From Volume 5, Issue Number 15 of EIR Online, Published Apr. 11, 2006

U.S. Economic/Financial News

New York Fed Warns Against Hedge Funds, Derivatives

New York Federal Reserve President Timothy Geithner, speaking April 5 before the New York Bankers Association, warned of the increasing risk of a blowout in the financial system. This is Geithner's third such public warning monitored by EIR this year, the other two having occurred on Jan. 11, at the New York Association of Business Economists, and on Feb. 28, at the Global Association of Risk Professionals.

"The more critical role played by hedge funds and other non-bank financial institutions in credit and other markets," he cautioned in this latest warning, "has the potential to magnify the impact of distress in those institutions on market dynamics and liquidity if counterparty risks are not managed appropriately."

He continued, "The proliferation of new forms of derivatives and structured financial products has changed the nature of leverage in the financial system. The addition of leverage imbedded in financial instruments ... may ... potentially amplify the impact of a sharp change in perceptions about macroeconomic risk or credit on asset prices and liquidity."

Greater concentration in some financial markets, he added, "has the potential to make the system more vulnerable" in the event of a bank failure.

We Told You So: Airline Dereg Advocate Admits It Failed

Tom Allison, chief counsel to the Senate Commerce Committee and strategist for the 1980 deregulation of the U.S. airline industry, stated, in a February interview with the International Herald Tribune, that if members of the Senate had known then what they know now, airline deregulation would never have passed.

By lifting Federal restrictions on itineraries and other regulations, Congress created disruption, gross inefficiencies, and higher costs, Allison stated. His remarks were cited in a column by William Pfaff in the April 4 IHT, as Europe debates airline deregulation. Allison noted that deregulation resulted in a "massive shift of airline debt to the public," via publicly funded pension guarantees. He also pointed to the cost increases or outright dropping of smaller routes. From any big American city, Allison said, "it's cheaper to fly to Paris than to Missoula, Montana."

State Bank Supervisors Chief: Regulate Mortgage Lending

Neil Milner, president of the Conference of State Bank Supervisors, called for housing market lending to be regulated, the Washington Times reported April 6. Milner noted that innovative loans like the interest-only mortgage can multiply a borrower's debt load within months, and, with the downturn in housing prices and sales slowing sharply, financial problems among overstretched borrowers will increase. He is calling on the states to regulate mortgage lenders so that practices, such as interest-only loans, will be brought under control. Most of the mortgage lenders are not banks, and are thus not under strict Federal regulation, and this must be corrected, Milner said.

Adjustable-Rate Mortgages Drive Borrowers Into Default

A report published by USA Today April 3 shows that 25% of all mortgages are adjustable rate (ARMs), and the rising interest rates are intersecting the collapsing auto and textile industries. The paper produced a chart indicating the "best case-worst case" for different types of mortgages, compared to a normal 30-year fixed-rate mortgage. The monthly payment on a fixed-rate mortgage on a $150,000 home purchased last year would fall from $999 to $881 over the next six years. An "interest only" mortgage would go from $791 to $872 (best case), or $1260 in the same six years (a 59.2% increase), while an "option adjustable rate mortgage," in which the payment can be even less than the interest, may increase by 162% as a worst case.

Needless to say, it was largely the working poor who were seduced into signing up for these rip-off schemes, and are now facing bankruptcy.

States Finally Take On Deregulation Fight

On April 3, the Florida Public Service Commission voted unanimously to participate in a Federal review of the proposed merger between the FPL Group and the Constellation Energy Group of Baltimore, the Palm Beach Post reported April 3. The merger would create the nation's third-largest utility company. Florida state law does not give the PSC regulatory authority over mergers. But as an intervenor in the Federal Energy Regulatory Commission approval proceedings, the PSC will gain access to otherwise confidential information on the effects of the merger on customers.

This merger has also been hit by the fallout caused from the political firestorm in Maryland, where Constellation Energy, the parent company of Baltimore Gas and Electric Co., has threatened to raise rates 72% this summer. The Maryland State Senate passed a law on March 31 to force Constellation to hold off on the rate hike, and at least phase it in gradually. The State House already has passed the bill. Although Gov. Robert Ehrlich (R) has indicated he would veto the bill, it was passed with enough of a margin to override a veto.

Citizens are now reaping what the Congress sowed last summer, with passage of the Energy Act, which repealed the Public Utility Holding Company Act of 1935. Unregulated mega-companies are now legal and have the free hand of the "marketplace." About half of the states have adopted deregulation legislation, but only one-third are restructuring, some having learned the lessons of California.

Beware! A Wal-Mart Is Coming Soon to Your Urban Neighborhood

Wal-Mart, despite opposition from trade unions and local retailers, announced plans to build 50 new stores in what the Washington Post April 5 called "blighted urban areas." Two years ago, Wal-Mart provoked the longest supermarket strike in the region when it tried to open a store in Southern California.

A study done last year by Wal-Mart itself found that there was "some evidence" that payroll per worker declined in the areas where Wal-Marts opened.

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