U.S. Unemployment-What Lies Ahead.

Unemployment in the U.S. which has already reached 9.5% is predicted to hit 9.6% when the next jobless figures are released. If this wasn't bad enough everybody from Obama and Geithner to Roubini predict that job losses will only get worse and probably cross 10% by the end of the year. They are expected to peak at about 10.6% sometime next year and decline gradually thereafter. This gloomy prediction comes amidst signs that the economy may be bottoming out.

These numbers are very significant for U.S. policy makers given that consumption expenditure accounts for almost 70% of U.S. G.D.P. Growing unemployment threatens to cap any rebound that the economy may witness as businesses rebuild inventories and residential housing stabilizes.Particularly difficult will be to time the withdrawal of stimulus funds from the economy. Economists the world over are warning that unless a plan to gradually withdraw excess liquidity is put in place, the world may witness runaway inflation and the consequences that follow. On the flip side, any increase in interest rates threatens to derail a fragile economic recovery.

Just how bad is the unemployment problem? It's really bad. The official unemployment figure of 9.5% only tells half the story. There are many more who are working only part time or have dropped out of the labor force.Making things worse is that the U.S. savings rate has shot up from 0% to almost 8%. At the same time those who want to spend are unable to borrow. Given that the value of household assets,be it homes or stocks, has plummeted even creditworthy consumers can no longer borrow as much as they used to before. In this scenario, given the dependance on consumption, the U.S. economy can create only a limited number of jobs in the near term.

Experts say that it will require sustained growth of 2.5% and above to create new jobs in the U.S. economy. Additionally, the tendency of U.S. corporates to outsource production to low cost centers outside the U.S. will need to be checked. Giving additional tax breaks if production is undertaken within the U.S. would be a welcome step.

Of late Bernanke sounds increasingly confident that things are under control. He has been joined by the former Fed chief Greenspan who too feels that the economy is on the mend. A few days back Bernanke had said that the Fed had been devoting considerable attention to issues relating to its exit strategy. He felt confident that the Fed has the necessary tools to implement the strategy when appropriate. He said 'We will not allow the broad measures of money circulating in the economy to rise at a rate that will cause inflation eventually'.

U.S. Economy--Recovery In Sight?

President Obama warned Saturday it would take 'many more months' for the U.S. to get out of recession even after GDP figures for the 2nd quarter were much better than expected, showing the economy shrank only 1% as against an expected 1.5%. What seems to worry him most is the worsening unemployment situation as figures due out next week are expected to show that more Americans are losing work.

Dr. Roubini had earlier expressed similar views. He said the recession will last roughly 24 months and will be over by year's end. 'I am not forecasting economic growth before year's end', he said.

Nevertheless the consensus is that the worst is definitely behind us and the economy should be returning to the growth path. The only debate now is over how soon recovery will start and how strong it will be. Analysts are now willing to stick their necks out and are predicting that recovery will start in the 3rd quarter itself. The most important reason for this, they say, is inventory rebuilding after businesses aggressively liquidated inventories in the earlier part of the year. Boosted by the 'cash for clunkers' scheme auto demand is expected to increase as is the demand for other consumer durables. The residential housing downturn also seems to have finally hit bottom and there are welcome signs of a rebound. Countrywide home resales in June are up 9% since January this year and the sales of new homes has risen 17%. Construction has climbed 20% and prices are showing signs of perking up. The impact of the fiscal stimulus as well as increased government spending is beginning to be felt.

What now worries analysts is whether the recovery will be a 'W' shaped one or it will be a steady climb out of the financial abyss. There is a definite possibility of the former as once the impetus provided by boosting inventory levels loses steam the economy may start a second leg downwards. Other factors contributing to this possibility are weak final demand due to high rates of unemployment, continuous de-leveraging by the private sector and excess capacity in the economy.

Dr. Roubini feels we are in a deep 'U' shaped recession and that recovery will be weak with growth averaging about 1% over the next couple of years. The latest GDP numbers have however led many analysts to revise growth projections sharply upwards from 0.5% to 3-4% in the third quarter as firms rebuild business inventories and housing ceases to be a drag. Growth is expected to soften once again over the longer term as the economy struggles to create jobs once again. Even the FOMC expects the labor market to improve gradually only from 2010 onwards, and the economy may take five or six years to converge to a sustainable growth rate.

Porsche vs. VW-What went wrong for Porsche?

For long Porsche had been a niche player in the world automobile market producing popular sports cars. It was also one of the most profitable auto companies. It then hit upon the daring idea of taking over VW, the largest European automaker, a company almost fifteen times its own size. For years it quietly built up its shareholding in VW till it reached a little over 50%. It also purchased options for an additional 20% of the shares in VW. How they managed to keep their moves and intentions secret is a mystery which is unlikely to be solved anytime soon.

Speculators,intrigued by the stability in the price of VW shares went short on a large scale. They took it on the chin to the tune of about 30 billion euros after Porshe announced that it controlled almost 75% of all VW shares. For a brief period VW became the world's most valuable company as short sellers scrambled to cover their short positions and VW's share price soared to over 1000 euros. The German regulator BaFin concluded an inquiry into possible share price manipulation by Porsche in the company's favor.

Now all of a sudden the boot's on the other foot. Porsche has agreed to be taken over by VW! What went wrong for Porsche? Following the collapse of Lehman Bros. all kinds of credit simply dried up,especially for the kind of adventure undertaken by Porsche. The economic crisis and the collapse of the auto industry in particular only made things worse. Porsche found it could not profitably hold on to its options and other investments. Additional finance was simply not available. Now it's burdened with about nine billion euros in debt and may have to bring in almost five billion euros in additional capital before merging with VW. The middle east is once again the beneficiary of this financial misadventure. The Sheik of Qatar is rumored to be putting in about seven billion euros in return for a seventeen percent stake in VW, making him its third largest shareholder.
As for the two Porsche executives who masterminded this gamble, their CEO Wendelin Wiedeking and the CFO Holger Haerter, they have been shown the door. They will not leave empty handed though. Wiedeking will receive a fifty million euro payoff while Haerter will receive twelve and a half million. They may receive additional money through other agreements or bonuses.
VW plans to merge Porsche fully with itself by mid 2011.

Are The Markets Right About The Recession?

Wall Street has had a run up of almost 40% over the last three months. The reason is slightly weird. The market cheered news that was less bad than expected. Die hard believers in the efficiency of the stock market insist that the recession ended sometime this spring. They claim that markets typically look forward at least nine months and they predict the economy will start recovering by the end of the year.

The pessimists are not convinced. They say that although the panic that set in after Lehman Brothers collapsed seems to have subsided the economy is still in decline. A lower rate of decline does not equal a recovery they say. Unemployment rates are rising and that will cap any stock market rally as more people have less money to spend. In any case the stock market has been wrong in the past as there are several instances of bear market rallies even during the Great Depression. They warn of another dip in economic activity before a slow recovery sets in, a classic example of a 'W' shaped recovery. A temporary improvement in economic activity, as businesses rebuild inventory dumped onto the markets at a discount after the credit markets froze,should not be confused with a recovery.

Nevertheless it is hard to ignore the signs of stabilization emerging around us. The Leading Indicators Index which considers consumer goods orders, building permits and several other data points rose in May by 1.2%, the second increase in as many months. The housing market also appears to be improving,by at least as far as the number of houses sold is concerned although not by prices. Cheaper homes are finally attracting buyers and people are beginning to have greater confidence about future incomes. Figures due to be released shortly are expected to show that both existing homes sales as well as fresh homes sales posted a healthy increase in May, helped by low mortgage rates and Obama's $8000 first time home buyer tax credit. The 'cash for clunkers' scheme will pump in additional billions of dollars into the ailing auto sector.

Typically recessions end before people realize they have ended. The economy is expected to start recovering by the last quarter of this year if not earlier. The experts may have got it right this time after all.

The Chrysler-Fiat Marriage.Will It Work?

After a very brief courtship ,Fiat and Chrysler announced earlier this year that they had reached a deal under which Fiat will acquire 35% Stake in Chrysler, the ailing U.S. automaker.It would seem at first sight that this may mark the end of Chrysler's troubles, but it is not so.Under the deal Fiat is not bringing in any money into Chrysler. In return for its stake in Chrysler it will just supply its latest fuel efficient technology to it.Fiat plans to convert a couple of Chrysler's U.S. factories to producing Fiat's small and medium sized vehicles. It's dealers worldwide will also sell Chrysler cars besides its own vehicles. In theory at least this should be a big plus for Chrysler which has a limited presence in overseas markets. Fiat argues that this will not only strengthen Chrysler's product range which is presently loaded in favor of trucks and SUV's, but also increase its global sales.

This marriage seems to have the blessings of the Obama administration,most probably because there are no other suitors for Chrysler. As a gift the government will give billions in fresh loans to Chrysler.It has also persuaded its major creditors to write down the value of their loans and accept about 29 cents to the dollar instead of trying to recover more by auctionong off the whole company.This has cleared the way for a sale in which Chrysler will be divided into two, with the good parts going to Fiat and the unviable parts being sold off.

The only question that now needs to be answered is, will it work? Fiat's exposure to the U.S. market and U.S. automakers is not new. It licensed its first plant in the U.S. in 1910 and its cars fetched a premium. This plant was shut down when theU.S. joined World War II in 1917. Later it again entered the U.S. market but withdrew in 1989, facing complaints over quality and competition from Japanese vehicles.GM acquired a stake in Fiat in 2000 with an option to purchase the entire company. In case GM chose not to buy out Fiat it had to pay a penalty of $2 billion! GM chose to pay the penalty and dissolved the agreement with Fiat in May 2005. Now Fiat is saddled with a car company that is constantly losing market share. Fiat seems to think that it is in a win-win situation as it is not paying cash for Chrysler and is only bringing in technology,besides spending time managing it. But car companies all over the world are losing money and closing plants.Fiat's introduction of a low volume niche product in the U.S., even if successful against Japanese and other American cars, is unlikely to make much of a difference to Chrysler's fortunes. Unless a miracle happens the marriage will last only as long as the U.S. government is willing to fund Chrysler.

What The Bank Stress Test Conceals!

In order to restore public confidence in the health of the U.S. banking system,the Fed decided to put nineteen of the biggest banks,each with assets of over $100 billion, through a 'stress test.' Since these banks together form about 65% of the U.S. banking system, it was felt that maintaining their health was of utmost importance in order to protect the entire banking system.Though the idea was conceived way back in September of last year it was implemented now.

The Fed's anxiety is reflected in the way this test was conducted.Discussions with the banks resulted in a more lenient test than originally planned and the results were 'leaked' a few days in advance. The official results showed that nine banks passed the test and would not need to raise any additional capital.The remaining ten banks would need to raise about $75 billion of additional capital which is lower than expected.

Even before the results were announced banks had announced their first quarter results for this fiscal which beat street estimates.But the real picture is not as rosy as it appears at first sight.Banks at the moment have borrowing costs which are close to zero.Additionally, due to changes in mark-to-market accounting rules by the FASB they are managing to avoid making write downs in the values of their loan portfolios.This also allows lower provisioning for future loan losses. Make no mistake, such losses are going to be substantial.Residential housing prices have still to hit bottom and the meltdown in commercial real estate prices has just begun. Rising unemployment is bound to increase credit card delinquencies.

Although banks are finding it very profitable to make new loans as the cost of borrowing is virtually zero, the stress test is silent about as to how these banks will go about repairing their damaged balance sheets. The visible options are that either the banks will raise more capital from private investors or the government will convert preferred shares into common stock. In all probability some mixture of the two alternatives will be pursued though it will dilute the value of the stocks held by present investors. Finally the test tells nothing about how the banking system is going to rid itself of the 'toxic assets' that continue to haunt these banks.All in all the banks continue to be weak and a lot of uncertainty still lies ahead.

'Porsche'-Auto Company Or Hedge Fund?

Thorsten Jacobs,a car industry analyst described Porsche as 'an investment bank with a car showroom attached.' Maybe with good reason.Under Holger Harter, its finance director,Porsche has been making more money from financial market operations than from selling cars,for the last several years.

It was Ferdinand Porsche, the founder of Porsche who had designed the Volkswagen Beetle,before setting up his own company which bears his name till this day.

So why was Porsche dabbling in stocks instead of concentrating on selling cars? Its long term goal has been to acquire VW,a company almost fifteen times its own size! Using cash-settled options Harter ensured that Porsche had cornered almost 75% of VW shares by October 2008. Strangely market speculators could never guess Porsche's interest in VW. The credit crunch had hit the auto industry very hard and auto shares all over the world were in freefall. VW shares defied logic and refused to budge. Hedge fund managers, sensing a killing, short sold VW shares in huge quantities.They reasoned that that it could not be long before VW shares also started sliding, following the likes of GM and Toyota. But this did not happen. The reason behind this was revealed on 26th October 2008 when Porsche announced that it controlled almost 75% of all VW shares.Hell broke loose on the trading floors on Monday,and by Tuesday VW shares crossed the 1000 euro mark as short sellers, caught on the wrong foot, desperately tried to cover their positions. In the process, VW now valued at 287 billion euros, briefly became the world's most valuable company.

Hedge funds, hit with losses of almost 30 billion euros, cried foul, prompting an investigation by the German regulator BaFin. Porsche on its part denied any wrongdoing. 'It is the funds themselves that are responsible, with their huge bets on a fall in VW shares that never happened,' a Porsche spokesman said. Porsche further offered to help hedge funds settle their loss making short positions on VW by offering to unwind some of its own positions.

In January this year Porsche announced that it had taken over VW by purchasing more than 50% of its shares. Thereafter in March, Germany's financial regulator BaFin halted its probe into Porsche regarding a possible manipulation in VW shares.'We didn't find any indications for a share manipulation,' said a spokesperson. Now on Wednesday after several weeks of talks, Porsche and VW have announced plans to merge, in the process creating a German car giant and one of the world's largest auto companies.