From Volume 4, Issue Number 30 of EIR Online, Published July 26, 2005

U.S. Economic/Financial News

LaRouche Was Right: Investors Fleeing Hedge Funds

A report issued by New York-based Tremont Capital Management on July 17 confirms Lyndon LaRouche's warnings in May, that in the June 15-July 15 period, hedge funds globally would be losing capital as investors pulled out, due to the funds' money-losing strategies. Under the headline, "Investors Turn on Hedge Funds," CNN reported the Tremont finding that, "for the first time in recent memory" [since 1998], hedge funds were losing capital. A Deutsche Bank report of ten days earlier had estimated that, whereas $120 billion in net capital flowed into hedge funds in 2004, only $40 billion in net investment would occur in 2005. But the Tremont report shows a worse picture: After attracting $25 billion in the first quarter of 2005, hedge funds globally suffered a net outflow of capital in the second quarter. This is because "funds suffered negative performance," especially with their hot-shot "convertible arbitrage" strategy of buying up debt of firms, while speculating against the stocks of the same firms.

Earnings Down, Ford Abandons Salvation Through SUVs

Ford reported a 19% drop in second-quarter earnings, compared to a year ago. MediaCorp noted July 20 that, "With fuel prices soaring, Ford and other automakers have seen a dramatic shift away from its most profitable sports utility vehicle (SUV) lineup." Ford's new solution is reflected in its announcement that it was cutting 250 jobs from its Jefferson County, Ky. pick-up truck plant, "which had been considered safe because of the popularity of its Super Duty trucks." These cuts will come on Sept. 30, when Ford stops producing its huge Excursion SUV.

And Ford is not alone: Market Watch reported that the cost of "credit-default swaps" on GM debt increased on July 20, in the wake of the announcement of GM's second-quarter losses. Market Watch explains, "credit-default swaps, or CDS, are derivatives that provide insurance against a company going bankrupt. Investors pay an annual spread, or premium, in return for a promise of a payment in the event of bankruptcy or a similar credit event." As of July 20, five-year GM CDS spreads stood at 650 basis points, which means that it costs $6.5 million annually to insure $100 million of GM debt against default. Market Watch compares this to the height of credit market disruptions in May, when spreads on GM CDS widened to as much as 1,100 basis points.

But not to worry. The Power Information Network (PIN) reports that, according to its aggregate of retail auto sales around the country, the Big Three's campaign to sell cars by giving employee discounts to all customers has been a smashing success, for sales have gone up in July. PIN is a service of J.D. Powers and Associates, a marketing-information unit of McGraw-Hill. How these increased sales-for-less will help the old plan of selling high-ticket items is not explained. This analysis is apparently from the school that believes you can fill up the Grand Canyon a shovelful at a time, and, likewise, that you can sell on a per-unit loss basis if you make it up in volume. Detroit's two major papers, located in the capital of the automotive real world, simply state the obvious from GM's announced losses: that they couldn't be saved by the enormous success of the discount program.

Top Companies Billions Short on Pension Payouts

Companies in the S&P 500 are still short $164.3 billion in covering their expected payouts to pensioners, according to a Standard & Poor's report released July 18. In 2003, the deficit was $164.8 billion. Of the 369 S&P 500 companies that offer pensions, 311 don't have enough money in their pension funds to cover their obligations. Ford Motor faces a deficit of $11.7 billion; ExxonMobil $10.1 billion; General Motors $8.6 billion; Boeing $6.7 billion; and IBM $5.8 billion.

Hedge Funds Become Lender of Last Resort

Hedge funds have increased their focus on lending money to troubled cash-hungry companies, who cannot get funds from their traditional lenders, according to the Wall Street Journal July 18. By often resisting amending loan agreements, hedge funds make it more likely that borrowers will file for bankruptcy protection. Moreover, hedge funds often "short" the stock or bonds of the struggling company (betting it will fall), meaning the funds lack a vested interest in the borrower's survival. Hedge funds are triggering bankruptcy filings, in order to make their short positions worth more.

Hedge funds lending money "are dramatically changing the landscape" of bankruptcy filings, making workouts far more complicated, says one restructuring adviser.

Hedge funds now dominate the the market in "second-lien" loans, loans that give lenders certain rights over some of the borrowing company's assets.

Bankrupt Tower Automotive, for example, lists hedge funds, such as Silver Point Capital Fund, among its creditors. Silver Point was elected as agent for credit facility in December, two months before Tower filed for Chapter 11 bankruptcy.

Atlanta Paper Cautions on Hedge Funds

The Atlanta Journal-Constitution ran a survey article July 21 on the crisis in hedge funds, and moves to regulate them. While providing plenty of ink to the arguments of the hedge-fund managers, the article gives some indication of the emerging danger: "First came stocks, then houses. Now some financial analysts see another potential 'bubble' on Wall Street: hedge funds. The classic signs seem to be there: accelerating returns over a long period, a big run-up in the number of such funds—from about 500 to almost 8,000 in 15 years—and, more recently, investor anxiety, withdrawal of funds and the failure of some large funds." The article prominently quotes Bill Gross for Pacific Investment Management Co. (one of the world's biggest bond funds) cautioning in last year's PIMCO investment outlook, "It's not just the competition and costs that should spell the eventual demise of the hedge fund craze, it's the realization ... that hedge funds can be manufactured in everyone's back yard like a gallon of Kentucky moonshine with revenue stamps attached, no less."

After giving hedge-fund managers' views, the Journal-Constitution reports that, contrary to Alan Greenspan's wishes, the move toward greater government regulation of hedge funds appears unstoppable. The paper attributes this to the fact that when they began, the hedge funds were a rich man's game, but in recent years, they've been made available to smaller investors, and that attracted the SEC's attention.

Hedge Funds' Death Toll Rises, as Investors Jump Ship

At least five hedge funds have gone belly-up in Minnesota alone during recent weeks, the Minneapolis Star Tribune reported July 16. American Express Financial Advisors has shut down three of its six funds that total about $1 billion, returning several hundred million dollars to investors. Red Sky, spun-off from AmEx Financial, shut down most or all of its operations on June 30. EBF & Associates, a Minnetonka-based flagship of the Twin Cities hedge fund sector, is shutting down a significant part of its business.

A Case Study in 'Real Estate Mania'

The Wall Street Journal July 20 ran a front-page profile of the sales tactics used by the top salesman at the California-based "Benchmark Lending Group, Inc." in pushing interest-only loans. Under the headline, "Easy Money: A Mortgage Salesman's Pitch," the Journal reports that Benchmark's founder is a former rock-band drummer; his lead salesman is a ne'er-do-well made rich from the 0.2-0.4% commission he makes on every loan he issues. The salesman scoffs at people who pay down their mortgage loans month by month, as "just a way of transferring money to your heirs." Benchmark's clients are welders, flight attendants, and the like, who hear about the company from its radio ads, and call its toll-free number. Some customers are borrowing up to seven times their annual income. Many are given "low documentation" loans (no pay stubs or income proof required, just the customer's claim).

Benchmark has no interest in insuring the mortgages can be paid, because they don't keep the mortgages they issue. They turn around and sell them to Wall Street firms and bigger mortgage companies for about 1.5% of the value of the loan. Those firms then securitize them—i.e., pool them with other bad loans into bond-like instruments which they then sell to pension funds, insurance companies, and investors! Of the 2,176 loans they issued last year, Benchmark kept only seven.

Sixty percent of Benchmark's loans are one form or another of interest-only mortgages. Take the case of the company's favored product, its "Freedom Loan": you pay only two-thirds of the monthly interest, and no principal, for the first five years—with the unpaid interest then capitalized on your loan. After five years, however, your payment schedule drastically changes, as you face full payments on the much larger loan resulting from the capitalized interest payments. Benchmark's salesman brushes off competitors who dub this "the prison loan," as a slur by people who don't understand the business.

The WSJ reports that there are 2,994 "consumer-finance lenders" like Benchmark licensed to do business in California, and the number is growing.

With a housing sector characterized by this madness, Federal Reserve chairman Alan Greenspan displayed his usual "signs of froth" on July 20, telling the House Financial Services Committee that there is some "speculative fervor" in some local housing markets, the which has raised house prices to "unsustainable levels," and which if they decline, "would be accompanied by some economic stress."

Denver Housing Bubble Deflation Is Omen for Nation

The red-hot housing market in Denver is rapidly cooling, hit by massive jobs losses in the telecom sector, the New York Times reported July 17. Five years ago, median house prices were jumping at an annual rate of nearly 17%; by the first quarter of 2005, the increase had fallen to 3%, according to data released by Sellers are being forced to cut prices, and offer big incentives, as houses are sitting on the market longer. The city's deflating housing bubble, propped up by interest-only loans, "may foreshadow what could happen" in other red-hot housing markets.

These markets may not simply "cool off," the article warns, but could "actually melt and send prices plummeting." Rather than a "soft landing," speculation-inflated markets like Naples and Miami, Fla., and New York, could face "dramatic price decreases," argues John H. Vogel Jr., adjunct professor of real estate at the Tuck School of Business at Dartmouth College.

Delta Considers Bankruptcy, While Northwest Faces Strike

While the Chief Executive Officer and the Chief Financial Officer and of Delta Airlines reportedly oppose a declaration of bankruptcy, they are now being pushed by the rest of the board, and the CFO and COO have resigned, the Wall Street Journal reported July 21. Also, the Board announced that the supposedly "bankruptcy-proof" pensions arranged recently are not that at all, leading to fears that there will now be a flight of execs and senior pilots from the company, collecting a lump sum pension before the company declares bankruptcy. Delta reported $388 million in second-quarter losses July 21, and expects $2 billion in losses for the year.

Meanwhile, Northwest Airlines was released by a Federal panel from mediation talks with the mechanics union, and the mechanics plan a strike. There will be a 30-day cooling-off period, after which a strike, and/or a company imposition of draconian conditions, including 2,000 layoffs and a 25% pay cut for those remaining—and/or a lockout. Northwest plans to outsource its mechanical maintenance if there is a strike.

Kodak To Cut 25,000 Jobs, Gutting Manufacturing Base

Eastman Kodak will eliminate up to 25,000 jobs over the next two years, gutting its manufacturing base. Photography giant Kodak is slashing another 10,000 jobs—20% of its global workforce (excluding acquisitions) by the middle of 2007, because of faster-than-expected drops in sales of consumer film and traditional photographic products, according to Bloomberg July 20. The world's largest photography company had previously announced 12-15,000 jobs cuts by the end of 2006. Since 1988, Kodak has gutted two-thirds of its workforce. One Kodak worker described the new jobs cuts as "a statement about globalization." Most of the new cuts—7,000 layoffs—will hit Kodak's massive, but rapidly shrinking manufacturing facilities, concentrated in Rochester, N.Y. As a result, Kodak will have slashed the value of its manufacturing infrastructure by two-thirds, to $1 billion, down from $2.9 billion in 2004. Kodak also reported its third straight quarterly loss, losing $146 million for the April-June period.

HP To Slash Thousands of Jobs, Cut Medical Benefits

Hewlett-Packard Co. will slash 14,500 jobs and cut retiree medical benefits, in order to "save" $1.9 billion a year. HP will trim its global workforce of 151,000 by 10% over the next 18 months. Most affected by cuts are the areas of information technology, human resources, and finance. Retained are the employees in sales, and research and development. Beginning in January, HP will freeze the pension and retiree medical-program benefits of current employees who don't meet defined criteria on age and years of company service. Instead, HP will add to its matching contribution to employees' 401(k) plans. "This is a triage," said Frank Gillet, an analyst at Forrester Research, one of many who say this restructuring is just the first of many before HP will "realize its potential."

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