Headwinds — Another Word for Recession

John Browne
Tuesday, Feb. 12, 2008
The Wall Street Journal front page item reads: "Headwind Blows As Top Executives Navigate Trouble."

The item quotes Ken Thompson, chairman and CEO of Wachovia, responding to a question as to how big will be the headwinds by saying, "Well right now it's a big headwind."

The item also quotes Rick Wagoner, CEO of General Motors, saying to auto analysts, "…we are facing some tough headwinds, particularly here in the U.S., with a relatively weak industry."

The Journal goes on to mention that, last month, even Yahoo! CEO Jerry Yang had said, "While we face headwinds, we expect our positive momentum to build this year."

The term "headwinds" appears to be fast becoming the approved jargon for recession, without the stigma of actually mentioning the "R" word!


As sobering as it is when top executives talk about economic headwinds, it is mild in comparison to the breaking news today that AIG, the world's largest insurer, filed an notice to the Securities and Exchange Commission to explain that its accountants had discovered a "material weakness" in how AIG had valued its credit default swap (CDS) portfolio. News of yet another derivatives problem looming!

Apparently, the new accounting standards, which require a more realistic valuation of derivative and non-marketable instruments (sometimes almost mockingly referred to as "securities") are beginning to bite.

Major banks, insurance companies and other large financial investment institutions are now being asked, in the interest of openness, to face reality!

According to CNBC, the AIG problem is not small. It appears that the initial loss exposure, reported as "fairly contained" (as were the initial losses both at Merrill Lynch and at Citigroup) at $1.6 billion, should, according to new accounting rules, be reported as $5.2 billion.

That's a whopping $3.6 billion, or 225 percent, greater exposure. Pretty soon you're talking real money.

According to CNBC analysts, the write-down will result in a $1.34 decline in AIG's earnings per share.

But if such a massive understatement can occur at AIG, what about the losses hidden by the misnomer "fairly contained" at other, less blue-chip insurance companies?

All this adds fuel to the fire now threatening the bond insurance business and the enormous monetary threat this implies to the holders of certain corporate and municipal bonds.

Sadly, many retired people have a major proportion of their retirement funds tied up in municipal bonds. A threat to their wealth carries very serious political implications. Plus, there is the specter of a taxpayer-funded bailout for Wall Street to pay for the banks' greed and multi-billion dollar bonuses of recent years.

The solvency and insurance problems now haunting the bond markets have worrying implications for all institutions that hold corporate and municipal bonds in their money funds.

[Editor's Note: A U.S. Recession Is Now Unavoidable. Take These Urgent Steps Now.]

Our readers will know that I have long said that the safest form of cash is the short-term Treasury stock of major, developed nations and have warned that investors should be careful of the "miraculously" higher yields offered by some money market funds, which invest not just in money markets but in corporate and municipal bonds to boost yields.

Talking about true and open accounting. There was a further item published today by my friend Ambrose Evans-Pritchard of the Telegraph warning that "there is still $300 billion of bad debt out there, and Japan could be hiding most of it."

It appears now that the total amount of bad debt resulting from the subprime scandal is estimated at between $300 billion and $500 billion (yes, half a trillion dollars)!

At the recent G-7 meetings in Tokyo, the German finance minister, Peer Steinbruck, said that "the G-7 feared write-offs of losses on securities linked to U.S. subprime mortgages could reach $400 billion."

So there you have it, a reliable source declares that the world's main central bankers feel there is a $400 billion problem. Not much to argue about there.

Well, American and European banks and financial institutions have, according to the Financial Times, so far owned-up to only $150 billion in write-downs. That leaves at least $250 billion yet to emerge. According to Evans-Pritchard, a large amount of this amount is being "hidden" in Japan, the second-largest economy in the world.

Furthermore, the Japanese economy is highly leveraged. Bank lending is a very important factor as Japan struggles to climb out of a long recession.

As I have pointed out in past items, a reduction of just $10 billion in a bank's capital base reduces its lending capacity by $140 billion!

Meanwhile, the debate rages on as to whether or not we are actually headed into recession.

The Financial Times reports that, at long last, our Treasury Secretary Hank Paulson now appears to agree with us on at least one important point. The FT reports him at the G-7 as describing "decoupling," the idea that the world can grow even if the U.S. contracts, as the myth that I have long maintained it to be.

However, the FT also reported Paulson as saying, "I believe we [the U.S.] are going to keep growing."

As our readers will know, I disagree and firmly believe that we are now entering a period of negative growth. But then, Treasury Secretary, Paulson can hardly express his "real," non-political view, can he?

As I have said, I believe what makes the looming recession likely and most unusual is the presence of not just one but two major additional downward economic pressures: the unfolding subprime problem and a growing solvency crisis.

It is like a person trying to do push-ups with a man standing with one foot on each shoulder — decidedly hard going, to say the least!

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