Published: Thursday October 16, 2008
US industrial production plunged a shock 2.8 percent in September, the steepest fall in 34 years, due to hurricanes in the Gulf of Mexico and a strike at Boeing, the Federal Reserve said Thursday.
Hurricanes Gustav and Ike, which hammered the Gulf of Mexico region, a key hub of the US oil and gas industries, and a machinists strike at Boeing that has crippled civilian aircraft production, "severely curtailed output," the central bank said.
The plunge in output far exceeded analysts' consensus forecast of a scant 0.8 percent decline. It was the strongest fall since December 1974.
The Fed estimated the disruptions from the hurricanes on total output contributed some 2.25 percentage points to the decline.
"In addition to reductions in oil and gas extraction, hurricane-related shutdowns of petroleum refineries and petrochemical producers factored significantly in the decline; other manufacturing industries with storm outages made smaller contributions to the drop in output," it said.
The ongoing machinists union strike at Boeing, begun on September 6, contributed an estimated half percentage point to the overall decrease in industrial output.
RDQ Economics analyst John Ryding rejected the Fed arguments that the freefall was due to the hurricanes and Boeing strike.
"The weakness in production was broad-based as the only major categories of production that posted gains were vehicles -- this can hardly be expected to be sustained given trends in auto sales and current vehicle inventory levels, apparel, and electric power generation," Ryding said.
"We think the recession had some significant effect on restraining output," he added.
Ian Shepherdson at High Frequency Economics said that "regardless of the source of the September drop, it is a direct hit on GDP (gross domestic product). We now reckon Q3 GDP fell by more than 1.0 percent at an annualized rate."
On a 12-month basis, industrial production was down 4.5 percent in September, compared with a decline of 1.5 percent in August.
For the third quarter as a whole, industrial out decreased at an annual rate of 6.0 percent, the Fed said.
The capacity utilization rate for total industry fell to 76.4 percent in September, compared with a rate of 78.7 percent in August. The September rate was a whopping 4.6 percentage points below its average level from 1972 to 2007, and significantly below market expectations of 78.0 percent.
Manufacturing production fell 2.6 percent in September, after a 0.9 percent decline in the prior month.
The output of mines and energy plunged 7.8 percent after holding steady in August, as crude oil and natural gas operations in the Gulf of Mexico were suspended because of the hurricanes.
Utilities' output rose 2.2 percent, rebounding from a decline of 3.1 percent in the prior month, as temperatures returned to more normal levels in September after a relatively cool August, the central bank said.
A key regional indicator showed a record plunge, underscoring the rapid deterioration in the industrial sector.
The Philadelphia Federal Reserve said its index of manufacturing activity in the Northeast's Mid-Atlantic region plummeted to a negative 37.5 in September from a positive 3.8 in August, its largest one-month decline ever.
The Case for Plain Vanilla Here is the radical implication of this collapse: The next financial system, rebuilt by governments on the ruins of the old one, needs to be plain vanilla.
October 16, 2008 | web only
"How did you go bankrupt?"
"Two Ways. Gradually, and then suddenly."
--Ernest Hemingway, The Sun Also Rises
I recently debated an economist from the University of Chicago on the economic value of exotic derivatives. "They add liquidity," he insisted, repeating the standard wisdom. But recent events have shown that such instruments indeed create liquidity -- until suddenly they destroy it.
For example, a credit default swap is an insurance contract against a bond defaulting. Many of the bonds thus insured were themselves derivatives, in this case bonds backed by sub-prime mortgages.
There are about $2 trillion dollars of subprime bonds in the marketplace -- but $62 trillion dollars of different kinds of "swaps" making bets for or against the failure of those bonds. This kind of leverage is why derivatives create a house of cards.
Supposedly, these derivatives on top of derivatives "spread risk," but in truth they spread risk the way an epidemic spreads diphtheria. Mainly, they created financial pyramids that hid risk, allowing ever thinner ratios of capital-to-debt with each added layer.
One bad bet on swaps by a tiny unit of A.I.G., the world’s largest insurance conglomerate, took down the whole company. Though ordinary insurance is well regulated, with required reserves against insurance losses, regulation of this particular exotic insurance was nobody’s responsibility. And just before the Federal Reserve acted to nationalize A.I.G, the New York State insurance commissioner had drafted an order permitting A.I.G to tap some $20 billion in strictly segregated insurance reserves to bail out its ailing swaps unit in London. Just as one credit default infects another, so regulatory lapses feed on one another.
With credit default swaps, investors were spared the need to perform the most basic of capitalist roles -- to have a close look at what they were buying. Swaps were moral hazard on stilts.
Why, after all, do people and financial systems go bankrupt "gradually, and then suddenly?" Because as their real situation worsens, they stave off the day of ruin by borrowing. Bankruptcy comes with terrible suddenness when creditors stop lending. The more exotic and opaque the security, the higher the tower of possible debt and the more devastating the eventual crash.
Here is the radical implication of these interconnected collapses: The next financial system, rebuilt by governments on the ruins of the old one, needs to be plain vanilla. The banking system should be restored to its basic role of supplying credit to the real economy, with as few complications as possible.
We need a system in which commercial banks take in deposits and make loans; and where investment banks underwrite securities such as ordinary stocks and bonds. This kind of system is transparent to regulators. They can measure the value of assets, and require banks to put aside reserves against non-performing loans. Without complex derivatives that have no trading market and hence no valuation, it again becomes possible for regulators to assure capital adequacy and limit the disguised layers of pyramiding. Investors can once again make informed decisions.
If financial engineering did all that its enthusiasts claim for it by way of improving the efficiency of capital markets, we would have seen the results in improved GDP. But growth was far higher in the era of plain vanilla finance.
The Chinese, have grown at about ten percent a year for two decades, with only the most rudimentary of financial systems. Banks take in deposits and underwrite industrial expansion. The system simply prohibits collateralized debt obligations. There are many unsavory aspects of China’s political system, but its financial system gets the job done.
It is fashionable to argue that financial engineers will always innovate around regulators, but until deregulation became the norm in the Thatcher-Reagan era, regulators did well. For the first two decades of the postwar era, entire categories of transactions were simply proscribed.
Lately, the regulatory problem has been less technical than political. In 1994 the U.S. Congress, then controlled by Democrats, passed a law prohibiting subprime mortgage underwriting. But Alan Greenspan, then Fed Chairman, refused to issue the necessary regulations. In 1995, Republicans took over Congress and no one held Greenspan’s feet to the fire.
Democrats also come in for their share of blame. When Brooksley Born, then the head of the Commodity Futures Trading Commission, proposed to regulate derivatives, the entire bipartisan political establishment came down on her -- Robert Rubin, Alan Greenspan, and other financial regulators. The allegation was that her proposal would "disrupt" financial markets. All it would have disrupted were exorbitant profits that built pyramids of risk.
In 2000, then Senator Phil Gramm, now an adviser to John McCain, got a law enacted for the benefit of Enron, effectively prohibiting the regulation of credit default swaps entirely. Had these two forms of regulation not been politically aborted, the current financial collapse would have been avoided. So the challenge of prohibiting the most dangerous of financial exotics is not technical, but political.
Robert Kuttner is co-founder and co-editor of The American Prospect magazine, as well as a Distinguished Senior Fellow of the think tank Demos. He was a longtime columnist for Business Week, and continues to write columns in the Boston Globe. He is the author of Obama's Challenge and other books. For more read our "about the editors" page.
Schumer: Treasury 'Receptive' To Guidelines On Bank Plan
Joint Economic Chairman Charles Schumer today said Treasury Department officials "seemed receptive" to several guidelines the New York Democrat wants imposed on how banks use funds provided by the government under the administration's plan to free up credit. Following a meeting this morning with Neel Kashkari, who heads the department's $700 billion rescue plan, Schumer said he is confident it "will be done on the level," but said he is concerned that the "capital infusions will not find their way to Main Street." Treasury Secretary Paulson has said the department will push banks receiving federal funds to loan out money, but acknowledged Treasury lacks formal power to stop banks from hoarding money. Schumer said he urged Treasury to impose four guidelines on banks' use of funds. They would bar use of "exotic financial instruments;" urge banks to use money so "it will go out in the economy" and aid small business; push banks to refinance troubled mortgages; and limit executive compensation at participating banks.
Schumer said that while existing guidelines announced by Treasury limit golden parachutes for departing executives and allow "clawback" of money if firms engaged in financial misconduct, they lack extensive limits on executive pay that he and other lawmakers want. "I told him in very stark terms the American people are watching this issue very closely," Schumer said. The senator did not offer details of his proposals. He said Kashkari and other officials appeared enthusiastic but offered no guarantees. Schumer also said he had urged Treasury to force banks to limit dividend payments to investors beyond the limits announced Tuesday by the department. Schumer said that while the "capital injections at least for a time have replaced direct purchase of trouble assets," Treasury still appears set on moving fast to conduct auctions of troubled assets.
Schumer's meeting with Treasury came as stocks continued to fluctuate wildly, with the Dow Jones industrial average down more than 500 points this morning on bad economic news. The National Retail Federation today called for Congress to hold a lame-duck session to pass an economic stimulus plan. Also today, House Financial Services ranking member Spencer Bachus, in a letter to SEC Chairman Christopher Cox, urged the agency to ease mark-to-market accounting rules that financial institutions claim have forced them to write down the value of assets the institutions believe will regain value under better market conditions. "The reduced value being placed on assets using the existing interpretation ... threaten to offset the beneficial impact of the capital being injected into the institutions by the government under the Emergency Economic Stabilization Act," Bachus wrote. The SEC is conducting a study of mark-to-market rules.
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