In this issue:

Leading U.S. Banks Hold Trillions in Dangerous Derivatives

Buffett's Alarm on Derivatives Sparks Policy Fight

U.S. Machine-Tool Consumption Continues Severe Decline

SEC Probes AOL for 'Aiding and Abetting' Schemes To Inflate Revenue

Stock Market Collapse Takes Down States' Pension Assets

Consumer Confidence Crumbles in Early March

Retail Sales Skid to New Lows in February

Merrill Lynch Banker Fears Fed's Proposed Use of 'Unconventional Tactics'

Bankrupt Worldcom Lowers Asset Value by $79.8 Billion

New York City Pension Funds Face $90-Million Loss from NCFE Bonds


From Volume 2, Issue Number 11 of Electronic Intelligence Weekly, Published Mar. 17, 2003

U.S. Economic/Financial News

Leading U.S. Banks Hold Trillions in Dangerous Derivatives

According to a report issued March 12 by the Comptroller of the Currency, U.S. bank holding companies held $58.3 trillion of derivatives bets at year-end 2002, led, as usual, by JP Morgan Chase, with $28.9 trillion; followed by Bank of America, with $12.5 trillion; and Citigroup, with $10.0 trillion. Close behind were Wachovia (née First Union) with $2.0 trillion, and Bank One with $1.1 trillion. The bank holding companies had $48.7 trillion in derivatives at the end of 2001, and $43.9 trillion at the end of 2000. U.S. banks held $635 billion of credit derivatives at the end of 2002, with Morgan Chase accounting for $366 billion, Citi for $132 billion and Bank of America for $92 billion. The banks charged off $73.6 million on their derivatives holdings in the fourth quarter, bringing derivatives charge-offs to $631 million from the third quarter (the 9/11 quarter) of 2001.

Buffett's Alarm on Derivatives Sparks Policy Fight

Following last week's warning by the "Oracle at Omaha," Warren Buffett, that financial derivatives should be seen as "time bombs" (see EIW #10 ECONOMICS NEWS DIGEST), a firestorm of debate over derivatives has erupted, suggesting that a major policy fight is being waged over how to handle the bankrupt derivatives banks and the system they represent. Buffett's comments were released, and promoted, by Fortune on March 3, and hardly a day has passed without a major article appearing on this normally hidden subject.

For example, the Washington Post, the Lazard-connected paper partly owned by Buffett, carried a March 6 business-page lead story contrasting Buffett's views with those of Federal Reserve chairman Sir Alan Greenspan (Buffett "put himself directly at odds with another financial sage ... Greenspan," the paper said, liberally quoting from both). On March 12, the Post carried an op-ed by economist Robert Samuelson, contrasting the Buffett and Greenspan positions and raising Greenspan's warning about the need to bail out the system in the "remote possibility of a chain reaction."

The Financial Times of London devoted an entire page to the subject March 10, featuring a huge picture of Buffett overlaid by selected quotes. The FT quoted International Accounting Standards Board Chairman Sir David Tweedle as warning: "The derivatives we have out there can destroy companies ... and you would not even know."

The rebuttal was handled by the rabidly pro-derivatives Wall Street Journal in its lead editorial March 11, which delicately criticized Buffett's comments as "grumpy" and unreasonable. "Warren Buffett is on a crusade (again)," the Journal complained, citing and then dismissing, his arguments. The voice of Wall Street waxed ecstatic about derivatives, calling them "little miracles of financial engineering," which save the banks by offloading "risk" (read: losses) to others. "Thus even after several years of a weak economy and shock defaults in the telecom sector, there have been no big bank failures.... Buffett is not only shooting the messenger, he's also blaming the gun."

U.S. Machine-Tool Consumption Continues Severe Decline

In January 2003, U.S. industry consumed $149.70 million worth of machine tools, which represents a fall of 19.0% compared to January 2002's level of $184.73 million, according to a March 10 announcement by the American Machine Tool Distributors Association (AMTDA), and the Association for Manufacturing Technology (AMT).

"Over half of U.S. manufacturers are working with machines made in the 1960s and 1970s," AMT president Albert W. Moore stated. This means that these machine tools, between 24 and 43 years old, are significantly beyond their useful life, which is considered to be 20-25 years. Moore added, "The only way they [these companies] can regain international competitiveness is to allow them to fully expense the purchase of equipment in the year that it is acquired." While an accelerated tax credit for manufacturers' purchase of machine tools could be helpful, AMT is refusing to face the fact that the U.S. financial-economic system is in a final phase of disintegration breakdown, and unless that problem is solved, U.S. machine tool consumption and production won't increase appreciably.

Annualizing the data for January, U.S. machine tool consumption in 2003 would total $1.80 billion.

U.S. Machine Tool Consumption, on an Annual Basis ($ billions)
1997 $5.56
1998 4.91
1999 3.90
2000 3.99
2001 2.67
2002 2.06

Thus, highlighting the collapse of the economy, U.S. machine-tool consumption in 2003 would be but one-third the level of 1997.

SEC Probes AOL for 'Aiding and Abetting' Schemes To Inflate Revenue

The Securities and Exchange Commission widened its probe of America Online and two of its former executives, to cover alleged schemes in which AOL and other companies, including online real-estate firm Homestore Inc., exchanged cash through bogus transactions, in order to artificially boost revenue. AOL Time Warner and the two former dealmakers, David Colburn and Eric Keller, could be found culpable not only for the media firm's own accounting fraud, but also for the financial wrongdoing of other companies.

Stock Market Collapse Takes Down States' Pension Assets

Due to the ongoing stock-market meltdown, the pension assets of U.S. states are now worth less than the benefits they are committed to pay out, the Washington Post reported March 13. Overall, the total value of assets in state employee pension plans fell to 91% of liabilities, as of the end of 2002, according to a report by Wilshire Associates Inc. Some 79% of "defined benefit" state pensions are underfunded, up from 31% in 2000. In fewer than one dozen states, are pension assets equal to or greater than liabilities; in about a dozen, assets are less than 75% of liabilities.

As a result, states will have to increase funding, possibly by raising taxes or cutting other programs, according to Wilshire.

Denying reality, state officials said that the report appeared to paint an unnecessarily bleak picture, claiming that the pension plans "are designed to withstand this sort of" market meltdown through "actuarial valuation methods."

Corporate pensions are currently underfunded by about $300 billion overall, the Pension Benefit Guaranty Corp. estimates.

Consumer Confidence Crumbles in Early March

Consumer confidence fell in March to the lowest level in more than a decade, according to a preliminary survey issued by the University of Michigan March 14. The survey found that consumer sentiment fell in early March for a third consecutive month, to 75.0, its lowest reading since October 1992, from 79.9 in February.

Lyndon LaRouche reportedly commented, that this is Michigan telling Bush, "It's the economy, stupid."

Retail Sales Skid to New Lows in February

Retail sales in February plunged by 1.6% over January, to $304.1 billion, the largest one-month drop since November 2001, according to figures released by the Department of Commerce March 13. Excluding sales of gasoline (whose average price jumped 12% in February), retail sales fell by 1.9%.

One key example: Ford Motor Company announced plans to cut second-quarter production by 17%, compared to a year ago, due in part to falling sales.

Merrill Lynch Banker Fears Fed's Proposed Use of 'Unconventional Tactics'

In his March 7 "Research and Commentary Report," Merrill Lynch's senior economist for North America, David Rosenberg, expressed high anxiety about state of the U.S. economy, writing, "The employment report for February is the ... most noteworthy piece of information suggesting the risk that the economy may be heading back down. The drop of 308,000 in payrolls is too big and too widely dispersed across too many industries to be blamed on bad weather or the call-up of military reserve personnel."

Rosenberg then offered his forecast: The Fed's Federal Open Market Committee (FOMC) will cut the Federal funds rate by 1/4 percent on March 18, and another 1/4 percent in May, which two cuts will lower the rate to 0.75%. Most critically, Rosenberg then said, "The Fed's next step, if needed, probably would be to purchase intermediate- and long-term Treasury securities directly, as [Fed] Chairman Alan Greenspan and [Fed] Governor Ben Bernanke have indicated."

On Nov. 19, 2002, speaking before the New York Council on Foreign Relations, Fed chairman Alan Greenspan praised derivatives, but then said that should there be a major derivatives failure, the Fed must consider becoming the "insurer of last resort," for the banks that have large derivatives holdings outstanding.

Two days later, in a move coordinated with Greenspan, Fed Governing Board member Ben Bernanke said that, in the event of extreme deflation or something going wrong in the financial system-economy, the Fed may approach the "zero bound condition," and could not lower interest rates any further. It would then have to resort to "unconventional measures." Normally, the Fed carries out procedures through its Federal funds window, by which it buys and sells three- to six-month U.S. Treasury securities, which affects short-term interest rates. Bernanke proposed that the Fed take the extraordinary step of directly buying two- to five-year U.S. Treasury securities, with the intent of bringing down long-term and intermediate interest rates. In his speech, Bernanke likened the most extreme form of his approach to a "helicopter drop of money," which would flood the economy-financial system with money.

Bankrupt Worldcom Lowers Asset Value by $79.8 Billion

Bankrupt Worldcom has lowered the value of its assets by nearly $80 billion, signifying that much of its telecom network is essentially worthless. Worldcom wrote off $45 billion in value of companies bought in its 1990s acquisition binge, wiping out "goodwill"--i.e., the difference between purchase price and market value. In addition, the bankrupt telecom giant slashed by about 75%, from $44.8 billion to $10 billion, the value of equipment and intangible assets in its fiber-optic network.

New York City Pension Funds Face $90-Million Loss from NCFE Bonds

New York City's employee pension system could lose almost $90 million on bonds it holds, which were issued by the now-bankrupt health-care looting operation known as National Century Financial Enterprises (NCFE), the New York Times reported March 14. The NCFE bonds were pawned off on the city pension plan by Citibank, which serves as its custodian and lending agent.

New York is not alone: More than 100 Arizona municipalities face total losses of $131 million on NCFE bonds held by an investment pool run by the state treasurer. The Flagstaff United School District announced March 13 that it is joining a class-action suit to attempt to recover over $18,000 held in the investment pool. Another $100,000 was lost by the surrounding county.

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