Russia expressed interest in using Cuban airfields during patrol missions of its strategic bombers, Russia’s Interfax news agency reported
Russian strategic bombers could use Cuba airfields
Wal-Mart vs. Target: During the Recession, It’s No Contest
When times are tough and consumers are “trading down” to buy more inexpensive goods, you’d think that a discount retailer like Target would flourish. After all, it’s the place you go for quality clothes at affordable prices — cheap-chic designer Isaac Mizrahi offers a line — low-cost home accessories, and perhaps a grocery item or two.
Alas, therein lies Target’s problem. Things are so bad, even cheap clothes are a luxury now. Why pull a new shirt off the store rack, when you can just snatch one out of the closet for free Food, however, is not discretionary. Everyone has to eat, and more consumers want to dine at home to shave expenses. And there’s a certain merchandising mammoth fulfilling that crucial grocer’s role for consumers much better than Target.
While Wal-Mart, the largest company in the world, has always dwarfed rival Target in size , until recently Target had been decisively winning the growth game. From 2003 though 2007, Target’s annual same-stores sales growth averaged 4.6%, while Wal-Mart’s clocked in at 2.9%. Over the same period, Target’s annual profit growth averaged 16%, while Wal-Mart lagged behind at 10.3%. “Target was frying Wal-Mart’s brains out,” says Howard Davidowitz, chairman of Davidowitz & Associates, a national retail investment banking and consulting firm.
At the onset of the recession, however, Target and Wal-Mart saw their fortunes flip. Target’s same-store sales have fallen for eight straight months; Wal-Mart’s have risen for 22 straight months. Target’s 2008 same-store sales fell 2.6%, while Wal-Mart’s rose 3.3%. Most recently, Target’s February sales dropped 4.1%, while Wal-Mart enjoyed a 5.1% jump.
More importantly, in 2008 Target’s profits dropped a stunning 22.3%, to $2.2 billion. That figure includes a 40.7% earnings collapse in the fourth quarter. Wal-Mart’s 2008 bottom line rose 5.9%, to $13.5 billion. Now, Target is getting trounced.
Davidowitz notes that a “double whammy” is driving Target down. First, the retailer’s product mix is not ideal in this economy. According to Davidowitz, Target devotes some 40% of its shelf space to home and apparel items, which are struggling, while setting aside less than 20% for consumables like food, health items and beauty care. Wal-Mart sets aside 45% of its space for consumables. “Wal-Mart sells what you need to have,” says Davidowitz, “as opposed to what you want to have.” Not only does Wal-Mart sell more of the grocery items that you need—the company is the world’s largest food retailer—it sells them at better prices. Britt Beemer, founder of America’s Research Group, says that customers have fled Target because they think of the company as an apparel retailer, and they believe that the groceries they do sell are overpriced.
The second whammy on Target’s performance is its credit business. Target is one of the last major retailers to own a part of its credit card portfolio. When consumers are drowning in mortgage and other credit card debt, they often ignore retail card obligations. Rising defaults and delinquencies have dragged earnings. Credit card profits dropped 80.5%, to $155 million, in 2008, and the company incurred a $135 million pre-tax loss on its credit segment in the fourth quarter. “The company did great with its credit business when the economy was up, but now that the it’s down, carrying your own credit is devastating,” says Davidowitz. At least Target can be grateful it made one smart move: in May, the company sold 47% of its receivables to JPMorgan Chase for $3.6 billion. Without that move, the devastation would be much worse.
So how is Target responding to the malaise The credit distress is hard to control, though the company has promised to tighten lending standards and increase collections. On the product side, the company knows it must offer more essentials. “We continue to invest in our food offering in recognition of its importance in driving greater frequency, increasing guest loyalty, and making Target a preferred shopping destination,” company CEO Gregg Steinhafel said on Target’s fourth quarter earnings call. For example, last year the company opened its first distribution center for perishable goods like fruits, vegetables, and meats, in Lake City, Fla. Target is slated to open another distribution center this year, in Cedar Falls, Iowa. “That’s a major step,” says Davidowitz. “Controlling your own distribution can improve food freshness on the shelves, and it allows you to hold onto more of the margins.”
Steinhafel also said that Target would sell perishables in most new and remodeled general merchandise stores; the retailer plans to open 75 new locations this year. The company already sells meat and produce in its 245 “SuperTarget” locations . Target has already enhanced its food investment in two general merchandise stores in the Minneapolis area. Davidowitz, for one, is impressed. “When I checked the perishables, they are very fresh, very well presented, very appetizing, and people were buying them,” he says.
Despite these efforts, Target’s transformation won’t guarantee success. It’s hard for a retailer to shake its reputation as a clothing outlet, while at the same time quickly master the management of perishable grocery items. “You can’t just flip the switch and change the store over night,” says David Heupel, a senior equity portfolio manager at Thirvent Financial in Minneapolis. Plus, if Target drops grocery prices below Wal-Mart’s levels, the big boy will quickly respond. “There’s no reason to put a stick in the bear’s eye,” says Ed Weller, a retail analyst at ThinkEquity Partners.
What’s Wal-Mart isn’t just some massive outlet that peddles cheap wares; it has focused on food for a long time, and is really hitting a stride during the recession. “Wal-Mart works hard to build a strategy around groceries,” says Beemer, the founder of America’s Research Group. “They look at groceries as a way to get people in the store for the first time. Target sees it as an add-on sale.” In a research note, entitled “It’s Wal-Mart’s Time & Investors’ Opportunity,” Deutsche Bank analyst Bill Dreher Jr. wrote: “Bottom line, Wal-Mart is executing flawlessly.”
Can Target reach Wal-Mart’s level of excellence It may have to rethink its mission. Issac Mizrahi is nice. But now shoppers want to see meat and potatoes.
See pictures of the recession of 1958.
See pictures of Americans in their homes.
Japan destroyers set sail on anti-piracy mission
Two Japanese destroyers set sail Saturday on an anti-piracy mission off Somalia, the Japanese defense ministry said.
The Japanese Cabinet approved the mission Friday. It marks the first policing action for the Maritime Self-Defense Force (MSDF), whose major overseas missions have previously focused on background support such as transport and refueling, Japan’s Kyodo news agency said. The move comes after Somali pirates released a Japanese-owned vessel that was hijacked in the pirate-infested Gulf of Aden in November, according to a nongovernmental group that monitors piracy. The ship was released last month. Roughly 400 MSDF personnel and eight coast guard officers are aboard the two destroyers, each of which carry two SH-60K patrol helicopters and two speedboats, officials told Kyodo.
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The 4,650-ton Sazanami and 4,550-ton Samidare destroyers left their base in the southern port city of Kure after a ceremony attended by Prime Minister Taro Aso and Defense Minister Yasukazu Hamada, Kyodo reported. Once the destroyers reach the Gulf of Aden in two to three weeks, they will escort vessels linked to Japan, such as Japanese-registered ships, vessels with Japanese nationals or cargo on board, or ships operated by Japanese shipping firms, Kyodo said. Japan Coast Guard officers are aboard the destroyers to process judicial matters, including collecting evidence and handling suspects, in the event that the vessels encounter pirates, Kyodo reported. MSDF members aboard the destroyers may fire warning shots if they encounter pirates, but under Japanese law they are not allowed to harm the pirates except in limited circumstances like self-defense, Kyodo reported. To better deal with pirate attacks, the Japanese government submitted an anti-piracy bill to Parliament on Friday which, if passed, would provide more latitude in stopping piracy, including firing at pirate boats that close in on commercial ships despite repeated warnings to stop, Kyodo reported. The bill would also enable the MSDF to protect any ship, including those without a Japanese connection — a provision government officials say is needed to fulfill Japan’s international obligations, Kyodo said.
Pakistan TV station reportedly blocked in parts of country
Pakistani television station GEO-TV has been shut down in locations across the country, according to the station’s managing director.
Government officials have instructed cable operators to remove the channel from the airwaves or push it farther down in the channel order, Azhar Abbas said Saturday. The channel signal has been blocked in certain areas, but other cable operators are still carrying it. The channel is functioning and broadcasting in some areas in Pakistan. Repeated phone calls from CNN to the Pakistani government for comment were not returned. Pakistan’s Information Minister Sherry Rehman has resigned to protest restrictions on local media, a high-ranking source in the Ministry of Information told CNN on Saturday. Rehman, a key member of Pakistan Peoples Party (PPP), handed in her resignation to Pakistani Prime Minister Syed Yusuf Raza Gilani, the source said.
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GEO-TV is one of the most popular television channels in the country and its coverage has been critical of the PPP-led government in recent weeks. The station has aired numerous reports on the recent lawyers’ movement. Lawyers in the country are publicly demanding the government restore judges the previous president ousted. Thousands of demonstrators were expected to head to Islamabad as part of a four-day “Long March.” The demonstrators plan a massive sit-in at the parliament building Monday. Many have tuned to GEO-TV, which is known to have an anti-establishment stance, for its critical coverage of the lawyers’ movement.
Bangladesh mall fire death toll hits 7
Bangladeshi authorities found seven bodies in the charred remains of a massive shopping complex that caught fire Friday afternoon.
Along with the seven deaths, 15 people were injured, said Mahabubor Rahman, deputy commissioner of police. Rescuers were searching for more trapped shoppers Saturday. Authorities were also trying to determine what caused the blaze. Though the fire had been extinguished, it was unclear how many people remained inside the 22-story complex. “A lot of (people) could be (trapped) there,” Rahman said, speaking by phone from Dhaka. Many people go to shopping areas Friday, which is a day off in Bangladesh. Thousands of shoppers rushed out of the crowded Bashundhara City shopping complex in Dhaka, Bangladesh’s capital, when the fire broke out on the top floors of the building. The injuries are a result of both the fire and the rush to leave the building, a Shamarita hospital official said. An estimated 10,000 people were in the building when the fire began about 1:45 p.m. (3:45 a.m. ET), Rahman said. Two people were evacuated by helicopter, including one who was injured, Rahman said. Flames and plumes of smoke emanated from the building’s upper levels, where the food court is located. Watch footage of fire »
Some firefighting units initially had trouble reaching the blaze because their ladders did not go past the 13th floor, according to a local newspaper, The Daily Star. iReport.com: Fire seen from apartment rooftop More than 25,000 people visit the shopping complex every day, according to developers. It opened five years ago and developers say it is the largest shopping mall in South Asia and the 12th largest in the world.
Family caught in Madoff swindle forced to sell Jewish heirlooms
Elisa Schindler says she is relieved her father, the late Rabbi Alexander Schindler, didn’t live to see the destruction caused by Wall Street swindler Bernard Madoff.
“Here’s a man who dedicated his entire life to making the world a better place and contrast that with a man who didn’t do that,” she says. Rabbi Schindler, who died in 2000, was a prominent clergyman who was a leader of Reform Judaism in the U.S. His eldest of five children, Elisa, says he invested his life savings with Madoff in 1996 but never met him. With everything wiped out, Schindler’s widow, Rhea, now must sell their family home in Connecticut. The family also is selling two sacred pieces of Judaica given to the rabbi as a retirement gift. Pieces, say Schindler, that would have been passed down to her sister who is a rabbi in Charlotte, North Carolina. “It probably would have ended up with her, so it was sad that we had to break the chain of history and not be able to pass on that legacy,” says Schindler, who calls Westport, Connecticut, home. Watch family describe pain of being ripped off » “I think that my father was extremely pragmatic, as are we, and we realized these were items we could part with, and needed to part with, in order to ensure that my mother would have the security she needs.” The pieces include a silver “Torah Crown,” likely made in the United States in the 20th century, and a “Torah Pointer” that dates back to as early as 1780, according to Jonathan Greenstein, an auctioneer specializing in antique Judaica. Greenstein says the “Torah Pointer” or “Yad” comes from the Netherlands and very few such items survived the Holocaust, adding “It’s extremely rare, extremely, extremely rare.”
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Greenstein plans to auction the items in June, the same month Madoff is scheduled to be sentenced after pleading guilty to 11 criminal counts on Thursday. He face 150 years in prison. Watch another Madoff investor tell her story » “I’d like the new owner of these two items to use them in celebration, not sadness,” Greenstein says. “It should not be ruined by Bernie Madoff or any other negative history that can be connected to it, but should be admired because it belonged to Rabbi Schindler,” Greenstein says. Elisa Schindler turned to Greenstein to sell them because “whether these items would end up in a private home, whether they would end up in a museum or with a synagogue, we just knew they’d find a fitting home.”
While she admits it’s heartbreaking, Schindler also reminds herself of other struggles her family has endured. “My father came out of Nazi Germany,” she said. “His mother once told me when she came out of Germany, ‘What’s in your mind and what’s in your heart, they can never take away from you.’ And that’s a lesson that’s always been with me. …Nobody can take that from you. And the rest of it is just things.”
Dad marries girlfriend, 17, to ‘fulfill a wish for Haleigh’
The father of missing child Haleigh Cummings’ married his 17-year-old-girlfriend, who was the last one known to have seen the child alive, the girl’s grandmother told Nancy Grace producers.
On Sunday Ronald Cummings asked his teenage girlfriend, Misty Croslin, for her hand in marriage at a local Chili’s restaurant. While he was with several family members, Cummings got down on one knee, asked Croslin to marry him and gave her Haleigh’s grandmother’s diamond ring. Because Croslin is only 17 years old, her mother filled out the paperwork so the two could be married. On Thursday, the pair tied the knot, after the three-day waiting period required by Florida law. Croslin, who was beaming earlier in the week after the engagement, told CNN affiliate WJXT-TV that while she knows there will be critics of the marriage and the timing, “everything is still about Haleigh.” Croslin said she wanted to be together as a family, just as Haleigh would have wanted. “Everybody is probably going to take this marriage thing the wrong way,” Croslin told WJXT. “This is what Haleigh wanted. She has always talked about it, and even if she’s not with us, she is still with us.” Croslin told police she tucked Haleigh and her 4-year-old brother into bed about 8 p.m. February 9 in their Satsuma, Florida, home. She said she went to sleep herself about 10 p.m. but woke at 3 a.m. to find Haleigh missing and a back door propped open by bricks.
Police are still actively searching for the girl, with a new search happening this week, and investigators Wednesday took the back door that was found propped open. In the middle of the search for the girl, the newlyweds will fly to New York Thursday night for their honeymoon and an exclusive appearance on the Today show.
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Haleigh’s grandmother, Teresa Neves, also acknowledged the timing might seem “unusual.” “Well, it is unusual for some onlookers, but those people didn’t live with my two grandchildren,” she told Nancy Grace. “My grandchildren, both Haleigh and Junior, have very often said that they would love for their daddy to marry Misty and that they wanted Misty to be their mommy. And so I feel like they are just trying to fulfill a wish for Haleigh so that when she comes home she will have that extra happiness to come home to.”
Before the wedding, Neves told CNN affiliate WKMG-TV the wedding would be difficult without Haleigh. “It’s an event that Haleigh really should be at, but when she comes home, we’ll have a great big wedding so she can be the flower girl and see it all again,” Neves said.
Joaquin Guzman Loera: Billionaire Drug Lord
You’ll no doubt recognize the names of Bill Gates, Warren Buffett and Oprah when scanning Forbes’ latest list of “The World’s Billionaires.” But amid the various business tycoons, A-list celebs and royal heirs on the annual roll call is someone known mainly by members of Mexico’s seedy underground and the police officers who chase them: Joaquin “El Chapo” Guzman Loera.
The 54-year-old, 5’6” drug lord is considered the country’s most wanted criminal. And because his Sinaloa cartel trafficks billions of dollars’ worth of cocaine to the U.S. each year, American authorities are no less interested in bringing him down. The U.S. government is offering a $5 million reward for his capture — a rather meager amount considering Guzman’s estimated net worth is $1 billion, putting him at #701 on the Forbes list, between a Swiss oil tycoon and an American heir to the Campbell Soup fortune. And unlike many of his fellow billionaires who’ve already lost untold fortunes to the global downturn, Guzman’s empire likely made even more money in 2008 — a banner year for cocaine trafficking.
He’s been on the lam since escaping federal prison in 2001. As Forbes senior editor Luisa Kroll told The Times of London: “He is not available for interviews, but his financial situation is doing quite well.” But while he’s not the first narco-kingpin to make the list , Guzman’s inclusion has rankled more than a few readers. As one commenter wrote on Forbes.com: “Since you have started glorifying drug lords and letting younger people see them as ‘Billionaires,’ this will be my last article.”
Fast Facts:
• Born on April 4, 1957, to a poor family in the rural town of La Tuna Badiraguato, his abusive father kicked him out of the house as a child. He’s poorly educated, and reportedly resorted to using a ghostwriter to compose love letters to a mistress.
• Began his career in the drug trade as an apprentice of “El Padrino” Miguel Angel Felix Gallardo, who once headed Mexico’s most powerful drug cartel. Guzman founded his own cartel in 1980, quickly establishing posts in 17 Mexican states. Sinaloa, his organization, takes its name from a Mexican state along the Pacific coast long known as a hotbed for drug trafficking. After Gallardo’s arrest in 1989, Guzman inherited some of his territory.
• Established notorious groups of henchmen, known as “Los Chachos,” “Los Negros,” “Los Texas,” and “Los Lobos,” which are suspected of committing more than 1,000 murders across Mexico, including the killing of cocaine rival Rodolfo Carrillo Fuentes of the Juarez Cartel.
• Arrested in Mexico in 1993 for murder and drug charges following the accidental shooting death of Mexican Bishop Juan Jesus Posadas Ocampo in Guadalajara, killed by a competing cartel who mistook Ocampo for Guzman. Convicted and sentenced to 7 years for conspiracy, bribery and “health crimes,” according to the BBC. While incarcerated, he paid prison officials to arrange conjugal visits and business meetings to maintain control of his empire.
• Indicted in San Diego in 1995 for money laundering and conspiracy to import tons of cocaine. His more creative means of transport included transferring the powder inside fire extinguishers and cans labeled CHILI PEPPERS.
• Escaped from the Puente Grande prison in Jalisco, Mexico in 2001, by bribing guards to smuggle him outside via a laundry truck; a federal investigation later led to the arrest of 71 prison officials. Puente Grande has since been mockingly rechristened the Puerta Grande” prison. Guzman once bragged that he spends $5 million a month on bribes to law enforcement officers.
• Suspected of helping Mexican and Colombian drug traffickers launder as much as $20 billion in wholesale profits during his 8 years on the run.
• Has become a popular subject of “Narcocorridos,” — pop songs about drug traffickers — and has gained an almost mythical status in Mexico, where he has been compared to Elvis and Osama bin Laden. One song, by Los Buitres , describes his life as a fugitive: “He sleeps at times in homes/ At times in tents/ Radio and rifle at the foot/ Of the bed/ Sometimes his roof is a cave/ Guzman does seem to be everywhere.”
• Rumored to have entered a restaurant in Culiacan in 2007 with a posse of 10 bodyguards who promptly confiscated every single patron’s cellphone so he could safely eat his favorite meal — steak — without fear of an ambush. Upon leaving, Guzman paid for everyone’s meal, and each cellphone was returned to its proper owner.
• Reportedly married his third wife, Emma, in 2007 on the day of her 18th birthday in a wedding attended by hundreds of people, including local politicians and police.
• Turf wars in May 2008 led to the shooting death of his son, Edgar, who was gunned down by rival traffickers outside of a shopping mall just a month after being released from prison. Currently battling two rival groups — the Juarez Cartel and the Beltran Leyva brothers, who had served as long-trusted aides until they severed ties with Guzman in early 2008.
• Nearly captured in a Nov. 2005 raid at his rural stronghold in the western Sierra Madre, when Mexican police recognized his voice on a wiretap. But he fled the ranch before 200 army paratroopers had arrived.
Quotes About:
“He is very agile and, of the kingpins, is the one who moves around the least.”
— Ismael Bojorquez, editor of the newspaper Riodoce in Culiacan, the capital of Sinaloa
“He remains fairly safe in Mexico because of his influence and his ability to corrupt.”
— Jack Riely, special agent in charge of the U.S. Drug Enforcement Administration’s El Paso division
“He is the last of the Mohicans. All of the other big cartels have been decapitated. That is why they want him so badly.”
— Jorge Chabat, a Mexico City expert on law enforcement, on the government’s inability to catch him despite the arrests of 18 cartel leaders since 2001
“People see Chapo Guzman as the social bandit, as a Robin Hood. He fixes up the towns and puts lights in the cemetary. He is part of Sinaloan folklore.”
— Victor Hugo Aguilar, a professor at the Autonomous University of Sinaloa, on Guzman’s influence over the region’s people and culture
See pictures of Mexico’s drug wars.
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This Journalist Is Brought to You by …
The panic comes in the morning. As I sit at my desk and drink a tall glass of Pom Wonderful pomegranate juice, I start to worry about my career. I may be the best journalist in the world, but if there are no journals left to be journalisting for, I’ll have to use my communication skills in some other way, like asking my parents for money.
That’s why I’ve decided to save print journalism. My first idea was to get every reporter to switch beats and cover only cats doing funny things. Then I had some more Pom Wonderful, allowed the antioxidants to flush out my free radicals and came up with the perfect solution: product placement.
Just like how on the show 24 Jack Bauer drives some brand of car that’s not paying me and on American Idol the judges drink some kind of soda that’s not paying me, last summer the anchors at the Fox News affiliates in New York City, Chicago, Las Vegas and Seattle put cups of iced coffee from a fast-food place that’s not paying me on their desks. This upset lots of people because they thought it compromised the objectivity of their local anchors. This marked the first time anyone has thought about the credibility of Las Vegas anchorpeople.
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To get journalists to embrace my radical solution, I decided to be the first columnist to solicit product placement. This would also allow me to show my bosses just how valuable I am — in cold, hard cash. If I’m pulling in high-end cars and watchmakers and Joe Klein has nothing but socialist beard trimmers, I think we know who’s going to survive the next round of layoffs.
Unfortunately, the athletic-shoe company I called first took a very long time getting back to me. Like past now. Same with the adult-beverage conglomerate and the hotel chain. I started to get worried when the cable station, broadcast network and sports league turned me down. There is nothing scarier than wanting to sell out and discovering that no one wants to buy in.
I was starting to worry about the value of my not-so-hard work when I contacted my college friend Matt Tupper, who has an extraordinarily healthy heart, prostate and ability to sustain an erection and is also president of Pom Wonderful. We met at an expensive restaurant and discussed, over delicious Pomtinis, what kind of deal we could cut. I reminded him that children are often assigned this column as classroom reading and that many assistants of high-level executives spend their downtime at work searching for my old articles. I asked him how much it would have been worth to have Mark Twain write The Celebrated Pom Wonderful of Pom Wonderful County. Those Pomtinis are strong.
I was prepared to have Tupper reject me. Instead, he offered $25,000. I was hoping for about a quarter of that, and I was expecting it less in cash and more in posters and caps. A $25,000 check would more than cover the entire cost of this column, even including the dinner I claimed I had with him both in the paragraph above and on my expense report. I quickly accepted the check on TIME’s behalf, promising that I’d subtly work his 100% American-made, antioxidant superpower juice into my column in a way no one would ever notice.
Then we called his marketing department to find out exactly how it approached product placement. Though it will supply free juice to lots of TV shows, movies and red-carpet events, the company is willing to pay to be in situations only if they highlight its core brand messages of health and luxury. “We wouldn’t pay a lot of money if it’s just sitting in front of Simon Cowell,” said senior vice president of marketing Diane Kuyoomjian. I was feeling pretty healthy and luxurious until she told me, as an example, that the company turned down a scene in a movie in which the Pom Wonderful bottle would have been used as a bong. When I asked if people at the company expected to read what I wrote before it was printed, I was relieved to find out that they are just given a general idea of what a scene is about and don’t get to see a final cut. Product placement was going to do less damage to my work than my editors do.
It was all going very smoothly until my editor’s editor’s editor decided we had a policy against the mingling of advertising and editorial content and we would have to give the Pom Wonderful money to charity. Oddly, I thought that was what I was doing this whole time. Instead, all my efforts did was teach me exactly why the proud, antediluvian print-journalism companies are in financial trouble. Not only is Time Inc. turning down $25,000, but it’s employing three editors for this column.
Read “How to Know When the Economy Is Turning Up.” See the best business deals of 2008.
Doubts Raised About Government Plan to Boost Consumer Lending
Get ready for the Toxic Asset Loan Factory. TALF, the U.S. government’s effort to boost consumer lending, finally launches next week. The program — officially the Term Asset-Backed-Securities Loan Facility — is targeted at restarting the market banks use to fund credit-card, auto and other consumer loans. But some worry TALF could create even more risky bonds that our nation’s wobbly financial firms don’t want and can’t sell — a perverse unintended consequence of a well-intended program.
Critics contend the plan does too much to stimulate demand for top-rated securities and not enough to draw in buyers for riskier bonds that have always been harder for banks to sell. “We need to get credit buyers back into the market,” says John McElravey, director of asset-backed research at Wachovia Capital Markets. “But TALF only addresses part of the problem.”
At the heart of the program — and the biggest cause of complaints — is an effort to reignite the process by which most banks get the money they use to make consumer loans. To fund credit-card, auto and education lending, banks typically gather up loans they already have made and pass them off to an investment bank. Wall Street firms then package these into bonds that pay interest based on borrowers’ loan payments. Completing the money-recycling loop, investors buy the bonds, and investment banks pass most of that money, minus a fee, back to the lenders. The lenders can then use that money to make new loans. The process is called securitization, and for much of the past few decades it has worked wonders to fuel our ever growing consumer economy.
But sometime last year, the mechanism broke down. Investors backed away from all types of consumer credit after getting burned in the mortgage market. Less than $200 billion in asset-backed loans was securitized in 2008, down from an annual rate of a trillion dollars at the height of the credit boom. This year there has been only a few billion dollars in securitized-debt deals.
The government hopes to revive securitizations by luring buyers back into the market. To do so, the TALF program offers cheap loans to investors who want to buy bonds backed by consumer loans. Even better, some of the TALF loans won’t have to be paid back. If the bonds pay as expected, investors will have to repay the government loans with interest. But if the bonds go bust, investors are off the hook, after losing the small down payment they made on the original loan. To limit taxpayer losses, the government is going to make loans only against bonds rated AAA, the highest rank.
And that’s what causes the problem. Every securitization deal creates some AAA-rated bonds and some lower-quality debts. In a typical credit-card securitization, as much as 15% of the bonds created will have ratings lower than AAA. And the government plan does nothing to help banks get those riskier bonds off their books. Worse, TALF might actually discourage investors who would normally be interested in these higher-yielding bonds from buying them.
That’s because TALF significantly sweetens the returns that can be earned from buying the AAA-rated bonds. Take a typical auto-loan bond. A top-rated auto ABS bond pays a dividend these days of about 3.5%, or a return of $3.5 million on an investment of $100 million, as long as the bond doesn’t go into default. That’s actually not a terrible yield right now. Just ask anyone with a savings account.
Under TALF, though, an investor has to make a down payment of just $8 million to get a loan from the government to buy $100 million in auto bonds. The loan costs 1.5% a year, or $1.5 million on $100 million, which lowers the investor’s take-home return to $2 million. But remember, the investor had to put up just $8 million. That means the annual return on the much smaller up-front investment zooms to a fat 25%. Lower-rated auto loans can pay as much as 30%, but they have a much higher rate of default — and potential buyers will not get access to those low-cost government loans. Plus, these days, few investors are willing to take more risk than they have to. With no one to sell the lower-quality stuff to, banks may be stuck holding it. The good news is that so far, credit-card and auto loans have not had the same high rates of default as home loans. But as the economic downturn worsens, analysts say it will become harder and harder for consumers to make even the minimum payments on credit-card debts that have racked up over years of overspending.
In the end, TALF may beget Son of TALF to deal with the sins of the father. And that will mean more taxpayer dollars.
Read “How to Know When the Economy Is Turning Up.”
See 25 people to blame for the financial crisis.