NEW YORK - Stocks plunged Wednesday as unrest in Greece threatened to further destabilize global financial markets. Major indexes had their biggest drop since June 1.

Investors piled into lower-risk assets like the dollar and U.S. government bonds. Both rose sharply.

If Greece defaults on its debt it could cause investors to dump the bonds of other weak European countries like Portugal, Spain and Ireland, raising borrowing costs for those countries. It could also cause the dollar to further strengthen against the euro, which would hurt U.S. exporters.

June is shaping up to be the worst month for the stock market since May 2010. Stocks have only risen on three days so far this month and have fallen for the other 11. The Dow Jones industrial average and the Standard & Poor's 500 index are now 7.3 percent below their recent highs reached in late April.

"It's sell and ask questions later," said Steven Goldman, chief market strategist at Weeden & Co. in Greenwich, Conn.

A report on manufacturing in the New York area also came in far below forecasts. That reignited fears that factory production, one of the few bright spots in the U.S. economy, may be weaker than many economists had believed.

The Dow Jones industrial average fell 177 points, or 1.5 percent, to 11,899, giving up its 123-point gain from Tuesday. The Dow has only had three days of gains in June.

The Standard & Poor's 500 index fell 22, or 1.7 percent, to 1,266. The Nasdaq composite fell 41, or 1.6 percent, to 2,637.

The technology-heavy Nasdaq index is now down 0.6 percent for the year. The S&P 500 is up less than 1 percent, while the Dow is up about 3 percent.

The euro slid more than 1 percent against the dollar as the worsening Greek debt crisis undermined confidence in Europe's shared currency. U.S. government bond prices climbed as investors sought out safer assets.

Thousands of people gathered on the streets of Athens to protest government cutbacks required to avoid a default on the government's debt. Demonstrators hurled rocks at riot police, who responded with tear gas. Greece's prime minister said he would reshuffle his Cabinet and seek a vote of confidence after coalition talks with opposition parties failed.

In the latest sign of how Greece's problems could affect other countries, credit ratings agency Moody's said it may downgrade its ratings of France's three largest banks because of their exposure to Greek debt.

Worries about Greece have contributed to a drop in U.S. stocks since late April. If Greece defaults on its debt, it would cause borrowing costs for other debt-ridden European countries like Spain and Portugal to soar as investors shun their debt. That could slow economic growth across the continent and throughout the rest of the world.

A Greek default would further weaken the euro and that could also put pressure on U.S. companies that do much of their business overseas. U.S. corporations have benefited from a weak dollar, which has made their exports more competitive in global markets.

Greece's fiscal problems appeared to be solved a year ago with a package of emergency loans, but it became clear this spring that the country would need more help from its European neighbors to avoid a default. On Monday, Standard & Poor's slashed Greece's creditworthiness to the bottom of the 131 countries that have ratings.

The yield on the 10-year Treasury note, which moves opposite its price, fell to 2.97 percent from 3.10 percent late Tuesday. That signaled a greater demand for low-risk investments. The euro weakened to $1.42 against the dollar from $1.44 late Tuesday, the weakest level for the European currency since May 30.

Oil fell to $95.36 a barrel from $99.37 Tuesday. Oil and other commodities are priced in dollars. So a stronger dollar makes them more expensive for buyers who use other currencies. The drop in oil prices pushed energy stocks down even more than the overall market. Energy stocks fell 2.4 percent, the most of the 10 company groups that make up the S&P 500.

The June Empire State Manufacturing Survey came in well below forecasts. The survey from the New York Federal Reserve found that conditions for New York manufacturers are weakening and new orders are falling. A measure of optimism among factory owners in the state fell to its lowest level since early 2009.

Analysts said investors should expect stock trading to be volatile as uncertainty about the economy persists. The housing market remains weak and the jobs market is sluggish. Questions loom about whether lawmakers will support raising the nation's borrowing limit by an Aug. 2 deadline. The Federal Reserve's $600 billion bond-buying program is also winding down at the end of June. The program was designed to keep interest rates low to encourage borrowing.

"The markets are nervous, investors are nervous, and so we expect volatility," said Oliver Pursche, president of Gary Goldberg Financial Services.

The Dow is down 5 percent this month, while the S&P and Nasdaq are both down 6 percent.

Pandora Media Inc. jumped 14 percent to $20.21 on its first day of trading. The Internet radio company priced its initial public offering at $16 a share, the high end of its range, reflecting hot demand for online companies. Professional networking site LinkedIn soared on its first day of trading last month, but has since fallen 19 percent.

Owens-Illinois Inc. fell 11 percent after the glass container company cut its second-quarter earnings outlook because it is facing higher manufacturing and delivery costs.

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PARIS - Tremors from Greece's debt crisis were felt in France when Moody's ratings agency said it may downgrade the three largest French banks over their potential losses on Greek bonds and banking operations.

BNP Paribas SA and Credit Agricole SA face one-notch downgrades and Societe Generale SA could see a two-notch decline, Moody's said Wednesday.

The risks come from the banks' holdings of government bonds that would turn to losses if Greece can't pay its debts in full, and through their local banking subsidiaries in Greece's troubled economy, Moody's said.

The move followed Moody's decision earlier this month to cut Greece's own rating by three notches from a B1 rating to Caa1 with a negative outlook, citing increased risk that the financially stricken country will be unable to handle its debt problems without an eventual restructuring.

Restructuring means paying creditors less than the full amount, or later than originally planned.

Greece got a euro110 billion ($160 billion) bailout last year from the eurozone countries and the International Monetary Fund, but continues to struggle financially and more bailout loans are under discussion.

European finance ministers failed to find agreement on new aid at a meeting Tuesday, with talks hung up over a standoff between Germany and the European Central Bank over whether to make bondholders share in the burden of helping Greece as a condition of more bailout loans.

Germany, the eurozone's biggest country and the largest funder of Greece's bailout, has pushed to make bondholders contribute by getting new bonds that mature later. Another proposal floated has been to ask banks to voluntarily roll over their holdings.

The ECB has vigorously opposed any change in debt terms that leads to a ruling of default by the ratings agencies, and has warned of that the costs to Greek banks could simply offset any money saved by changing bond repayments. German and French banks also hold the bonds.

Societe Generale CEO Frederic Oudea has said a possible Greek debt restructuring "would be unpleasant but manageable" for the bank. A spokeswoman for the bank declined to comment further Wednesday. Spokespeople for BNP Paribas and Credit Agricole didn't immediately return calls for comment.

A government spokesman downplayed the possibility of a downgrade.

"We're not worried," said Francois Baroin after the weekly cabinet meeting. "You know, French banks are among the most highly rated large international banks today, the strongest, they've stood up to all the international tests."

Shareholders took a more cautious view, selling off the banks' shares to the tune of 1.6 percent for BNP Paribas, 1.4 percent for Credit Agricole, and 2 percent for Societe Generale.

Credit Agricole has only a "modest" exposure to Greek government debt, Moody's said, but it owns Athens-based bank Emporiki, which Moody's had already downgraded earlier this month.

Societe Generale also owns a small Greek bank, Geniki, but the main risk comes from its holdings of Greek government debt, reported to be euro2.5 billion at the end of the first quarter, Moody's said.

BNP Paribas's holdings of Greek government debt are twice that, euro5 billion, but unlike the others it has no local subsidiary.

The impact could spread beyond France, Moody's warned. "Moody's may take similar actions on other banks with direct exposures to Greece in the coming weeks," it said. It is also "closely monitoring" the risks of a Greek default scenario, including the impact on weaker countries, capital markets, and funding conditions. "Banks across the euro zone" are potentially vulnerable, Moody's said.

The ECB's vice president, Victor Constancio, reiterated at a news conference the bank's opposition to any restructuring that costs creditors money or which leads to a default label being slapped on Greece.

Constancio refused to be drawn out on whether the bank would approve of asking banks to renew Greek debt holdings as they expire, on a supposedly voluntary basis. The ECB is not the one proposing bondholder sacrifices, he said, "so it's not really for us to provide solutions to an issue that wasn't raised by us."

The ECB warned Wednesday that the eurozone's financial system faced "extremely challenging" conditions, with the worst risk being the connection between shaky government finances and the banking system.

Troubles in government and bank finances are intertwined because a defaulting government would hit banks holdings of its bonds, while banks that suffer heaving losses could need taxpayer-paid recapitalization.

"The main risk to euro area financial stability remains the interplay between the vulnerabilities of public finances and the finacial sector with their potential for adverse contagion effects," the ECB said in its report.

Still, the ECB said in its regular assessment of the financial system's stability that Europe's 20 largest crossborder banks were in better shape than they were six months ago thanks to stronger earnings.

The European Union is in the process of subjecting banks to "stress tests," or scenarios involving more economic and financial trouble, to assess whether they need to be pushed to strengthen their finances. Results are expected in June.

---

McHugh contributed from Frankfurt. Greg Keller can be reached at http://twitter.com/Greg-Keller

LONDON - Escalating political turmoil in near-bankrupt Greece intensified concerns Wednesday that the Mediterranean nation may be spiraling toward a calamitous default with investors, potentially igniting a new phase in Europe's debt crisis.

Global markets shuddered as embattled Greek Prime Minister George Papandreou launched a risky gambit to push his Parliament to pass another round of austerity measures. Failure to pass the cuts could lead the European Union and International Monetary Fund to withhold bailout money, leaving Greece short of cash to pay its creditors as early as next month - an event that some economists warn could destabilize the global financial system.

After thousands of protesters clashed with police as Parliament debated the measures in Athens, Papandreou tried and failed to forge a coalition government to ensure the package's approval. In a late-night speech to the nation, he then said he would reshuffle his cabinet and call for a vote of confidence this weekend, wagering his job in an attempt to strong-arm politicians into passing the hugely unpopular package next week.

The spectacle spooked investors; in the United States, the Dow Jones industrial average fell 1.5 percent, almost 179 points, to 11,897.27. Markets around Europe dropped by a similar amount Wednesday.

The political drama in Greece is playing out against deepening fears that the Mediterranean country poses a broader risk to the economic recovery underway in Europe and the United States. Some experts have compared a Greek default to the collapse of Lehman Brothers in September 2008, suggesting it could touch off a run of bank failures that could ripple across the globe.

The high stakes could yet force the Europeans to continue aiding Greece, and pressure mounted on E.U. leaders to end weeks of infighting over how and whether to continue propping Athens up.

The European Central Bank on Wednesday said that risks associated with high levels of government debt were now Europe's "most pressing concern" and that the year-long effort to quell the crisis was "fraught with some detrimental shortcomings." Though European officials have tried to contain the crisis by throwing bailouts to three small, troubled nations - Greece, Ireland and Portugal - investors are worried that far larger, heavily indebted nations such as Spain and Italy could be next. The sheer size of their economies could challenge the ability of the E.U. and IMF to bail them out.

Some rating agencies are now putting the risk of a Greek default as high as 50 percent. The effects could cascade through the global financial system, particularly in Europe, where major banks hold massive portfolios of government bonds from Greece as well as other financially troubled nations in the region. Emphasizing that point, Moody's Investor Services on Tuesday said it may downgrade the credit rating of several major French banks because of their holdings of Greek government bonds and other investments in the Greek economy.

A Greek default could affect other governments as well, undermining confidence throughout the 17-nation euro zone and driving up the borrowing costs of countries across the region. U.S. banks generally have limited exposure to Greek debt but could be affected by problems in Europe's banking system.

To forestall that, European and IMF officials have been in talks for weeks over a new aid package for Greece, which was provided with a $160 billion, three-year bailout last year that has proved inadequate. Growth has been less than expected, tax receipts have run behind schedule and government-promised changes have been slow to produce results.

Those talks, however, have produced as much discord as agreement. Along with forcing Greece to make further concessions - and triggering the political crisis - there has been a standoff between the European Central Bank and a group of European nations, most notably Germany, that say they will not lend Greece more money unless private investors contribute to the country's rescue. The German finance minister has suggested that Greek bondholders extend the term of their investment by seven years, giving the country more time to invigorate its economy.

The political turmoil in Athens, however, has raised the prospect that the crisis in Greece could escalate fast.

"A political situation like this is the last thing you need when you're already on the edge of a cliff," said Ioannis Sokos, market analyst at BNP Paribas in London.

Though Papandreou - a U.S.-educated champion of efforts to rekindle economic growth - maintains a narrow majority in Parliament, some of his Socialist Party members have recently turned against his austerity drive. If he cannot bring them in line to support him in the confidence vote this weekend, his government may fall.

"He is going to win this," said a Greek government official who was not authorized to comment publicly and spoke on the condition of anonymity. "Of course there is always a risk, but he is doing this for the country. He will pull through."

Papandreou told the nation Wednesday that he was taking such drastic steps because the conservative opposition had rejected his offer to forge a new coalition government - an offer in which he said he would resign if his opponents agreed to vote for the austerity measures. The conservative opposition, however, has argued that the plan backed by the IMF and E.U. - particularly the raising of taxes - has succeeded only in driving the country further into recession, and instead it demanded a renegotiation of the bailout terms.

"I have learned in my life to fight for the country, for the economy, for the people," Papandreou told the nation.

The IMF has said that disbursement of the next tranche of bailout funds - a little more than $3 billion from the IMF and nearly $9 billion from other European countries - is contingent on the Greek Parliament approving the new concessions.

Yet analysts said European officials, whose nations stand to lose the most in a Greek collapse, may ultimately prove more forgiving, perhaps finding a way to provide Greece with bridge funds if it is unable to pass the measures.

"European leaders want to stop this from spreading. Spain in particular is still very vulnerable," Sokos said. "Even in a worst-case scenario, if the reforms don't pass, that could push Europe to at least give enough money to keep Greece alive."

faiolaa@washpost.com

schneiderh@washpost.com

Schneider reported from Washington.

Exactly one month ago, the Treasury Department began issuing IOUs rather than bonds to some government pension funds. That allowed for continued auctions of so-called risk-free Treasury bonds until Aug. 2.

Unless Congress acts by then, the world's richest nation unable to borrow $4 billion a day to pay its bills would risk default.

Or would it?

To hear Treasury Secretary Timothy Geithner tell it, interest rates would spike, stock and home values would sink, savings and investment would dry up, jobs would disappear, businesses would fail, and everything from tax refunds to troops' salaries would go unpaid.

Federal Reserve Chairman Ben Bernanke says it would lead to "severe disruptions" in financial markets, lower credit ratings and damage to the dollar and Treasury securities.

The centrist Democratic think tank Third Way claims the gyrations in labor, financial and stock markets would cost 642,500 jobs, add $19,175 to every mortgage in process and lop $8,816 from the typical 401(k) account.

Others say the doomsday scenarios are hogwash.

Sen. Pat Toomey, R-Pa., says it would take a simple law laying out who gets paid first when the government no longer can borrow 41 cents of each dollar it spends. As long as bondholders collect interest on time, he says, there would be no default just "sudden, drastic spending cuts" such as furloughing federal workers or delaying welfare payments.

Virtually no one expects this to happen. But to date, the White House and Congress haven't found a way to avoid it.

During the past six months, Washington has faced partisan showdowns over tax cuts, then spending cuts.

Now comes the need to increase the government's $14.3 trillion debt limit the amount of money it can owe creditors ranging from China to the Social Security Trust Fund. The ceiling was reached May 16, and only action by a reluctant Congress can raise it.

The federal government relies on borrowed money like a fish needs water. Threaten to take it away, and you risk a global crisis with economic, political, diplomatic and even moral implications.

What happens if America can't pay its bills?

"Nobody knows what would happen, but why in the world would you want to try to find out?" says David Walker, the former U.S. comptroller general now heading the fiscal watchdog group Comeback America Initiative.

"At least we experimented with nuclear bombs before we dropped one."

In the past half-century, Congress has acted 78 times to raise, extend or revise the debt limit the amount of money the government can borrow to repay bond holders. The red ink has risen 49 times under Republican presidents, 29 times under Democrats. It's gone up 10 times since 2001.

Lawmakers often find ways to make the vote less damaging politically. Since 1980, the House has "deemed" a higher debt limit 15 times when passing a budget resolution, without spelling it out in the legislation.

In 1985, Congress attached a system of automatic spending cuts that would apply when the deficit exceeded annual targets. It lessened the blow for skittish lawmakers, only to be cast aside when the cuts proved too stringent.

This time is different.

The House must take a stand because of a change in its rules. And not since the postwar years after World War II has the debt been so damaging nearly the size of the entire $15 trillion economy. That has Republicans calling for spending cuts at least equal in size to any increase in the debt limit.

Says former Democratic congressman John Tanner of Tennessee: "The debt ceiling issue is a live-fire exercise."

Both parties share the blame

How did we get $14,300,000,000,000 into debt?

For three decades after World War II, the nation's debt grew only incrementally, fueled mostly by interest costs. In 1981, the debt was still less than $1 trillion, and just one-third the size of the economy manageable by any standard.

The Obama administration has taken to citing Ronald Reagan's promotion of debt ceiling increases as proof that it's not just a Democrat's desire. Indeed, it was Reagan's defense buildup and tax cuts, along with a major recession, that helped triple the debt on his watch, to nearly $3 trillion half the size of the economy at that time.

George H.W. Bush oversaw an increase to more than $4 trillion, nearly two-thirds the size of the flagging economy then. From a deficit-fighting standpoint, even that was a victory, fueled by Bush's reluctant agreement to raise taxes in 1990 a decision that helped make him a one-term president.

Four years of economic boom at the end of Bill Clinton's administration produced historic budget surpluses and reduced the debt as a percentage of the economy to 56%. But the accumulated interest costs still caused the debt to rise to $5.7 trillion.

From there, it took off.

George W. Bush's tax cuts, wars in Afghanistan and Iraq, and expansion of Medicare to include prescription drugs were deficit-financed, sending the debt past $10 trillion.

The recession and Obama's economic stimulus package in 2009 sent it higher still. And in December, Obama agreed to extend the Bush tax cuts through 2012.

Today the debt isn't just a problem because of its size. Nearly half of the $9.7 trillion "public" debt as opposed to the $4.6 trillion held by the Social Security trust fund and other government accounts is owned by foreign investors. Nearly half of that $4.5 trillion can be traced to two countries, China and Japan.

Perhaps the biggest problem is the burden of the debt itself: $225 billion in interest costs, projected to grow to nearly $800 billion in 10 years. That money doesn't buy a thing.

Because of those rising interest costs and a growing, aging population, even the deficit-reduction plans floated by Republicans, the White House and various outside groups wouldn't stop the debt from growing.

The most draconian House Republicans' plan to slash $4.4 trillion from the deficit in the next decade, then transform Medicare into a voucher-like program projects a $16.2 trillion debt next year. By 2021, even with all the cuts, it would be $23 trillion.

"This problem," says Sen. Mark Warner, D-Va., a leader of a bipartisan Senate effort to control the debt, "just gets exponentially worse."

Republicans are in the driver's seat

For now, the nation's ability to borrow money is the big problem.

The Treasury Department makes about 1 billion payments a year, 80 million a month. Without borrowing authority, some payments couldn't be made.

Obama and Senate Democratic leader Harry Reid control two-thirds of the negotiations, but Republican House Speaker John Boehner is in the driver's seat.

He's demanding that federal spending be trimmed by more than the debt ceiling is raised perhaps $2 trillion or more, if the ceiling is to be raised enough to get past the 2012 elections.

Republicans are insisting that entitlement programs such as Medicare and Medicaid be included in the cuts, but that tax increases be left out.

Obama wants to target tax breaks enjoyed by oil companies and others, and he's pushing for a "debt cap" aimed at locking in the savings over five years by forcing automatic reductions if needed.

House Majority Leader Eric Cantor, R-Va., says more than $1 trillion in spending cuts already has been identified by GOP and Democratic negotiators meeting regularly with Vice President Biden. Some of the proposals cited by both sides include reducing farm subsidies, overhauling the federal pension system and capping non-security spending for several years.

As Aug. 2 nears, it becomes less likely that a deal to raise the debt limit can get through Congress in time. That means a short-term extension would be needed to avoid default.

The deadlocked debate has spooked financial markets and all three major financial ratings agencies. Pimco, the world's largest bond investor, unloaded its U.S. government debt in March.

"It's a very dangerous game of roulette that we're playing right now," says Neel Kashkari, Pimco's managing director.

Standard & Poor's put the government on notice in April that its triple-A rating was in jeopardy. Moody's Investors Service warned this month of a similar downgrade. Fitch Ratings says Treasury bonds could be rated as "junk" by August.

Among the world's nearly 20 AAA-rated nations, "the U.S. really is the only one that has not yet adopted a serious plan to reverse the upward path of the debt," says Steven Hess, senior credit officer at Moody's.

Default clocks and payment plans

That failure has at least some lawmakers preparing for default something Congressional Budget Office director Douglas Elmendorf calls "a dangerous gamble."

One school of thought: It would never happen. The Treasury Department would find some way to extend the clock. Geithner's Aug. 2 deadline isn't real.

Geithner counters that as soon as the nation failed to pay any of its bills on time from salaries and contracts to tax refunds "the world would recognize it as a first-ever failure by the United States to meet its commitments."

As the deadline gets closer, raising the specter of 'default clocks' on cable television for all the world to see, some lawmakers have introduced legislation that would determine who gets paid and who doesn't.

Toomey has proposed that principal and interest owed to bond holders take priority. Sen. David Vitter, R-La., wants Social Security benefits given the same priority. Rep. Marlin Stutzman, R-Ind., would add military spending to the mix.

What actually would happen in the event Congress doesn't raise the debt limit is unclear.

Would federal workers be laid off, and would they be rehired and paid later? Would Social Security benefits be delayed? Would federal "prompt payment" rules require the government to pay interest on late payments?

The whole mess could be avoided if Democrats and Republicans agree to work together something Senate GOP leader Mitch McConnell says would prevent either side from gaining political advantage.

"We can do something important for the country together, and this is the opportunity," he says. "That is the importance of this debt ceiling moment."

(c) Copyright 2011 USA TODAY, a division of Gannett Co. Inc.

GLOBAL FINANCE before the crisis which began in 2007 was like the Titanic, according to the most-cited academic economist in the world.

Speaking at a conference in Trinity College Dublin, Andrei Shleifer, professor of economics at Harvard University, said that just as those who designed the ill-fated ship believed it to be the safest afloat, those at the helm of large financial institutions believed the wider system was sound. He said they did not understand its weaknesses and the risks they were running.

This ignorance was the most likely explanation for the financial crisis, he said. In support, Dr Shleifer cited the internal reports of some large investment banks which he believes strongly suggest they hugely underestimated the riskiness of their businesses as late as 2008. He went on to reject moral-hazard-based explanations of the financial crisis.

Among the most frequently articulated explanations of the crisis is that those who ran financial institutions "too big to fail" took excessively risky bets on financial markets. This was in the knowledge that they would profit if the bets paid off but that government would step in to bail them out if their losses proved too large.

In the US those who ran these institutions will spend the next decade in consultation with their lawyers, he said. He did not believe they knew they were running such a risk before 2007.

He also rejected arguments based on the crisis being an aberration and thus impossible to predict. Although the crisis may be bigger than previous crises in recent decades, he said, it was not sufficiently different to support the freak-event thesis.

Dr Shleifer, who coined the phrase "zombie banks", described credit ratings agencies as "idiots".

He was giving a keynote address at the ninth annual Infiniti conference on international finance. With 250 delegates from 42 countries, it is the largest such conference in Europe according to the conference chair, TCD's Prof Brian Lucey.

It is understood Dr Shleifer held a number of meetings with politicians and policymakers during his visit, including the governor of the Central Bank, Patrick Honohan.

Originally published by DAN O'BRIEN.

(c) 2011 Irish Times. Provided by ProQuest LLC. All rights Reserved.

LONDON - The British government intends to force banks to insulate their retail operations from their more volatile investment banking, a Treasury source confirmed Wednesday.
The policy is intended to help prevent a repeat of the financial crisis of 2008 and resolve the problem of banks which become too big to be allowed to fail.
Treasury chief George Osborne will announce the decision Wednesday evening in a speech to financial executives, the source said on condition of anonymity.
Shares in Britain's big banks fell Wednesday, with Barclays down 1.8 percent, while bailed-out Royal Bank of Scotland and Lloyds Banking Group fell 1.4 percent and 0.7 percent, respectively. HSBC was also down 0.7 percent.
The Independent Commission on Banking, chaired by Sir John Vickers, a former chief economist of the Bank of England, has recommended a clear separation of retail and investment banking; details of the commission's proposal are expected in a final report on Sept. 12. In it, the panel is expected to recommend how retail operations are separated into a distinct subsidiary within a larger banking group.
In his interim report in April, Vickers said that "ring-fencing" retail banking would make it easier and less costly to sort out a crisis. This would allow retail operations including current accounts, consumer loans and mortgages to continue, while the investment side could be allowed to fail.
Vickers said the split, along with higher capital requirements on the retail side, "could curtail taxpayer exposure and thereby sharpen commercial disciplines on risk taking."
Not everyone is so keen about the proposals.
Stephen Hester, chief executive of Royal Bank of Scotland, recently told a parliamentary committee that ring-fending could backfire by creating "a protected beast that the government would support," inadvertently encouraging excessive risk-taking on the retail side.
Hester added that the removal of implicit government support would also make other parts of the bank more exposed.
RBS and Barclays favor a limited ring-fencing which only covers retail deposits, while HSBC Chairman Douglas Flint recommended that the retail side should include some corporate deposits and loans.
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Earlier in the day, Treasurys rose after Standard & Poor's warned that it was becoming more likely that Greece would default on its debt.

The rating agency cut Greece's credit rating to CCC on Monday. S&P said the risk of Greece defaulting on its debts within the next year has "increased significantly." The rating agency doubts that Greece will be able to access bond markets to finance its budgets in 2012.

The news helped briefly lift prices for Treasurys, which are used as a refuge by many global investors.

Bond prices fell later in the day. Treasury prices have been rising over the past two months on fears that Europe's debt crisis could spread and on signs that the U.S. economy was slowing down. Those worries pushed bond yields to 2011 lows last week.

Many bond traders expect the trend to reverse and for bond yields to rise in the coming months.

The price of the 10-year Treasury note slipped 9.3 cents for every $100 invested. The dip in price pushed the yield to 2.99 percent on Monday, down from 2.97 percent late Friday. When bond prices fall their yields rise.

The 10-year yield touched 2.94 percent last week, its low for the year.

In other trading, the 30-year bond dropped 34.3 cents, while its yield rose to 4.20 percent from 4.18 percent. The yield on the two-year note was unchanged at 0.40 percent.

The three-month Treasury bill paid a 0.03 percent yield at a discount of 0.04 percent.

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An often-ignored corner of the municipal bond market is causing outsize troubles for investors.

A spate of municipal bond defaults in recent months has included a $43-million issue that went to pay for a Hampton Inn in Boston and $15 million in bonds that funded a commercial cargo facility at an Alaska airport.

These are not traditional municipal bonds used to finance sewers and schools. These debts are a form of financing known as conduit bonds. Conduits allow private entities to tap into low-cost municipal bond financing for projects that boost economic development. State or local governments are paid fees to issue the bonds on behalf of companies or nonprofits, which are responsible for repaying investors.

Conduits have grown roughly three times faster than the general municipal market over the last five years, according to data from Thomson Reuters, a New York data firm; $84 billion of these bonds were issued last year alone.

Investors don't have to pay taxes on the interest from municipal bonds, enabling companies such as the Boston hotel developer to borrow money at lower interest rates than they could get on their own. Borrowers also don't have to provide as much financial disclosure as they would if they went through the taxable corporate bond market.

And for cities and states, they get to encourage economic development, earn fees for their service and incur little risk if the bonds default.

But as the market has grown -- and a wider variety of private companies have gotten access to tax-free financing -- these bonds have begun attracting scrutiny.

Although conduits account for roughly 20% of all municipal bonds, they have been responsible for about 70% of all defaults in the municipal bond market in recent years, according to Income Securities Advisors, a Florida research firm. Over the last two years, the five municipal bond issuers with the most troubled bonds have all been conduit bond issuers, according to Municipal Market Advisors, a Concord, Mass., research firm.

"It's the conduit bonds that are really at the root of the default problem," said Richard Lehmann, the founder and president of Income Securities Advisors Inc. Lehmann's firm estimates that $35.7 billion worth of conduit bonds have defaulted since 1980, and many of those have returned little to investors.

The bonds have also been costly for the federal government, which is expected to lose out on about $10 billion in tax revenue this year because of the exemption, according to White House statistics. Beneficiaries of this low-cost financing have included United Airlines and General Motors Co., companies that could easily borrow in the corporate bond market.

"A lot of these are corporate bonds disguised as municipal bonds," said Michael Lissack, a former municipal investment banker at Smith Barney who is now a critic of the industry. "How is this a good use of our tax expenditures? I would prefer to use that money seeing that kids get vaccinated or learn to read."

These defaults are also having a ripple effect on the broader municipal market, which has been under siege after financial analyst Meredith Whitney predicted hundreds of defaults on muni bonds. That statement led to a broad sell-off in the muni market.

Frank Hoadley, who is in charge of selling traditional municipal bonds for the state of Wisconsin, said that the riskiness of conduit bonds has driven up borrowing costs for cities and states. He said Wisconsin paid $4 million more in annual interest than it would otherwise have had to on new bonds issued in January because of investor fears about the municipal market.

"Government issuers like Wisconsin are swept up in the smear that is tarnishing the whole municipal market because of conduit borrower problems," said Hoadley, Wisconsin's capital finance director.

Although average investors might not understand the difference between conduits and traditional municipal bonds, the difference is quite marked. Conventional munis make interest payments from dedicated streams of revenue such as taxes, fees and tolls. In contrast, conduit bonds are generally only as good as the projects they fund. When the hotel in Boston goes under, so does the bond.

Not all conduit bonds are risky. Some public issuers force corporate or nonprofit borrowers to pass rigorous credit tests. Some of the largest state-run issuers, such as the California Health Facilities Financing Authority, have seen few of their conduit bonds default.

But a series of recent defaults in conduits, particularly those issued for low-income housing, healthcare facilities and industrial development projects, has caught the attention of regulators.

"The market which used to be mom and apple pie now doesn't look like mom and apple pie anymore when you get further and further away from a traditional public purpose," said Lynnette Kelly Hotchkiss, the executive director of the Municipal Securities Rulemaking Board, the congressionally appointed regulator for the municipal bond industry. "That has the potential to ruin it for everybody."

Hotchkiss is not the only regulator taking a closer look at the market.

On Wednesday, the Internal Revenue Service, which defines what projects can qualify for conduit financing, is set to release a report from its independent advisory panel. The report will discuss how little attention has been given to oversight of conduit bond issuers.

"There's never been a considered examination of what these entities are actually supposed to be doing," said Michael Bailey, a Chicago tax lawyer on the IRS committee.

The Securities and Exchange Commission is considering whether conduit borrowers should be required to provide more information to investors.

Conduits, or private activity bonds, have been around in various forms for decades. Still, most aren't graded by credit rating companies, and even basic data, such as information on defaults, are hard to come by.

Local governments are supposed to provide oversight, but they apply widely differing standards on what projects qualify for conduit financing. Moreover, because governments aren't financially liable for the bonds, they have an incentive to issue conduits to earn fee income, regardless of the risk to investors.

A state agency, the California Statewide Communities Development Authority, has become one of the largest issuers of municipal bonds in the country. It also has had more bonds encounter credit trouble since 2009 than all but one other municipal bond issuer, according to Municipal Market Advisors.

The development authority is a public agency run by a for-profit company, HB Capital Resources, which receives money for each bond the agency issues.

Another California issuer, the California Municipal Finance Authority, is set up on a similar business model and has grown quickly since 2004. State Assemblyman Mike Feuer (D-Los Angeles) called on the Legislature to audit both agencies last month.

The development authority's founder, Stephen Hamill, said last month that his organization's credit standards were similar to those of its competitors, and that his agency has been successful because it has helped encourage economic growth.

In Texas, a conduit bond agency run by Tarrant County -- the home of Fort Worth -- has specialized in risky housing and hospital bonds and was responsible for almost 10% of all defaults on investment-grade municipal bonds from 1970 to 2009, according to a recent study by Moody's Investors Service.

Hotchkiss at the Municipal Securities Rulemaking Board said the aggressiveness of some issuers "could possibly impugn the integrity of the whole market."

--

nathaniel.popper@latimes.com

Barclays and JP Morgan banks are leading a counter-attack against political banker-bashing. Sean Farrell and Stephen Foley report

LAST week saw the latest installment of the banks' fightback on both sides of the Atlantic. In the UK, Bob Diamond put on a defiant show at the Treasury Select Committee.

There was no implicit taxpayer subsidy of investment banking and ring-fencing retail banking was not a good idea, Barclays chief executive told MPs.

Mr Diamond said any state backing was "an implied government guarantee" and that ring-fencing of retail deposits "wouldn't be my first choice... or best alternative, but there is a way to make it work".

In doing so, he rejected arguments of the Independent Commission on Banking (ICB), which is due to submit a final report in September.

Meanwhile in the US, Jamie Dimon, the chief executive of JPMorgan Chase, took the extraordinary step of challenging the chairman of the Federal Reserve in public over the effects of regulation on banks lending.

"I have a great fear someone's going to try to write a book in 20 years and the book is going to talk about all the things we did in the middle of the crisis to actually slow down recovery," Mr Dimon told Ben Bernanke at a conference in Atlanta.

Mr Diamond and Mr Dimon have been the most forceful bankers in resisting efforts to rein the banks in. Neither Barclays nor JPMorgan took direct government investment to bail them out in the crisis and this appears to have emboldened them to tell politicians once again how the world works.

In the UK, the turning point appears to have come in the second half of last year.

Under its then-chief executive, John Varley, Barclays launched Project Merlin -- a lobbying effort to draw a line under political bank-bashing in return for concessions on pay and lending to support the economy.

As talks on Merlin progressed in January, Mr Diamond, by now in charge at Barclays, delivered his famous remarks to the Treasury Committee.

"I think they [government ministers] recognise that there was a period of remorse and apology for banks. I think that period needs to be over; we need our banks willing to take risks, confident, and working with the private sector in the UK so that we can create jobs and we can improve the economic growth."

So there you had it. Banks had taken their medicine but it was time to get off their backs and let them get on it. If not, the economy would suffer from lack of credit.

At about the same time, Mr Dimon had had enough, too. At Davos, he launched a scalding attack on politicians, the media and ordinary people who have been bashing bankers ever since the credit crisis.

"I don't lump all media together," he said. "There's good and there's bad. There's irresponsible and ignorant and there's really smart media. Well, not all bankers are the same. I just think this constant refrain "bankers, bankers, bankers" -- it's just a really unproductive and unfair way of treating people."

Like Mr Diamond, he has argued that all bankers have been tarred unfairly, that giant banks such as his eased the credit crisis, and that regulations imposed on the industry since then unjustifiably crimp banks' profits and ability to lend.

His vociferousness has emboldened others. In Washington, the lobbying capital of the world, the banks have pushed hard for exemptions to rules tightening trading of derivatives contracts and others that force them to hold on to some of the securities created from their loans to keep lending standards high.

Now, lobbyists are arguing against a key plank of the post- crisis consensus, namely that systemically important banks should be forced to hold proportionally more capital than smaller banks, whose demise would have less of an impact.

Sheila Bair, chairman of the Federal Deposit Insurance Corporation, was so concerned about the push-back that she warned of "amnesia" setting in about the credit crisis.

The arguments of Mr Diamond and Mr Varley illustrate the apparent dilemma for politicians and their regulators. The banks may have been to blame for the crisis but if tough constraints are imposed, they cannot lend to businesses to get the economy going.

I have a great fear someone's going to write a book about all the things we did in the middle of the crisis

CAPTION: JPMorgan's Jamie Dimon wants banks to be allowed to work

(c) 2011 Belfast Telegraph. Provided by ProQuest LLC. All rights Reserved.

The International Monetary Fund put its weight behind the Bank of England's stance on interest rates last week in a report that broadly endorsed the UK's economic policy.

In its report the IMF concluded that the high level of inflation is largely driven by transitory factors, which will drop out towards the end of 2012.

It says there is therefore no need to adjust the government's economic policies or increase interest rates at the present time.

The report predicts inflation will remain above 4% for most of 2011, then fall back to its 2% target at the end of next year.

The IMF says that if economic growth resumes as expected in the coming quarters, the case for hiking rates would increase but any rise should be gradual.

The Bank's Monetary Policy Committee again voted to keep the base rate on hold at 0.5% last week.

Interest rates have been at 0.5% since March 2009.

Fahim Antoniades, group director of the Mortgage Centre IFA, agrees there is no need to raise interest rates at the moment.

He says: "Economic growth remains sluggish and we will need to see stronger evidence of economic recovery before rates can rise.

"But it is good to get independent verification from an organisation like the IMF that the UK is taking the right action on the economy."

The IMF also backs the Financial Services Authority's stringent capital and liquidity requirements for lenders, stating this is necessary for financial stability.

But while it praises the banks for strengthening their capital positions over the past year, the report points out that forbearance may have hidden lenders' true exposure to risk.

It says: "Stress tests for major banks reveal adequate levels of capitalisation under severe macroeconomic scenarios - with the caveat that lender forbearance may, in some cases, have masked the extent of risks, given the high indebtedness of the household and commercial real estate sectors."

Copyright: Centaur Communications Ltd. and licensors

June 11--Growing opposition to a rule that would require lenders to assume some of the risk of loans packaged for the secondary market has caused regulators to extend the comment period about 60 days.

The Friday deadline was extended "to allow interested persons more time to analyze the issues and prepare their comments," the Federal Reserve announced this week.

The proposed rule, part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, generally would require sponsors of asset-backed securities to retain at least 5 percent of the credit risk of the assets underlying the securities. Sponsors would not be allowed to transfer or hedge that risk, according to federal regulators.

The proposal would define "qualified residential mortgages," a class of loans that would be exempt from the risk-retention requirement. Criteria for those loans would include borrowers' credit histories, payment terms, and loan-to-value ratios "designed to ensure they are of very high credit quality."

Housing and consumer groups, however, contend that the rule would require most buyers to put down a minimum of 20 percent to have their loans considered "qualified residential mortgages," eligible for the lowest competitive rates.

What that means, National Urban League president Marc Morial said, is that prospective borrowers would need to present 20 percent down payments, spend less than 28 percent of monthly gross income on housing, and have monthly household debt capped at less than 36 percent.

Data from the Mortgage Bankers Association, which also opposes this definition, show that to buy a house at the current median price of $208,000, a typical Philadelphia resident with the median annual household income of $36,669 would need to save 15 years to accumulate a 20 percent down payment, 71/2 years to put down 10 percent.

That assumes the borrower could save $234 a month, every month.

Since down payments and closing costs are cited by prospective first-time buyers as the toughest hurdles to overcome, housing and consumer groups say the "qualified residential mortgage" definition would shut millions out of homeownership.

About 62 percent of current first mortgages taken out to purchase homes would not have qualified under the proposed standard because they had down payments of less than 20 percent, according to LPS Applied Analytics, which tracks mortgage data.

John Taylor, of the National Community Reinvestment Coalition, said the proposal would create a separate and unequal system of finance for people of color and working-class people, regardless of creditworthiness.

Barry Rutenberg, first vice chairman of the National Association of Home Builders, said low-down-payment loans had been originated safely for decades and did not drive the current crisis.

"Subprime, no-doc, and other alternative mortgage products crashed our economy," Rutenberg said.

Contact real estate writer Alan J. Heavens at 215-854-2472, aheavens@phillynews.com, or @alheavens at Twitter.

SEOUL, June 10 Asia Pulse - South Korea's top financial regulator will seek every means possible to prop up a local savings bank that is floundering due to massive deposit withdrawals, the regulator's chief said Friday.

Prime Savings Bank has been suffering a bank run since Wednesday on reports that authorities filed a criminal charge against it for extending excessive loans. So far, deposits worth 88 billion won (US$81 million) have been withdrawn, throwing the lender into a liquidity crisis.

"(We) will seek all possible measures ... We will make sure there is sufficient liquidity support (if a liquidity crunch occurs)," Kim Seok-dong, chairman of the Financial Services Commission (FSC), told reporters.

The crisis at Prime Savings Bank comes on the heels of a major bank run that occurred earlier this year, which had posed further risks to South Korea's savings bank sector struggling under a mountain of bad property loans.

In January and February, the FSC suspended operations of eight savings banks, whose asset quality had tumbled on growing defaults on soured project finance loans. The move triggered a rush for deposit withdrawals.

Meanwhile, prosecutors said earlier that they have not found any signs of illegal loans made by Prime Savings Bank via paper companies, unlike Busan Savings Bank Group.

South Korea's savings bank sector has recently been marred by a scandal involving former senior regulatory officials and major shareholders of Busan Savings Bank Group.

Some employees at Busan Savings Bank were accused of tipping off their relatives and VIP customers about its impending business suspension in February so as to help them withdraw their deposits in advance.

The savings bank was later found to have engaged in extending illegal loans to large shareholders and other financial irregularities involving a total of 7 trillion won. Its chairman, Park Yeon-ho, and several major shareholders have been prosecuted.

(Yonhap) ms 10-06 1610

June 10--JEDDAH -- Economists have warned Saudi investors that mounting US debt and a weakening dollar is putting at risk a traditional safe haven for investment: US treasury bonds, which make up 70 percent of Saudi investment in the US.

Economists told Al-Eqtisadiah, a sister publication of Arab News, they believed that the hegemony of the US dollar in the world economy would not last long in light of $8 trillion in US debt.

Financial expert Raja Al-Marzouki said the declining US dollar would have a negative impact on Saudi investments abroad.

"As a result all investments and deposits would diminish, affecting Saudis' income, purchasing power and profitability," he said, predicting the decline of the dollar would continue. "Saudi investors must be aware of the danger posed by investing in a single currency."

According to him, there is no single major currency to replace the dollar and expected a basket of currencies would control the world economy in the future. He suggested that Saudis must distribute their investment in different currencies to reduce the impact of a falling dollar.

In the event of a basket of currencies replacing the dollar, it should include those from developing countries, considering their increasing contribution to the world economy, Al-Marzouki said.

Abdul Rahman Al-Sanie, an economics professor at the College of Business Administration, advised Saudi investors to withdraw their investment in the US as quickly as possible before it is too late.

"For the last 20 years the US dollar has been in a falling mode as a result of the country's economic and political policies, such as the Gulf War, the war in Afghanistan and Iraq, and the US banking crisis, which resulted in increasing the country's public debts to $8 trillion."

Al-Sanie believed that the dominance of the dollar would not last more than five years. "We have to review our investment in the dollar," he said. "About 30 percent of our foreign investment is in the US. This is a huge amount with regard to the Saudi economy."

He expected that the G20 would remove the US dollar as the basic currency of the World Bank and propose a basket of currencies and gold reserves to strengthen the bank.

"We expect more industrialized countries to return to the previous policy of the gold standard," he added.

A central bank or nation keeps gold reserves as a store of value and as a guarantee to redeem promises to pay depositors, note holders (e.g., paper money), or trading peers, or to secure a currency.

He said there is no single currency strong enough to replace the dollar. The euro is suffering from disturbances and insolvencies in EU member countries, such as Portugal and Greece, while the yen is falling sharply in the wake of the Japanese tsunami and nuclear crisis, and the British pound sterling suffers from inflation.

Ihsan Bu-Hulaiga, an economist and a former member of the Shoura Council, said the fall in the value of the dollar would also affect investment in multinational companies.

"The general situation of the world economy is still unclear in the wake of the falling dollar and other strong currencies, and I believe that the dollar is a good option for investment -- although not the best."

He also believed that investments in commodities in the US would not be affected by the falling dollar.

-----

To see more of the Arab News or to subscribe to the newspaper, go to http://www.arabnews.com.

Copyright (c) 2011, Arab News, Jeddah, Saudi Arabia

Distributed by McClatchy-Tribune Information Services.

BANGKOK, June 9 Asia Pulse - The World Bank on Wednesday maintained a steady economic outlook for Thailand with 3.7 per cent of the Gross Domestic Product (GDP) projected as this year's growth but warning that the countrys inflation is on the rise.

Frederico Gil Sander, a Bangkok-based World Bank economist, told a news briefing on Thailands economic prospects that the countrys economy this year will continue to grow at the rate of 3.7 per cent.

The Thai economy in the first quarter of this year expanded more than earlier forecast but growth in the second quarter was at a slower pace owing to effects of the devastating March 11 earthquake and tsunami in Japan.

The World Bank economist viewed that the Thai economy in the second half of this year will face some risk factors, including the European public debt crisis, Chinas economic slowdown due to the ongoing tightening of its monetary policy, rising oil prices and domestic political stability after the July 3 general election.

However, the bank will revise its figure upward if the risk factors lessen.

Meanwhile, Mr Sander cautioned that the countrys inflation will be steadily rising given that the government will gradually lift its price-control measures and diesel subsidy scheme which capped the fuel's price at Bt30 per litre (about US$1)

The economist said, however, that he believed that inflation is unlikely to cause price crisis as the Bank of Thailand could produce measures to keep inflation at bay.

In the meantime, the worlds leading financial institute projected that the 2011 global GDP to slow to 3.2 per cent, before edging up to 3.6 per cent in 2012, according to its Washington-based June 2011 edition of Global Economic Prospects.

Currently, global financial stability is confronted by rising oil and food prices which have negative consequences on the worlds economy, Hans Timmer, director of Development Prospects at the World Bank said in the bank's latest report.

Mr Timmer explained that food price controls have negative impacts and results in spending a flood of money to subsidise prices in each country. He advised individual nations to proceed with food aid-related measures to support the poor, build food banks as well as not export food from some countries facing food shortages.

However, the commodity prices are likely to drop which will benefit the prices in each country.

In the East and Pacific region, the growth is projected to slow but remain strong, with GDP gains easing from 9.6 per cent in 2010 to 8.5 per cent in 2011.

The inflation in the region having reached 5.3 per cent in April 2011 remains a challenge for the regional economy, particularly in China and Thailand.

Mr Timmer urged the countries to solve domestic problems and to proceed with strict monetary and fiscal policies to tackle the inflation and the accelerating commodity prices.

The ongoing tightening of monetary and fiscal policies is projected to contribute to the projected slowing in growth toward more sustainable growth rates.

(TNA-OANA) nt 09-06 2006

The U.S. Federal Reserve said Friday it is seeking public comments on a proposal to make stress tests for big banks an annual event.

The central bank said it would "build on the Comprehensive Capital Analysis and Review" that was conducted earlier this year for "top tier" U.S. banks.

The Fed defined "top tier" as banks with $50 billion or more in consolidated assets.

The goal of the tests, similar to other reviews given since the financial crisis of 2008, would be to ensure large banks "have sufficient capital, so that they can continue to lend to households and businesses, even under adverse conditions."

In previous reviews that were quickly dubbed stress tests in the media, 19 large banks were involved. By setting the bar at banks with $50 billion or more in assets, the Fed would be reviewing capital plans for 35 banks each year.

The Fed said the capital plans would vary "based on the company's size, complexity, risk profile and scope of operations."

A service of YellowBrix, Inc.

LONDON - Concerns over the U.S. economic recovery and expectations China will raise interest rates again weighed on stock markets Monday, while the euro was steady at the start of a potentially crucial week in the Greek debt crisis.

Over the past month, the economic newsflow has turned distinctly negative, particularly out of the U.S. Investors are now worried that the mark up in share prices in the early part of the year may have been overdone - stocks are effectively a leading indicator of economic output for the period ahead.

Nouriel Roubini, a New York University economics professor notorious for predicting the 2008 financial crisis, cautioned against risky investments.

"In the last month, things have changed, the evidence is that maybe this is not just a soft patch but something worse," he said in a speech in Singapore. "If your horizon is the next two or three months, I would be a bit defensive on equities...This is time to be cautious, and safe rather than sorry."

In Europe, the FTSE 100 index of leading British shares was up 0.2 percent at 5,777, while France's CAC-40 rose 0.1 percent to 3,809.22. Germany's DAX fell 0.1 percent to 7,065. Trading activity in Europe was low as many countries, including Germany and France, were on national holiday though stock markets remained open for business.

Wall Street was poised for a lackluster opening - Dow futures were up 0.1 percent to 11,885, while the broader Standard & Poor's 500 futures rose an equivalent rate to 1,265.

Given the public holidays in many parts of Europe and a light economic calendar in the U.S., analysts were skeptical that stocks would gain any momentum over the day.

Tuesday may have more to offer, with Chinese inflation data likely to stoke concerns that the People's Bank of China will tighten monetary policy again soon. U.S. retail sales figures for May will also provide an insight into the state of the U.S. economic recovery - consumer spending accounts for around 70 percent of the U.S. economy.

"All stock markets remain under pressure going into this week, and in the short-term at least, it is difficult to see the catalyst that is going to spark off a sustainable rally," said David Jones, chief market strategist at IG Index.

In the currency markets, investors continue to monitor any developments surrounding the Greek debt crisis ahead of next week's meeting of eurozone finance ministers in Brussels, where a fresh Greek bailout is on the agenda.

On Friday, the euro tanked amid signs that policymakers in Europe have divergent views on how to deal with the Greek crisis, with the European Central Bank and the German government at odds on getting Greece's bondholders to share some of the pain in helping the country.

Germany's finance minister Wolfgang Schaeuble has proposed that bondholders contribute a "substantial" portion of a fresh bailout package for Greece by giving the country an extra seven years to repay existing bonds. But European Central Bank president Jean-Claude Trichet has said nothing should be done that would be deemed "a credit event" by the ratings agencies and that any private sector involvement has to be done on a voluntary basis.

"A failure to achieve a workable agreement by the end of the eurogroup meeting next Monday threatens the real risk of what Schaeuble described last week as the first unorderly default within the eurozone," said Simon Derrick, senior currency strategist at the Bank of New York Mellon.

By late morning London time, the euro was up 0.1 percent at $1.4355. That's three cents lower than the one-month highs it reached only last Thursday.

Earlier in Asian trading, Japan's Nikkei 225 dropped 0.7 percent to close at 9,448.21 after the government reported that core machinery orders fell unexpectedly by 3.3 percent during April. The drop came as companies canceled orders following a devastating March 11 earthquake and tsunami in northeastern Japan that destroyed or damaged scores of factories.

The decline was the first in four months, evidence that the twin disasters continue to take their toll on Japan's economy. The seasonally adjusted figure includes heavily electrical machinery, engines, machine tools, road vehicles and aircraft but excludes orders for ships and utilities because of their volatility.

South Korea's Kospi closed 0.1 percent higher at 2,048.74 while Hong Kong's Hang Seng Index finished 0.4 percent higher at 22,508.08.

But mainland Chinese shares edged lower as market players reacted to data showing a dip in bank lending and awaited the inflation figures that could show the consumer price index surging to more than 6 percent.

The Shanghai Composite Index fell 0.2 percent to 2,700.38 after dipping more than 1 percent earlier in the day. The Shenzhen Composite Index fell 0.2 percent to 1,110.89.

In the oil markets, crude continued to fall on concerns over the global economic recovery and speculation that Saudi Arabia will decide to raise production levels despite last week's surprise decision by the OPEC oil cartel to maintain current levels.

Benchmark oil for July delivery was down $1 at $98.32 a barrel in electronic trading on the New York Mercantile Exchange.

----

Pamela Sampson in Bangkok contributed to this story.

WASHINGTON - Fitch Ratings says it might downgrade U.S. debt if lawmakers fail to increase the nation's borrowing limit before the government runs out of money in August.

The rating agency, based in New York, said Wednesday that it will put the debt on watch for a possible downgrade if lawmakers have not reached a deal by Aug. 2. That's the date by which the Treasury Department will have exhausted stopgap measures it is using to delay a default.

Fitch expects the debt ceiling to be increased. If that doesn't happen, the nation might default, implying "a crisis of governance" and threatening the stability of the world financial system, the rating agency said.

"Default by the world's largest borrower and issuer of the pre-eminent reserve currency would be extraordinary and threaten the still fragile financial stability in the U.S. and the world as a whole, especially against the backdrop of the European sovereign debt crisis," said David Riley, head of Sovereign Ratings at Fitch, in a statement.

A lower credit rating could spread through the economy, increasing the cost of borrowing for consumers and businesses That's because many loans, including mortgages, tend to follow yields on U.S. Treasury bonds. If investors demand higher yields to offset the increased risk associated with Treasury debt, rates for other loans would rise, as well.

If borrowing and spending decrease sharply, the sluggish economic recovery could run out of steam.

The government reached its borrowing limit of $14.29 billion on May 16. Since then, Treasury Secretary Timothy Geithner has employed what he calls "extraordinary measures" to continue paying the government's bills. They include borrowing from two federal employee pension funds and halting a program under which Treasury issues securities to help state and local governments meet their investment obligations.

President Barack Obama and congressional Republicans agree that the nation must reduce its annual deficit. They disagree about how to do it. Republicans want to solve the problem with spending cuts, while Democrats insist that tax increases also must be part of the plan.

Failing to increase the borrowing limit could upend the financial system and imperil the economic recovery, the administration has warned. Business groups and Wall Street firms agree. But some Republicans believe that a default would not have long-term reverberations. They refuse to support a higher debt ceiling unless Democrats agree to billions in spending cuts.

If Congress and the Obama administration fail to reach a deal before Treasury runs out of time, Fitch will place U.S. debt on "Rating Watch Negative." Major banks and other companies closely linked to government debt also would be reviewed, Fitch said.

If Treasury can't repay $52 billion of Treasury notes and coupon payments due on Aug. 15, the nation's sovereign debt rating would be deemed in "Restricted Default" until the government has made good on its debts, Fitch said. At that point, Fitch would increase the sovereign rating to "a level commensurate with Fitch's assessment of the creditworthiness of the U.S. government," the rating agency said.

It is not the first such warning. Moody's Investors Service said last week that it might begin reviewing the nation's credit rating next month.

In April, Standard & Poor's lowered its long-term outlook for the government's fiscal health to "negative" from "stable." S&P warned that it could strip the government of its top credit rating over the next two years if lawmakers failed to rein in the deficit.

A service of YellowBrix, Inc.

WASHINGTON _ When the federal government releases its closely watched May jobs report on Friday, it's likely to raise more concerns that the U.S. economic recovery is losing steam. What's not clear is whether this signals a temporary slowdown or something more ominous.

All eyes will be on the Labor Department. Its monthly employment reports are economic indicators that point backward, but they also help cement expectations of the future. The past two monthly jobs reports showed robust hiring, but Wednesday's ADP National Employment Report, which measures private-sector payrolls, pointed to a sharp downturn in hiring.

That's but the latest disquieting note in a quickly developing trend; all kinds of other economic indicators are also pointing to a slowdown. This week alone data on manufacturing, car sales, home prices and unemployment claims all pointed to a weakening economy. But how weak, and for how long? Forecasters aren't sure.

On top of that, Washington is unlikely to do anything more to spur the economy. There's little appetite in Congress for more government spending; in fact, all the momentum there is toward cutting spending in the name of debt reduction.

In addition, at the end of this month, the Federal Reserve will end its unprecedented $600 billion purchase of government bonds. It was intended to lower bond interest rates and thus stimulate financial markets by spurring investors out of safe bond havens and into more risk taking, such as stocks. Ending the Fed's program removes that stimulus.

All this has led forecasters to lower their projections for near-term economic growth. Macroeconomic Advisers dialed back its 3.5 percent growth projection for the second quarter of 2011, dropping it to 2.7 percent on Wednesday, then another notch down to 2.6 percent on Thursday.

Few economists predict a return to recession, yet many are increasingly concerned that the slowdown may be growing worse.

"There's a certain trepidation right now that there wasn't a month ago," said Steven Ricchiuto, chief economist for Mizuho Securities USA Inc. "A month ago, people thought the end of QE2 (the Fed's bond-purchase program) would be no issue. People are a little bit more worried that this is a repeat of last year, and to be honest with you, it is a very difficult question to ascertain at this juncture."

Last year, the economy hit a soft spot in spring, and the Federal Reserve stepped in with an aggressive plan to purchase $600 billion in Treasury bonds, a move credited with sparking life into financial markets but also blamed for driving up the price of crude oil and a range of agricultural commodities.

Fed Chairman Ben Bernanke suggested in a rare April news conference that the bar would be awfully high for another round of bond purchases, and some analysts fear that the Fed may be out of bullets. After all, its benchmark interest rate has been effectively at zero since late 2008, so cutting rates further isn't an option.

Laurence Meyer, a former vice chairman of the Fed, doesn't think the central bank is out of bullets, but he acknowledges that the economy is in a rough spot.

"It's complicated because we can identify temporary factors that slowed the growth in the first quarter quite a bit. The supply chain effects (from Japan's natural disaster) clearly seem to have slowed second-quarter growth," Meyer said in an interview. "But it does seem like the U.S. and almost every place you look around the world has slowed, so there is a more fundamental loss of momentum, not only in the U.S., but all around the world."

Although the Fed cannot lower rates further, he said, it could signal to markets that rates won't rise for a longer period than now expected. That would create an expectation of cheap borrowing costs over a longer horizon and help boost long-term investments.

Additionally, although the Fed this month will hit the zenith of its bond purchases, that's precisely when the program's supposed to have its biggest spark for the economy. It will serve as a tailwind against the headwind factors that are slowing growth.

"Stimulus is measured not by the rate of (bond) purchases, but by the level of assets on the Fed's balance sheet," Meyer noted, saying the purchases should be akin to cutting rates, already at zero, by another half a percentage point.

In addition, even though the Fed is halting its purchases, it continues to reinvest its earnings from the holdings, providing continued spark, said Meyer, now vice chairman of Macroeconomic Advisers.

For Meyer and other economists, the next important signposts will be Friday's jobs report, then the next report on durable goods _ big-ticket items such as refrigerators _ and data on international trade. Imports, primarily higher priced crude oil, offset the gains made by U.S. exports and have lowered the U.S. growth rate.

Some causes of the slowdown are clear. They include high energy prices that have more than sucked away any benefit from this year's payroll tax holiday. Soaring pump prices have eaten into consumer spending, and consumption drives more than two-thirds of economic activity.

The continued slide in home prices is also limiting people's mobility and dampening their appetite to consume as they see the value of their most important asset continue to drop.

"We've got to be careful about hoping this is going to be a consumer-led economy as in the past," warned Michael Hanson, an economist with Bank of America Merrill Lynch in New York.

Consumers also have less access to credit than in the past, and they cannot count on their homes to create wealth for them as they did in recent years, he said.

The hard fact may be that the U.S. economy is going to grow in fits and starts for several years, said Vincent Reinhart, the former top economist on the Fed's rate-setting Open Market Committee.

"Economies grow more slowly after a financial crisis. The unemployment rate stays persistently high, and house prices tend to keep declining well into an (economic) expansion," he said. "We're pretty much following that path."

Together with his wife, Carmen Reinhart, a prominent economist, the former Fed official published research last summer that showed that the U.S., despite its status as the world's leading economy, is following the script of other nations that suffered through a severe financial crisis.

"We also tend to react so that 'it' never happens again. So we require banks to hold more capital, we put in more regulation and we raise the cost of doing business," he said. "We accumulate a lot of debt during the crisis, and that slows economic recovery."

Indeed the gross national debt, now at its ceiling of $14.3 trillion, factors squarely into the question of whether this is a soft patch for the economy or begins a slide back into recession. If steep immediate cuts in federal spending accompany the expected rise in the debt ceiling later this summer, that could further weigh down a slowing economy.

It all points to a long slog still ahead.

"People got sucked into belief that one quarter is a trend. The economy is doing the best it can given underlying conditions," said Ricchiuto of Mizuho Securities. "I'm not sure policymakers can jumpstart the economy ... it's the post-crisis workout period. There's a lot of uncertainty."

___ (c) 2011, McClatchy-Tribune Information Services.

Michigan Treasurer Andy Dillon is considering a proposal to create a joint alternative investments pool.

The pool of limited partnership interests in private equity, hedge funds and other alternative investment funds would give investors their alternative investment exposure -- and liquidity too, he says.

Mr. Dillon came up with the strategy as one way to head off a move -- made before he was appointed state treasurer on Jan. 1 -- to shrink the alternative investments portfolio of the $51 billion State of Michigan Retirement Systems to a 14% target from its current 20% actual allocation. Mr. Dillon, who is sole fiduciary of the system, said he opposed reducing alternatives because it is Michigan's best-performing asset class.

His plan is for institutional investors to pool limited partnership interests in alternative investments such as private equity and hedge funds. The pool would be securitized using leverage for liquidity.

Leverage would supply the liquidity, Mr. Dillon explained in an interview. "You can't run with the herd" if you want to overcome the investment hurdles, he said.

Mr. Dillon's concept is building on a theme of collaboration among institutional investors, an idea that has been gaining popularity since the economic crisis, especially with alternative investments. Investors started by supporting guidelines created by the Institutional Limited Partners Association to promote better alignment of interests, governance and transparency between general partners and limited partners.

Institutional investors also have been meeting for more than a year to pursue more investor-friendly deal terms for their real estate, private equity and hedge fund investments. They also are discussing making joint infrastructure investments, said Joseph Dear, chief investment officer of $235.2 billion California Public Employees' Retirement System, Sacramento.

The only way to achieve more investor-friendly goals is for limited partners to work together, Mr. Dear said in an interview.

Mr. Dear participated in a panel discussion earlier this month at the Milken Institute Global Conference in Beverly Hills, Calif., with Mr. Dillon, where the idea was discussed.

"It's an interesting idea, but I've had no follow-up conversation on it," Mr. Dear said in a recent e-mail. "It's not in our work plan for the year."

Industry insiders say a version of Mr. Dillon's approach has been considered before but not in the same way.

Similar concept

David Fann, president and CEO of La Jolla, Calif., investment management firm PCG Asset Management, said the concept is similar to collateralized fund obligations, in which the underlying assets are private equity and venture capital portfolios.

"The tough part, or the trick, about this is that for one to issue debt in scale, one needs to get a ratings agency comfortable with the cash flow streams of the underlying private equity or venture capital portfolios that will allow the ratings agency to rate the debt for the prospective investors," Mr. Fann said.

In the early part of the decade, CFOs were created that contained mostly hedge fund interests. During the financial crisis, ratings agencies downgraded a number of the CFOs fearing investors would pull out of the underlying hedge funds.

An alternative would be to use the secondary market to sell some of the funds. And that secondary market "is booming right now," Mr. Fann said.

Around 2003, a few large investment managers, including Deutsche Bank and AIG Investments, now PineBridge Investments, launched collateralized debt obligations, said Steve Costabile, managing direct and global head of private funds for PineBridge Investments, a New York private equity and CDO management firm.

Mr. Costabile was in the group that created AIG's $1 billion CDO, which was made up of AIG's limited partnership interests in leveraged buyouts. The AIG CDO was divided into six tranches and AIG kept all but the AAA-rated, senior debt piece, which was sold to institutions such as insurance companies. The $250 million raised by the sale of the senior debt provided liquidity for AIG.

"Funds backing a CDO have to be sufficiently diversified by strategy, vintage year, portfolio company industry and generally, have significantly less unfunded commitments than net asset values," he said.

However, given the leverage involved, there are limits to how much venture capital a CDO can handle due to venture funds' longer holding periods and unfunded commitments.

"Mostly buyouts that do mature deals and that have shorter holding periods are accretive to generating cash flow from the structure," Mr. Costabile said.

These structures are very complicated and expensive to create. Once the markets came back in 2003 and 2004, these types of CDOs were less attractive. But times have changed since then. "The regulatory environment was more flexible in 2003," Mr. Costabile said.

The economic crisis pointed out the pitfalls of securitizations. "It turns out liquid, better understood asset pools -- commercial loans and mortgages -- couldn't be easily evaluated for black swan events," PCG Asset Management's Mr. Fann said.

Would a rating agency take on the risk of rating illiquid private equity funds, which are even harder to evaluate, Mr. Fann asked. "2008 showed that you couldn't solely rely on history to forecast the future," he stated.

More liquidity

The advantage of securitization over secondary market sales is the liquidity it gives institutional investors, while still holding the limited partnership interests, Mr. Costabile said.

Still, investors can't throw just any old alternative investment into the pool and hope it will produce the returns needed to borrow against.

There's a huge discrepancy in performance between managers, said Josh Lerner, the Jacob H. Schiff Professor of Investment Banking at Harvard Business School, Boston.

"Buying a private equity bundle does not get you very far," he said. "Performance is not driven by the asset class, but the managers selected."

Investing in a broad spectrum of private equity or hedge funds does not produce top-tier returns, he noted. "You have to invest in the upper half or quartile of managers to justify the risk and illiquidity."

Such a strategy also is likely to come with an added layer of fees, which would also push down returns, he said.

To avoid adverse selection, rating agencies require that the investment pool include investors' best limited partnership interests, otherwise it will not get a sufficient rating, Mr. Costabile said.

"It is not dissimilar to a municipal bond offering. If it is high quality, a lot of people will be interested in buying in," said Eric Bernstein, chief operating officer in New York for eFront, a private equity administrator.

Since investors share equally in the entire CDO's profits, outperforming managers will sacrifice return in order to participate in the pool, Mr. Costabile said.

Conversely, significant underperformance by one contributor in a CDO can lead to delayed cash flow due to failed collateral tests -- or even worse, a default that the outperforming or average manager wouldn't have been exposed to, Mr. Costabile said.

"It would only work if the investors put in identical LP interests. Unless it's apples to apples, it's not so easy to mush a portfolio with five or six names. Somebody will be disappointed."

Even so, large investors don't necessarily have the highest-returning alternative investments portfolios, Mr. Lerner said. "Most of the evidence suggests that the largest investors' portfolios performed more poorly than the portfolios of smaller endowments or foundations."

Part of the reason is that larger investors tend to invest in larger funds, which tend to have poorer performance, Mr. Lerner said.

A service of YellowBrix, Inc.

The rush of money into U.S. Treasury bonds this spring is turning into a deluge as nervous investors seek relative safety.

Lousy economic reports Wednesday fueled another buying wave in the Treasury market, driving the benchmark 10-year T-note yield to 2.94%, down from 3.07% on Tuesday and the lowest since early December. As a bond's yield falls, its price rises.

The Treasury market has been rallying since early April as some investors have been fleeing stocks. That was the case Wednesday as well: The Dow Jones industrial average tumbled 279 points, or 2.2%.

The latest reports on U.S. manufacturing activity, auto sales and job growth all point to a further slowing of the economy -- just one month away from the day when the Federal Reserve is supposed to complete its $600-billion Treasury-bond-buying program launched in November.

The program has been aimed at keeping the recovery on track by pumping more money into the financial system.

If economic data continue to weaken, the focus may quickly turn to whether the Fed might launch yet another stimulus program -- though some analysts believe that any such move by the central bank could spook the markets rather than soothe them.

The latest dive in Treasury yields should help pull mortgage rates lower. But with home prices continuing to drop, it isn't clear whether lower loan rates would be much of a lure for potential buyers.

Meanwhile, Pimco bond guru Bill Gross continued Wednesday to warn investors away from Treasuries. The fund manager has taken some heat for missing the spring plunge in yields, but he clearly isn't interested in changing his strategy now.

In his monthly commentary posted on Pimco's website, Gross argued that yields at these levels "fail to adequately compensate investors for the risk of holding them."

--

tom.petruno@latimes.com

The economic recovery is faltering, and Washington is running out of ways to get it back on track.

Two bright spots over the past few months - manufacturing and job creation by private companies - both slowed in May, according to new reports Wednesday. The data come amid other reports of falling home prices, declining auto sales, weaker consumer spending and a rising pace of layoffs.

Stocks tumbled Wednesday on the discouraging economic news, with the Standard & Poor's 500-stock index off 2.3 percent. It was the index's steepest decline since August.

Just a few months ago, the economy seemed poised to finally strengthen. Business confidence was rising, and extensive government efforts to foster growth were underway. But those hopes are being dashed. Forecasters who once projected economic growth of 3.5 to 4 percent for the year have slashed their estimates with each round of disappointing numbers.

Instead of accelerating, the U.S. economy is puttering along at a growth rate of 2 to 3 percent - barely enough to bring down joblessness slowly, if at all.

"The recovery continues, but at a disturbingly slow pace," said Diane Swonk, chief economist for Mesirow Financial.

The weak growth comes despite government efforts to boost it: a payroll tax cut that took effect in January and an initiative by the Federal Reserve to pump $600 billion into the ailing economy. But the Fed is unlikely to take further action, and Congress is focused on reducing the budget deficit, not tax cuts or new spending that might spur economic activity.

The worsening economic prospects reflect, in part, the effects of a spike in oil prices this year and of the Japanese earthquake in March, which caused disruptions for some U.S. manufacturers. But it is the underlying weakness of the U.S. economy that may have allowed these developments to knock the recovery off course.

"We're structurally in a place where we're going to be more vulnerable to downside risks than if the economy was growing strongly, and that's what we're seeing right now," said Robert A. Dye, senior economist at PNC Financial Services Group. "We're not far above stall speed."

The signs are not all bad. The stock market has held up well in recent weeks, aside from Wednesday's decline. Prices for oil and other globally traded commodities are down substantially since the end of April, a decline that will eventually mean lower prices for gasoline and other goods, and the impact of the earthquake will subside as factories in Japan reopen. Moreover, U.S. businesses this year have been cutting inventories that they will eventually need to rebuild, spurring economic activity.

But the outlook, as projected by economic forecasters and implied in government data, is clearly dimming. Economists at J.P. Morgan Chase on Wednesday lowered their projection for 2011 growth in gross domestic product to 2 percent. A week ago, those same economists had reduced the figure to 2.5 percent.

Reflecting rising pessimism, the interest rate that the Treasury Department must pay to borrow money for 10 years fell to 2.95 percent Wednesday, from 3.06 percent on Tuesday and 3.74 percent in February. As investors grow anxious, they are moving money into the safety of government bonds. Investors are also anticipating that the Federal Reserve will seek to support the recovery by keeping interest rates low for longer than previously expected.

Among the economic information that unsettled markets was a report by the Institute for Supply Management, which said that its index of manufacturing activity fell to 53.5 in May from 60.4 in April. Numbers above 50 indicate expansion, and analysts had expected a more modest pullback to 57.1. The new numbers showed the slowest rate of factory expansion since September 2009.

New orders and production fell the most. This was probably caused by disruptions in automobile and other production after the Japanese disaster, which hurt supply chains around the world.

"Elevated commodity prices, slowing global growth and an increasingly questionable outlook for the U.S. economy are creating head winds for the factory sector, which thus far has been the one strong element in an otherwise sluggish U.S. economic rebound," said Cliff Waldman, economist at the Manufacturers Alliance/MAPI, a trade group.

Also Wednesday, ADP, the payroll processing company, said that the rate of job creation at private businesses slowed sharply last month. Firms added 38,000 jobs, ADP estimated, compared with 179,000 jobs added in April.

On Friday, the Labor Department will release its report on May job growth and the unemployment rate. Economists expect that about 180,000 jobs were created last month, dropping from 244,000 in April, and that the unemployment rate has edged down to 8.9 percent from 9 percent.

The U.S. economy has sputtered several times while recovering from the trauma of the financial crisis. Last summer, as growth slowed and analysts began to fear a dip back into recession, the government swung into action. The Fed began discussing what would become known as QE2, or the second round of quantitative easing - a $600 billion bond-purchase program aimed at fueling growth. And by the end of the year, the Obama administration had reached an accord with Congress to temporarily cut payroll taxes to boost growth.

But the prospects for another round of government help are slim. The Fed had undertaken its massive bond-buying program last year in large part because leaders of the central bank were worried about the risk of deflation, or falling prices. By contrast, prices today are edging up. The bond market is pricing in inflation of just under 2 percent a year over the coming five years, exactly the level the Fed seeks.

Moreover, Fed officials believe that further efforts could have less bang for the buck than previous ones.

The administration and Congress, meanwhile, are now more concerned with cutting the federal budget deficit than with supporting the recovery through government spending and tax breaks.

irwinn@washpost.com

June 2--Bank of America Corp. chief executive Brian Moynihan insisted Wednesday that his company won't have to raise additional capital as it absorbs mortgage-related losses.

Banks need to keep sufficient capital on hand as a cushion against unexpected losses. In the wake of the financial crisis, new global standards will require them to hold even more over time.

Moynihan, who has been CEO for 18 months, has repeatedly said the Charlotte bank is improving its capital ratios by accumulating earnings and shedding riskier assets, but he faced another round of questions about the issue Wednesday at an investor conference in New York.

"We don't see any reason to raise capital at all," Moynihan responded.

Bank of America faces billions of dollar in requests from investors to buy back soured mortgage loans originated by Bank of America and Countrywide Financial, which it bought in 2008. It has reached settlements with some investors and continues to have talks with others.

Moynihan said the bank wants to put the issue behind it, while also paying settlement amounts that are "reasonable" to its shareholders.

On another issue of keen interest to investors, the CEO wasn't specific about when Bank of America will ask the Federal Reserve for permission to increase its penny-per-share quarterly dividend. The Fed in March rejected the bank's request to modestly hike the payout in the second half of this year, even as other big banks received permission for increases.

"Stay tuned," Moynihan said. "We've learned our lessons about the process."

Echoing comments he made at the bank's annual shareholder meeting last month, Moynihan said Bank of America needs to finish integrating Merrill Lynch risk management systems and continue reducing "unknown risk" at the company, likely referring to the mortgage repurchase requests.

Asked about settlement talks with state attorneys general over foreclosure-related errors at major loan servicers, Moynihan said the dialogue is ongoing, but it will take longer than people think to reach an agreement because of the amount of work involved.

Bank of America shares are down more than 15 percent this year, closing at $11.24 on Wednesday after falling more than 4 percent on a down day for Wall Street.

-----

Copyright (c) 2011, The Charlotte Observer, N.C.

HONG KONG, May 30 Asia Pulse - Moody's Investors Service said Monday that the outlook for South Korea's banking industry is stable, citing the country's sustained economic growth and the sector's modest financial improvement.

The global credit appraiser said South Korean banks will post higher earnings over the next 12 to 18 months, supported by stable interest margins and fewer expenses.

South Korea's sluggish loan growth prospects will result in further improvements in the banking sector's already strong capital adequacy ratio, a ration of a lender's capital to risk-weighted assets.

The average capital adequacy ratio of 18 local banks came to 14.23 per cent in the first quarter this year, down 0.32 percentage point from the end of 2010.

Moody's also expected the loan-to-deposit ratio of South Korean banks to continue to drop.

While asset quality should be improving, a number of concerns still remain in the banking sector, the credit rating agency warned.

"A key credit issue facing the system is high and rising consumer leverage," Choi Young-il, vice president and senior analyst at Moody's, said.

South Korea's household credit exceeded the 800 trillion won (US$731.7 billion) mark for the first time in the first quarter on a rise in banks' home-backed lending, but the growth pace slowed due to seasonal factors.

"We believe that Korea's household debt to disposable income is one of the highest globally, and it continues to rise," Choi said.

The uncertainty about the future ownership of the three banks in the country -- Woori Bank, Korea Development Bank (KDB) and Korea Exchange Bank (KEB, KSE:004940) -- is another key issue in the South Korean banking system, Moody's said.

The Financial Services Commission (FSC) has recently delayed regulatory permission indefinitely for Hana Financial Group Inc's (KSE:086790) purchase of KEB from the U.S. buyout fund Lone Star, while the privatization of the state-run parent companies of Woori Bank and KDB has been stalled.

Moody's said the lack of clarity about the future of the industry's makeup and the extent of long-term government control over important segments of the banking system creates uncertainties regarding the competitive dynamics and long-term profitability prospects of the banks.

(Yonhap) ms 30-05 1714

A service of YellowBrix, Inc.

LONDON - A surprisingly weak U.S. payrolls survey weighed on stock markets Wednesday as investors gear up for the government's official jobs report at the end of the week. The euro, meanwhile, remained near three-week highs against the dollar on hopes Greece will get more help with its debts.

At the start of each month, investors have a slew of U.S. economic indicators to digest, in particular the monthly nonfarm payrolls data, which often set the tone in markets for a week or two after their release.

Investor sentiment was jolted by Wednesday's news from the ADP payrolls firm that private employers only added 38,000 jobs during the month. That was far lower than the 175,000 expected in the markets.

The figures reinforced fears that the U.S. economic recovery is quickly running out of steam and that Friday's official government data may come in lower than anticipated. Before the ADP figures, the consensus in the markets was that Friday's government data will show that around 200,000 jobs were added during May, slightly down on April's 244,000 increase.

"This is a very weak result, and puts substantial downside risk to Friday's nonfarm figure," said Jennifer Lee, an economist at BMO Capital Markets.

Concerns over the U.S. economy have combined with Europe's debt crisis, particularly whether Greece will get more emergency loans, to weigh on stock markets in recent weeks.

Further clues about the U.S. recovery will come later when the Institute for Supply Management publishes its May survey into the manufacturing survey. The release is considered a top-tier gauge of economic activity in the U.S. The consensus in the markets is that the ISM's main index will drop to around 57 from the previous month's 60.4

Following the weak ADP report, Wall Street futures turned sharply lower, pushing stocks in Europe down, too.

In Europe, the FTSE 100 index of leading British shares was down 0.4 percent at 5,964 while Germany's DAX fell 0.5 percent to 7,256. The CAC-40 in France was 0.3 percent lower at 3,993.

Wall Street was poised for similar losses at the open - Dow futures were down 0.4 percent at 12,512 while the broader Standard & Poor's 500 futures fell 0.4 percent to 1,338.

The ADP figures also had an impact in the currency markets, pushing the dollar down, particularly against the yen. By mid-afternoon London time, the dollar was 0.6 percent lower at 80.55 yen.

The dollar was faring a little better against the euro, trading flat at $1.4431.

The euro has enjoyed a strong run over the past few trading sessions on expectations that Greece will get more help from its partners in the eurozone and the International Monetary Fund to meet financing commitments through to 2013. Alongside a second rescue package following last year's euro110 billion package of loans, Greece is expected to have to increase its privatization program and make more austerity cuts.

Few analysts, however, think that a second rescue package would necessarily prevent a Greek debt restructuring down the line given weak economic growth forecasts and political infighting.

"We remain sceptical that the modest rebound in risk sentiment over the past week will prove sustainable beyond the near-term especially any renewed optimism regarding Greece where a rehash of previously unsuccessful support steps will likely fail again," said Lee Hardman, a currency strategist at the Bank of Tokyo-Mitsubishi UFJ.

Earlier in Asia, Japan's Nikkei 225 rose 0.3 percent to close at 9,719.61 after Bank of Japan Governor Masaaki Shirakawa said in a speech that supply and electricity disruptions caused by the March 11 earthquake and tsunami were easing. The economy could stage a moderate recovery starting in the second half of fiscal 2011, he said.

Elsewhere, South Korea's Kospi index slipped less than 0.1 percent to 2,141.34 after the government announced the country's inflation rate eased for a second straight month in May, to 4.1 percent.

Hong Kong's Hang Seng index drifted 0.2 percent lower to 23,626.43 while mainland China's Shanghai Composite Index dropped 0.3 percent after data showed China's manufacturing sector easing in April. The state-affiliated China Federation of Logistics and Purchasing reported that its purchasing managers index, or PMI, fell to 52.9 in April, down from 53.4 in March.

Australia's S&P/ASX 200 failed to hold onto gains and closed flat at 4,707.30.

In the oil markets, the price of crude continued to hover around the $100 a barrel mark. Benchmark oil for July delivery was down 1 cent to $102.69 a barrel in electronic trading on the New York Mercantile Exchange after a $2 plus gain on Tuesday.

---- Pamela Sampson in Bangkok contributed to this report.

There is a little more to fixed income investing than meets the eye and Peter Harvey, who runs Cazenove Strategic Bond, has had more than a little vision when it comes to successful investing.

Managing a bond fund is quite simple, really, says Peter Harvey, who runs Cazenove Strategic Bond. All you have to do is avoid company defaults.

Harvey is a deep pragmatist who eschews much of the jargon that inhabits the world of bond investing. His background is in corporate restructuring, which he got into after joining Lloyds Bank as a graduate trainee. He even worked on picking up the pieces at the Daily Mirror after Robert Maxwell fell (or jumped) off the Lady Ghislaine.

Years of trawling through the remnants of bust companies taught him a key lesson about corporate behaviour. "I learnt that what really, really matters in companies is the quality of the management."

It became even more crucial when, after leaving Lloyds, Harvey became a manager of emerging markets debt at Foreign & Colonial. "Lending to Latin American countries is about picking those ones where you are going to get your money back without using a stick." He adds: "Central to my entire process is loss avoidance. If you can avoid defaults, fixed income will largely sort itself out."

It sounds admirably honest, but there is of course a little more to bond investing than that, especially if you're the man behind one of the biggest strategic bond funds in the country. The Cazenove fund has pound 720m in assets under management, and over five years - taking in the 2007-2009 period when bond fund performance diverged so remarkably - it is the third-best performing out of 44 funds.

It is up 30% compared with the sector average of 20% over five years, beaten only by Invesco Perpetual's Monthly Income Plus and Fidelity's Strategic Bond fund. The range in performance is huge - down at the bottom of the table, the Axa Sterling Strategic Bond fund has managed to lose its investors 2.7% over the period. It's a wonder there's pound 47m still sitting in it.

Harvey was there at the launch in April 2006, and has stuck to the same management technique throughout. The fund's target is to achieve a total return significantly ahead of sterling cash interest rates - his specific aim is the London inter-bank offered rate (Libor) plus 2.75 percentage points - and to get there Harvey uses not just plain vanilla bonds but also a range of other instruments. That includes consistently running a short position in bond and gilt futures, credit default swaps to express a view on a company without using fixed rate bonds, and floating rate notes, which can be up to one quarter of the entire portfolio. He says these instruments let him keep the interest rate risk low and focus on sector and stock selection without worrying about the day-to-day movements in inflation and interest rates.

Crucial to Harvey's bond selection is CCC. No, it's not some sort of ultra-junk rating, but the Cazenove Core Confidence rating on a stock. This is a process in which he first looks at the fundamental business risk of a company, then its financial risk, then its management and regulatory environment. He points to the Daily Mail group (DMGT) as an example. Business risk includes items such as advertising, the strength of hold it has over its readership, and its ability to migrate on to the internet. Financial risk is largely balance sheet data such as debt levels. "If you're over-leveraged, you're toast," he says.

When Harvey runs his CCC slide rule over Daily Mail group, he says it comes up better than any other media group. He seems to forget he's talking to someone who makes most of his living from the Guardian.

But the process isn't one that just drives Harvey into expensive quality stock. One of the key periods when this fund moved swiftly ahead of its competitors was during the financial crisis in early 2009. Almost alone among major bond fund managers, Harvey was happy to buy bank bonds at huge discounts, some of them on remarkably short duration. "Nationwide was trading at 60 cents to the dollar, UBS... UBS, a giant Swiss bank, for heaven's sake... was trading at 65 cents to the dollar. Other people thought they were cheap too, but very few had the powder dry to do anything about it. Back in May 2009 I put in a cheeky bid for some stock in Barclays. I got a call from the broker late on the Friday night to say I'd got all $40m I had asked for."

More recently he has pegged back his financial exposure, while building a bigger position in pharmaceuticals.

His short positions today are in retail and some European property plays. Cazenove doesn't like to talk about its short positions, but not long after, Harvey is talking about recent high yield bond issues from the likes of DFS, Moto, Phones4U and Matalan, and you get the feeling he's not altogether enthusiastic about every one of them.

He also says the cinema industry is likely to move into deep distress. He's not talking about Hollywood itself, but the physical cinema chains face a serious challenge from video on demand. He points to the shortening gap between cinema release and video release, and the fact that the pipeline of blockbusters is now aimed almost exclusively at the kids market, as adults are deserting the multiplexes.

Harvey is happy to report that at the worst point in its five year life, his fund has lost only 5%, which considering the crisis we've been through is saying something. But he also argues that problems remain. Globally, the most obvious problem is Greece, Portugal and Ireland, and he says that predicting a default (or two) is so uncontroversial it's commonplace. "Of course, we won't call it a default, it will be something like a 'reprofiling'. But the risk is that it will creep into core Europe. The key issue is whether it hits Spain. I think that's actually a remote possibility, but it's something you of course have to watch. It would be another Lehman event. And at the moment I feel you are not being properly rewarded for the risk in Spanish debt. The risk premium is just 2%, which is not enough. It's also why I don't hold any Santander or BBVA."

As he says earlier in the conversation, "Dodging the bullets is what matters."

PATRICK COLLINSON The Guardian Personal Finance Editor

Copyright: Centaur Communications Ltd. and licensors

June 1--DUBAI -- Most banks in the Gulf are set for slow recovery because of "sluggish loan growth and difficult funding conditions," Standard & Poor's said on Tuesday.

The ratings agency said the financial profiles of most of the Gulf banks are expected to remain relatively stable or keep improving, but slowly because of listless loan growth and difficult funding conditions.

S&P noted in its report that most sovereigns and by extension banks in the GCC will continue to remain isolated from the political turmoil in other parts of the Middle East and North Africa.

"As a result, most of the GCC banks we rate will remain spared from any big indirect effects because most have limited operations and exposures to Mena economies, according to our base scenario," said S&P's credit analyst Goeksenin Karagoez in the report titled, "Banks in the Gulf are on the way to recovery, but has the dust settled?"

The ratings agency said it could not rule out a further correction in real estate markets or a wider escalation of political troubles with negative effects for the creditworthiness of the banks it rates in the GCC.

It noted that for the first time in more than two decades, the public unrest has tarnished the reputation of Bahrain, home to the GCC's largest offshore banking system.

"As our negative rating actions indicate, questions remain about how the country will regain its status as a stable financial hub," said. Karagoez.

"As for Dubai, the overall debt overhang remains a concern and some large borrowers have been discussing debt restructuring with their lenders," Karagoez added. S&P said with the exception of a few banks, the financial metrics of the 26 banks it rates in the GCC continued to show resilience or even signs of a gradual improvement. "The ratio of nonperforming loans (NPLs) to total loans for about half of these banks declined last year. In addition, the total stock of NPLs stabilised at about $20 billion. The average NPL ratio per country for the GCC banks we rate ranged from 1.5 per cent in Qatar to 8.1 per cent in Kuwait at the end of 2010."

"However, we believe that the asset quality figures that some banks report don't give a completely accurate picture because of country-specific differences. For instance, Kuwaiti banks, as well as BankMuscat in Oman, moved sizable amounts of fully provisioned NPLs off balance sheet in the second half of 2010. Overall, cost of risk has declined, with the banks allocating 27 per cent of operating revenues for loan loss reserves in 2010 versus 34 per cent in 2009.

S&P report notes that balance-sheet growth remained largely subdued in 2010, except in Qatar where most banks grew at double-digit rates. "Nevertheless, in line with the focus on cost control, healthy margins, and decline in cost of risk, bottom-line profitability largely stabilised. Consequently, return on average assets stood at an adequate 1.3 per cent in last year."

The ratings agency said capital strength of most banks improved in 2010 as a result of the modest balance sheet growth, capital injections for some banks, and continued growth in retained earnings as most banks posted profits.

In April, another S&P report said governance among rated GCC banks was at a more advanced stage than in the corporate sector. "However, the level of problems faced by GCC banks during the global financial crisis indicates to us that there is room for improvement. We believe that many GCC banks could have limited their losses if the overall oversight of their activities by the board were more sophisticated."

-- issac@khaleejtimes.com

THE European debt crisis escalated sharply last week amid growing fears that Greece would soon default on its debt -- with Ireland to follow suit.

The threat of Greece being forced out of the euro also loomed larger after the Greek EU commissioner Maria Damanaki (right) became the first senior European official to warn that the debt crisis rocking her country could force it leave the euro.

Europe's response to its debt crisis clearly isn't working. It needs to come up with solutions fast before a union that is over 50 years old starts to fall to pieces. What options does it have?

EUROBOND

Some believe the answer to Europe's debt crises lies in the creation of a new bond, dubbed the eurobond. EU countries would essentially pool their government debt by issuing eurobonds, which would then be held by a central European debt warehouse. Doing so would allow troubled economies to refinance their existing debt at lower interest rates, improving their solvency and making it easier for them to raise money. To prevent the eurobond promoting reckless lending, it would only be available to help countries repay responsible borrowing.

Proponents of the eurobond believe it would represent far less of a financial risk to Europe than to actively bail a country out. They also believe it would enable debt-ridden countries to get back on their feet quicker and make them less likely to default, thereby increasing the stability of the eurozone.

"Lending money to debt-ridden countries is not a solution in itself," said Ronan Reid chairman of Dolmen Securities. "The European Central Bank (ECB) needs to create a structure where they buy back some of the debt and create a warehouse for that debt. Buying out some of the debt is a big risk for the ECB, but it either does that or it will have to write off some of the debt if a country defaults."

GROWTH BOND

Central Bank governor Patrick Honohan (above) last month suggested that Ireland's debt bill should be linked to its economic growth. Honohan advocated GNP-linked bonds, where Ireland would pay back a greater share of the repayments on bonds issued by the European Financial Stability Facility (an EU bailout fund) if its economic growth was strong. Conversely, Ireland would have to pay back less if its economic growth was weak.

SOFTER BAILOUT

Gray believes that the best way to resolve the debt crisis is for Europe and the International Monetary Fund (IMF) to give countries such as Ireland and Greece a longer time to clear their debts. He also believes Europe and the IMF should reduce interest rates.

"An immediate step that should be taken is for a more reasonable interest rate to be applied to the Irish loans," said Gray.

"This will not be a panacea for Ireland but will ease the adjustment it must make (to repay its debt) in some small measure."

Simon Tilford, chief economist of the Centre for European Reform, believes that Europe will have to write off half of the debt of countries such as Greece and Ireland. "Far from improving access to the financial markets, the support packages for Greece and Ireland have left these countries facing record borrowing costs," said Tilford.

"Initially, the EU will no doubt try and get away with 'soft' restructurings, involving a combination of longer maturities and lower interest rates. Unfortunately, in the case of Greece and Portugal at least, even this will not guarantee continued membership of the euro."

ECONOMIC REFORM

Greece, Ireland and Portugal must get back on their feet economically -- otherwise any moves to resolve their debt crises will be meaningless. To prevent a similar crisis re-occurring, Reid believes the ECB needs to lay down some simple rules for EU banks.

"The ECB also needs to change its mandate to one that fosters economic growth rather than one which controls inflation and ensures the stability of the monetary system," said Reid.

ONE EUROZONE ECONOMY

Some believe the only way to stop debt-ridden countries like Greece and Ireland dropping out of the euro is to create a eurozone with tighter political and fiscal integration.

In a report last month, Adalbert Winkler, a professor of finance at Frankfurt's School of Finance and Management, said: "A substantially more comprehensive economic union might be needed."

The problem with a single eurozone economy is that it is "politically near-impossible", said Alan McQuaid, chief economist with Bloxham Stockbrokers.

"Not only would it mean surrendering sovereignty -- few issues are more sovereign than collecting taxes and financing a budget -- but it would be the bailout to end all bailouts. Wealthy European countries such as Germany and the Netherlands would assume the collective debts and risks of the likes of Portugal and Greece.

"It would also mean that those countries 'rescued' would face no incentive to overhaul their economies to make themselves more competitive and grow.

"They would be more likely to go on as they have done, knowing they are protected under the eurozone banner."The European Central Bank needs to create a structure where they buy back some of the debt

CAPTION: It will require a huge financial effort to save the euro

(c) 2011 Belfast Telegraph. Provided by ProQuest LLC. All rights Reserved.

May 27--Leaders of the Group of Eight industrialised nations today declared the global economic recovery was becoming "self-sustained" despite concerns in many quarters.

But they cautioned that the high cost of commodities is hampering growth.

In a communique set to be released in the French resort of Deauville, where their summit is being held, the G8 leaders are expected to say: "The global recovery is gaining strength and is becoming more self-sustained.

"However, downside risks remain, and internal and external imbalances are still a concern."

It adds: "The sharp increase in commodity prices and their excessive volatility pose a significant headwind to the recovery. In this context, we agreed to remain focused on the action required to enhance the sustainability of public finances, to strengthen the recovery and foster employment, to reduce risks and ensure strong, sustainable and balanced growth, including through structural reforms."

Investors were still reeling from yesterday's comments by Jean-Claude Juncker, head of the eurozone finance ministers group, who claimed the International Monetary Fund could withhold its next instalment of aid to Greece. Junker said the European Union would not be able to make up the difference.

Greek Prime Minister George Papandreou today opened talks with opposition leaders to drive a consensus on the tough policies needed to tackle its huge debts.

WASHINGTON _ Congress is playing a game of "chicken" with the nation's finances, and the U.S. economy is at stake, with an Aug. 2 deadline.

The gross federal debt hit $14.3 trillion on May 16. That's as high as the law allows. Unless Congress raises the legal ceiling to permit more federal borrowing, a financial disaster is all too possible.

Treasury Secretary Timothy Geithner has said he can juggle accounts until Aug. 2, but no longer. Then the U.S. may default on its debt, something that experts agree should be unthinkable, because it could cause enormous financial damage worldwide.

Congressional leaders of both parties acknowledge this and say they won't let it happen. But Republicans are holding the increase in the debt's ceiling hostage to Democratic agreement to cut $2 trillion from federal spending over the next 10 years. Negotiations to do that are slogging along behind closed doors. Meanwhile, experts warn that delay is increasingly risky.

On May 20, Prince Alwaleed bin Talal, the Saudi investment mogul, warned on CNBC that "the United States is not giving much care and attention to this time bomb that you have right now here."

The dollar is the world's favored reserve currency. Treasury debt long has been considered the safest investment in the world. The very suggestion that the U.S. might default on its debt raises a host of unknowns.

"We don't know how this would work out, because it's never happened," said Nigel Gault, the chief U.S. economist for forecaster IHS Global Insight.

Congress has raised the debt ceiling 10 times since 2001. Geithner, Federal Reserve Chairman Ben Bernanke and virtually every prominent economist are warning that failing to raise it now could be catastrophic.

Here's what's all too possible:

A default would mean that Washington would stop paying interest to those who own government bonds. Credit markets could seize up. Stock markets could plummet. The recession could come roaring back into our lives.

Bond rating agencies would downgrade the U.S. AAA credit rating; Standard & Poor's already put it on a negative outlook status on April 18. That would mean the U.S. government is seen as less creditworthy.

Interest rates would rise across the economy, not just for government bonds but also for corporate bonds and consumer loans to buy homes, cars, everything.

"You'd clearly see substantially higher interest rates, and this flows through as the markets seize up. ... People wouldn't be sure whether anyone else's collateral is any good," Gault said.

The near-crash of the U.S. financial system in 2008 taught us that once credit markets begin to seize up, the extension of virtually all credit follows suit. Companies can't roll over their debt. Even plain-vanilla investments such as money market funds are suddenly stricken.

Since 40 cents out of every dollar the government spends now comes from borrowing, and the government then could spend only what it took in, federal spending would fall by 40 percent.

What spending would be cut? Soldiers' pay? Social Security benefits?

That's not to say that Washington doesn't have to stop piling on debt. Government debt held by the public has doubled over the past four years. In 2008, it was $5.8 trillion. For the fiscal year that starts Oct. 1, it's projected to be $11.8 trillion. This excludes debt the government owes itself _ borrowed from trust funds such as Social Security's _ which brings the gross federal debt total today to $14.3 trillion.

If current law remains unchanged, debt held by the public will grow steadily to peak at $18.2 trillion in 2021, the nonpartisan Congressional Budget Office projects.

Simply paying interest to the bondholders of all that debt will cost about $242 billion next year, according to the White House Office of Management and Budget. It'll more than double to $562 billion by 2016, the OMB estimates.

So experts agree that Washington needs to arrest its debt addiction by changing spending and tax policies. But they also agree that it needs to raise its debt limit first, independent of that, to avoid possible financial chaos.

"The rest of the world, where a lot of the investors are, doesn't understand American politics, and is completely baffled by the idea that we might deliberately provoke a debt default," said Alan Blinder, a former vice chairman of the Federal Reserve.

If it seems implausible that Congress could fail to raise the debt ceiling given the possible consequences of not doing so, remember this date: Sept. 29, 2008.

That's when Republicans in the House of Representatives defied their president and defeated a bank bailout bill, shocking financial markets. The Dow Jones Industrial Average fell almost 800 points, the largest one-day point drop ever.

Although Congress later reversed itself, historical financial data show that this was the inflection point that sharply deepened the financial crisis and intensified the Great Recession.

Now fast-forward to this May 17. House Budget Committee Chairman Paul Ryan, R-Wis., told CNBC television that "lots" of Wall Street players weren't worried about a debt default so long as it lasted just a few days.

"I think most people think that's nuts," Gault said.

In a May 20 research report, economists at Bank of America Merrill Lynch warned that a manufactured debt crisis would "undermine long-run fiscal stability, both directly and through psychological effects on investors. We continue to see the debt limit as a poor tool to force fiscal discipline."

Blinder fears that the government is already close to hurting itself even if default is avoided.

"If it gets threatened now and it goes to the brink like the recent (near) government shutdown ... then I think you start to establish a precedent, that when we have divided government this becomes a tool in the kit of a minority party" said Blinder, who's now a Princeton University economist.

Then we could go through this threat again and again.

A classic rule of both shopping and investing is that when most people steer clear of something, there may be bargains for the smart money.

Yet it doesn't always work that way at your local dollar store -- or with beaten-down stocks.

That's the challenge investors face with bank shares, particularly those of the industry's titans.

Many Americans see bankers as pariahs and can't understand why so few industry executives have faced prosecution for the excesses of the mortgage-bubble era.

But if the bankers have avoided jail, their stocks haven't: After bouncing since 2009, bank shares are the biggest losers of any major industry sector this year, even as the market overall has rallied.

The KBW index of 24 major U.S. bank stocks is down nearly 5% year to date, while the Standard & Poor's 500 index is up 5.8%.

The declines have been most severe among the largest banks. Shares of Bank of America Corp. are down 12% in 2011. Citigroup's stock is off 13%, Wells Fargo & Co. has fallen 9% and Goldman Sachs Group Inc. has plunged 17%.

JPMorgan Chase & Co. has the best performance of the lot, flat for the year.

The megabanks "have the tobacco-company tinge," said David Ellison, a veteran bank-stock investor at money manager Friedman Billings Ramsey in Boston.

Like the tobacco giants in the 1990s, the megabanks now are viewed as prime sources of society's ills -- and logical targets from which to demand hefty financial penalties.

The public hasn't gotten the banker perp walks it might have hoped for, but state attorneys general are trying to force the biggest banks to pony up somewhere around $20 billion to settle allegations of unfair home foreclosure practices.

And this week, California Atty. Gen. Kamala Harris formed a 25-person task force to target mortgage fraud, including deceptive bank lending practices, past and present.

The money merchants' legal ills don't end there. Goldman Sachs' stock has been hammered since Sen. Carl Levin (D-Mich.) last month asked the Justice Department to look into the findings of a two-year Senate probe of the bank's dealings in mortgage-backed securities. The implication is that Goldman executives could face criminal charges related to what Levin called "misleading" testimony to Congress.

Goldman said its testimony was "truthful and accurate."

Unrelated to the mortgage debacle, two other big banks -- State Street Corp. and Bank of New York Mellon -- are fighting state lawsuits alleging that the banks overcharged pension funds for currency trades.

"You name it, someone is suing the banks over it," said Dick Bove, banking industry analyst at Rochdale Securities in Lutz, Fla.

Even without its legal woes, the industry faces growing questions about its fundamental health.

The government's bailout program launched in late 2008 kept the financial system from spiraling into a black hole, and the Federal Reserve's easy-money policy has supported the banks since then by keeping their deposit costs near rock bottom as they work off bum loans and boost their capital cushions.

But investors this year are focused on three concerns about the industry's future:

* Earnings are up but revenue is down.

The nation's 7,500 banks and thrifts reported total earnings of $29 billion in the first quarter, the most for any quarter since the second period of 2007, according to the Federal Deposit Insurance Corp. But total industry revenue fell from a year earlier, only the second such drop in 27 years, the FDIC said.

What's more, revenue weakness was concentrated among the biggest banks. Why? A lack of loan growth and declines in certain consumer service charges as ordered under the Dodd-Frank financial reform bill that Congress passed last year.

With any business, if you can't generate revenue growth, you're eventually going to have a hard time generating earnings growth.

* The housing market is sinking again.

The hoped-for spring recovery mostly is a no-show, with home prices continuing to slide and sales lackluster despite another drop in mortgage rates.

Banks wrote off $149 billion in bad home mortgage loans from mid-2007 through 2010, Standard & Poor's calculates in a new report. The $1.8 trillion in residential loans still on the books account for about 14% of banks' total assets. Home equity loans are an additional 4.6% of assets and mortgage-backed bond holdings are 11%.

S&P looked at what a serious double dip in housing might mean for future bank loan losses. Assuming home prices were to fall another 15% by December 2012, S&P estimated that losses on banks' remaining home loans and mortgage-backed bonds would be as much as $80 billion more than if the average home price decline were limited to about 5%.

That $80 billion would amount to about 35% of the industry's projected pretax operating income for the period, S&P said. That is a "sizable potential risk" for the industry, it said.

* What happens when short-term interest rates rise?

A popular perception is that rising rates are bad for financial firms. And in fact, bank shares overall lagged behind the broader market in 2004 and 2005, when the Fed was continually lifting its benchmark short-term rate.

But rising rates can be good for banks if they can boost their loan rates faster than their deposit rates, which of course would be their preferred strategy. And if the reason for higher interest rates was that the economy was picking up speed, that could be positive for banks by fueling loan growth and reducing the risk of loss on outstanding loans.

In any case, the likelihood of the Fed raising rates any time soon has faded with the economy's slowdown in recent months.

Megabank investors should be more concerned about the status quo, said Christopher Whalen, a principal at research firm Institutional Risk Analytics. By maintaining near-zero short-term rates, he said, the Fed is "turning the largest U.S. banks into permanent zombies with unprofitable core banking operations."

Still, if all of these negatives are known to investors, the bullish case for bank stocks is that they may already be priced for the worst-case scenario, and don't reflect what might go right for the industry. Despite their gains since March 2009, bank stocks in general remain shadows of their former selves. The KBW index of 24 bank issues still is down 44% from the end of 2007 while the S&P 500 index is off 9% in the same period.

A rational argument for buying bank shares is that we can't have a healthy economy again without a healthy financial sector.

But if the U.S. economy can get back to some semblance of health, investors may figure there will be plenty of stocks to own that are more exciting -- and less viscerally objectionable -- than the banks'.

May 25--Anyone who thought the banking crisis was abating will have been abruptly disillusioned by a string of revelations this week.

Credit ratings agency Moody's yesterday indicated it may downgrade 14 UK lenders, including state-controlled Lloyds Banking Group and Royal Bank of Scotland, Santander's UK operations, the Bank of Ireland and the Nationwide building society.

It is keeping a 'negative' outlook on international bank HSBC and has changed its view on Barclays' future debt ratings to 'negative' from 'stable.'

The move came because analysts at the agency believe the UK government will be more reluctant to channel taxpayer money into bailing out the banks in future.

The Moody's assessment points to a deeper issue for policymakers: the bloated size of the banking sector in relation to the UK economy.

The total balance sheet of UK banks is more than four times annual GDP, much larger than in other developed countries, meaning our public finances are particularly vulnerable to a major financial collapse.

Sir John Vickers, who is chairing the Independent Commission on Banking -- charged with protecting taxpayers from banks that are too big to fail -- appeared in front of a committee of MPs for a grilling yesterday.

As one senior banker says: 'It is an irony that this Moody's report suggesting the banks are now less safe comes just as the Independent Commission on Banking is putting forward its recommendations which are supposed to make the system a safer one.'

Vickers' proposals include bigger buffers of capital against losses and measures to ring-fence risky 'casino'-style activities from day to day savings and loans.

But as he conceded yesterday, they will not fully fireproof the system.

'There are always going to be circumstances where the government will feel committed to come to the rescue of banks,' he said.

Vickers also admitted some bonuses to bankers had been partly financed by the billions of pounds of taxpayer aid handed to the industry.

This goes to the heart of the conundrum: taxpayers have been told there was no alternative but to funnel billions of pounds of their money into supporting the banks.

Otherwise, they were told, the entire system would fail -- yet the banks have shown little sign of repentance or of mending their ways on pay.

Adding to the rage against the banking machine, major lenders this week were shown to have failed at their prime function of channelling funds to businesses to kickstart economic growth.

The first set of figures from the controversial Project Merlin peace deal between the government and the banks showed that the big High Street players fell short of their lending targets to small firms by more than UKpound2bn in the first quarter.

The banks say they are pulling out all the stops to lend to any customer that is credit-worthy, but there is a lack of demand for loans.

Business lobby groups say firms are the victims of shoddy treatment and are being fobbed off with high interest rates and onerous terms and conditions.

'The reality is that there has been a breakdown of firms' trust in us. We have to rebuild that and we have done a fairly lousy job of it so far,' added the banking source.

Unless that happens quickly, Merlin -- an initiative concocted by former Barclays chief executive John Varley in an attempt to head off a clampdown on bonuses by the government -- is at risk of collapsing into public disrepute.

Under the Merlin agreement, the banks were meant to exercise restraint on bonuses, but politicians have no obvious way of enforcing that.

Business Secretary Vince Cable has been making noises about more bank taxes if they fail to fulfil their side of the bargain, but that would be met with furious resistance from the banking lobby. The banks' efforts to rehabilitate themselves have not been helped by claims from union leaders that 700 RBS job losses in Telford, Shropshire, Plymouth and Leeds will have a 'devastating' effect on local communities.

Nor has their image been burnished by the scandal over mis-selling Personal Protection Insurance, which led to a UKpound3bn write-off at state controlled Lloyds alone.

Then there are the rarely mentioned risks lurking just beneath the surface: exposure to losses in the eurozone and in the property sector, along with risk of more bad debt from consumers when rock-bottom base rates begin to rise.

The banks have a long way to go before they can claim to be back on an even keel following the financial crisis.

They are even further from restoring their battered public image.

Copyright (c) 2011, Daily Mail, London

Despite several catastrophes around the world with billions of dollars in losses, an overall market hardening is not imminent for U.S. reinsurance buyers, observers agree.

They disagree, however, about whether losses from earthquakes in Japan and New Zealand, floods in Australia and storms in the United States will have an impact on property catastrophe rates and whether renewals will see at least some increases.

One major unknown is the severity of the upcoming hurricane season.

Observers say the impact of the catastrophes on rates will become increasingly apparent over the course of the June, July and January renewals.
Another factor in the insurance rate picture is the new version of Newark, Calif.-based Risk Management Solutions Inc.'s U.S. hurricane model, which was released in February (see related story).

"In part because of the timing of some of these natural catastrophes, both globally and here in the U.S., it's really added to the uncertainty in the marketplace in a couple of areas," said John H. Vasturia, president of the regional clients division of Munich Reinsurance America Inc. in Princeton, N.J. "No. 1, what's pricing going to look like, and No. 2, what capacity will be like in the marketplace?"

"Something to keep in mind is that the impact is probably not going to be across the board," Mr. Vasturia said. "It will probably be different based on where you are in the world, what impact the losses have had on you as an individual company, and the types of business that you write and where the business is written," he said. "There is so much diversity across the industry."

Many moving parts

Aside from the issue of whether the catastrophes will have enough impact on the sector's capital to create a major change in the market, there also are "latent catalysts," including trends around reserves, cash flow and inflation/noninflation, said David Flandro, London-based global head of business intelligence for reinsurance intermediary Guy Carpenter & Co. L.L.C. "There are many, many moving parts out there. We're in a very different world than the one we were in three months ago."

"For the most part, the brunt of these international earthquake losses are being paid for by global reinsurers who are, of course, turning around and increasing pricing on those renewals" in the affected areas, said John DeMartini, Stamford, Conn.-based leader of Towers Watson & Co.'s catastrophe risk management and its U.S. property reinsurance specialty practices.

Observers disagree about the extent to which non-U.S. catastrophes will affect the U.S. property market.

The earthquakes "will have an impact on the places that lost money, so I think property exposures overseas will see higher prices," said J. Paul Newsome, managing partner at Sandler O'Neill & Partners L.L.P. in Chicago. He added, though, "I don't think it will have much of an impact on the U.S. marketplace."

"I don't see that as a big driver of the U.S. market," James Auden, an analyst with Fitch Ratings in Chicago, said of the foreign catastrophes. While American International Group Inc. "has quite a bit" of coverage in the affected areas, other large U.S. commercial primary insurers -- including Travelers Cos. Inc., The Hartford Financial Services Group Inc. and CNA Financial Corp. -- had very little, he said.

"I think they're putting their capacity out there and writing like they were; and we haven't seen withdrawal of capacity tied to those events in the U.S. market, so I think from a competitive standpoint," things remain unchanged, Mr. Auden said.

Cathy Seifert, an equities analyst with Standard & Poor's Corp. in New York, said insured losses from U.S. storms and floods, which risk modelers have estimated range from $5 billion to $7 billion, "could be largely personal, but there still certainly commercial exposure down there."

Some observers do expect some increase in reinsurance rates.

"Between the Japanese earthquake and the RMS model change," it feels like there have been some positive changes for the reinsurers, said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.

Mr. Gallant said that three months ago he would have predicted that reinsurance rates for the upcoming renewals would fall by 5% to 10%. Now, he said he expects them to be flat to down 5%. "It's certainly a positive change" for reinsurers, although not a "post-Katrina type of market," he said.

James Eck, New York-based vp at Moody's Investors Service, also said he had expected reinsurance renewals to fall 5% to 10% compared with last year, but now expects rates to be flat to increase by single digits. Reinsurers are "a little bit more optimistic about pricing," he said.

"There seems to be very early indications that there will be some momentum" for price increases in July, said Laline Carvalho, a director at S&P in New York. But, "We won't know the full impact of pricing until Jan. 1 of next year."

Robert DeRose, vp at Oldwick, N.J.-based A.M. Best Co. Inc., said property rates will likely start to stabilize and rates begin to rise in July, "the more dramatic impact might not be felt until January."

"It stands to reason there's going to be some additional catastrophes the balance of the year" due to the upcoming hurricane season and reinsurers "will probably want to see some payback, and that will probably be reflected at January renewals," Mr. DeRose said.

The Japanese quake "is a catalyst and it will firm market conditions," but "not to the extent 9/11 or Katrina did," said Ms. Seifert. "It will not be a dramatic turn."
While the catastrophes are not expected to affect casualty rates, Mr. Eck said some short-tail lines, such as energy and other property coverage, may see some firming, but the trend will not affect long-tail lines, including casualty. "Those still seem to have maybe a little bit of weakness to them, from what we're hearing," he said.

While "the market is starting to improve for property, for casualty reinsurance, there's more uncertainty. There's still excess capacity in the marketplace," Mr. DeRose said.

"Primary companies continue to retain more exposure. There are still some head winds in the economy. We're not seeing growth in exposure, so our view is the market is bottoming out," but rates will not yet increase over the near term to the extent seen in the property market, he said.

The timing of an overall turn is still hard to predict, say observers.

"There's still sufficient capital in the industry to allow for meaningful competition," said Bryon Ehrhart, chairman of Aon Benfield Inc.'s analytics and investment banking divisions in Chicago. "As long as that exists, you'll continue to have a set of circumstances that'll make it difficult for reinsurers to get" material rate increases, he said.

"From some of the companies we've talked to, they think one big hurricane this year should do the trick. In the absence of a large loss from hurricane season, we could start to drift downward again," Mr. Eck said.

A service of YellowBrix, Inc.

SYDNEY, May 26 Asia Pulse - The commodity prices boom fuelling Australia's economy is being driven by a strengthening global economy and is likely to continue for some time, a central bank official says.

Reserve Bank of Australia (RBA) deputy governor Ric Battellino on Thursday dismissed any notion of a commodity price "bubble".

"The word bubble is a very emotive term," Mr Batellino told the 2011 Annual Stockbrokers conference.

"There is no doubt that the world economy is very strong," he said, answering questions from the floor.

"Last year the economy grew by five per cent.

"Every time the world economy grows by five per cent, commodity prices rise, and the same thing is happening now."

What was unusual about the current boom was that was being driven by demand from Asia, Mr Battellino said.

"From all the work we've done, most of what we've seen in commodity prices today is driven by fundamental demand/supply factors.

"There's no doubt there's a bit of speculative activity still, but fundamentally it's very strong demand that is driving this."

Mr Battellino could not forecast how long demand would remain strong, but suggested prices had not reached a peak yet.

"Most people have forecast the next year, at least, before prices come down (and) they keep going up," he said.

"It's not clear that they've even peaked yet."

The world economy is in an upswing, Mr Battellino said.

"We're at the stage of the cycle where the world economy is still gaining strength. That's been the dominant force of the world.

"In that environment, it would be normal to see inflationary pressures continue to rise.

"That's likely to be accompanied by rises in global interest rates."

In an earlier, prepared statement, Mr Battellino said the RBA would welcome a continued rise in household savings, as it would ameliorate pressure when productivity was already being stretched by the resources boom.

Consumer spending was lower due to household caution, but rising incomes could fuel a recovery amid continuing strong saving levels, he said later.

Asked about risks to the Australian economy from overseas, Mr Battellino said the RBA shared general concern that government debt levels in the world were "too high".

"The problem is what to do with it. Government debt is a really hard issue to deal with," he said.

"Quite often in the past, when government debt has got to these levels, the result has been inflation because everything else has been too difficult."

(AAP) ms 26-05 1119

SECURITISATION RETURNS : In the wake of the subprime mortgage crisis, and the financial crash it caused, securitised financial products were considered toxic. But they are becoming big business again, with firms trading hundreds of millions dollars in collateralised funds once more.

SOME SAY IT was the reason why the markets blew up in 2008, why Bear Stearns and Lehman Brothers collapsed and sent a wave of mass destruction around the world, effectively toppling the Irish banks. So why is the business at the heart of the credit crunch starting to take off once more and have any lessons been learnt?

Securitisation has its origins in the mortgage-bond trading desks of Wall Street in the 1970s. In essence, it is about extracting tomorrow's value out of an asset today. So, for example, instead of waiting for 10,000 customers to repay their mortgages, a bank can instead securitise these loans, sell them off to investors, and reap the rewards today.

"It's about meeting the demands of investors for exposure to a particular asset class and to release funding of capital for the originator to be able to continue with their business," explains Alan Kerr, managing director of Harbourmaster Capital Management, the Dublin-based investment manager of subinvestment-grade corporate loans.

In Ireland, securitisation helped fund the credit boom, as banks securitised their residential mortgages and used the proceeds to lend out again to other borrowers. It got off the ground in 1996 with a pound(s)200 million ([euro]254 million) transaction but grew to a [euro]38 billion market by 2009.

Moreover, Ireland's international financial services sector emerged as a hub for the international business, with debt securities listings exploding on the Irish Stock Exchange, and Ireland becoming the largest location in Europe for special purpose vehicles (SPVs), the structures used to house the loans which were being shunted off a bank's balance sheet. Ireland now has a quarter of this market.

But while securitisation has its merits as a funding tool, it became a dirty word when layer upon layer of complexity and leverage were built into products based on dodgy US subprime mortgages, which were given out to borrowers with no source of income. When the mortgages started to default, propelling the US and Europe into financial meltdown, securitisation was blamed and the market for it grinded to a halt.

"There's a perception that all securitisation is bad, but all securitisation is not bad in the same way that all equity investment is not bad," says Kerr, adding, "there were many bad transactions - but it doesn't mean it's a bad thing."

Indeed Harbourmaster has been an investor in asset-backed securities (ABS) in the past, and between 2002 and 2005 built up a portfolio of [euro]1 billion in "vanilla", or more conservative securitisation assets, such as car loans and credit-card products.

However, it took the view to reduce its book to about [euro]100 million in 2005 on the grounds that the spreads were too tight, indicating that the risks had become too skewed to the downside.

And while the investment manager did have investment banks knocking on its door to sell it subprime products back in the day, Kerr says they were never attracted to it.

"We didn't think that the risks were appropriately captured in the returns," he says.

After the subprime market collapsed, the securitisation market dried up. According to Conor O'Toole, a director with Deutsche Bank in London, the European market fell from [euro]550 billion a year at its peak in 2006, to literally zero in 2008.

Now, however, the market is showing signs of recovery. While the markets officially reopened in September 2009 with a deal by car manufacturer Volkswagen, volumes did not take off, but now O'Toole is forecasting issuance of [euro]100 billion for this year.

Indeed, back in March Northern Rock, one of the pioneers of securitisation in Europe, returned to the market, in a deal that was "well-received", according to O'Toole, while Investec even got a pound(s)128 million ([euro]146.8 million) subprime deal away in the UK market, an important milestone.

If the business continues to pick up, Ireland's cash-strapped banks could look to securitisation to raise funds. "Once the banking crisis gets resolved, it could be an important funding tool for peripheral banks," says O'Toole.

And it could be a positive for the international business based in Dublin, given that the stock exchange has seen its debt security listings decline by more than 77 per cent from 2007.

But has the market learnt any lessons from its recent past? Northern Rock, after all, relied on asset-backed bonds for its funding, and when the markets closed in 2007 was unable to fund itself and had to turn to the British taxpayer for a bailout. Is its return to the markets a sign that it's back to business as usual?
Market players don't think so.

"The new issue market is only AAA," says O'Toole, adding that it's only the less risky, vanilla-type products, such as UK prime RMBS and auto deals, that are taking place, and that we won't see the same degree of "tranching", or leverage, that characterised the boom years for some time yet.

In addition, the issuance of more complex structured products, such as subprime collateralised debt obligations (CDOs) and CDO squared, has dried up. "That's a good thing probably," notes Kerr.

And there's no sign of the US subprime market coming back.

"The door on US subprime issuance remains firmly shut for now," says O'Toole.

Moreover, while the US leveraged loan or collateralised loan obligations (CLO) market may be picking up once more, in Europe the market remains dead, due to the dearth of arbitrage opportunities. Avoca Capital, a Dublin-based CLO manager with a portfolio of about [euro]6 billion, has had to adapt to this change by concentrating on other related vehicles. According to a spokesman for the firm, this has seen it raising funds from large investors such as pension funds to manage the money in an unrated CLO fund. In addition, earlier this year it acquired a credit hedge fund, LionTrust, to invest in high-yield bonds, something it is "very excited" about.

There has also been a dramatic difference in how rating agencies are perceived. Blamed for inaccurately attributing AAA ratings to assets which were anything but risk-free, credit agencies opened up the ABS market to a whole new world of investors, who were otherwise restricted to buying only the safest of securities.

In doing so, they created more demand for ever more exotic products and exacerbated the scale of the meltdown. According to the New York Times this month, 91 per cent of AAA securities backed by subprime mortgages issued in 2007 have since been downgraded to junk status.

"There was an over-reliance on ratings, and investors were effectively buying without due regard to the investment analysis that needs to be done," says O'Toole.
Now, however, investors are taking more responsibility for their own due diligence, but just because the rating agencies messed up, doesn't mean they still don't have a place.

"The banking world does require rating agencies - they won't go away," says Kerr, but adds, "maybe three to four agencies isn't enough".

And with a much tougher regulatory environment, which requires originators to keep some "skin in the game" by holding on to a percentage of their portfolio, investors are slowly coming back to ABS.

"Investors feel there's a better alignment of interests," notes Kerr.

They're also looking for a decent upside. With yields on government bonds - Ireland apart - and corporate bonds close to record lows, some investors are prepared to take on more risk to get better returns.

Last year, there were just two or three US dollar investors looking at European ABS, but now the figure is closer to 30, notes O'Toole, adding that structured products are looking "quite cheap" compared to other products.

But, while it may be "very vanilla prime paper that is offering an attractive risk opportunity" at the moment, according to O'Toole, the search for yield and greater returns could lead investors to seek out better returns through riskier products.

This time around, however, it will be hoped that everyone has learnt their lesson and there won't be a repeat of the subprime crisis.

Originally published by FIONA REDDAN.

May 25--PETERBOROUGH -- More than a few people were happy to see the former E.F. Lane Hotel reopen in downtown Keene early this month, including a bank in Peterborough whose $1.3 million loan to the original enterprise went sour.

That negative experience led to a foreclosure auction last fall, and also helped bring about a searing federal regulatory review of the lender, Monadnock Community Bank.

Last November, the federal Office of Thrift Supervision ordered the Peterborough bank to clean up its balance sheet, mainly by reducing its share of bad loans, and to revise its lending practices, both of which caught the attention of government officials during a routine examination last June.

In its order last November, the federal regulatory agency said that Monadnock had "engaged in unsafe and unsound banking practices" that included carrying too many high-risk loans, not having enough capital and not setting aside adequate reserves for loans that might go bad.

The bank did not contest the charges, and it agreed to change a number of its practices.

William Pierce, the president of the bank, said in an interview this week that the institution has taken a number of austerity steps, including closing its branch operation in nearby Winchendon, Mass., and has gone to work on its loan portfolio.

Of the federal regulators, he said, "They told us we have to start getting a little tougher" on delinquent borrowers.

Pierce said the bank, which lost money last year, will continue to lose money in 2011 as it works out its problems.

He said, however, that, on the basis of a new business plan that the government demanded, and boosted by an economy that he said he senses is on the mend, Monadnock will return to strength. "We expect to be profitable in 2012," he said.

Meanwhile, the bank has shrunk in size. Its most recent financial filings with the Office of Thrift Supervision lists total assets of $96.2 million, compared with $112.6 million a year ago.

In the same report, it records capital of $9.2 million, down from $10.6 million a year earlier.

The ratio of capital to assets reflected in these and other measures of banking performance falls within ranges that are considered normal in the industry.

The small bank, which got its start as a credit union in 1971, and later converted to bank status and sold shares to the public, de-registered its stock in 2009, ostensibly to save on regulatory costs.

Until recently the bank exhibited signs of stability; managers of the federal government's financial recovery program thought enough of the bank in December 2008 to issued the bank $1.8 million of capital to stimulate lending in its market.

The action came at the same time as the government's bailout of troubled large banks, but was different because the money was aimed at encouraging what the government called "viable" financial institutions to lend.

But conditions took a bad turn. The hotel loan went sour, as its then-owner, a boutique hotel chain called Someplaces Different, struggled. The experience hurt because the loan constituted a comparatively large commitment. But Pierce said that other borrowers also got into trouble, among them Sims Press, a Peterborough company that was also the subject of a foreclosure sale.

The hotel loan situation is not entirely resolved. When the property was sold at auction last fall, a new owner -- the nonprofit development entity Monadnock Economic Development Corp. -- took out a short-term loan from the bank; the financing was used to help prepare the property for eventual resale, which is expected expected to occur next month.

The intended purchaser is related to the management company that is now running the hotel.

Under those new managers, the establishment recently opened its refurbished 40 rooms to the public, and will also eventually add business tenants.

Meanwhile, Monadnock banker Pierce said he is confident the institution, which is the only bank headquartered in Peterborough, will emerge from the experience in better shape, after a lot of work. The federal regulatory order requires a heavy regimen of status reports on corrective actions.

"We hope to have (those requirements) lifted next year," Pierce said.

CANBERRA, May 25 Asia Pulse - Australian banks believe that forcing them to provide a fact sheet on new products is a waste of time.

Parliament is considering draft laws that would require banks to provide consumers with a standardised one-page fact sheet to compare loans, and ban unsolicited offers to increase credit limits.

Australian Bankers' Association (ABA) chief executive Steven Munchenberg told a House of Representatives inquiry hearing on Wednesday that information and calculators already were available on bank websites so that consumers could make comparisons on different loans and credit cards.

"It just seems in the 21st century, we find it strange to be handing out sheets and sheets of paper," he said, adding the information on them would not actually reflect the repayments borrowers would be making.

Not only would banks have to make changes to their systems and practices, it risked delivering information that potentially could be misrepresented.

"It doesn't mean we are giving you a loan and it doesn't mean ultimately that's what you are going to be paying," Mr Munchenberg said.

Under the draft laws banks would not be able to offer unsolicited increases to credit card limits.

The bankers' chief said opt-out provisions existed already that would stop banks making such offers.

Reserve Bank figures show that just 1.1 per cent of credit card holders are in trouble making repayments, while a vast majority of customers pay off their credit card every month in full, or most of their debt each month.

The new rules would mean it would no longer be commercially viable for banks to offer low or zero-interest balance transfers on credit cards, which allow customers to consolidate their debt, Mr Munchenberg said.

Opposition members of committee conducting the inquiry believe it is up to individuals to make responsible decisions, but Treasury officials defending the new rules said responsible lending requirements were needed.

It was argued that an individual may have too many credit cards they no longer could afford to repay.

"(But) there is a distinction between someone choosing to apply for a credit card with a different provider and simply ticking a box in a pre-approved offer," Treasury official Geoff Miller told the hearing.

The opposition is concerned the new laws will come at a cost to banks that will be passed on to their customers.

Mr Miller admitted the banks would incur transitional costs to meet the new requirements, but said they would be minuscule in comparison to the size of bank profits.

"It would be very hard to discern if you were a consumer if you have got an increased cost because of this," he said.

(AAP) nt 25-05 2007

Dubai-based investment bank Rasmala plans to shut its retail brokerage operations in the UAE, as part of a restructuring programme that began in November last year, Reuters has reported, citing an internal memo. "We debated extensively whether to maintain the UAE retail brokerage operations and concluded that the infrastructure it requires, in terms of staff, operations and risk management exposes us to a heavy operational burden and high risk for a minimal return," Ali al Shihabi, Rasmala's founder and chairman said in the internal document. The bank plans to focus solely on institutional brokerage and research, asset management and corporate finance after its board approved the updated strategic plan, the document said.

(c) 2011 Middle East Financial News.

CANBERRA, May 20 Asia Pulse - Don't get too panicked about an interest rate rise just yet.

The spread of economic data in the past week or so suggests Reserve Bank of Australia governor Glenn Stevens won't be getting too hot under the collar when he sits down with his board on June 7.

Weak demand for housing loans, soft consumer sentiment and restrained wages growth are hardly the stuff to force the central bank off the sidelines with a rate rise for the first time since last November.

But the central bank's rhetoric has clearly changed since last month's release of the March quarter consumer price index (CPI), which showed price rises were even stronger than everyone was expecting, including the bank itself.

While this was a reflection of a spike in fresh food prices in the wake of this summer's natural disasters and higher fuel costs, the more worrying sign was a solid lift in underlying inflation in the quarter, even though this measure takes out volatile price swings.

The Reserve Bank now believes that interest rates will have to rise "at some point" to keep inflation within its two to three per cent target over the medium term, as opposed to its previous view that monetary policy was currently "appropriate".

This change of heart had some economists expecting an interest rate rise sooner rather than later, and possibly as early as June.

But the recent run of data, particularly on wages growth, suggests that the central bank won't be that hasty.

National Australia Bank's head of research Peter Jolly said a June 7 rate rise always had "messaging issues" coming after a probable negative quarter of economic growth when the March quarter national accounts are released on June 1.

A contraction in growth, the first since the December quarter 2008, would again be the result of the spate of disasters both at home and in neighbouring trading partners Japan and New Zealand.

But before current and potential borrowers get too comfortable, Mr Jolly still sees the risk of a rate rise at the July 5 board meeting.

Others, like RBC Capital Markets head of Australian and New Zealand strategy, Su-Lin Ong, see the Reserve Bank holding off until August, by which time it will have seen the June quarter CPI.

"We continue to think that the RBA may take a little more time to gather more data and anecdotes to gauge the underlying pulse of the economy before feeling confident enough to raise rates again," Ms Ong said.

Financial markets are currently pricing in a 50 per cent chance of an increase in August and it's not until February next year that a 25-basis-point increase is fully priced in.

Still, Mr Jolly said an awful lot of words and nuances are devoted to what will be a modest rate increase, and whether it is June, July or August, there is a risk of losing sight of the bigger picture.

"The RBA's broader concern remains managing Australia through this once-in-a-century commodity boom that they expect to run for a good while," Mr Jolly said.

The risk through this period, as it has been in every prior commodity boom over the past century, is of breakout in inflation.

"So while China is on, and commodity prices are high, RBA policy can be biased in only one direction - tighter," Mr Jolly said.

The good news for borrowers is that Mr Jolly believes with the central bank having so far been pre-emptive in its rate decisions, it may not have that much more to do, possibly 50 basis points in total.

Other economists, however, expect there could be a further 100 basis points worth of rises.

Still, the performance of the Australian dollar will play a big part in determining the extent of future rate increases.

In its May board meeting minutes released on Tuesday, the central bank noted that the recent rise in the exchange rate was likely to have further tightened financial conditions in some sectors of the economy.

"The recent appreciation of the exchange rate and a continuation of the relatively high saving ratio by households would help to contain some of the inflationary pressures coming from the resources boom," it said.

Mr Jolly expects that if the Aussie dollar goes above 110 US cents, it may require just one 25-basis-point increase.

Managing the mining boom has been the mantra of the Gillard government surrounding last week's 2011/12 federal budget.

It is why, the government said, there is a need to get the budget back to surplus as quickly as possible and why it is encouraging greater participation in the workforce to relieve pressures from the boom.

While there is much debate whether the government is doing enough to take pressure off interest rates, the Reserve Bank in this month's quarterly monetary policy statement said that fiscal policy would be "contractionary over the next couple of years".

This, along the high exchange rate, is helping to partially offset pressures that will be dominated by a build-up in mining investment and the boost to incomes from a rising terms of trade.

Sure, that statement was released a few days before the budget was delivered, but given one of the board members is the Treasury secretary, one must assume that he at least indicated that this would remain the case, without giving too much else away.

After all, the government has been talking about a 2012/13 surplus seemingly forever.

And the still relatively new Treasury secretary Martin Parkinson believes that if fiscal policy was any tighter it would put the economy at risk.

Treasury has forecast the budget recovering from a $49.4 billion deficit in 2010/11 to a $3.5 billion surplus two years later, the fastest consolidation in over 40 years.

"My own sense is that doing significantly more to tighten fiscal policy in the short run would inject another risk - that of slowing the economy excessively - and could undermine the prospects for achieving the promised fiscal consolidation," Dr Parkinson said in his first post-budget speech at an economists' lunch on Tuesday.

Not that that will stop the opposition and borrowers getting fired up when the rate rise eventually comes.

(AAP) nt 20-05 1940

THE INTERNATIONAL Monetary Fund has issued its strongest hint yet that other European countries and EU institutions should share the costs of Ireland's banking crisis.

During a telephone conference yesterday, Ajai Chopra - the most senior fund official dealing with the Ireland brief - said Ireland's problems were "a shared European problem that requires a shared European solution".

He said more European funding needed to be made available for bailed-out countries if the euro area crisis is to be contained.

The bailout mechanism needed to provide the "right amount of financing, on the right terms and for the right duration".

The countries concerned "cannot do it alone", he said, and a "disproportionate burden" was being placed upon them by budgetary cuts that "may not be economically or politically feasible".

He also suggested that the European Central Bank should provide medium-term funding to the Irish banking system.

He described proposals made by some EU states to have Ireland raise its rate of corporation tax as "not consistent with the goals of the programme in restoring growth".

Yesterday's report and statements mark a clear difference between the IMF and the European Commission on the budgetary stance in the future.

This week the Brussels-based institution hinted that a larger budget adjustment next year might by advisable.

The IMF yesterday opposed any further austerity beyond the measures already planned, saying an acceleration of the fiscal adjustment would not mitigate risks Ireland faced and would "further retard growth in an already weak economic environment".

On all contentious issues the IMF sided clearly with the Irish authorities.

The IMF is, however, the least influential member of the troika of organisations overseeing the bailout.

While he praised the Irish authorities for their "decisive" actions, Mr Chopra warned that even if all the bailout terms were implemented they might not be sufficient to ensure their objective - allowing the State to return to the bond market - will be met.

He noted a number of negative developments since the package was put in place half a year ago.

These included lower economic growth, a worsening unemployment picture, further downgrades to the State's credit rating and a deterioration in the wider euro area crisis.

An accompanying IMF report also noted the destabilising effect the withdrawal of deposits has had on the banking system.

Despite considerable successes in downsizing the banking system, its loan-to-deposit ratio had deteriorated because of these withdrawals. The report said the value of outstanding bank loans at the end of December 2010 was double the banks' total deposits.

More positively, the report says the sustainability of the State's debt has improved "somewhat" over the past six months because the cost of recapitalising the banking system will require an additional [euro]19 billion of borrowings, rather than the previously envisaged [euro]35 billion.

The IMF now expects public indebtedness to peak at 120 per cent of gross domestic product, rather than 125 per cent.

The new projections are, however, subject to continued risks, according to the report, most notably from lower economic growth and higher interest rates.

On the euro area response, Mr Chopra was critical of both short- term and long-term responses.

The temporary rescue facility, which will be in place until 2013, requires an "upgrade", he said.

The permanent facility, to come into being in 2013, has worried investors and makes solving the crisis an "uphill battle".

"Europe needs more integration, not less," Mr Chopra concluded.

Originally published by DAN O'BRIEN, Economics Editor.

(c) 2011 Irish Times. Provided by ProQuest LLC. All rights Reserved.

The Ireland that President Obama visits for the first time today is down on its luck and therein lies a lesson for the United States.

Gone is the economic boom that transformed Ireland over the past decade. In its place: crushing government austerity measures following a sovereign debt crisis that required an embarrassing bailout from the European Union and International Monetary Fund.

Jobs have been jettisoned, salaries slashed, pensions and health benefits reduced. Unemployment hovers near 15%. The economy, which shrank 8% in 2009 and 1% in 2010, is barely back in the black and the government is paying 5.8% interest on its bailout loans.

With Greece and Portugal struggling under their own debt burdens and bailout packages, the 17-nation eurozone has put the brakes on government stimulus measures that were needed to climb out of the 2008 global financial crisis. They're doing what the United States has yet to do cutting back.

"It's a tough, tough slog," says Michael Collins, the Irish ambassador to the U.S. "Everybody has had to take a share of pain."

The austere times shared by Great Britain, which is not a member of the eurozone but has begun a program of deficit reduction can't be good for the U.S. economy, either. Collectively, Europe is America's biggest trading partner.

Financial experts and credit-ratings agencies say the mess is a warning for Obama and Washington lawmakers: Get your fiscal house in order or risk the same fate.

"In the United States, there's more time than the Irish had," says Moody's senior credit officer Steven Hess. "But certainly, what has happened in Ireland is a demonstration of the kinds of pressures that the U.S. faces over the long term."

Although Ireland's debt crisis was caused by a housing bust and credit meltdown far worse and more poorly managed than the U.S. version, there is one haunting similarity: government debt, counting what's owed by state and local governments, is in the same ballpark.

"How much worse does it get if instead of taking care of the problem yourself, you allow the problem to take care of you?" says Joseph Minarik, senior vice president at the Committee for Economic Development.

"Ireland got to the latter point. They had the situation rubbed in their faces," he says.

Ireland's debt was about 25% of its economy before the housing and credit bust prompted the government to bail out the banks. Now it's 112% and rising.

"The banks ripped us off. The government ripped us off," says Paddy Quigley, 56, a resident of Moneygall, Obama's ancestral home. "Our economy is down, and we need something to boost us."

The cutbacks are a heavy tax on Ireland's 4.5 million people. "Adjusting one's economy in the wake of a crisis inevitably entails a decline in the standard of living," says Bruce Stokes, a trans-Atlantic economics scholar at the German Marshall Fund of the United States.

Even while visiting tiny Moneygall (pop. 296) and speaking at a raucous rock concert in Dublin, Obama is sure to see signs of Ireland's decline. Experts hope it makes an impression on him.

"This will be an important chance for the president to see what this has done, politically, socially and economically," says Heather Conley, director of the Europe program at the Center for Strategic and International Studies. She cites the rise of nationalist, populist and anti-immigration groups.

Obama might rather study Ireland's pro-business environment its 12.5% corporate tax rate is a major attraction. But some European officials have argued that the low rate should be raised to provide more revenue. Obama, caught in the middle, may sidestep the issue.

As Europe headed toward austerity in 2010, the Obama administration was still calling for fiscal stimulus measures on both sides of the Atlantic.

Today, not so much. The White House and congressional leaders are seeking ways to reduce a $1.4 trillion budget deficit just to win passage of an increase in the $14.3 trillion debt ceiling.

"I think we're all talking the same language," says Nigel Sheinwald, British ambassador to the United States.

Not a moment too soon, say ratings agency officials. When Standard & Poor's said last month that its top (AAA) rating on U.S. debt was at risk, that was a signal that policymakers must get their act together.

European nations are cutting back and "that's a striking contrast to where the debate still is in the United States," says David Beers, S&P's global head of sovereign ratings. "It seems to us that it requires leadership ... and a kind of sustained effort to explain to voters what the choices are."

(c) Copyright 2011 USA TODAY, a division of Gannett Co. Inc.

Using risk factors to dynamically manage investment risk in pension and sovereign wealth funds is becoming more widespread, and big money managers are getting in on the act.

Managers are increasingly offering multiasset strategies run with a risk factor-allocation approach, and preaching the benefits of adopting the approach for entire portfolios.

Goldman Sachs Asset Management, J.P. Morgan Asset Management and PIMCO are promoting the idea to clients as part of their solutions businesses, looking to use their firm-wide risk systems to develop closer relationships with clients. Meanwhile, PIMCO and Schroder Investment Management are developing multiasset strategies that employ factor allocation, and BlackRock Inc. has seen significant inflows to similar strategies.

"Over the past five years, we've seen a huge increase in interest in factor analysis" from institutional clients, said Charles Baillie, London-based global head of portfolio solutions at GSAM. "Factor analysis is a smarter way of thinking about risk and downside protection."

Reliable picture

Risk factors are components of asset-class returns; analyzing them gives a more detailed and reliable picture of what's driving returns. For example, returns of high-yield bonds, which might sit in a bond portfolio, are driven as equity factors in addition to credit ones.

James Moore, managing director and co-head of investment solutions at Pacific Investment Management Co., Newport Beach, Calif., said a colleague uses the analogy of a Mexican restaurant to explain risk factors. Although the restaurant's menu lists many dishes, each contains the same seven or so ingredients used in various proportions.

Large pension plans and sovereign wealth funds such as the $240.5 billion California Public Employees' Retirement System, Sacramento; the $39.9 billion Alaska Permanent Fund, Juneau; and the 220.8 billion Swedish kronor ($34.9 billion) AP3, Stockholm, have adopted factor-based asset allocation approaches.

However, implementation is "very difficult to do on your own without the proper systems," GSAM's Mr. Baillie said.

Interest is growing because risk factors allow investors to understand more clearly what's driving returns. Plus, they can aid diversification and enhanced downside protection.

"After the crisis in 2008, investors really took to heart that diversification in capital terms is not equivalent to diversification in risk terms," Kevin Kneafsey, managing director and head of research for BlackRock's multiasset client solutions group in San Francisco, said in an e-mailed response to questions.

"In reality, balanced portfolios such as 60% equities/40% bonds allocate about 90% of their risk budget to equities. This leaves them exposed to the risk of large economic slowdowns, which have happened twice over the past decade."

Investors are searching for new risk management tools, and looking to managers for help, said Anthony Werley, managing director and chief strategist, endowment and foundations group, at J.P. Morgan Asset Management, New York. "After 2008 and 2009, people are saying to themselves, 'We need to get a better handle on the risks we're taking.' " Mr. Werley wrote a white paper titled, "Factor Risk Management: A Generalized Methodology for Multiasset Class Portfolios," last week. He hopes endowments and foundations will migrate to using a factor-based allocation approach.

"The most sophisticated endowments and foundations are certainly familiar with it and some are using it. But this isn't a widely dispersed tool," he said. JPMAM offers clients use of its factor model. "We're not here to charge a fee for the analysis," he said. "We want that to lead to a deeper relationship" with the client.

Said PIMCO's Mr. Moore: "The solutions effort is in large part about knowledge-sharing on a two-way street. Obviously we have a depth of resources ... but also what's very valuable to us is that it helps us better understand our clients." That knowledge can be used to develop strategies with wider appeal, or to prioritize timing of new strategies, he said.

"Clearly there's a big shift to a more complete offering on the asset manager side," Frank Nielsen, New York-based executive director and head of index and applied research-Americas at MSCI Inc., said in an interview. "For those kinds of mandates, the challenge is to show they are capable of managing the risks."

Risk management has greatly improved since the global financial crisis, Mr. Nielsen said. In December 2009, MSCI released a survey showing that money managers and institutional investors were scrambling to boost their risk management capabilities. At the time, Mr. Nielsen said that claiming to have cross-asset-class risk management capabilities "was more of a marketing function" than reality.

Since then, "we have seen a strong trend to improve internal risk management capabilities at asset management firms, including cross-asset-class and firm-wide assessment of investment risks," Mr. Nielsen said in an e-mailed response to questions.

In addition to offering risk analysis as way to develop closer ties with investors, managers are using factor analysis in customized multiasset strategies or solutions.

$3 billion managed

BlackRock ran $3 billion globally in multiasset strategies based on factor allocations as of April 30, up from "several hundred million dollars" as of mid-2009, according to data supplied by the firm. BlackRock recently won an as-yet-unfunded mandate from the National Employment Savings Trust, the U.K.'s nationwide defined contribution plan, which is expected to be up and running this year.

Because these strategies get cheap exposure to beta through derivatives and provide equity-like returns with less risk, managers say they're a natural pick for DC default options.

GSAM's Mr. Baillie said all of the firm's multiasset strategies are run using factor allocations. Sometimes, though, exposures are communicated to less sophisticated clients in an asset management framework because that's what they're accustomed to, he noted. GSAM would not disclose AUM data.

PIMCO's Mr. Moore added that an asset class focus and a factor focus are "both necessary -- you can't just readily buy factors."

There are a number of ways to use factors to analyze a portfolio, from estimating typical factor exposures present in asset class investments to looking at actual portfolio holdings. Consultants say that in the past year or so, a modeling approach has become a standard supplementary tool in reviewing clients' portfolios.

Understanding the underlying return drivers makes investors better able to predict how their portfolios might perform under certain scenarios, such as in a high-inflation environment.

"That is part of our formal strategic process, to consider risk factors," said Nick Sykes, European director of consulting at Mercer Inc., London.

Matthew Roberts, senior investment consultant and head of multiasset diversified growth research at Towers Watson & Co., London, added that "it's something we think is pretty important to build into the allocation process, as well."

Nicolaas Marais, head of multiasset solutions at Schroder Investment Management Ltd., London, said the use of factor allocation in multiasset strategies is sensible for the same reasons that investors might want to use the strategy across their portfolio.

But he added that risk factors provide a "common language" for investment teams at his firm, as well as a "very elegant framework" for understanding risks and aggregating complex investments in multiasset strategies.

"I'm adamant that a renewed focus on downside protection is a key part of these strategies," he said. He said Schroders is building a strategy, but declined to provide details.

Managers have used factor analysis in single-asset-class strategies for years. "The concept is not that foreign," Mr. Marais said. "It's that the multiasset space has lagged behind in sophistication."

A service of YellowBrix, Inc.

May 17--DUBAI -- The Government of Dubai on Monday took over Dubai Bank, a Shariah-compliant financial institution, after a capital injection, a statement issued by the Dubai Government Media Office said.

The injection will effectively dilute the complete holding of Dubai Bank's current shareholders, and consequently allow the 100 per cent takeover of the bank by the Government of Dubai.

Before this acquisition, Dubai Bank was jointly owned by Dubai Holding and Emaar Properties at 70 and 30 per cent, respectively.

The statement further clarified that the intervention is designed to ensure that Dubai Bank's business continues uninterrupted while options for the bank's future, whether to be run on a stand-alone basis or be potentially merged with another bank in which the government has ownership, are being assessed.

The government emphasised that it has decided to act swiftly to ensure the preservation of all of Dubai Bank's depositors' interests, the statement added. The UAE Central Bank and the Ministry of Finance have extended their support to Dubai Government's initiative.

The management team at Dubai Bank will not be affected by the takeover and will remain in place without any changes, the statement said.

In March, ratings agency Fitch downgraded the bank citing its weakened financial flexibility and exposure to certain Dubai entities that are being restructured.

Dubai Bank, which has not reported its 2010 financial results, declared a loss of Dh290.6 million in 2009. At the end of 2009, it had total assets of Dh17.4 billion ($4.74 billion), against total liabilities of Dh15.7 billion. Customers' deposits for the period stood at Dh14.9 billion.

"The situation of Dubai Bank has been pretty weak and always questionable," Mohammed Yasin, chief investment officer at CAPM Investments in Abu Dhabi, told Reuters.

"There have been questions raised about the sustainability and continuity of their operations for a while. The bank has some serious liabilities outstanding and those need to be addressed," Yasin said.

"In terms of credibility of the UAE banking system, it was very important that the bank did not default. A default by Dubai Bank would have raised worries about other local banks operating in the country," he added.

Dubai Bank reorganised its operations in 2010 and positioned itself as a retail bank for premium customers with merchant banking on the corporate side.

"This seemingly takes care of one of the areas of systemic risk that we have been worrying about," said Raj Madha, a banking analyst at Rasmala.

"This has been in the works for some time, it is the Dubai Government rearranging its holdings," Dubai Bank's Chief Financial Officer Ahmed Elshall later told Zawya Dow Jones.

Dubai Bank several years ago put itself up for sale but potential suitors lost interest because of the high sale price and the risk of looming loan losses as a result of the regional property downturn. One banker familiar with the situation said that the bank may require "a couple of hundreds of millions of dollars" worth of capital to repair its balance sheet.

"Capitalisation may be required for other reasons," said Dubai Bank's Elshall. "You may need capital to pursue new strategies for the future," he said.

"From a realistic point of view, there a number of banks owned by governments, that is the case for Abu Dhabi for example, and it is likely in view of the period we've gone through there will be some consolidation," Elshall said.

Analysts at AlembicHC said a possible scenario could involve Emirates NBD, one of the region's biggest banks by assets.

"Emirates NBD always stressed it would only do an acquisition on commercial terms, which is only possible after a capital injection and proper cleansing of Dubai Bank's loan book," said Jaap Meijer, head of the banking team at AlembicHC.

"Even if Emirates NBD [56 per cent owned by Investment Corp of Dubai] would get Dubai Bank for free, it would reduce its Tier-1 by 90bps [although less negative than a takeover of Amlak], taking into account a 12.5 per cent write off of Dubai Bank's loan book, as its loan loss provision needs would exceed Dubai Bank's capital base," he added.

Dubai Bank was turned into an Islamic bank in 2007 and last year appointed Giel-Jan Van Der Tol, a former ABN Amro banker, as its new chief executive.

-- abdulbasit@khaleejtimes.com

The expected growth of sovereign wealth funds highlighted the Milken Institute Global Conference May 2-4 in Beverly Hills, Calif.

Broader topics at the conference included investors using the lessons learned from the 2008-'09 financial crisis to develop plans, such as new and revamped asset classes like impact investing, clean technology and shareholder activism, and how public pension funds were incorporating risk into their asset allocations.

Sovereign wealth funds worldwide are expected to grow an estimated 50% to $6 trillion in two years, according to data from the Milken Institute. That growth is to come from new funds being created by governments and an improving economy, Patrick Mitchell, senior managing director and portfolio manager at Guggenheim Partners, said at a May 4 panel discussion.

Although total assets invested by sovereign wealth funds fell in 2010, the number of investments grew, said Drosten Fisher, principal with consulting firm Monitor Group, unveiling research at the conference. Sovereign wealth funds invested $53 billion in 172 investments in 2010, compared with $69 billion in 113 investments the year before.

Half of the assets in 2010 were invested by Middle East and North Africa-based sovereign wealth funds. Most of the MENA investments, $13.5 billion in 17 transactions, were in the Asia-Pacific region. Some $7.5 billion was invested by MENA sovereign wealth funds in 14 deals in Europe and $2.7 billion in one deal in Latin America.

Asian sovereign wealth funds were the most active. The majority of the transactions -- 51 deals worth $11.5 billion -- were in Asia, with the second largest number of transactions in North America -- $8.6 billion in 23 deals.

U.S. investing

Elsewhere at the conference, alternatives managers explained issues related to investing in the U.S. Carlyle Group has become the largest private equity investor in emerging markets, said David Rubenstein, managing director and founder, during a panel discussion on May 2. The firm now invests in 20 emerging and developed countries, he said.

"The U.S. is the single best place to invest, but you can't be centered on the U.S. as we were 10 to 20 years ago to get reasonable rates of return," Mr. Rubenstein said.

At the same time, U.S.-based real estate investors are also losing their dominance at home, a panel of real estate managers claimed.

"The American investor used to be the guy," said Barry Sternlicht, chairman and CEO of real estate investment firm Starwood Capital Group. Now foreign investors are coming to the U.S. looking for real estate bargains. Mr. Sternlicht noted that a Dutch pension plan recently bought a building in New York "for 30% off." He did not provide details.

Institutional investors at the conference spoke of investment risks in the post-economic crisis world. Janet Cowell, North Carolina state treasurer and sole trustee of the $72.4 billion North Carolina Retirement Systems, Raleigh, said the system is investing more overseas so it's not "completely reliant on the U.S.," during a May 2 panel discussion titled, "The View from Institutional Investors."

Hazel McNeilage, head of funds management at Queensland Investment Corp., a Brisbane, Australia, investment manager with A$57 billion (US$61 billion) under management, said her firm is "very very focused on diversification" but not by asset-class labels. Instead, QIC executives think about risk drivers and diversify risk, said Ms. McNeilage, who spoke on the same panel as Ms. Cowell.

Ms. McNeilage said that QIC has the capability to make short-term shifts in allocation because it doesn't have a strategic asset allocation, but uses asset allocation ranges instead.

"We think it (volatility) will be here for a long time and it is a more appropriate way to manage asset allocations," she said.

The portfolios Ms. McNeilage manages feature infrastructure and real estate prominently; she sees opportunity in U.S. real estate right now. QIC's clients also have smaller allocations to private equity, which is included with equities, and is exposed to a broad range of alternatives including music royalties, timber and catastrophe bonds.

"If you go into some of these alternative areas, you have to get in at the right time to capture the risk premium," she said. "We are always looking for the opportunities to diversify returns and risk drivers."

Andy Dillon, Michigan state treasurer, noted that the $51 billion State of Michigan Retirement Systems, Lansing, is 80% funded and that with fixed income earning "very little," fund officials are searching for enhanced returns. The pension fund already has 20% in private equity and 5% in real estate, and fund officials are starting to move toward absolute return and are looking at global infrastructure.

"Troubled governments around the world will shed (infrastructure) assets," he said.

Fund officials are attracted to infrastructure because it can produce a 9% to 10% return and the infrastructure assets have 40-year lives, which is a good fit for a pension fund, he said.

Part of Michigan's risk management includes a 15% currency hedge. The pension fund's global equity allocation is 45% domestic, 45% developed markets and 10% emerging markets. The fund has non-U.S. exposure because many large domestic companies do a lot of business overseas, he said.

Portfolio risk

The $240.5 billion California Public Employees' Retirement System, Sacramento, is looking at portfolio risk, Joseph Dear, chief investment officer, said on the institutional investor panel. CalPERS officials looked at the system's exposure to growth risk, inflation and liquidity risk and the opportunities to hedge out these risks, he said.

"Markowitz's mean variance portfolio optimizer assumes rational investors ... and those things do not hold in this world," Mr. Dear said. As a result, CalPERS needs the capability to make short-term shifts.

Mr. Dear said that the lesson that came out of the economic meltdown is that pension plans have to break away from the pack. "You have to be prepared to be independent," he said. "That's what makes this job fun."

At the same time, CalPERS is continuing to stress collaboration with other institutional investors, he said, teaming up for real estate, private equity and hedge fund investments to get better terms and keep expenses down. "The only way to achieve this is if LPs (limited partners) work together," he said.

Investors also can join together in investments such as infrastructure that pension funds are "particularly suited to make without the typical structure like a general partnership," Mr. Dear said.

A service of YellowBrix, Inc.