether these companies are valuing opaque instruments properly. Some firms may be carrying enough toxic sludge to sink them, while others may be relatively unscathed.

“Until those assets can be removed from the balance sheets of the bank, or until the owners get a better understanding of what these assets are worth, we will have uncertainty,” said Douglas Peta, an independent market analyst.

A broader focus for policy makers will be reviving the economy. Most financial and political analysts expect the Obama administration to enact a stimulus package that could approach $1 trillion. The effort will aim to create three million jobs by spending money on infrastructure, green energy technology, aid to states and other initiatives.

Many analysts say such an effort would help revive the economy, but they warn that it will not have immediate results. Infrastructure spending, for instance, can have a powerful impact by stimulating demand and creating jobs but, like much else in the economy, it often takes time to work.

Some are looking to efforts by the Treasury and Fed to jump start lending by lowering mortgage rates and improving the market for bonds backed by small business, auto and credit card loans. A recent drop in mortgage rates has already sparked a refinance boom, but analysts say home prices in many parts of the country are still too high for many would-be home buyers. Furthermore, employment and household savings, which began to rise sharply in the spring of last year, will likely have climb for some time before consumers have enough confidence to buy homes and money for down payments.

“Across the board, they can potentially prevent a further slide, and they deserve a lot of credit if they achieve that,” Martin S. Fridson, chief executive of Fridson Investment Advisors, a bond-trading firm, said about policy makers. “I just don’t think that they can push a button and have the economy and the stock market turn around.”

Thomas J. Lee, the chief equity strategist at J.P. Morgan Chase, said a recovery early in the year could give way to another sell-off before the stock market finally bottoms later in the year. He said his forecast reflects “how unconventional the current recession is.” Unlike in the past, policy makers cannot rely on consumers to push the economy ahead by borrowing and spending, he said.

“This is a recession where households are net debtors,” he said. “They have lost money on houses and equities. That has rarely happened, at least since the 1950s.”

Mr. Doll of BlackRock agreed that consumers will not “run back and power the economy ahead.” But he nonetheless contends that several important markets, including stocks, may be close to their bottom. The Fed, he argued, has taken on a more activist role in the markets and the new administration is likely push through a massive stimulus.

Such sentiments have probably helped drive the S.& P. 500 index up by 20 percent since Nov. 20 and investment-grade corporate bonds up by nearly 9 percent since October.

“Perhaps we have seen a bottom,” Mr. Doll said. But he added that like the economy, “the stock market recovery will be more muted as well.”

http://www.nytimes.com/2009/01/01/business/economy/01markets.html?ref=business&pagewanted=all

http://www.ft.com/cms/s/1/a8e1a6d4-cf87-11dd-abf9-000077b07658.html

Credit spreads

Published: December 21 2008 18:03 | Last updated: December 21 2008 23:34

Retail investors may have been transfixed by crashing equities in 2008. But the dramatic spread widening in corporate credit has led to some truly wild anomalies. Some of these involve derivative markets, which admittedly can be distorted by illiquidity. Even so, corporate debt spreads have now blown out to an eye-popping extent, implying cumulative default rates of 30 per cent for investment grade, according to HSBC calculations.

To put that in perspective, the default rate during the Great Depression for all corporates (including the equivalent of today’s issuers of high-yield paper) was about 20 per cent. With everything that central bankers and governments are doing to avoid the catastrophic collapse in economic output of the 1930s, these yields look aberrant.

In another, more technical twist on credit pricing, one can find a company’s bonds trading at wider spreads than the same company’s credit default swaps – a derivative that protects investors from losses in the event of default. What this means, in effect, is that an investor could buy a corporate bond, hedge out the credit risk of the company going bust thanks to the CDS, and still make a return, as Barclays Capital has pointed out. But this may not be quite the free lunch it appears. Investors still bear the danger of counterparty risk, as there is a chance the counterparty to the CDS trade could go under like Lehman Brothers did. But it is very rare for such odd relative pricing to persist for so long.

There are reasons why corporate credit has stayed so cheap. Hedge funds and banks are deleveraging. As they do so, one of the attractions of corporate bonds – their use as collateral in exchange for cash – has waned. It is possible that more of this same deleveraging will keep credit cheap for a bit longer. But it seems more likely to believe that corporate credit is due a sustained rally. Dollar investment grade spreads have only been wider than at present once in the past 90 years and that was in 1932, which proved to be a pretty good opportunity to buy.

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Copyright The Financial Times Limited 2008

• DECEMBER 31, 2008, 3:26 P.M. ET

Obama Expected to Name Labor Economist to Advisory Council

By DEBORAH SOLOMON

President-elect Barack Obama is expected to round out his economic team next week with the selection of Cecilia Rouse, a Princeton University labor economist well-known for her work on the economics of educational investments, according to an Obama economic transition aide.

Ms. Rouse will join Christina Romer and Austan Goolsbee as the third member of the Council of Economic Advisers, which advises the President on economic policy. All three are academic economists with distinct specialties:  Ms. Romer is an economic historian schooled in the Great Depression while Mr. Goolsbee is a taxation expert.

Mr. Obama is expected to draw on Ms. Rouse’s expertise in the economic benefits of education investments as he prepares a stimulus package to help jumpstart the ailing economy. Among other things, the package is expected to focus on preparing workers for jobs in a global economy.

Ms. Rouse has written on the benefits of attending community college. She has also argued that the use of school vouchers — a staple of the Bush administration’s stance on education — doesn’t dramatically improve student achievement.

She is also well-known for a paper on discrimination, in which she and a co-author found that “blind” auditions were more likely to result in female musicians being hired into an orchestra.

Write to Deborah Solomon at deborah.solomon@wsj.com

http://online.wsj.com/article/SB123075402884446253.html

Cecilia E. Rouse
Chair

Cecilia Elena Rouse is currently the Theodore A. Wells ‘29 Professor of Economics and Public Affairs at Princeton University. Her primary research and teaching interests are in labor economics with a particular focus on the economics of education. She has studied the economic benefit of community college attendance, evaluated the Milwaukee Parental Choice Program, examined the effects of education inputs on student achievement, tested for the existence of discrimination in symphony orchestras, and studied unions in South Africa and the effect of financial aid on college matriculation.

Her current research evaluates Florida’s school accountability and voucher programs. In addition, she is currently conducting randomized evaluations of technology-based programs in schools in three large urban school districts as well as a randomized evaluation of strategies for increasing educational attainment among community college students. She is also studying the impact of student loans on post-college occupational choices.

Rouse is currently a senior editor of The Future of Children (a Princeton-Brooking publication) and an editor of the Journal of Labor Economics. She is the founding director of the Princeton University Education Research Section and is currently the director of the Industrial Relations Section as well. She is also a member of the MacArthur Foundation’s Research Network on the Transition to Adulthood. In 1998-99 she served a year in the White House at the National Economic Council. She holds a Ph.D. in economics from Harvard University.

http://www.vanderbilt.edu/AEA/CSMGEP/about/rouse.html