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News : International Last Updated: Apr 24, 2009 - 5:31:05 PM


Friday Newspaper Review - Irish Business News and International Stories - - October 31, 2008
By Finfacts Team
Oct 31, 2008 - 7:07:30 AM

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The Irish Independent reports that the Government was forced into its third major Budget climbdown last night -- just one hour after Taoiseach Brian Cowen said tough spending cuts could not be avoided.

Mr Cowen's attempts to talk tough on the economy were immediately undermined by his Government's latest embarrassing U-turn.

This time, it was the turn of Social Welfare Minister Mary Hanafin, who caved in to pressure and announced that 16- and 17-year-olds would continue to get the disability allowance.

Shortly before her announcement, Mr Cowen had starkly warned that the country was "battling the most severe global economic and financial conditions for a century".

In a sign of the ongoing disarray within the Government, the Irish Independent understands Mr Cowen was not expecting Ms Hanafin to make the announcement right after his hardline speech to top business leaders.

There were signals from the Government of further rowbacks on agriculture cuts, with ministers indicating there was leeway for examining measures there.

Mr Cowen said the Government needed allies in dealing with the economic situation and communicating the changed circumstances to the public at large.

Business, unions and the social partners needed to stand up and inform people of the gravity of the situation.

And Mr Cowen said people had to be prepared to "take a step back" in terms of incomes and public spending in order to be able to take two steps forward when recovery came.

"At the end of the day, if everyone stands up and says, 'Not me, mate', don't be surprised if we don't get there as quick as we should," he said.

The Taoiseach said the public had not yet grasped the seriousness of the situation before the country.

"We have seen already how resistant public opinion is, firstly to comprehension of the new paradigm in which we have to operate; and secondly, to the rationale behind the decisions we have had to take," he said.

"At the moment, 10pc of the cost of every teacher, doctor and nurse is being paid from borrowing. Any extra ones would be paid for 100pc from borrowing, which will have to be paid back by future generations of Irish people," he said.

Ms Hanafin said the climbdown on disability payments came after some families expressed concerns about the fact that they had an expectation the overall family income would increase significantly once their son or daughter reached the age of 16.

The change of heart means another €4m will have to be found in the social welfare budget. Ms Hanafin had discussed the change with Finance Minister Brian Lenihan and Mr Cowen, so the Taoiseach knew it was coming -- just not when.

Ms Hanafin's spokesperson said Mr Cowen was aware of the change and the minister wanted to clarify the issue as soon as possible.

Change

"She didn't indicate to Cabinet when she was going to make the announcement," the spokesperson said. Mr Cowen's spokesman also insisted the Taoiseach knew the change was coming.

Intensifying the speculation about a fourth major climbdown, Agriculture Minister Brendan Smith hinted at possible changes to cuts affecting new entrants to the farming industry and the 1pc income levy imposed on farmers.

The one area under which the Government appears to have drawn a line is on the cuts to school spending.

The Green Party was left humiliated as it was forced to back the cuts to school funding, despite its alleged opposition.

After saying he could not stand by the cuts and threatening to pull out of Government, Green TD Paul Gogarty fully backed Education Minister Batt O'Keeffe.

Also last night, it emerged the taxpayer would bear the immediate cost of any bailout of a failing bank, Mr Lenihan made clear.

Apparently contrary to what Mr Cowen was saying, Mr Lenihan scotched the idea of a whip-round by other banks in such a scenario -- which could conceivably save the Exchequer hundreds of millions of euro.

"This puts Joe and Mary Public in the frontline in the case of any bank collapse," Labour Party finance spokesman Joan Burton said last night.

The Irish Independent also reports that shares in Irish drug company Elan plummeted almost 50pc in Dublin yesterday after the drugmaker said that a third case of a life-threatening brain disease has been discovered in a patient using its Tysabri multiple sclerosis treatment.

The announcement comes as a further blow to investors, although the number of patients to have developed the disease so far remains well within the permitted safety parameters.

The stock recovered later during the day to close down almost 16pc at €4.92. The US Food and Drug Administration has previously determined that one case of PML (progressive multifocal leukoencephalopathy) in 1,000 users is an acceptable safety risk. Approximately 36,000 patients are currently using Tysabri. The three new PML cases equate to just one detection amongst each 12,000 users since 2006.

Analyst Ian Hunter with Goodbody Stockbrokers said that the new PML case should "do little to projected numbers of patients on Tysabri".

Releasing third-quarter results last week, Elan chief executive Kelly Martin said that of the two PML cases uncovered during the summer in two Europe-based patients, one was doing well, while the other was "not in good shape".

Elan and its US development and marketing partner Biogen Idec were forced to pull Tysabri from the market in 2005 after a patient using the treatment died from PML. The drug was re-released the following year with enhanced warnings, while Elan and Biogen also initiated a patient risk management plan.

It's likely that system helped to detect the latest PML case, which was found in a US patient. The discovery was made while the disease was in its early stages.

Mr Hunter noted yesterday that the patient in which the latest case had been detected had been using Tysabri for 13 months.

He pointed out that of the two PML cases revealed in the summer, one patient had been using the therapy for 14 months, and the other for 17 months.

Mr Hunter said the timeframes may "suggest that there is a timing issue" and that it could take over a year of Tysabri use for the interaction between drug and patient to lead to the development of PML.

"The potential for an increased number of patients to take a drug holiday may, therefore, increase," he warned.

Elan adds about $100m in annual profit to its bottom line for every 10,000 Tysabri patients. The company reckons its target of 100,000 patients using Tysabri by the end of 2010 remains achievable. Last week Elan revealed a 53pc year-on-year rise in revenue during the third quarter to $270.1m on the back of increased Tysabri use.

The Irish Times reports that the bank guarantee scheme hasn't satisfied the market or solved the funding crisis.

A lot done, much more to do. And no one is exactly sure how much more needs to be done.

This is the general view of the Irish bank guarantee scheme one month after it was unveiled.

The €440 billion guarantee flooded the six Irish-owned financial institutions with deposits after it was announced on the last day of September, though it appears the banks mostly recovered what they had lost in the preceding weeks.

It helped to stop further leakage of deposits and gave much-needed short-term liquidity to the cash-starved Irish banks. However, it has not solved the long-term funding issue or encouraged bloodied debt investors and asset managers to place large lump sums with Irish banks.

Other countries went a step further, guaranteeing the banks in full, not just their deposits and debts as the Government here did. In some cases they injected capital, bullet-proofing their banks against rising bad debts amid the crisis.

Belgian-owned IIB Bank (now KBC Bank Ireland) and UK-owned Halifax-Bank of Scotland (Ireland) have opted out of the Irish scheme because of massive state investments in their parent banks based in countries whose bank rescues have trumped the Irish guarantee.

HBOS Ireland's decision to stay outside the scheme speaks volumes about how quickly things have changed over the last month. The bank aggressively lobbied to be included in the guarantee shortly after it was announced.

On Tuesday, its chief executive Mark Duffy said the £13 billion state investment in its parent bank, HBOS, left it "rock solid". He criticised the Irish scheme, describing it as "discriminatory" and "a disproportionate solution" that would blunt his bank's competitive edge and its ability to offer attractive products to customers - one of the reasons it entered the Irish market.

Many banks are also concerned about the confusion over a clause in the scheme, which suggested that all guaranteed banks would have to cover the State's costs if it had to bail out one failed bank.

The Government has rowed back on this, but some bankers feel further clarification is needed.

Another pressing question is whether the banks have to raise additional capital to absorb their rising bad debts. The stock market says yes; the banks, the Irish Financial Services Regulatory Authority and the Government say no, though most acknowledge the rules are changing fast.

Stock market investors clearly believe that the Irish bank guarantee has not gone far enough. The share prices of the four public banks are between 13 per cent (Anglo Irish Bank) and 50 per cent (Bank of Ireland) lower than their closing levels on September 29th, when the worst share falls in a quarter of a century forced the Government to react strongly.

Analyst Sebastian Orsi at stockbrokers Merrion says investors are "holding back", believing that banks will have to raise more capital.

Fresh capital injections in RBS, owner of Ulster Bank and First Active in Ireland, and HBOS have brought their core tier one capital ratios - a key buffer against losses and a measure of financial strength - well above 8 per cent.

AIB, Bank of Ireland and Anglo Irish are hovering around 6 per cent and would need to raise between €8.7 billion and €12 billion to bring their capital ratios up to match those of the UK banks.

"The big question is, do the Irish banks need to follow the UK?" asked Scott Rankin at Davy stockbrokers. "The banks are saying they don't. Investors believe they do. There is a bit of a standoff."

Investors are also pricing heavy losses on bad loans over the three banks' exposure to builders and developers in the first instance and then on commercial property.

The decision by Danish-owned National Irish Bank to write off €69 million on bad loans to developers in one quarter - eclipsing a €25 million charge in the first six months of the year - will put pressure on the Irish banks to take a long hard look at their loan books.

"With the level of bank capital increasing across Europe, this is likely to put pressure on the Irish banks to raise more capital," said Ross Abercromby, banking analyst at credit rating agency, Moody's. "How much will depend on the risk profile of each bank."

Anglo Irish has more than 80 per cent of its loan book secured on commercial property and development finance, compared with about 37 per cent at AIB and 25 per cent at Bank of Ireland.

AIB chief executive Eugene Sheehy told a gathering of private investors last week that the bank would "rather die than raise equity" and that it had "options for self help" other than raising fresh equity. The bank could sell its interests in the US and Poland.

Anglo appears to have taken steps to attract new capital. The bank has reportedly hired Morgan Stanley to speak to private equity groups to raise capital. The banks could also raise equity by issuing preferential shares.

As concerns about capital persist, international asset managers and big ticket debt investors, who have been badly burnt by the global banking crisis, are holding tightly on to their purse strings before they decide to place long-term money with Irish banks.

One treasury executive in an Irish bank said debt investors had to wait until last week for the Government's market notice on the scheme and to see the terms of the guarantee for each bank before they could assess the scheme.

They must now also wait for regulator-approved prospectus documents before committing long-term lump sums to Irish banks.

"The guarantee is hugely helpful, but it hasn't really been road-tested,"said a senior banker who stressed that debt investors were still fearful of all banks, not just Irish financial institutions.

Mr Abercromby, analyst at Moody's, said:"Debt investors want to know if they're going to get paid on the day if there is a default by a bank. To replace the credit of a bank with the credit of Ireland, we have to be sure that the guarantee is water-tight."

The cost of Irish State debt has also been rising in recent weeks. Irish Government bonds have been priced higher to account for the added risk of covering the Irish banks, although the deteriorating economy has also played a part.

The Irish 10-year bond's spread over the benchmark German bond has risen from 0.52 per cent (52 basis points) the day before the guarantee was unveiled to 0.89 per cent yesterday.

That means it has risen above the cost that the Government had expected to shoulder, which was used to set the guarantee charge to the banks.

The State may yet be forced into further action to strengthen its rescue of the Irish banking system.

The Irish Times also reports that Ned Sullivan, Eircom's new non-executive chairman, arrives at the former State telco as its Australian owner strives to brush off an unwanted takeover approach from LIT, an investment firm that listed on London's small-cap market only weeks ago.

His appointment follows the departure of Pierre Danon, the French businessman who planned to stay in Eircom for five years when he joined the firm in 2006.

Neither Danon nor Rex Comb, Eircom's Australian chief, had any background in Irish business before they came to the firm. Thus Sullivan's elevation sends a signal that Eircom will in future be run with an eye to local nuance.

This was not strictly the case when the company's immediate parent, investment fund Babcock Brown Capital (BCM), engaged in a lengthy and unsuccessful campaign to persuade the Government to acquiesce to the formal separation of Eircom's network and retail units. The fund and its parent, investment bank Babcock Brown, sought an immediate change to Government policy, but it was not forthcoming.

Such a separation - which would have enabled BCM and Babcock to sell the retail business - was embraced in the Programme for Government agreed last summer. The plan never really took off and was put on the long finger, delaying a swift investment return for BCM and Babcock.

With LIT plc's approach to BCM putting Eircom into play, Mr Sullivan's stewardship of the board comes at a time when the company faces into what could be a fifth change of ownership in less than a decade. Still, the extent to which LIT can muster the firepower to execute a takeover of BCM and assume Eircom's considerable liabilities is in some doubt.

LIT's market capitalisation of little more than £107 million (€136.4 million) means it is tiny in comparison with Eircom, BCM's prime asset. Eircom's debt exceeds €4 billion and the firm was valued at €2.4 billion when BCM took over the business with the Eircom employee share ownership trust (Esot), which has a 35 per cent stake.

LIT's current investments are of considerably smaller scale. The firm was formed to assume the interests of an investment trust run by its parent, Laxey Partners.

The portfolio includes a 6.7 per cent stake in BCM, interests in a number of Sri Lankan tea companies, and shareholdings of less than 1 per cent in Swiss construction firm Implenia, British software company Civica and South Korean construction firm Sambu.

On that basis, it is difficult to see how LIT could make a convincing case that it would make a better fist of running BCM. Still, the very fact that BCM should find itself pushed on to the defensive in the face of an approach from a suitor of LIT's scale illustrates how badly fortunes have turned for BCM and Babcock. The fund's shares are down 59 per cent in the past year, while the bank's shares are down 95 per cent.

In one analysis, LIT is merely seeking to force a decision from BCM on a long-awaited return of capital to shareholders. An indicative takeover proposal is quite an aggressive way of doing that.

As BCM struggles to regain investor and bond-holder confidence for its discredited business model, LIT's intervention could yet force other potential bidders into the open. Credit crunch notwithstanding, Eircom's banks are unlikely to stand by while BCM's market capitalisation puts a value on the fund of only Aus$338 million (€176 million).

The Irish Examiner reports that asset quality indicators at Irish banks, many of which saw their share prices jump yesterday, are deteriorating as a property market slump forces more borrowers to default on loans.

This is according to Moody’s analyst, Ross Abercrombie who said that considering the housing and commercial property sectors have slowed, asset quality indicators have begun to show signs of deterioration.

Loans in arrears are rising, eroding banks’ “previously good profitability,” while provisions for bad debt will rise from “historical lows,” he said.

The country’s banks are also highly exposed to buy-to-let loans, according to Mr Abercrombie.

About 26% of loans in Ireland are to landlords, compared with 10% in Britain.

The ISEQ index of shares closed up 90.80 points or 3.4% at 2,770.17 yesterday after a shaky start in early morning trading.

This was caused primarily by a sharp fall in Elan who reported a third case of the brain disease progressive multifocal leukoencephalopathy (PML) in a patient taking its multiple scelroris drug Tysabri since the drug’s return to the market in 2006. The stock closed down 93c at 4.92.

Shares in AIB closed up 30c or 9% at €3.65, Bank of Ireland gained 5c or 3% to €1.63, Anglo Irish Bank jumped 29c or 17% to €1.99, while Irish Life & Permanent finished up 5c or 2% at €2.15.

In the construction sector CRH soared €1.32 to €16.70, Kingspan fell 13c to €4.51, while Grafton Group dipped 4c to 2.40.

Ryanair moved up 3c to 2.50, Paddy Power progressed €1.10 to 12.30, Kerry Group fell back 80c to 18.00, while Clonmel drinks company C&C increased 5c to €1.12.

The Financial Times reports that Alistair Darling is pressing banks to change their voluntary code on lending to small businesses after admitting on Thursday that the government was powerless to dictate the amounts or terms the banks offered the sector.

Ministers have been in secret talks with high street lenders to rewrite the voluntary code, ensuring small business customers are given reasonable notice before loans and overdrafts are axed or made more expensive.

“There’s a good case for strengthening the code, as we did for mortgage lending,” one government official told the Financial Times. An announcement could be made next week.

The move comes amid increasing political concern that the £400bn state bail-out of the sector is not reaping the promised benefits for smaller companies.

Gordon Brown, prime minister, has insisted repeatedly that support for such companies is a condition of the £37bn taxpayer-funded recapitalisation of Royal Bank of Scotland, Lloyds TSB and HBOS.

But Mr Darling, chancellor, said the government’s requirement that the three banks make lending available at 2007 levels simply means “the pool of money is there”. Decisions on whether to lend that money, and at what cost, remained with the banks. “In any banking operation, whether it is lending to individuals or to businesses, there must be discretion,” he said.

That same right of individual bank discretion applies to the £4bn four-year funding from the European Investment Bank (EIB) being channelled through the banks that the government announced on Thursday. The £4bn represents less than 10 per cent of the total borrowing by small businesses in the UK.

Vince Cable, Liberal Democrat Treasury spokesman, attacked the government’s “utterly pathetic” position. “The whole point about this deal with the lenders was that there was supposed to be a tough quid pro quo. It’s perfectly obvious now that the banks got the quids and there’s no quo,” he told the FT.

Bank executives say privately that the government’s 2007 criterion does not bar them from tightening lending criteria or increasing interest charges. “We don’t sense any purpose in providing small businesses with loans that they cannot afford to repay,” said Eric Leenders, executive director retail, at the British Bankers’ Association.

As the EIB deal was unveiled on Thursday, Mr Brown stressed:“We must continue to encourage banks to lend. Having recapitalised the banks, we must ensure that the money is used to sustain credit lines on normal terms to solvent businesses.”

The prime minister added a personal note of exhortation: “I urge banks not to change the terms and charges for existing lending to small and medium-sized enterprises.”

But political opponents warned that mere rhetoric could not force the banks to change their behaviour. Angry MPs told the chancellor in the Commons on Thursday that the experience of small companies in their constituencies suggested the £37bn deal, agreed more than a fortnight ago, had yet to change practices on the high street.

Don Touhig, a Labour MP, complained that many small companies were being “faced with bully-boy tactics from British banks, which are simply cancelling their overdraft facilities and denying them vital capital to invest”.

Richard Spring, the Tory MP, reported some banks“changing small businesses’ overdraft facilities to loan facilities” – changes that could be “devastating . . . to businesses’ cash flow and chances of survival”.

John McFall, the Labour head of the Treasury select committee that will grill the chancellor on Monday, complained the banks “do not play fair” with business and urged Mr Darling to ensure the taxpayer was not the “sucker of last resort”.

The FT also reports that the European Investment Bank funding announced on Thursday will be too little too late for many businesses that are struggling for cash in the face of customers tightening their payment terms and high street lenders withdrawing facilities.

The Federation of Small Businesses welcomed Thursday’s announcement as a step in the right direction. However, Andrew Cave, FSB spokesman, said the problem was that the money was unlikely to be available to the companies that need it for at least five months.

This would be too late for Mark Olbrich, director of Salade, an upmarket sandwich shop chain, which opened five stores before its bank pulled vital credit ­facilities.

Mr Olbrich’s problem is that he needs at least six stores to break even and he has run out of cash from his own resources. “It is touch and go right now,” he said.

Sally Preston, founder of frozen babyfood producer Babylicious, said her business has kept its head above water in part by shaving expenditure on items, such as insurance.

“Everybody needs liquidity because payment terms are being slashed everywhere,” she said, adding that many of the businesses she knows are on the verge of going under because they cannot get credit.

“Banks want more and more personal security for loans, which at a time when your house is going down in value is difficult to do.”

She holds out little hope of renewing her overdraft facility after hearing of another business with a £1m contract with Tesco that was refused an overdraft by its bank.

However, Andrew Carruthers, chief executive of Spark Ventures, an early- stage venture capital investor, said provision of additional funding support for loans missed the point – the main problem for many small businesses now was falling sales due to the economic downturn.

“It actually may have started in the banking sector, but it has gone past that point,”he said.“A lot of small businesses are saying that contracts they expected to raise this month have either been pulled or delayed. It is now for the banks to assess whether they are good risks or not.”

The Forum of Private Business, which represents 25,000 small and medium-sized enterprises, has seen increasing numbers of members call with stories of increased overdraft rates and withdrawn credit lines.

“There can be no excuse for the major lenders not to live up to their responsibilities to small businesses,”said Nick Palin, the FPB’s director of finance.

Kevin Whiting, who runs Sherdon Estate Agents, near Basingstoke, has banked with HSBC for 17 years. However, his application to increase his small mortgage in order to develop the site, which he estimates will bring in an additional £600 each month, was rejected.

“Small businesses like mine are being seriously hit by these economic conditions,” he said. “Over the past eight weeks or so banking issues have compounded an already difficult situation. I suffered bad experiences during the previous recession and, unless the banks free up funding, it will ultimately be the employees of small firms who suffer.”

John Wright, the national chairman of the Federation of Small Businesses, said:“The government must insist more banks apply to the EIB so more small businesses can access the much-needed funds. More than 80 per cent of small businesses use the four major banks, yet only one – Barclays – currently supplies EIB finance. We need to be assured that this money will actually filter down to small businesses.”

The New York Times reports that less than a week before Americans go to the polls to select a president, the government reported on Thursday that the economy contracted from July through September. In a stark indication of widening national distress, consumer spending dipped for the first time in 17 years.

Economists said the drop in economic activity — with the gross domestic product shrinking at a 0.3 percent annual rate — presages more bad news in the months ahead. The impacts of a now-global financial crisis are continuing to squeeze companies and impede investment, causing more layoffs and austerity, while prompting Congress to consider a fresh round of spending aimed at stimulating commerce.

“The economy has taken a turn for the worse, big time,” said Allen Sinai, chief global economist for Decision Economics, a consulting and forecasting group. “Consumption literally caved in. It is a prelude to much worse news on the economy over the next couple of quarters. The fundamentals around the consumer are all negative, and there are no signs of any help anytime soon, from anywhere.”

With the economy the dominant issue in the presidential election, the latest batch of dismal data offered no comfort to the Republican nominee, Senator John McCain of Arizona, who has been running behind the Democratic nominee, Senator Barack Obama of Illinois, in polls.

On Thursday, Mr. Obama seized on the latest evidence of the backsliding economy to warn that Mr. McCain would deliver more of the same.

“Our falling G.D.P. is a direct result of eight years of the trickle-down, Wall Street-first, Main Street-last policies that have driven our economy into a ditch,”Mr. Obama said while campaigning in Florida. “If you want to know where Senator McCain will drive this economy, just look in the rearview mirror. Because, when it comes to our economic policies, John McCain has stood with President Bush every step of the way.”

Mr. McCain’s campaign asserted that Mr. Obama’s efforts to increase taxes on wealthy Americans would deepen economic troubles.

“Obama’s ideologically driven plans to redistribute income will impose higher taxes on families, small businesses and investors,”Mr. McCain’s chief economic adviser, Douglas J. Holtz-Eakin, said in a statement distributed to reporters.

Economic downturns have proved unkind to the incumbent party in elections. Many analysts argue that the recession of 1990 and 1991 cost President George H. W. Bush a chance at re-election in 1992. President Jimmy Carter, a Democrat, lost his 1980 re-election bid to Ronald Reagan after a particularly nasty recession earlier that year. In 1960, in the midst of a recession, John F. Kennedy, a Democrat, defeated Richard M. Nixon, who had been vice president in the Eisenhower administration.

Not since 1900, when William McKinley, a Republican, won re-election, has the incumbent party retained the White House in the midst of a recession or within a few months after one.

In a statement Thursday morning, the White House acknowledged the weakening of the economy, while pinning the blame on a series of unusual events and arguing that the $700 billion bailout of the financial system would soon deliver relief.

“Today’s G.D.P. report is weak, but it is not unexpected,” said a White House spokeswoman, Dana M. Perino.“A number of things contributed to the slowing economy in the third quarter — record high energy prices, housing and credit concerns, two major hurricanes and a prolonged Boeing strike. The president is taking forceful actions to return the economy to growth and job creation by early next year.”

Whoever captures the White House seems certain to inherit a starkly challenging economic picture. The economy began slipping in the last three months of 2007, dipping at a 0.2 percent annual rate. Then it grew modestly for six months, aided by tax rebate checks, but has since succumbed anew to slowdown.

Consumer spending — which makes up more than 70 percent of American economic activity — dipped at a 3.1 percent annual rate between July and September, after growing at a 1.2 percent annual rate in the previous three months.

That was the largest three-month drop since the second quarter of 1980, a contraction that was in some sense artificial: the Carter administration, seeking to suffocate inflation, imposed limits on bank borrowing. Putting that episode aside, this year’s drop represents the sharpest decline in consumer spending since the end of 1974.

Economists saw in the data a testament to the degree to which many households are so strapped that the very culture of American consumption has been altered.

After years of pulling winnings from soaring stock markets, borrowing against the appreciating value of homes and leaning on abundant credit cards, Americans are finding those arteries of finance sharply constricted.

“The American consumer is finally hitting a wall that simply hasn’t been there for 17 years,”said Jared Bernstein, senior economist at the labor-oriented Economic Policy Institute in Washington. “What you see here is just a confluence of negative events closing every avenue that consumers have tapped over the years. There’s only a couple of ways that consumers can finance their spending. It’s labor income or nonlabor income, and both are on the mat.”

The economy has shed 760,000 jobs since the beginning of the year, with layoffs accelerating in recent months. Many companies have cut the hours of workers on the payroll, further diminishing paychecks.

Housing prices have continued to plunge, removing home loans as a channel for finance. Banks still reckoning with disastrous investments on real estate have cut credit even to people with relatively decent histories.

This month, consumer confidence, a broadly watched gauge of American sentiment in use since 1967, plunged to its lowest level on record, attesting to the new psychology of worry and scrimping that now holds sway.

Tucked into the data released Thursday was a worrying sign of a new, potentially pernicious phase of the downturn. Investment by businesses for things like machinery, trucks, computers and software slipped by 1 percent in the third quarter. If past downturns are a guide, that dip could swiftly accelerate, as companies recognize diminishing business opportunities and forgo purchases.

In the last recession, in 2001, this type of outlay, capital spending, slipped at a 14 percent annual rate in the worst quarter.

“When business decides it’s time to cut back, it happens quickly,”Mr. Sinai said. “They say: ‘We’re not hiring, so why do we have to buy equipment if we don’t have additional workers? Why do we have to replace equipment?’ ”

As orders dry up, layoffs accelerate, further diminishing spending power and further reducing business in a downward spiral.

This is the thinking behind forecasts that now broadly assume the unemployment rate could jump from the current 6.1 percent to beyond 8 percent by the middle of next year, a level last seen a quarter-century ago.

This is the image that has many analysts assuming that the next six months will bring more pronounced contraction, as the downturn deepens into the most painful recession since the early 1980s, and perhaps even the 1970s, when the oil shocks assailed the nation.

“We are now entering the harshest part of the recession,” Nigel Gault, chief United States economist for the research group, IHS Global Insight, declared in a note to clients.

One bright spot throughout the downturn has been American exports, which continued to advance in the third quarter, expanding at a 5.9 percent annual rate. But that was down sharply from the 12.3 percent clip seen from April to June.

Most economists think a continued slowdown in exports is inevitable as much of the globe follows the United States into disarray. The financial crisis born in the United States has spread to Asia, Europe, Latin America and the Middle East. Many countries that have been major buyers of American-made goods are now suffering.

“How are you going to export into that world?”asked Barry P. Bosworth, an economist at the Brookings Institution in Washington.

Another continued source of economic growth is government spending, which expanded at a 5.8 percent annual pace in the third quarter. Military spending surged at an 18.1 percent annual rate, and federal spending over all jumped at a 13.8 percent annual clip.

“There’s a message in that,” said Mr. Bernstein, the Economic Policy Institute economist, who has urged Congress to create another package of government spending measures to stimulate the economy. “The one part of the G.D.P. we can reliably count on in these times is government.”

The NYT also reports that as the Treasury Department prepares a $40 billion program to help delinquent homeowners avoid foreclosure, it confronts a difficult challenge: not making the plan too tempting to people like Todd Lawrence.

An airline pilot who lives outside Norwich, Conn., Mr. Lawrence has a traditional 30-year mortgage that he has no trouble paying every month. But, thanks to the plunging real estate market, he owes more on his house than it is worth, like millions of other people.

If the banks, which frequently lent irresponsibly, and many homeowners, who often borrowed irresponsibly, are getting government assistance, Mr. Lawrence says he believes sober souls like himself are also due a break.

“Why am I being punished for having bought a house I could afford?” he asked.“I am beginning to think I would have rocks in my head if I keep paying my mortgage.”

The plan, still under development by Treasury, is part of the economic rescue package passed by Congress earlier this month. It is aimed at aiding up to three million beleaguered homeowners by reducing their monthly payments.

Washington and Wall Street are frantically seeking to stabilize markets by curtailing the onslaught of foreclosures. There are now at least four major plans to aid homeowners. But experts say it is difficult to design these programs in ways that reduce the indebtedness of the distressed without giving everyone else a reason to mail the keys back to their lenders.

“If the lunch truly is free, the demand for free lunches will be large,”said Paul McCulley, a managing director with the investment firm Pimco.

More than 10 million homeowners are underwater like Mr. Lawrence, and their ranks are swelling. In theory, Mr. McCulley points out, underwater homeowners benefit when a neighbor is bailed out instead of surrendering his house to foreclosure. With a foreclosure, the owner becomes the bank, which will care for the house minimally. When the bank finally manages to unload the house months later, the fire-sale price will establish a new floor for the remaining neighbors.

But the benefits of a bailout for his neighbors seem ephemeral to the 45-year-old Mr. Lawrence, especially because he figures the cost of helping them will come, one way or another, out of his pocket as a taxpayer. “I’m basically financing my own financial destruction,” he said.

Government officials say that homeowner bailouts are not a gift. For one thing, they assert, most mortgages will simply be revamped so the monthly payments become affordable for the next few years. Reductions in loan balances, which are drawing the most attention, will generally be a last resort.

“This is not about trying to create fairness,” said Michael H. Krimminger, special adviser for policy at the Federal Deposit Insurance Corporation, which is working with Treasury on the latest plan.“The goal is to keep people in their houses.”

Still, he acknowledged, “a lot of people are angry because they feel some people are getting something they don’t deserve.”

Going into default, whether as a gambit to get a loan modification or to get rid of a burdensome house payment, carries risks. Under some conditions, lenders have the right to sue a borrower for assets beyond the house itself. Then there is the inevitable blot on the borrower’s credit record.

Other factors are intangible: Many owners like their houses and neighborhoods and do not want to leave them. And many people, even as their retirement funds vaporize, consider paying their debts a moral obligation.

Against those considerations must be measured the burden of paying a $500,000 mortgage on a property now worth $350,000.

“From a purely economic standpoint, there’s not a whole lot to be gained from staying,”said Rich Toscano, a San Diego financial adviser whose popular blog, Piggington.com, predicted the collapse.

Homeowners are not the only ones weighing their options. Real estate investors are also wondering if they will be left behind.

“We told our lenders that if you’re writing down 90 percent of your portfolio, we want to be in on it,”said Jason Luker, a principal at Cardinal Group Investments in San Diego. Cardinal owns homes that it rents out.

“If all of our neighbors are getting bailed out despite their own bad decisions, arrogance or ignorance, and we’re asked to keep playing by the rules for the sake of the greater good, I don’t want to participate,”Mr. Luker said.

Peter Schiff, the president of Euro Pacific Capital in Darien, Conn., who prophesied doom before it became fashionable, says he thinks just about everyone who is underwater and has few other assets should stop paying.

“If the government says, ‘Prove that you can’t afford your house and we’ll redo your mortgage,’ then people are going to try to qualify,”Mr. Schiff said.

In that situation, those who will benefit the most are the ones who, unlike Mr. Lawrence, spent far beyond their means — who refinanced their houses and used the cash to buy toys and lavish vacations, or sometimes just to pay the bills.

“You put something down, you have something to lose,” Mr. Schiff said. “You put nothing down, you’ve got nothing to lose.”

Though hard numbers are scarce, estimates are that foreclosures will surpass one million this year. Losses on home loans are piling up faster than banks can deal with them. First Federal Bank of California said this week that as of June 30 it owned 380 foreclosed houses. It managed to sell 329 of them during the third quarter but acquired another 450.

This sense of rapidly losing ground underlies the urgency behind the Treasury’s new plan, which is being developed even as various homeowner bailouts that were announced earlier are just getting under way.

A White House spokeswoman, Dana M. Perino, said on Thursday that the plan was not “imminent” and that several different proposals were being considered.

“If we find one that we think strikes the right notes and could meet all of those standards that we want to protect taxpayers, make sure that it’s also fair and that it would actually have an impact, then we would move forward and we would announce it,” Ms. Perino said.

The Federal Housing Administration began Hope for Homeowners on Oct. 1, aimed at making as many as 400,000 mortgages affordable. Under the program, lenders will refinance loans to 90 percent of a house’s current value, automatically giving the owner 10 percent equity.

The loans will be insured by the government, which will take a share of any gain when the house is sold. If a sale occurs in the first year, the government takes it all. The second year, it takes 90 percent; and so on down a sliding scale. After five years, it takes half the gain.

To guard against fraud, an F.H.A. spokesman said, borrowers will have to certify they did not “intentionally” default.

The Hope Now Alliance, an initiative by a range of lenders, trade groups and counseling agencies, says it has aided 2.3 million borrowers in the last year. Nearly half of Hope Now’s most recent workouts involved modifications of the original loan, including reducing the principal or the interest rate.

Countrywide Financialsays it will help 400,000 of its customers through the Nationwide Homeownership Retention Program, slated to begin in December. Countrywide, an aggressive lender during the boom, is now a division of Bank of America.

The $8.4 billion program arose out of a legal settlement, but a Countrywide spokesman, Rick Simon, said the lender now realized that it was cheaper to keep owners in their homes than to let them go into foreclosure.

But not every owner. The program, aimed at those spending more than a third of their household income on a mortgage, property taxes and insurance, is limited to borrowers with subprime and pay-option adjustable-rate mortgages — the worst of the many exotic loan types that proliferated during the boom.

“Confusion or misrepresentation went into the marketing of these loans,” Mr. Simon said. By contrast, a buyer with a standard 30-year mortgage “probably understood the terms.”

Countrywide says it will write down pay-option mortgages to as low as 95 percent of the current value of the home. The borrowers must either be in default or “reasonably likely” to default.

“I guess they are forcing me to deliberately stop paying to look worse than I am,” said one borrower with a Countrywide pay-option loan. “Crazy, don’t you think?”

The borrower, who lives in suburban Los Angeles, took nearly $200,000 in cash out of his house and then paid less than the monthly interest due on his new loan.

He now owes about $350,000 on a house that is worth only $150,000. He asked not to be identified for fear he would not get a modification, which could reduce his mortgage to $142,500.


© Copyright 2007 by Finfacts.com

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