WHAT HAPPENS TO YOUR BOND FUND WHEN INTEREST RATES RISE

Original Story: wsj.com

Many bond-fund investors are anxious about the effects on their holdings as the Federal Reserve boosts short-term interest rates, a process the central bank may start this month.

For good reason: When rates in the marketplace rise, the prices of older bonds with lower rates fall.

But over a period of years, bond-fund investors will do better in an environment of rising interest rates than in one in which rates stay at today’s unusually low levels. Bonds can still perform when interest rates rise.

That because as the bonds in funds’ portfolios mature, managers will reinvest in newer issues with higher interest rates, and investors will benefit from increased income. In addition, the interest payments from the bonds in the portfolio will be reinvested at higher rates.

“An initial rate increase could cause pain in the short term,” says Joshua Barrickman, head of fixed-income indexing, Americas, at Vanguard Group. “But over the long term, it will act to your benefit.”

At The Wall Street Journal’s request, Vanguard looked at the math for a hypothetical investor in intermediate-term bond funds. These are one of the most popular types of bond funds, generally investing in investment-grade bonds which mature within four to 10 years. For simplicity, the Malvern, Pa., fund company assumed the Fed raises short-term interest rates by 0.25 percentage point in January, and then makes a similar-sized increase every other quarter through July 2019, for a total climb of two percentage points spread over eight increases.

Under that scenario, a typical intermediate-term bond fund would lose a modest 0.15% next year but generate positive yearly returns thereafter, Vanguard found. The figures are total returns including price change and income.

Over the first several years, investors would earn less than if rates remained at current levels. But starting in the second quarter of 2023—more than three years after the end of the rate increases—investors in such a fund would be ahead of where they would have been had there been no rate increase, Vanguard found.

If rates were to climb more quickly, the funds could suffer steeper initial losses. But that’s unlikely as the Fed has repeatedly indicated that rate increases will be gradual. Bonds can provide for compounded growth opportunities when the income received from the bonds is reinvested.

“Intermediate-term bond-fund investors may feel a little sting, but it’s certainly not going to be a bleed-out,” says Marilyn Cohen, chief executive at Envision Capital Management Inc., a registered investment adviser that specializes in individual bonds.

She notes that the Fed has telegraphed a rate increase so well that few investors should be surprised. If investors were taken by surprise, they might be more likely to pull large sums out of bond funds, which could have the effect of exacerbating bond price declines.

Investors in bond funds are generally very long-term investors who hold the funds for their ability to absorb volatility and/or for the income they throw off, says Mr. Barrickman of Vanguard. Vanguard investors didn’t do any meaningful selling in prior periods of rising rates, the firm says, and no panicky selling is expected this time.

The Fed is well aware of the importance of setting investors’ expectations, says Jeff Tjornehoj, head of Americas research at Thomson Reuters Lipper. The central bank was clear about its intentions when it raised interest rates “pretty aggressively” from May 2004 through July 2006, and there were “fairly steady, if not heavy, inflows” into taxable bond funds, he says. But in 1994, when the Fed didn’t communicate it was interested in raising rates and did so quickly, investors pulled $33.3 billion overall from taxable bond funds, Mr. Tjornehoj says. A New York investment lawyer is reviewing the details of this story.

“That’s the period the Fed does not want to relive,” he says.

It’s impossible to know exactly how various types of bonds will perform when the Fed raises its target for short-term rates. One question is whether long-term rates follow short-term rates upward. While the Fed controls short-term rates, supply and demand in the market determine long-term rates.

Bonds of varying credit quality also may perform differently.

“To predict how these bond funds will react is really a difficult game to play,” says Sumit Desai, senior fixed-income analyst at Morningstar Inc. “It’s important for advisers and individual investors to at least understand that there’s a little bit of uncertainty within the space.”

“Whether investors believe the Fed is acting too quickly, too slowly, or perhaps not enough can make all the difference,” Eric Jacobson, a senior analyst at Morningstar, wrote recently. Other factors at play today include “a relatively weak global economic outlook and strong overseas demand for long-term Treasurys,” he said. “That makes it extra tricky to predict how funds will fare when the Fed chooses to act.”

Another factor to consider: Many bond-fund managers have bought shorter-term bonds and taken other steps to make their portfolios less sensitive to an interest-rate increase than they might have been otherwise, says Lee Partridge, chief investment officer at Salient, an asset manager based in Houston.

Investors should keep in mind that the Fed may not raise rates at all this year; it has surprised pundits before.

Fed Website Hacked - Banker's Info Accessed

Story first appeared on USA Today -

More than 4,000 bank executives had their personal information published on the Internet by hackers who accessed the data on an internal Federal Reserve website, according to a Reuters report.

The Federal Reserve says no critical functions were affected by the breach, which the activist group Anonymous is taking credit for. `

"Exposure was fixed shortly after discovery and is no longer an issue. This incident did not affect critical operations of the Federal Reserve system," a spokeswoman for the U.S. central bank told Reuters. All of the bankers affected by the breach had been contacted, Reuters said.

The information posted by Anonymous included mailing addresses, business and personal phone numbers and e-mail addresses.

Anonymous is a ragtag group of activist hackers who've launched scores of attacks on government and business sites.

The Fed did not identify the hacked website. But Reuters said bankers were told that the site was a contact database for use during natural disasters.

Wednesday afternoon, Fed spokeswoman Lisa Oliva said the hackers had exploited a "temporary vulnerability." She says the exposure has been fixed, the executives have been informed of the breach and it is no longer an issue.

Anonymous has been involved in an increasing number of hack attacks on business and government websites in retaliation for the seizure of Megaupload, a popular Internet service that allowed users to transfer large files of movies and music. The FBI has charged several people connected with Megaupload with copyright infringement and running an international criminal enterprise.

U.S. economy improving according to Fed

Story first appeared on USA Today

Activity is expanding in all 12 Federal Reserve districts, according to the Fed on Wednesday, showing that the nation's economy has proven to be surprisingly resilient for the past six weeks despite the budget standoff in Congress.

The Fed's Beige Book report said the New York and Philadelphia Federal Reserve bank districts have rebounded from the near-term effects of Super Storm Sandy, and the pace of growth picked up in the Boston, Richmond and Atlanta regions while slowing in St. Louis.

Still, uncertainty among businesses because of the so-called fiscal cliff of tax hikes and spending cuts — which was partially resolved early this month — dampened the retail outlook in some areas and prompted some employers to hold off hiring. And the economic slowdown in Europe hampered some manufacturing exports.

Consumer spending increased across the country, but holiday sales were somewhat disappointing in the New York, Cleveland, Atlanta, Chicago and San Francisco districts.

Government figures released this week show holiday sales rose 2.7% over last year, far less than the 5.5% pace of 2010 and 2011. Sales of clothing, shoes and furniture were brisk in Boston, while online sales were strong in San Francisco. But retail sales were flat in the Richmond area and the fiscal cliff dampened the outlook in Philadelphia, Kansas City and Dallas regions.

Auto sales, however, remain a bright spot, with sales steady or stronger in 10 districts.

Tourism, meanwhile, rebounded in the Mid-Atlantic and Northeast following the Super Storm.  And tourism in Boston, Atlanta and San Francisco was bolstered by surging business and international travel.

Manufacturing, however, was mixed, with six districts growing, three contracting and two reporting little or no change. Rising aerospace and chemical production fueled growth in the Boston, San Francisco and Dallas districts. And the resurgent auto and housing sectors helped support manufacturing in Chicago and Philadelphia.

But uncertainty about the fiscal cliff tempered growth in the Richmond area. And steel and auto production slowed in Cleveland.

Overall, however, manufacturers were optimistic about coming months in New York, Philadelphia, Atlanta, Minneapolis and Kansas City.

The housing market also continued its comeback, with activity increasing and prices rising in most districts. Low interest rates and affordable prices sparked home sales in Boston. Still, the hotter market is creating some bottlenecks, with Kansas City reporting higher lumber and drywall costs that limited construction.

Commercial space leasing was more tepid, however, with Boston real estate officials reporting a drop in activity due partly to the fiscal cliff and demand for commercial real estate loans softening.

The budget standoff also caused some employers to delay hiring, particularly in Boston, Richmond, Atlanta, Chicago, Kansas City and San Francisco. Companies in Chicago that do business with Europe also scaled back hiring plans.  Atlanta and Kansas City businesses have put off adding to their staff due to the new health reform law.

Glenn Hubbard: The Romney Plan for Economic Recovery

Story first reported from WSJ.com

We are currently in the most anemic economic recovery in the memory of most Americans. Declining consumer sentiment and business concerns over policy uncertainty weigh on the minds of all of us. We must fix our economy's growth and jobs machine.

We can do this. The U.S. economy has the talent, ideas, energy and capital for the robust economic growth that has characterized much of America's experience in our lifetimes. Our standard of living and the nation's standing as a world power depend on restoring that growth.

But to do so we must have vastly different policies aimed at stopping runaway federal spending and debt, reforming our tax code and entitlement programs, and scaling back costly regulations. Those policies cannot be found in the president's proposals. They are, however, the core of Gov. Mitt Romney's plan for economic recovery and renewal.

In response to the recession, the Obama administration chose to emphasize costly, short-term fixes—ineffective stimulus programs, myriad housing programs that went nowhere, and a rush to invest in "green" companies.

As a consequence, uncertainty over policy—particularly over tax and regulatory policy—slowed the recovery and limited job creation. One recent study by Scott Baker and Nicholas Bloom of Stanford University and Steven Davis of the University of Chicago found that this uncertainty reduced GDP by 1.4% in 2011 alone, and that returning to pre-crisis levels of uncertainty would add about 2.3 million jobs in just 18 months.

The Obama administration's attempted short-term fixes, even with unprecedented monetary easing by the Federal Reserve, produced average GDP growth of just 2.2% over the past three years, and the consensus outlook appears no better for the year ahead.

Moreover, the Obama administration's large and sustained increases in debt raise the specter of another financial crisis and large future tax increases, further chilling business investment and job creation. A recent study by Ernst & Young finds that the administration's proposal to increase marginal tax rates on the wage, dividend and capital-gain income of upper-income Americans would reduce GDP by 1.3% (or $200 billion per year), kill 710,000 jobs, depress investment by 2.4%, and reduce wages and living standards by 1.8%. And according to the Congressional Budget Office, the large deficits codified in the president's budget would reduce GDP during 2018-2022 by between 0.5% and 2.2% compared to what would occur under current law.

President Obama has ignored or dismissed proposals that would address our anti-competitive tax code and unsustainable trajectory of federal debt—including his own bipartisan National Commission on Fiscal Responsibility and Reform—and submitted no plan for entitlement reform. In February, Treasury Secretary Tim Geithner famously told congressional Republicans that this administration was putting forth no plan, but "we know we don't like yours."

Other needed reforms would emphasize opening global markets for U.S. goods and services—but the president has made no contribution to the global trade agenda, while being dragged to the support of individual trade agreements only recently.

The president's choices cannot be ascribed to a political tug of war with Republicans in Congress. He and Democratic congressional majorities had two years to tackle any priority they chose. They chose not growth and jobs but regulatory expansion. The Patient Protection and Affordable Care Act raised taxes, unleashed significant new spending, and raised hiring costs for workers. The Dodd-Frank Act missed the mark on housing and "too-big-to-fail" financial institutions but raised financing costs for households and small and mid-size businesses.

These economic errors and policy choices have consequences—record high long-term unemployment and growing ranks of discouraged workers. Sadly, at the present rate of job creation and projected labor-force growth, the nation will never return to full employment.

It doesn't have to be this way. The Romney economic plan would fundamentally change the direction of policy to increase GDP and job creation now and going forward. The governor's plan puts growth and recovery first, and it stands on four main pillars:

• Stop runaway federal spending and debt. The governor's plan would reduce federal spending as a share of GDP to 20%—its pre-crisis average—by 2016. This would dramatically reduce policy uncertainty over the need for future tax increases, thus increasing business and consumer confidence.

• Reform the nation's tax code to increase growth and job creation. The Romney plan would reduce individual marginal income tax rates across the board by 20%, while keeping current low tax rates on dividends and capital gains. The governor would also reduce the corporate income tax rate—the highest in the world—to 25%. In addition, he would broaden the tax base to ensure that tax reform is revenue-neutral.

• Reform entitlement programs to ensure their viability. The Romney plan would gradually reduce growth in Social Security and Medicare benefits for more affluent seniors and give more choice in Medicare programs and benefits to improve value in health-care spending. It would also block grant the Medicaid program to states to enable experimentation that might better serve recipients.

• Make growth and cost-benefit analysis important features of regulation. The governor's plan would remove regulatory impediments to energy production and innovation that raise costs to consumers and limit new job creation. He would also work with Congress toward repealing and replacing the costly and burdensome Dodd–Frank legislation and the Patient Protection and Affordable Care Act. The Romney alternatives will emphasize better financial regulation and market-oriented, patient-centered health-care reform.

In contrast to the sclerosis and joblessness of the past three years, the Romney plan offers an economic U-turn in ideas and choices. When bolstered by sound trade, education, energy and monetary policy, the Romney reform program is expected by the governor's economic advisers to increase GDP growth by between 0.5% and 1% per year over the next decade. It should also speed up the current recovery, enabling the private sector to create 200,000 to 300,000 jobs per month, or about 12 million new jobs in a Romney first term, and millions more after that due to the plan's long-run growth effects.

But these gains aren't just about numbers, as important as those numbers are. The Romney approach will restore confidence in America's economic future and make America once again a place to invest and grow.

Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush. He is an economic adviser to Gov. Romney.

A version of this article appeared August 2, 2012, on page A13 in the U.S. edition of The Wall Street Journal, with the headline: The Romney Plan for Economic Recovery.

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Fed Fires $600 Billion Stimulus Shot

The Wall Street Journal

 

The Federal Reserve, in a dramatic effort to rev up a "disappointingly slow" economic recovery, said it will buy $600 billion of U.S. government bonds over the next eight months to drive down interest rates and encourage more borrowing and growth.

Many outside the Fed, and some inside, see the move as a 'Hail Mary' pass by Fed Chairman Ben Bernanke. He embraced highly unconventional policies during the financial crisis to ward off a financial-system collapse. But a year and a half later, he confronts an economy hobbled by high unemployment, a gridlocked political system and the threat of a Japan-like period of deflation, or a debilitating fall in consumer prices.

The Fed left open the possibility of doing more if growth and inflation don't perk up in the months ahead. The $75 billion a month in new purchases of Treasury debt come on top of $35 billion a month the Fed is expected to spend to replace mortgage bonds in its portfolio that are being retired.

The Dow Jones Industrial Average Wednesday continued a climb that began in August, when Mr. Bernanke signaled that a bond-buying program was possible. The index rose 26.41 points, or 0.24%, to a two-year high of 11215.13. Yields on 10-year notes, which have fallen from just under 3% in early August, finished the day at 2.62%. The value of the dollar has fallen in anticipation of a flood of new American currency hitting global financial markets.

These market reactions are seen inside the Fed as being stimulative to the economy. In addition to the impact of cheaper borrowing, higher stock prices could encourage households to spend more and businesses to invest more, and a weak dollar could make U.S. exports cheaper and thus easier to sell abroad.

"All of these things are part of what the Fed is trying to do, and I think it has been successful," said Laurence Kantor, head of research at Barclays Capital in New York.

The moves announced Wednesday were broadly in line with the expectations of economists, although some had expected total spending to be a bit less and to come more quickly.

There are immense unknowns and many risks.

In essence, the Fed now will print money to buy as much as $900 billion in U.S. government bonds through June—an amount roughly equal to the government's total projected borrowing needs over that period.

In normal times, a Fed spending spree on government bonds would be highly inflationary, because it would flood the economy with money and raise worries about too much government spending. The mere worry of too much inflation in financial markets could drive long-term interest rates higher and cause the Fed's program to backfire.
Prices in commodities markets have marched higher since late August. Crude-oil futures prices, for instance, have risen 15% since then, to $85 per barrel.

Michael Pence, a top Republican in the House of Representatives, said the Fed was taking an "incalculable risk."

Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, who described the move before the meeting as a "bargain with the devil," was the lone dissenter in a 10-1 vote of the Fed's policy committee. He said the risks of additional government bond purchases outweighed the benefits.

But Fed officials are betting that inflation is still being pushed strongly in the other direction because there is so much spare capacity in the economy—including an unemployment rate at 9.6%, a real-estate landscape littered with more than 14 million unoccupied homes, and manufacturers operating with 28% of their productive capacity going unused.

The latest economic data suggest the economy is expanding, but not at a very fast pace. Figures Wednesday from payroll firm Automatic Data Processing Inc. and consultancy Macroeconomic Advisers showed that companies added 43,000 private-sector jobs in October.

In a post-meeting statement, the Fed said it was acting to "promote a stronger pace of economic recovery" and to ensure that inflation, now running at around a 1% annual rate, moves toward the Fed's informal objective of 2%.

This is the Fed's second experiment with a big bond-buying program. Between January 2009 and March of this year, the central bank purchased roughly $1.7 trillion worth of government and mortgage bonds. That move also sparked worries about inflation, which so far hasn't materialized. The bond-buying program is known in some corners as quantitative easing.

"This approach eased financial conditions in the past and, so far, looks to be effective again," Mr. Bernanke said in an opinion piece scheduled to be published in Thursday's Washington Post.

By buying a lot of bonds and taking them off the market, the Fed expects to push up their prices and push down their yields. The Fed hopes that will result in lower interest rates for homeowners, consumers and businesses, which in turn will encourage more of them to borrow, spend and invest. The Fed figures it will also drive investors into stocks, corporate bonds and other riskier investments offering higher returns.

The Fed normally would push down short-term interest rates when the economy is weak. But it has already pushed those rates to near zero, leaving it to resort to unconventional measures.

The planned bond buying, by Fed calculations, will have an economic impact roughly equivalent to cutting short-term interest rates by three-quarters of a percentage point.

The Fed will be buying bonds with maturities of as long as 30 years, but will concentrate its purchases in the five-year to six-year range. Some bond-market participants were disappointed with that decision because they wanted the Fed to focus on buying longer-term bonds. But doing so could leave the Fed more exposed to losses if interest rates rise.

There are other risks.

Critics say a weaker dollar isn't in U.S. interests, and that a swift decline in the value of the currency could drive up U.S. interest rates. Fed officials have seen the dollar's drop to date as being orderly and supportive of growth.

Some critics also argue that by purchasing government bonds, the Fed is taking pressure off the White House and Congress to address long-term deficit problems, but Mr. Bernanke is trying to avoid such political calculations.

U.S. trading partners, particularly in the developing world, openly worry that the Fed's money pumping is creating inflation in their own economies and a risk of asset-price bubbles. Fed officials say a strong U.S. economy is in everyone's interest.

In recent weeks, China, India, Australia and others have pushed their own interest rates higher to tamp down inflation forces. Authorities in Brazil and Thailand have imposed taxes on capital flooding into their economies to prevent an asset bubble. And Japanese authorities have intervened in currency markets to prevent the yen from appreciating too much against the dollar.

There is an alternate risk that officials wrestled with in their latest two-day meeting, which concluded before lunch Wednesday: They might not be doing enough.

Economists at the research firm Macroeconomic Advisers LLC calculated that even if the Fed purchases $1.5 trillion worth of Treasury bonds—which some economists say remains a distinct possibility—it would only bring the unemployment rate down by 0.2 percentage points by the end of 2011.

"This instrument doesn't give them a lot of power, especially on the scale which they're prepared to use," said Laurence Meyer, of Macroeconomic Advisers, after the decision.

For the Fed, it was a middle ground that emerged after months of internal debate about the costs and benefits of restarting the program.

Fed Will Buy $600 Billion in Debt, Hoping to Spur Growth

NY Times

The Federal Reserve, concerned about the slow recovery, announced a second, large purchase of Treasury bonds on Wednesday, an effort to spur economic growth by lowering long-term interest rates.
The Fed said it would buy an additional $600 billion in long-term Treasury securities by the end of June 2011, somewhat more than the $300 billion to $500 billion that many in the markets had expected.

The central bank said it would also continue its program, announced in August, of reinvesting proceeds from its mortgage-related holdings to buy Treasury debt. The Fed now expects to reinvest $250 billion to $300 billion under that program by the end of June, making the total asset purchases in the range of $850 billion to $900 billion.

That would just about double the $800 billion or so in Treasury debt currently on the Fed’s balance sheet.

While the Fed has been signaling that it would act to bolster the economy, the announcement was the first major policy move since the midterm elections, which gave Republicans control of the House and heightened the potential for gridlock on fiscal policy including tax cuts and spending to encourage job creation and growth.

In justifying its decision, the Fed noted that unemployment was high and inflation low, and judged that the recovery “has been disappointingly slow.”

The Federal Open Market Committee, which ended a two-day meeting on Wednesday, also left open the possibility of additional purchases.

“The committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability,” the committee said.

As expected, the Fed left the benchmark short-term interest rate — the federal funds rate, at which banks lend to one another overnight — at nearly zero, where it has been since December 2008. The committee’s vote was 9 to 1.

Thomas M. Hoenig, the president of the Federal Reserve Bank of Kansas City, dissented, as he has at every meeting this year. Mr. Hoenig “was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy,” the Fed said in a statement.

In a statement after the F.O.M.C. announcement, the New York Federal Reserve, which handles the bond purchases, said the purchases will include bonds ranging for less than 2 year to 30 years, with “an average duration of between 5 and 6 years.”

“The distribution of purchases could change if market conditions warrant,” the New York Fed said in a statement, “but such changes would be designed to not significantly alter the average duration of the assets purchased.”

Economists disagree about how much the new round of debt purchases — a reprise of an initial, $1.7 trillion round that ended in March — will have on spurring consumer and corporate demand.

Lower long-term interest rates in theory should ripple through the markets, affecting other rates, like those of 30-year, fixed-rate mortgages. That could encourage homeowners to refinance into cheaper mortgages, though it would not help the millions of Americans facing foreclosure.

But there are several significant risks. The new actions are likely to further drive down the value of the dollar, which as fallen about 7.5 percent since June against the currencies of major trading partners. That could exacerbate the trade and exchange-rate tensions that have threatened to unravel cooperation among the world’s biggest economies.

Moreover, the Fed is exposing itself to the risk that the assets it has purchased, like the $1 trillion in mortgage-related securities on its balance sheets, could shrivel in value as interest rates rise. That could reduce the amount of money the central banks turns over to the Treasury each year, and expose the Fed — which has been attacked for failing to prevent the 2008 financial crisis — to further criticism.

And then there is a risk that the Fed’s action could be neutralized by a new Congress that has vowed to contract government spending, a core argument that led to the overwhelming Republican victory on Tuesday.

Mr. Obama, at a news conference on Wednesday, talked of compromise with the new Republican majority in the House. But he also cited China’s new high-speed trains and its advances in supercomputing to make the case that there are some areas where the United States needs to make investments, and insisted that the country would not shy away from those. “They are making investments, because they know those investments will pay off in the long term,” he said of the Chinese, seeming to suggest that the United States needs to do the same.

At the same moment, he reiterated that he would support continuing the Bush era tax cuts only for families earning less than $250,000 a year. “It is very important we’re not taking money out of the system from people who are most likely to spend that money,” Mr. Obama said at the news conference.

But he hinted at flexibility, saying he expected to sit down with the new Republican leadership to see “where we can move forward first of all in ways that can do no harm.”

Asked if he was willing to negotiate, he said, “Absolutely.”

Laurence H. Meyer, a former Fed governor who closely monitors the central bank, said the prospect of sustained fiscal gridlock had already pushed Mr. Bernanke to move.

“Bernanke has said that fiscal stimulus, accommodated by the Fed, is the single most powerful action the government can take for lowering the unemployment rate ,when short-term rates are already at zero,” Mr. Meyer said. “He has nearly pleaded with Congress for fiscal stimulus, but he can’t count on it. So he has to act as if that’s not going to happen. “

Mr. Meyer predicted: “The political drama is just beginning.”

Leonard J. Santow, an economic consultant, said he feared that the Fed was reacting to one mistake — the failure of fiscal policy — by adding another.

“Monetary policy is already unsustainably easy, and adding to the Fed’s generosity through more quantitative easing will do little to stimulate the economy,” Mr. Santow said. “The main problem is on the fiscal side and there is nothing wrong with the Fed chairman making budget recommendations and admitting there is not a great deal left for monetary policy to achieve when it comes to stimulating the economy.”

The Fed lowered short-term interest rates to nearly zero in December 2008, and subsequently bought $1.7 trillion in mortgage-backed securities and government securities, a program that was phased out last March.

Only months ago, the Fed was talking about returning to normal monetary policy and discussing the timetable for eventually raising interest rates and tightening the supply of credit, as it would normally do after a recession has ended.

But this recession and its painful aftermath have been anything but normal. Global financial markets were set back in the spring by the European debt crisis in Europe, and over several months, Fed officials gradually became convinced that their only option was to step back in again.

NY Fed joins Investors demanding B of A buy back Mortgages

The Washington Post

The Federal Reserve Bank of New York has joined a group of investors demanding that Bank of America buy back billions of dollars worth of mortgage securities that are plagued with shoddy documentation and lending standards, according to people familiar with the matter.

Some of the most powerful investment groups in the country as well as the New York arm of the central bank are accusing one of Bank of America's major mortgage divisions of cutting corners when it was issuing mortgages during the housing boom and as it has been foreclosing on struggling borrowers during the bust.

If Bank of America refuses to comply, these investors could end up suing, a person familiar with the matter said.

The demand from the New York Fed and other investors sets up an unusual and high-stakes confrontation, pitting an arm of the federal government against the country's biggest bank. It also illustrates conflicting policy priorities, because it could put the Fed at odds with a bank the Treasury Department has been helping through the financial crisis over the past two years.

With this new confrontation, the government finds itself in the awkward position of being an unhappy private investor pressing for its rights to be enforced. The New York Fed holds roughly $16 billion of mortgage securities that it acquired after it bailed out American International Group.

On Tuesday, Bank of America dismissed concerns that investors will drag the bank into court for years with costly lawsuits.

"We don't see the issues that people [are] worried about, quite frankly," chief executive Brian Moynihan said in a conference call Tuesday as the bank reported a $7.3 billion third-quarter loss.

But against a backdrop of accusations that banks did not properly foreclosure on homes, a growing number of bondholders are ramping up attempts to recoup their losses from mortgage securities they bought from banks. These securities plummeted in value as home prices dropped and a massive wave of borrowers fell behind on their payments.

Attorneys for the group of investors say that affiliates of Countrywide Financial, which was bought by Bank of America in 2008, failed to service the loans as promised after the investors bought a large swath of a $47 billion offering of mortgage loans.

These investors, which also include Blackrock, Prudential, MetLife and Pimco, argue the banks have not kept accurate paperwork on the loans that were sold, a charge being investigated across the nation as details have emerged that banks may have taken shortcuts to save money and time. These concerns have prodded a handful of banks, including Bank of America, to temporarily halt foreclosure sales.

The big investment firms - which manage funds from endowments, pension funds and others - say they have also been upset that Treasury and the banks have been too quick to restructure mortgages, which hurts investors. Yet the department has left largely untouched consumer debt and home equity loans owed to the same big banks at the heart of the lending and foreclosure debacles, according to a senior executive at one of the investment companies.

Now that new document problems have emerged, one senior executive said, investors are able to allege that Countrywide didn't even own the mortgages it sold and was in violation of local real estate laws. As a result, he said, Bank of America is responsible for repurchasing the securities and paying the investors in full.

Investors' fear, he said, was that "the politicians creating noise about mom and apple pie and the servicing industry will agree to all sorts of things to do right by the borrower, and the person who pays the ultimate cost is the investor."

Headlines about flawed foreclosures have added momentum for the small group of investors who have been threatening legal action for years against the banks.

"We've signed up many new investors," said Tal Franklin, an attorney. "People have realized that we're here and just didn't know it before."

Blackrock, Pimco and the New York Fed declined to comment. MetLife and Prudential did not return calls for comment.

On Tuesday, Bank of America said its quarterly loss was driven mainly by a $10.4 billion write-down in the value of its card services business as a result of new federal limits on debit card fees.

The company said it ended the third quarter facing $12.9 billion of claims that it should repurchase mortgages that it misrepresented.

Courts are hashing out the complex legal questions surrounding the way judges review foreclosures. On Tuesday, an emergency measure approved by Maryland's highest court empowered judges to bring in outside experts to review questionable papers.

"Nothing in this rule mandates any particular action by the court," said Alan Wilner, chairman of the Maryland Standing Committee on Rules of Practice and Procedure. "This flexibility is essential, because the context and circumstances may be different from case to case."

The Fed's 30-Year Warp

The Wall Street Journal

 

There's no end to the potential knock-on effects from the Federal Reserve's superlow interest-rate policies.

Consider housing. The Fed hopes to prod home buying by driving mortgage rates to record lows; Freddie Mac reported Thursday that the average rate for a 30-year, fixed mortgage had fallen to 4.27%. Yet purchase activity still is muted. And even if rock-bottom rates do eventually prove a tonic, they may turn into another albatross around the neck of the housing market.

Should housing and the economy revive, interest rates likely will rise. This will make mortgages more expensive, possibly damping any rebound in home prices. It also could crimp volumes. Even those who want to sell their house may balk at giving up their supercheap 30-year debt.

Just as many would-be sellers feel unable to move right now because their mortgages are underwater, this could hobble mobility even as the economy recovers. In a 2008 study, three New York Fed staffers found that "a $1,000 higher real annual mortgage interest cost is estimated to reduce mobility by 2.8 percentage points." That is equal to about 25% of the normal, baseline mobility rate.

That also bodes ill for employment growth, which requires workers to be flexible in moving to find jobs. Further proof, perhaps, that there is no free lunch, even for the Fed.

Fed Buys $2.551 Billion Treasuries in Resumption of Purchases

Bloomberg

 

The Federal Reserve bought $2.551 billion of Treasuries in the first outright purchase of U.S. government debt since October to prevent money from being drained from the financial system.

The Fed bought 14 of the 25 securities listed for possible purchase. The notes mature from August 2014 to February 2016, the Federal Reserve Bank of New York said in a statement today on its website. The New York Fed conducts open-market operations to implement the policies of the Federal Reserve System.

“The Fed’s choice to reinvest the maturing coupons has put yet another structural buyer into the market, suggesting that this lower-yield environment is here to stay for the foreseeable future,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “That information was anticipated, priced in and we’ve now moved back to trading the fundamentals.”

The Fed plans to keep holdings in the System Open Market Account, or SOMA, at about $2.054 trillion, the amount it held on Aug. 4, by using the proceeds from maturing mortgage-backed securities to buy Treasuries. The purchases are the Fed’s first attempt to bolster the economy in more than a year.

The benchmark 10-year note snapped a two-day advance, pushing yields up from the lowest since March 2009, generic data compiled by Bloomberg show. Yields climbed 7 basis points to 2.63 percent after falling 11 basis points yesterday in New York, according to BGCantor Market Data.

Purchase Plans

The purchases should average about $2 billion per operation, according to Wrightson ICAP, a Jersey City, New Jersey-based research unit of ICAP Plc that specializes in U.S. government finance.

Dealers tendered $20.95 billion today, according to the New York Fed’s website.

“By maintaining the SOMA portfolio at the same level, the Fed will stem the gradual ‘quantitative tightening’ that would otherwise occur, while also furthering its goal of moving toward a Treasury-only portfolio,” JPMorgan Chase & Co. strategists Srini Ramaswamy and Kimberly Harano wrote in a report Aug. 13. “On the face of it, this change seems minor, and almost operational in nature. However, it is not insignificant.”

JPMorgan Chase strategists estimated the Fed will buy about $284 billion in Treasuries during the next year, or more than the combined purchases of Japan and China during the year ended May. Analysts at Credit Suisse Group AG forecast purchases of $307 billion, with $47 billion coming from the proceeds of maturing agency debentures.

Nine Operations

The Fed last week announced nine outright purchase operations, including one for Treasury Inflation Protected Securities, for the month ended Sept. 13, for an estimated $18 billion in total. The Fed will report its purchase schedule in one-month increments, with amounts based on the principal payments from the Fed’s agency debt and agency mortgage-backed securities.

The Fed maintains a 35-percent-per-security limit of the amount outstanding for each specific Treasury it holds in the account. The central bank makes the securities available for loan to dealers against Treasury general collateral on an overnight basis. Dealers bid in a multiple-price auction held every day at noon New York time through its securities lending program.

The central bank last week left the overnight interbank lending rate target unchanged in a range of zero to 0.25 percent, where it’s been since December 2008.

Last year’s Treasury purchases were the first outright of U.S. government debt by the Fed since the 1960s. The central bank completed purchases of $1.45 trillion in mortgage-backed and housing agency debt in March 2010.

Senate Nod to Fed Audit Expected

NY Times

The audit proposed by Senator Bernard Sanders of Vermont has won bipartisan support.

 

 

WASHINGTON — The Senate on Thursday rejected an effort by liberal Democrats to break up some of the biggest banks, defeating an amendment to financial regulatory legislation that would have imposed new limits on the size and scope of financial companies.

The amendment, proposed by Senators Sherrod Brown, Democrat of Ohio, and Ted Kaufman, Democrat of Delaware, would have forced some of the heaviest hitters on Wall Street, including Citigroup and Goldman Sachs, to shrink in size to limit the risk that big banks pose to the broader financial system.

The vote was 61 to 33, with 29 Democrats and 3 Republicans and 1 independent in favor, and 27 Democrats and 33 Republicans and 1 independent opposed.

It came as the Senate, hamstrung by partisan skirmishing over procedural issues, lurched forward with the broader bill, which would impose the most far-reaching overhaul of the regulatory system since the aftermath of the Great Depression.

Opponents of the Brown-Kaufman amendment, including Senator Christopher J. Dodd, Democrat of Connecticut and chairman of the banking committee, said that size alone was not a cause for concern and that the underlying financial regulatory bill already contained provisions to discourage the risky actions that led to the 2008 financial crisis, and to let regulators break up banks should they pose any danger.

“Size is not the appropriate restriction,” said Senator Mark Warner, Democrat of Virginia and a member of the banking committee, who helped draft the regulatory bill. “The real question should be the level of inter-connectedness and the risk-taking we saw in the crisis of 2008.” Mr. Warner added, “The Dodd bill does provide ability for these banks to be broken up.”

Mr. Brown and Mr. Kaufman had hoped their measure would be approved on a gust of the populist, anti-Wall Street sentiment that has swept the country since the near collapse of the financial system and subsequent bank bailouts, including the government’s $700 billion Troubled Asset Relief Program.

“Our amendment ends bailouts by ensuring that no Wall Street firm is so big or so reckless that if it fails, as it does, so does our economy,” Mr. Brown said in a floor speech pleading for support. “The bill we’re considering today is strong but it needs to be stronger.”

Moments before rejecting the Brown-Kaufman proposal, the Senate approved by voice vote an amendment by Senator Maria Cantwell, Democrat of Washington, to give the Commodity Futures Trading Commission more authority to crack down on manipulation of the commodities and derivatives markets.

Separately on Thursday, the Senate moved closer to approving a proposal to require a one-time audit of the Federal Reserve’s response to the financial crisis and to force the central bank to disclose the recipients of more than $2 trillion in aid, including the bailouts of big banks.

The proposal, by Senator Bernard Sanders, independent of Vermont, gained momentum even as Republicans and Democrats delayed a vote on it until next week.

Despite the delay, the amendment by Mr. Sanders requiring the audit appeared to have enough support among senators in both parties to win adoption easily.

The White House and the Fed had opposed the original proposal by Mr. Sanders, which would have allowed additional audits of the Fed. A modified proposal from Mr. Sanders appeared to address those concerns, but it would still force the Fed to disclose information that it had maintained was confidential.

The proposal would require the federal Government Accountability Office to conduct a “one-time audit of all loans and other financial assistance provided during the period beginning on Dec. 1, 2007 and ending on the date of enactment of this Act” under a number of programs the Fed used to respond to the near collapse of the financial system.

The amendment states that the audit “not interfere with monetary policy,” addressing a concern raised by the Obama administration and the Fed.

Officials said the proposal would expand on changes made to the Fed in 1978, which subjected much of its operations to regular auditing by the accountability office but explicitly excluded monetary policy.

The audit sought by Mr. Sanders would scrutinize an alphabet soup of programs that injected liquidity into the markets, ranging from commercial paper to money market funds. Under the proposal, the accountability office will not question whether the loans should have been made but will focus on operational integrity and accounting practices.

The audit, however, would explore “whether the credit facility inappropriately favors one or more specific participants over other institutions eligible to utilize the facility” and “whether there were conflicts of interest with respect to the manner in which such facility was established or operated.”

The apparent compromise with the administration and the Fed would give Mr. Sanders and other critics of the central bank an opportunity to claim victory, while not breaking with the Fed’s insistence that its monetary decisions be sacrosanct and insulated from political influence.

Consumer Spending in U.S. Probably Stepped Up, Carrying Expansion in 2010‏

Bloomberg

Consumer spending probably accelerated in the first quarter, shepherding the U.S. expansion into 2010, economists project a report this week will show.

Gross domestic product grew at a 3.4 percent annual pace after increasing at a 5.6 percent rate in the last three months of 2009, according to the median estimate of 67 economists surveyed by Bloomberg News. Household purchases may have climbed by the most in three years.

“Jobs are the critical component of the entire scenario,” said Russell Price, a senior economist at Ameriprise Financial Inc. in Detroit. “The signs do point to impending employment gains.”

Improving demand boosts the odds the recovery will be self- sustaining, benefiting companies such as Starbucks Corp., as rising sales lead to additional hiring, which in turn fosters even more spending. A lack of inflation gives Federal Reserve policy makers the green light to keep interest rates low when they meet this week to ensure the world’s largest economy continues to grow.

Central bankers will keep the target for the benchmark borrowing cost on overnight loans between banks near zero at the conclusion of their two-day meeting on April 28, economists surveyed forecast.

Fed Chairman Ben S. Bernanke told Congress on April 14 that high unemployment and weak construction were among the “significant restraints” on the pace of growth. At their March 16 meeting, central bankers said economic conditions are likely to warrant “exceptionally low levels of the federal funds rate for an extended period.”

GDP Report

The Commerce Department’s advance estimate of first-quarter GDP is due April 30. The world’s largest economy grew at the fastest pace in six years during the last three months of 2009 after expanding at a 2.2 percent rate in the third quarter.

For all of 2009, the economy shrank 2.4 percent in 2009, the worst single-year performance since 1946.

Consumer spending probably increased at a 3.1 percent annual rate last quarter, almost double the 1.6 percent pace of the previous three months, the GDP report is also projected to show.

Households led the expansion last quarter, taking the baton from gains in production that reflected efforts to stabilize stockpiles. A swing to smaller inventory reductions accounted for 3.8 percentage points of growth in the fourth quarter.

Inventory Boost

That contribution, while diminished, probably continued last quarter as companies boosted stockpiles for the first time in two years, according to economists such as economist Aaron Smith of Moody’s Economy.com.

Inventories climbed 0.5 percent in February, the fourth gain in five months, according to Commerce Department data.

Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts, is among those saying more jobs are a necessary component of a sustained recovery. Payrolls rose by 162,000 in March, the most in three years, the Labor Department reported April 2. The unemployment rate was 9.7 percent for a third month and has not increased since reaching a 26-year high of 10.1 percent in October.

Stocks gained in the first quarter of the year on mounting signs the economic recovery was taking hold. The Standard & Poor’s 500 Index climbed 4.9 percent from January through March, and has increased 9.2 percent so far this month.

Households may become more optimistic as the labor market improves. A Conference Board report on April 27 may show its measure of consumer confidence rose this month to 53.5 from 52.5, according to the survey median. The gauge averaged 45 in 2009, and 98 during the economic expansion that ended in December 2007.

‘Little Bit Better’

“We’re benefiting from a consumer who’s feeling just a little bit better,” Troy Alstead, chief financial officer of Starbucks, said in a telephone interview after the Seattle-based company announced earnings on April 21.

Starbucks, the world’s largest coffee-shop operator, raised its annual forecast after reporting second-quarter profit that beat analysts’ estimates. The chain’s sales at stores open at least a year advanced 7 percent in the U.S., driven by a 3 percent increase in the number of customer visits and a 5 percent jump in the amount of the average sale.

Confidence measures may give conflicting signals this month. The Reuters/University of Michigan index of consumer sentiment for April probably fell to 71 from 73.6 the prior month, according to the survey median. The figures are due April 30. A preliminary reading earlier this month came in at 69.5.

Signs of stabilization in the housing market may also help shore up confidence. A report from S&P/Case-Shiller, due April 27, may show home prices in 20 U.S. metropolitan areas increased 1.3 percent in February from a year earlier, the first year- over-year rise since December 2006, according to the survey median.

Dodd's New Plan for Finance Rules Aims to Give More Muscle to Fed

The Wall Street Journal

WASHINGTON—The political battle over rewriting the rules of Wall Street will intensify Monday afternoon when Senate Banking Committee Chairman Christopher Dodd is expected to introduce legislation tougher on financial companies than was expected just a few weeks ago.

The shift follows a push from the Obama administration, which sees a political advantage in pushing legislation taking aim at Wall Street. Mr. Dodd's bill would allow the Fed to examine any bank-holding company with more than $50 billion in assets, and large financial companies that aren't banks could be lassoed into the Fed's supervisory orbit. This came after Treasury officials pushed Mr. Dodd to bring more companies under the Fed's purview.



Any financial company, from small payday lenders to huge megabanks, would have to abide by new rules written by an autonomous Fed division that would be given the job of protecting consumers. This division would also be able to sanction any bank with more than $10 billion of assets for violations of consumer rules. Other industries could face enforcement if regulators decide to expand the division's powers. This is a departure from a more-constrained setup Republicans thought they had secured in recent talks.

The bill would now give the government more power to crack down on risky practices or certain types of lending.

In other highlights, under the proposed legislation the government would have power to seize and dismantle failing financial companies; complex financial instruments such as derivatives would face more scrutiny; shareholders would have more say in the way publicly traded companies operate; and the government would have more tools to force banks to reduce their risk.

Mr. Dodd has courted Republican support for months and said Sunday in an interview he still hoped to pass a bill with broad support. But he also appeared emboldened, and called Republican efforts to delay a vote "totally unrealistic and wrong." He suggested Republicans who wanted to make changes to the bill would have to "back up their commitment with the votes."

He dismissed arguments from some in the banking sector that have said more regulations would constrain credit. He called this a "Chicken Little" argument, calling it alarmist and arguing that financial crises are what dry up credit.

With Mr. Dodd intent on moving quickly, the banking industry will have limited time to try to shape the bill. "The industry will be subject to these new rules for the next 50 years or so, so this is a major moment in the history of the financial-services industry," said Scott Talbott, a senior vice president at the Financial Services Roundtable, a trade group representing large financial companies.

The Dodd bill comes nearly 18 months after the height of the financial crisis in 2008. Whether it can quickly gain traction could help determine the fate of the Obama administration's yearlong effort to rein in banks.

"There's no question that Treasury is pushing left, and that's what I would expect at this point," said Sen. Bob Corker (R., Tenn.), who negotiated for weeks with Mr. Dodd on parts of the bill.

The biggest winner in Mr. Dodd's bill appears to be the central bank. It would police previously unregulated sectors of the economy and would have a new division to write consumer-protection policy. The biggest losers appear to be large financial companies, who would face a muscular, centralized regulatory architecture for perhaps the first time in U.S. history.

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Bill's Highlights

Dodd's proposal touches on several areas. Key points:

    * Consumers: A consumer-protection division would be created within the Federal Reserve, with the ability to write new rules governing the way companies offer financial products such as mortgages and credit cards. It would have authority over any bank with more than $10 billion of assets, and certain nonbank lenders.

    * Banks: The Fed would oversee bank holding companies with more than $50 billion of assets. Regulators would have the discretion to force banks to reduce their risk or halt certain speculative trading practices.

    * Failing companies: The government would be able to seize and break up large failing financial companies. Big companies would have to pay into a $50 billion fund to finance the dissolution of a failing firm.

    * Systemic risk: A new council of regulators would be created to monitor broader risks to the economy. The council could strongly urge individual agencies to take specific actions to curb risk.

    * Corporate governance: The Securities and Exchange Commission would have authority to write rules giving proxy access to shareholders who own a certain amount of stock. Shareholders would have a nonbinding vote on compensation packages for top executives.

    * Hedge funds: Large funds would have to register with the government.
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Democrats opted last week to forge ahead and introduce a bill without Republican support. Central parts of the bill—especially consumer protection and the role of the Fed—could precipitate a clash, making the bill's prospects cloudy. Democrats believe they can rally public support, with many people still angry at the banking industry in the wake of the financial crisis.

"It would be great to find a bipartisan solution, but if we can't, we have to be true to the policy of ending the malpractice on Wall Street," said Sen. Jeff Merkley (D., Ore.), a member of Mr. Dodd's committee.

Mr. Dodd hopes he can begin holding votes in his committee starting next week. The legislation could come to the Senate floor by late April.

The House of Representatives passed its version in December. Any differences would have to be reconciled with a potential Senate version.

Republicans have said they wanted new market rules. They have blamed the White House for forcing Democrats to push ahead before a bipartisan deal could be struck. The party has not spelled out a strategy for responding to Mr. Dodd's bill, and it's possible Republicans could try to filibuster it, with Democrats one shy of the 60 Senate votes they need to end debate. On Friday, the 10 Republicans on the Senate Banking Committee urged Democrats to slow the process down.

Mr. Dodd's bill is expected to more closely align with the White House's initial proposal, after diverging from it during weeks of negotiations with Republicans. Mr. Dodd, in an earlier proposal, had cut the Fed out of bank supervision. After aggressive lobbying by Treasury Secretary Timothy Geithner and Fed officials, Mr. Dodd agreed to expand the Fed's scope to allow it to monitor any large financial companies.

Fed Lays Out Case For Continued Role In Banking Supervision

The Wall Street Journal

WASHINGTON—Facing the stripping of some its powers, the Federal Reserve on Thursday took the rare step of laying out its case for continuing to supervise the U.S. banking system.

In a letter to lawmakers, the Fed acknowledged regulatory "shortcomings," cited improvements it has made to its practices and worked to illustrate how its supervisory and monetary policy roles complement one another.

"Elimination of the Federal Reserve's role in supervision would severely undermine the Federal Reserve's ability to obtain in a timely way and to evaluate the information it needs to conduct its central banking functions effectively," the Fed said.

Its argument includes several points laid out over 12 pages:

-The Fed said its participation in the banking system "significantly improves" its ability to carry out its central banking duties. "Federal Reserve's ability to effectively address actual and potential financial crises depends critically on the information, expertise, and powers that it gains by virtue of being both a bank supervisor and a central bank," it said.

-The Fed said it recognizes that bank supervision needs to be more effective, noting that it is working to improve its capital and liquidity regulation and has begun changing the way it oversees large banking organizations. "These changes are intended to ensure that we fully employ our expertise to implement a more systemic and effective approach to our supervisory activities going forward," it said.

-The Fed noted that the shadow banking system and firms not under its own supervision were among the biggest drivers of the financial crisis. "These firms...were instead subject to consolidated supervision under statutory or regulatory schemes that were far less comprehensive than that applicable to bank holding companies," the letter said.

The Fed conceded that it can't and shouldn't be responsible for overseeing the entire financial system. "No agency has the breadth of expertise and information needed to survey the entire system," it said.

Still, it argued, "Both effective consolidated supervision and addressing macroprudential risks require a deep expertise in the areas of macroeconomic forecasting, financial markets, and payments systems. As a result of its central banking responsibilities, the Federal Reserve possesses expertise in those areas that is unmatched in government and that would be difficult and costly for another agency to replicate."

The letter comes as the nation's central bank is facing increasing criticism on Capitol Hill, which is considering stripping away some of its regulatory powers, and as Ben Bernanke still hasn't seen his continued role as Fed chairman reconfirmed.

N.Y. Fed Told AIG To Shield Payments

The Wall Street Journal

The Federal Reserve Bank of New York told American International Group Inc. not to disclose key details of their agreements to make big payouts to banks in the insurer's regulatory filings in late 2008, according to a set of email exchanges released Thursday.

AIG later amended its regulatory filings several times over the following months and provided the information after the Securities and Exchange Commission requested more disclosure. Congress also pressured the insurer to release the names of banks that were paid off in full on $62 billion in bets on soured mortgage securities. The biggest payouts went to French bank Société Générale and to Wall Street firm Goldman Sachs Group Inc., AIG finally said publicly in mid-March 2009.

The government's handling of the AIG bailout continues to draw scrutiny and has created political difficulty for Treasury Secretary Timothy Geithner, who was president of the New York Fed when it first bailed out AIG in September 2008. He played a key role in the regional Fed bank's controversial November 2008 decision to make U.S. and European banks whole on their mortgage gambles with AIG, according to a government audit last year.

Treasury spokeswoman Meg Reilly said what has been overshadowed is the fact that the government expects to be repaid in full, with interest, on the money it provided to buy the AIG-linked securities.

 

But a Treasury spokeswoman said Mr. Geithner wasn't involved in AIG's disclosure decisions, even though discussions about them took place in late November 2008, when he was selected as treasury secretary by President Obama. Mr. Geithner "played no role in these decisions and indeed, by Nov. 24, he was recused from working on issues involving specific companies, including AIG," the spokeswoman said.

"There was no effort to mislead the public," said Thomas Baxter, general counsel of the New York Fed, on Thursday. He said it was "appropriate" for the institution to comment on AIG's disclosures on transactions involving the New York Fed, "with the understanding that the final decision rested with AIG and its external securities counsel."

"Our focus was on ensuring accuracy and protecting the taxpayers' interests during a time of severe economic distress," Mr. Baxter said. Amid the financial crisis in late 2008, the Fed was reluctant to have AIG's trading partners identified because it feared such information would discourage other firms from doing business with the insurer and spark worries about the banks themselves.

An AIG spokesman declined to comment on the issue.

Copies of email exchanges from late November 2008 to March 2009 between lawyers representing AIG and the New York Fed were released by Rep. Darrell Issa (R., Calif.), ranking minority member of the House Committee on Oversight and Government Reform.

The emails show lawyers discussing what to disclose in AIG's December SEC filings about agreements the New York Fed and AIG's financial-products division struck to make banks whole on credit-default swap contracts they had purchased from AIG.

In a Nov. 25 email, Peter Bazos, an attorney at law firm Davis Polk & Wardwell, which represents the New York Fed, wrote that certain agreements "do not need to be filed." One agreement contained the names of banks that received payouts from AIG. A Davis Polk spokesman declined to comment.

In response, an AIG in-house lawyer, Kathleen Shannon, said the company and its law firm Sullivan & Cromwell "believe that the better practice and better disclosure in this complex area is to file the agreements." She also wrote that staff at the SEC "would not be particularly happy with a decision to withhold the documents at this time."

Subsequent email exchanges in December 2008 showed extensive editing that lawyers for the New York Fed made to an AIG draft filing and press release. When AIG released its 8-K filing on Dec 24, it made mention of a list of its derivative transactions, but a schedule supposed to contain them was left blank.

Six days later, on Dec 30, the SEC sent a letter to Edward Liddy, AIG's CEO at the time, requesting revisions to the filing and more information about the agreement, including the list of derivative transactions. In mid- January 2009, AIG amended its filing and submitted the list of deals to the SEC, but its public filings didn't include the list, saying that "confidential treatment has been requested for the omitted portions."

In early March, Federal Reserve vice chairman Donald Kohn told a congressional hearing he couldn't reveal the names of AIG's counterparties or how much was paid to each of them, saying that information "would undermine the stability of the company and could have serious knock-on effects to the rest of the financial markets and the government's efforts to stabilize them."

Days after the hearing, AIG released the names of its counterparties, listing 16 banks that had received a total of $62.1 billion in payments as part of agreements to tear up their derivative contracts with the insurer.

Mr. Geithner has become a convenient target for lawmakers angered by how top officials went about bailing out the financial system. At a series of increasingly contentious hearings on Capitol Hill, Mr. Geithner was taken to task for events and actions that occurred both during and after his time at the New York Fed, from issues such as bonuses paid to AIG executives and the failure to negotiate aggressively with the insurer's counterparties.

Treasury spokeswoman Meg Reilly said what has been overshadowed is the fact that the government expects to be repaid in full, with interest, on the money it provided to buy the AIG-linked securities.

"Somehow that fact that the government's loan is 'above water' gets lost in all the consternation," Ms. Reilly said. The outstanding loan balance stood at $18.6 billion at the end of December, while the fair market value of the securities portfolio was $22.6 billion, according to Treasury figures.

Fed Advice To AIG Scrutinized

NY Times

New revelations that the government stopped the American International Group from revealing information about its bailout had securities lawyers and policy makers buzzing on Thursday about whether the information had to be disclosed under federal securities law, and if so, what to do about the lack of compliance.

Joel Seligman, a historian of the Securities and Exchange Commission, said the disclosure rules were supposed to apply to all public companies, with only a few narrow exceptions for things like trade secrets and national security. There was no exception for “too big to fail” companies on federal life support, he said. Companies are supposed to disclose all information that could be material, though that term is not clearly defined.

“When an organization is troubled, it actually makes disclosures of this kind more important,” Mr. Seligman said.

Others disagreed, saying that bank and insurance regulators normally keep their discussions with struggling financial institutions private, to keep from inciting runs. There has always been tension, one securities lawyer said, between banking regulators, who want to resolve problems behind closed doors, and the federal securities laws, which compel disclosure.

The latest concerns that the government was suppressing important information about A.I.G. arose on Thursday after Representative Darrell Issa, a Republican of California, obtained e-mail messages between the insurer and the Federal Reserve Bank of New York, in which a Fed lawyer told A.I.G. “there should be no discussion” of certain details of the bailout in a regulatory filing.

The e-mail messages dealt with one of the most controversial aspects of A.I.G.’s bailout: that the Fed was paying the insurer’s trading partners 100 cents on the dollar for their soured investments. A.I.G. cited this fact, but the lawyer crossed the reference out.

The Fed also struck a paragraph about other investments that could not be unwound.

The New York Fed said on Thursday that it was offering advice, not orders, and that the second reference was irrelevant and did not apply to the transaction that A.I.G. was describing in its regulatory filing.

Securities requirements aside, Mr. Issa said this secretiveness flew in the face of good public policy and said he wanted to bring the Treasury secretary, Timothy F. Geithner, to Capitol Hill “to get every side of the story and understand what the motive and intent was of these actions.”

Mr. Geithner was president of the New York Fed at the time of the e-mail exchange. As part of its bailout, the government took a 79.9 percent stake in A.I.G., and Mr. Issa said he thought taxpayers had the right to know the details of the company’s finances.

The contents of the messages were first reported by Bloomberg News.

The messages showed that in December 2008, A.I.G. was preparing a filing to explain how it had eliminated a portfolio of derivatives, known as credit-default swaps, through an entity created with the Fed called Maiden Lane III.

The swaps served as insurance on debt securities held by financial institutions around the world. Maiden Lane III bought up the debts, making the financial institutions whole and allowing A.I.G. to tear up the swaps.

One troublesome set of swaps, worth about $10 billion, could not be torn up, because they did not insure debts that could be bought by Maiden Lane III — they insured amorphous bundles of derivatives. A.I.G. has never found a way to cancel them, and they are still in force.

The existence of these particular swaps has been controversial, because they suggest that A.I.G. and its trading partners were dealing not just in newfangled insurance, but in highly speculative bets on the real estate markets.

The Fed’s lawyer, Ethan T. James, of Davis Polk & Wardwell, deleted all references to the $10 billion in swaps that could not be torn up. He wrote in the margin: “There should be no discussion or suggestion that A.I.G. and the N.Y. Fed are working to structure anything else at this point.”

After receiving his instructions, A.I.G. deleted the reference to the $10 billion derivatives problem from its regulatory filing.

An official of the New York Fed said its reasons for telling A.I.G. not to mention the $10 billion of special swaps were innocuous. The New York Fed issued a statement by its general counsel, Thomas C. Baxter, saying it was “appropriate” to have given A.I.G. guidance on what to say in the S.E.C. filing, because the New York Fed had helped create Maiden Lane III.

“Our focus was on ensuring accuracy and protecting the taxpayers’ interests, during a time of severe economic distress,” Mr. Baxter said. “All information was in fact disclosed that was required to be disclosed by the company, showing that the counterparties received par value. There was no effort to mislead the public.”

Mr. Baxter, the general counsel, also said that while the New York Fed had offered its opinions about the filing, “the final decision rested with A.I.G. and its external securities counsel.”

Mark Herr, a spokesman for A.I.G., said that the company would not comment on the matter.

Mr. Issa, the senior Republican on the House oversight committee, said he was writing to the committee chairman, Edolphus Towns of Maryland, about including the questions of disclosure in the committee’s inquiry into the bailout.

Thursday’s controversy follows other disputes over whether the Federal Reserve was suppressing information about A.I.G. that the public had a right to know. Early in the bailout, the company and the Fed refused to name the financial institutions that were counterparties to the company’s derivatives.

The Federal Reserve’s vice chairman, Donald L. Kohn, told angry senators in a hearing that the Fed thought A.I.G. would lose customers if such information were made public, and any loss of customers would only hurt the taxpayers.

But the senators warned that unless the names were revealed, no more bailout money would be forthcoming, and not long after that, the names were made public.

The inspector general for the bailout, Neil Barofsky, said in an audit of A.I.G. that the arguments against transparency simply did not withstand scrutiny. “Notwithstanding the Federal Reserve’s warnings, the sky did not fall,” he wrote in November.

More recently, attempts by the New York Fed and A.I.G. executives to soften pay restrictions included references to the company’s condition that some thought should have been disclosed to shareholders.

The officials argued that the executives would resign if they were paid in company stock, citing projections showing that the stock might be worthless — something the taxpayers, as shareholders, might like to know — according to people with knowledge of the analysis.

Those discussions were disclosed on Sunday in an article in The New York Times Magazine.

A.I.G. did not comment. Others said that its regulatory filings stated that the company expected to be viable for more than 12 months only if the government continued its support, and that well captured the level of investor risk.