NINE MILES AND SPREADING
BY PETER LANDESMAN
Wednesday, December 12, 2007 - 11:00 am
Late Christmas Eve 2005, Demond Whiting and a friend left the recreation center at Nickerson Gardens and turned right down Compton Avenue. Whiting was 32 and an original gangster in the Bounty Hunter Bloods. The Bounty Hunters control and terrorize Nickerson Gardens, the sprawling housing development in Watts, and use it as a base for a nationwide drug-trafficking network. Whiting, who was fresh from a long stretch in prison for armed robbery, was chatting about his new life as a civilian, when someone stuck an AK-47 out the window of a passing car and fired two rounds. One hit Whiting in the back, severing his spine and paralyzing him.
Early the next morning — Christmas morning — a Bounty Hunter named Antoine Staffer, a.k.a. Pig, left Nickerson Gardens, walked about a half mile to the edge of the dusty, treeless Jordan Downs housing project, strolled up to a car and shot the driver in the face. The victim was Brandon “B.L.” Bullard, a key player in the Grape Street Crips, the gang that controls Jordan Downs. Ten minutes later, a Bounty Hunter heading into Jordan Downs for a Christmas visit with cousins was ambushed and shot seven times. Two more Bounty Hunters were murdered in quick succession. The cycle of retribution — in the form of drive-bys with AK-47s, Uzis, MAC-10s and 9mm semi automatic handguns — lasted six weeks, left 26 people wounded, nine dead, the local schools largely empty of students, and a large swath of Watts under siege.
What triggered all this depends on whom you talk to. Some say it was an argument at a mall over a young woman, others say it was a yanked necklace. Whatever it was, it wouldn’t have taken much. This was just the latest spasm in a long-running vendetta between the Grape Street Crips and Bounty Hunter Bloods, just one of hundreds of hair-trigger blood feuds that disrupt or terrorize neighborhoods throughout Los Angeles, the most gang-saturated city in the world. No one I spoke to could explain why the Grape Street Crips and Bounty Hunter Bloods revile each other so; they only know that they do.
Even the gang members were feeling trapped. “I remember us thinking, how long is this going to go, how much is this going to trigger, how bad is this going to get, how many people are going to die?” a former Bounty Hunter named Damien Hartfield told me during the height of the conflict.
In March, I visited Demond Whiting at a rehabilitation hospital outside Watts. I drove with James (not his real name), a serious, powerfully built 30-something O.G. Bounty Hunter from Nickerson Gardens. James didn’t say much, only that he’d spent his 20s in prison for a variety of things, including armed robbery and involuntary manslaughter, and now was struggling to keep his gangbanging behind him.
We found Whiting, a lean man with a wisp of a beard and prominent cheekbones, lying in a darkened room, his legs already heavily atrophied beneath the blankets. He was eager for visitors, and was strangely sanguine about his plight. “The only sense of direction [in the neighborhood] is to follow the negative,” he said with a shrug. “I never knew the walk of being a good guy.”
Now, of course, he’ll never walk again. But there was little sense of catastrophe about him; his paralysis was merely a possible consequence of the life he’d led. I asked him how he felt about the Christmas Day retaliation against the Grape Street Crips, and the war it set off, and he said, simply, “They knew they had to do that.”
James and I drove back to Nickerson Gardens and parked outside the recreation center. He didn’t move to get out, and we sat in silence for a time. It began to rain, lightly at first, then heavily. We faced the long front wall of the recreation center that had been turned into a memorial for Nickerson Gardens residents killed in gang violence. The names were listed in neat columns. There were 300 of them.
Eventually, James started talking. He told me he’d started gangbanging when he was 12. “I got shot when I was 15, and that’s when it got bad,” he said softly. “I got extreme after I got shot.” James started teaching youngsters from Nickerson how to gangbang. Using rival gangbangers for practice, he taught his students how to hunt and kill. “You teach a person how not to take losses, how to be gladiators, run them down, gun them down,” he explained.
James wasn’t remorseful, but he was far from proud. In truth, he seemed numb; his life of crime and death hung about him in a static haze. There is a personal demilitarized zone in the advanced lives of former hardcore gang members, should they survive their 20s, where they live as neither soldier nor citizen. James said he struggles to keep a gun out of his own hands every day, but that in January he was tempted to join the battle with the Grape Street Crips after a young Bounty Hunter he knew was killed.
I asked him why he thought Whiting had been shot in the first place. He shrugged and then looked at me like it didn’t matter. This was all part of a continuum that stretched beyond his memory and over which he had no control. The thing that seemed to bother him most was that he probably knew who the shooter was. “Everybody knows each other in these projects — everybody,” he said bitterly. “A lot of people are related. Brothers and fathers — brothers and sisters on different sides.” Which only amps up the hate required to shoot someone in cold blood, he said. “When somebody closer to home violates you, it’s harder to accept.”
The next day, at Jordan Downs, I put a similar question to a Grape Street Crip named Ronny Pugh. Pugh, 23, was wiry, and wore a necklace of purple beads — Grape Street colors. When I asked what his beef against Nickerson Gardens was, he didn’t seem to know. “I wish I could just take a big-ass can of roach spray and spray it all over the whole place and kill everybody. Mamas, children and all,” he said. “Fuck them and anything that can grow from there.”
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We were talking against the side of a building in the projects. I could see faces in the windows above us. Jordan Downs feels more menacing than Nickerson Gardens. Its 103 two-story buildings are laid out in a strict grid; the windows are barred. There are almost no trees, so the few patches of grass are sun-baked. As a deterrent to crime, the city has installed closed-circuit cameras high on the light poles behind slabs of military-grade ballistic Plexiglas designed to survive .50-caliber bullets.
Death or glory: War casualties find a home on a wall at Nickerson Gardens
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How many more times? Mourners at the funeral of Devon Perry
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Mourners file past Devon Perry's body.
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As Pugh and I spoke, half a dozen or so young men gathered loosely around us. Two of them walked up behind and pressed against me, asking what was going on. Pugh waved them down and said I was cool, and they moved on.
I asked Pugh if he’d taken part in the string of drive-by murders in Nickerson Garden that started over Christmas. “I’m a part of everything and anything, put it like that,” he said, almost eagerly. “If I’m out here, you do it.” He stopped, looked around and said, “I love this right here. I love this life. I can’t even see myself abandoning this. I don’t care if I got money, or work Monday through Friday. I just go shoot a motherfucker on the weekends. If that’s what need to be done to keep my hood and my young ones around here safe, then that’s what to get done.”
Street gangs, like all closed societies, hold sacred certain articles of faith that are central to their identity. One of them appears to be that the violence has to continue no matter what. After all, the members of the Grape Street Crips and Bounty Hunter Bloods are all young black men from the same part of the same city, most of them jobless and without education. Most of their families are Christian. A good number of them are related. There seems no real reason for the feud, except the feud itself. One wonders if the gangs would even exist without the violence between them.
Two hours after I left Pugh, my cell phone rang. I knew the caller, and he told me my conversation with Pugh had been overheard. He’d been told to tell me I’d been “green lit” in Jordan Downs — if I went back there, I’d be killed.
The Bounty Hunter–Grape Street murders over that Christmas season were among the 273 gang-related homicides in Los Angeles last year. Gang-related killings have dropped to 187 so far this year. While it’s easy to see the ebb and flow in killings as just chapters in L.A.’s infamous gang wars, gang experts, police and even gang members themselves say that the truth is that something ominous is happening. Gang crime in South Los Angeles spiked 24 percent in 2006, 14 percent in the city overall and more than 60 percent in the San Fernando Valley.
Nationwide, juvenile gang homicides have spiked 23 percent since 2000. There are six times as many gangs in L.A. as there were a quarter century ago, and twice as many gang members. But as important as the gang activity itself is what’s different about the violence. In America’s urban ganglands, and in L.A. in particular, the ferocity of the thuggery has surged; gang members, their victims and police long on the gang beat tell me the fighting has become more codeless, more arbitrary and more brutal than ever.
And it is everywhere. According to the Department of Justice, today America has at least 30,000 gangs, with 800,000 members, in 2,500 communities across the United States. (Gang experts at the University of Southern California claim the number of American jurisdictions with gang problems has reached 4,000.) Federal, state and local law enforcement across the country agree that street gangs connected to or mimicking the L.A. model have become a national epidemic.
Last January, a report on gang violence commissioned by the Los Angeles City Council found that the gang epidemic is largely immune to general declines in crime nationwide. In other words, gang crime is surging just as other violent crime is decreasing. And unlike other categories of crime, gangs and gang-related crime are spreading to formerly safe middle-class communities, or, “to a neighborhood near you,” says the report’s author, civil rights attorney Constance Rice.
What this means is that the communities gangs come from are pulling away from mainstream society more than ever, and the gangs that plague them, like storm systems, are growing and feeding on themselves, gathering destructive strength. In Los Angeles, law enforcement officials now warn that they have arrived at the end of their ability to contain gangs to poor minority and immigrant hot zones.
“This is the monster, this is what drives people’s fears,” says LAPD Deputy Chief Charles Beck.
Father Gregory Boyle, a Jesuit priest whose Homeboy Industries has helped willing gangbangers in mostly Hispanic East L.A. escape the life, tells me that gang behavior is changing, and the change is chilling. Everywhere he sees signs of the erosion of known and protected codes of conduct, such as methods of assassination that used to protect the innocent, and territorial respect — which he says reflect an accelerating sense of desolation among poor urban youth. Gangs today are less about neighborhoods and rivalries. They’ve become repositories for hopelessness.
“Gangs are the places where kids go when they encounter their life as misery without exception,” says Boyle. “When [gangbangers] go out to commit crimes now, they’re not going out seeking to kill — you can’t reason or rationalize this: These are kids who don’t care. They’re going out hoping to die.”
Last January, Los Angeles Mayor Antonio Villaraigosa cried uncle, saying that it was time for government and law enforcement to admit they have failed to stop gangs or even understand what they are. He appealed for federal help to make a Marshall Plan–style push to tackle what’s been an intractable problem.
“Los Angeles is the epicenter of the nation’s gang crisis, and an effective assault on gang crime will require increased suppression, intervention and prevention measures,” Villaraigosa said after Rice’s report was released. “Street gangs are responsible for the majority of all the murders in Los Angeles and nearly 70 percent of all the shootings. We must work to address gang violence in a truly comprehensive way.”
The problem is that for the most part traditional (and failed) models of gangs and gang suppression do not apply, because not only are gangs better armed and more ferocious, but they look different. The accelerating current of gang violence is colliding with a growing wave of Hispanic migration from Mexico and Central America into the United States. Hispanic gangs now dominate the hardcore narcotics business nationwide, and they are physically pushing historically entrenched black gangs out of their territories.
Squeezed by a shrinking share of the drug market, desperate for new business, gang members and their families are retreating out of the city, establishing new street gangs where they land. According to the FBI, gangs are showing up and spreading in suburban and rural America, in counties like Westchester and Suffolk in New York, and rural parts of North Carolina and Virginia, places that have no experience with street gangs and organized crime, and police who don’t know how to fight it.
A few years ago, officers responding to a call to Nickerson Gardens found a young Bounty Hunter who had lit a dog on fire. Already on probation for animal cruelty, a juvenile court judge exiled the young gangbanger to San Bernardino, a small city 70 miles east of L.A., where the boy had relatives. Within a few weeks, the boy recruited a few local kids to form a robbery crew and went on a spree of armed home invasions. They made a point of bragging to their victims that they were Bounty Hunters from L.A. They shot their last victim to death. The San Bernardino chapter of the Bounty Hunter Bloods was born.
L.A.’s sprawl has turned gritty former Mormon and railroad settlements such as San Bernardino into bedroom communities, ripe territory for construction and for industrial growth. Pinched by spiking real estate prices and displaced by a surging Hispanic migration, many of South L.A.’s blacks are relocating to the Inland Empire. So are gangs.
In October, I spent an evening with Andre (not his real name), who’d left Nickerson Gardens a few years ago for San Bernardino. With the desert and the craggy San Bernardino mountain range a constant backdrop, we drove from point to point around town as he collected envelopes of cash or checked supply at drug spots. “My family moved trying to get away from the trauma of Watts,” Andre explained.
Other Bounty Hunters he knew fled Nickerson because other gangs or the police were hunting them. They go where relatives are, to New Jersey, or Little Rock. Or here, he said. Wherever they go, they bring their relationships, reputations and skills. For an L.A. gangbanger, that usually means the drug or robbery business.
That’s how it spreads, Andre said. “A few knuckleheads from around here start wanting to get down with us. But they’re not official. They’re called add-ons. Outside of L.A. there will always be somebody official in the gang; everybody else is an add-on.” Add-ons are like kites on a string, easily cut off if they draw trouble. “It’s like we rent them. There’s no real connection to us. If we have a shootout, they’re not tied to us whatsoever.”
Almost anywhere in America a migrating gangbanger lands, he is fairly sure to find a receptive supply of recruits.
“Trying out gangs is becoming more and more popular,” says Dr. Malcolm Klein, a sociologist at the University of Southern California who has been studying gangs since 1962. “Kids are shown how to ape gang behavior by MTV and the Gap.” Today, rap is a multibillion-dollar industry that dresses up violence with bling and sex. Eventually, real street gangsters picked up on the fantasy and took on the fetishes of gang life as told back to them by millionaire musicians who had either left the streets or were never part of it.
“Now gangs are fads, it’s cool to be a Crip and Blood,” says Detective Sergeant Ronald Hampton of the New Jersey State Police’s gang unit.
New Jersey’s hardcore — mostly urban — gang population has almost doubled since 2001, from 9,000 to 17,000. But in the last few years, even nontraditional gang areas in the Northeast like Westchester County, Long Island and Princeton, New Jersey, have started having gang problems. There are tens of thousands of wannabe gangsters in New Jersey alone, Hampton says. Police call them “wangsters.” Mostly, they traffic in what they think is cool about gangs, the sort of young white men of means and options who go to upscale Manhattan private schools and wear baggy pants and talk ghetto.
The bigger and more dangerous portion of the country’s 800,000-odd gang members are disaffected and marginalized youths looking to identify with something. Of New Jersey’s 38 hardcore Blood sets, 13 are transplanted L.A. gangs, including the Bounty Hunter Bloods from Nickerson Gardens. The Grape Street Crips are the largest Crip set on the East Coast. State and federal agencies track money transfers from East Coast gang members back to the accounts of gang members in L.A. Search warrants and wiretaps on the East Coast often lead them back to L.A.
“Most of what we’re seeing in the east are L.A. street gangs,” says Special Agent Alec J. Turner, the director of the FBI’s National Gang Intelligence Center, a joint effort with the U.S. Marshals, the Department of Justice and the Bureau of Alcohol, Tobacco and Firearms. “We are seeing influence from MS-13 [Mara Salvatrucha] cliques getting some direction from higher-level MS-13 people in L.A.”
The migration of gang members out of L.A. is an even spray pattern, the FBI says. Gangs have coalesced most heavily in the Northeast, the country’s most lucrative narcotics market, but they are also moving to the Northwest (San Francisco and Seattle) and across the Midwest and South (Little Rock and Charlotte). “And it’s not just national migration,” Turner says, “but also from urban settings to rural settings, based on gangs’ knowledge that law enforcement in rural and suburban areas has less scrutiny. The police are softer.”
Once migrant gang members claim virgin drug territory for themselves, L.A.-style gang chaos and murder is inevitable. “It’s a power struggle between new gangs,” Andre told me. “Who’s running what? Who has more money? Who’s got more squad? That’s what it all comes down to, whose squad is willing to kill. And that is when the young kids come in, because they don’t give a fuck. They come in, and they kill other kids.”
The cycle is hard-wired into the gang dynamic. And because it’s not geography specific, and is spreading through an expanding population of potential recruits, the federal government is making a paradigm shift toward thinking of street gangs under the rubric of domestic terrorism. “There’s an analogy to modern terror organizations,” says the Rand Corporation’s Jack Riley. “The members are not persuadable in any regular sense.”
The modern American gang was born here. The enormous spread of the city and the lack of public transportation turned its vast freeway and street system into a network of boundaries that cuts the city into hundreds of isolated pieces. Watts, for instance, is boxed in by the 105 freeway to the south, the 110 freeway to the west, the Compton railway to the east and Century Boulevard to the north. Watts is bisected by 103rd Street, roughly the halfway point between the Nickerson Gardens and Jordan Downs projects, and the recognized DMZ between the Bounty Hunter Bloods and Grape Street Crips.
As in meiosis, L.A.’s bigger neighborhoods and their gangs will usually divide into subgangs, or cliques, focusing on cul-de-sacs and parking lots that are claimed as sovereign territory. Nickerson’s Bounty Hunter Bloods street gang is split into at least a half dozen cliques around the numbered streets that cross the project (the Five-Line Bounty Hunters hang out on 115th Street, the Four-Lines on 114th Street, etc.). It doesn’t matter that the demarcations separate people identical in race, class and marginality. The people identify with their shared piece of pavement.
Some Los Angeles gangs are strictly robbery crews, others jack cars, Vietnamese gangs specialize in identity theft, Russian and Armenian gangs do mostly extortion and human trafficking. At last count, Los Angeles County had more than 714 gangs and 80,000 gang members. That makes one of every hundred county residents either a hardcore soldier in a gang or an “associate” — the getaway drivers, lookouts, “cookers” (people who know how to turn cocaine into crack) and “hooks” (people who direct customers to drug houses) — or an “affiliate,” a gang member with no specific duties. But no section of L.A. is more defined by gangs than the nine square miles of Watts terrorized by the Bounty Hunter Bloods and Grape Street Crips: the Nickerson Gardens and Jordan Downs housing projects, along with Imperial Courts and Gonzaque Village, and the streets that connect them.
Every yard, doorway, shop and parking lot is the fiefdom of one of Watts’ 65 gangs and their roughly 15,000 hardcore gang members. In that area alone, gang members shoot 500 people a year, and kill 90. Nearly every citizen living there is enjoined by membership or affiliation; those who try to stay out of the life incur their local gang’s wrath, sometimes with fatal consequences. The average American has a 1-in-18,000 chance of being murdered. In this area of Los Angeles, the chances are 1 in 250.
On New Year’s Eve so much automatic weapons fire pours into Watts’ airspace that LAX air traffic control must divert the flight path of incoming planes. The U.S. military sends its medics to train at local trauma hospitals because the conditions in their trauma units so resemble live warfare. At a community meeting I attended in March 2006, LAPD Chief William Bratton declared the Jordan Downs–Nickerson Gardens area “the most violent community in the country. This is now the most dangerous place in America,” he said.
I first visited Nickerson Gardens one night last January, trolling the streets with a Los Angeles Fire Department paramedic captain named Marc Segal. Built in 1955 as temporary housing for military personnel, Nickerson is the largest project west of the Mississippi, with roughly 5,000 residents. Its 1,054 federally subsidized units — which rent for as little as $175 a month — are arranged around parking lots. They are painted institutional white and labeled like cell blocks.
As we neared the project, Segal told me to put on a Kevlar vest. Nickerson Gardens was then in the grips of the lethal gang war that had begun with the Demond Whiting shooting that Christmas Eve.
“The Fire Department used to not get shot at,” he lamented. Now, paramedics are wary of entering the projects without heavy police escort. That means the sick and the wounded sometimes wait a long time for rescue.
“Now tell me if you notice anything strange,” Segal said as we approached Nickerson Gardens. I looked, considered, and then replied, “The fence.”
Nickerson Gardens is partly enclosed by a 7-foot wrought-iron fence topped by sharp spikes, the sort usually meant to keep intruders out. But these spikes stabbed down into the projects; they were there to keep people in. “These people are born in a prison,” Segal said, and then drove quickly with his headlights off.
The street lamps were out, and nearly all the windows were dark. I could make out the silhouettes of people hanging out in doorways, and the glowing cherries of their cigarettes. Later, I learned that most residents of Nickerson Gardens and Jordan Downs keep their lights off at night to avoid becoming targets in drive-by shootings. Segal was relieved when we got out of there. “I probably shouldn’t have done that,” he said.
It wasn’t always this way.
Originally, L.A.’s street gangs were social and support organizations for immigrants and packs of neighborhood pals. Mostly their crimes were petty, and scores were settled with fists. Latinos and blacks generally stayed out of each other’s way.
All that changed forever in the late 1980s, when crack cocaine hit Los Angeles and neighborhood affiliation became secondary to what all the gangs now really wanted: a piece of the drug business. By then, Colombian cartels, looking to reduce the risk of American prosecution, had transferred the bulk of the trafficking part of the drug business to Mexican and Hispanic-American gangs. Now in control of the cocaine supply, and suddenly flush, many of them squared up into efficient, vertically integrated, multilevel organizations.
“They quickly understood the benefits of economic diversification, and that the real money is in wholesaling drugs coming over the border to other gangs,” Luis Li, a former assistant U.S. attorney and chief of the Department of Justice’s L.A. organized-crime division, told me.
Mexican gang leaders from Los Angeles jailed in Tracy State Prison banded together to retain control of their narcotics business on the street. The Mexican Mafia — or Eme — was born, and has replaced the Cosa Nostra as the most powerful single criminal entity in the country. “They make a big effort to make a business-friendly environment,” Li says. “They are trying to get people in Los Angeles — middle-, upper-middle- and upper-class people — to drive through and buy drugs.”
“But as the war on drugs went into overdrive, and law enforcement had this fixation on crack, it was really seen as a black thing,” a federal prosecutor told me. “Government officials were obsessing about blacks doing crack, but not Hispanics.”
Hispanic gangs weren’t immune from prosecution, the prosecutor told me, but black gangs were seen as more dangerous, their violence more anarchic and lethal to innocent civilians; their communities were seen as being at greater risk than Latino neighborhoods. It virtually became government policy to isolate black gangs.
“Maybe the federal government saw black gangs as a greater threat,” says Lieutenant John P. Sullivan, an intelligence and counterterrorism expert in the Los Angeles County Sheriff’s Department. “Or maybe black gangs were just easier to penetrate.”
The effect on black gangs was a virtual decapitation. With most of their leaders in prison, what little organization there was evaporated and black gangbangers turned on each other and themselves. “Whether targeting black gangs was a good idea,” the prosecutor now wondered, “in retrospect I think it probably wasn’t.”
The truth is that gangs are merely reflections of their communities. America’s huge pool of poorly educated urban black men was being pushed farther than ever to the fringes of mainstream society. New studies by experts at Columbia, Princeton, Harvard and other institutions show how the numbers of young black American men without jobs climbed relentlessly during that period. By 2000, 65 percent of black male high school dropouts in their 20s were jobless — unable to find work, not seeking it or in jail. By 2004, the number had climbed to 72 percent (compared with 34 percent of white and 19 percent of Hispanic dropouts). Today, 75 percent of Watts’ adult black male population will at some point go to jail or prison.
The children of these men are born to the belief that they have no options. Impotent and hungry for family, these kids often turn to the embrace of a gang. But what the gang really represents, more than neighborhood, is nihilism.
Leaderless black gangs like the Bounty Hunters have divided into competitive cliques; inexperienced young gangbangers are fighting and killing for control. The Bounty Hunters, for instance, have become notorious for killing each other to move up in the gang. “They mistake the fear they create for respect,” says LAPD Detective Victor Ross, a gang unit detective. “Today, a Bounty Hunter gets what he thinks is respect by murdering his own.”
Recently, in Jordan Downs, a Grape Street clique rebuffed by a 14-year-old boy who refused to join gang-raped his 12-year-old sister, taped the attack, and showed the video to the boy. The boy gave in and joined. Older gang members and veteran police say the neighborhoods are codeless and anarchic. “The hood is lost because we ain’t got no guidance right now,” a hardcore Bounty Hunter Blood told me. “It’s just us young gangsters.”
The differences between black and Latino gangs are stark. And the black gang members I spoke with readily admit that the difference is fatal. Damien Hartfield, the former Bounty Hunter, explained, “Blacks do what they want. When Latinos go gangbanging they have a solid plan. Blacks don’t go to war like that. It’s spontaneous. Something just happens. Latinos make a call, make a plan. They have a structure.”
LAPD Chief Bratton admits he is bewildered by how anarchic L.A.’s black gangs have become.
“African-American violence is totally out of proportion to their numbers,” he said. “With Latinos, there is so much more family structure, while it’s not as if blacks rally around the African-American community just because they are black. They associate more with their gang colors than they do with their own color as African-Americans. It’s almost as if they lost identities as African-Americans.”
Watts and neighboring Compton, historically and famously black neighborhoods, are already roughly 70 percent Hispanic. Hispanic gangs know they don’t need to wage war against black gangs. They are happy to wait it out as black gangs sabotage themselves. Gangbangers in Watts tell me they know they can’t keep up. And they know their fate.
“Ten years from now gangs from all other races besides Hispanic are going to be pushed out of everywhere,” Andre says.
Late one night last April, a 17-year-old African-American boy named Devon Perry was jumped in South Los Angeles and shot execution style in the back of the head. Devon had grown up in Nickerson Gardens, less than a mile away from where he was shot. Devon’s family had numerous Bounty Hunter members or associates. Devon’s mother, Theresa, had sent him to live with relatives outside the project and away from the gang.
About a thousand people jammed into Devon’s funeral at a small neighborhood church in South L.A., including gangbangers from various sets of Crips and Bloods. The Perry family claimed Devon wasn’t a gang member, but many of the mourners wore T-shirts silk-screened with a photo of Devon smiling and contorting his hands in gang signs. Some in attendance wore red or blue — Blood and Crip colors — T-shirts under their clothes. A few young women had dyed their hair red.
As the crowd filed by the open coffin, Theresa Perry wept uncontrollably, screaming, “My beautiful boy! My beautiful boy!” Her friends screamed back “Jesus!” into her face. Devon’s cousins sat in the front row in pallbearers’ uniforms — bright cream suits and white gloves. The oldest, a short and muscular young man named De’Andre Perry, a hardcore Bounty Hunter, was awash in tears. Just before the mourners filed out, the pastor warned that they were in dangerous gang territory. “Go straight to your cars,” he pleaded. “Watch your backs.”
It was a wonderfully bright day. The convoy to the cemetery was more pep rally than mourners’ column. Crip and Blood gang members, festooned with red and blue hats and scarves, hung out car windows, throwing gang signs with their fingers and taunting each other. Many of the cars shuddered with gangsta rap.
Improbably, the procession swept into the gaudy Hollywood Forever Cemetery, “The Resting Place of Hollywood’s Immortals.” The cemetery shares a wall with Paramount Studios and is home to the obelisks and tombs of movie royalty like Rudolph Valentino, Jayne Mansfield and Cecil B. DeMille.
Doves meant to symbolize Devon’s soul were released to applause from the crowd. Then De’Andre and the other pallbearers wheeled Devon’s white coffin to a fortresslike mausoleum. The mausoleum was long and narrow; crypts were stacked seven high. The crowd gathered behind a white teddy bear perched to look up to a crypt two from the top.
Two Mexican gravediggers slid the coffin onto a hydraulic lift. The men were visibly nervous. No doubt, they knew this was a gang funeral, and that among the big, emotional crowd were a number of hardcore gangbangers.
As the coffin rose above the crowd, the jittery gravediggers made a fateful mistake. As they pushed the front of the coffin into the crypt, they fumbled the lift’s controls. The rear of the coffin kept rising, until it teetered, tilting sharply down, wedging hard against the marble. There was the terrible sound of groaning wood, then a loud crack. The crowd gasped, confused. Quickly, the gravediggers leveled the coffin and shoved it the rest of the way in. But Theresa Perry exploded in grief. Someone in the crowd called out in anger. The funeral director stepped forward with her clipboard, promising Theresa that all was well with her son. To prove it, she offered to bring the coffin back down. The gravediggers hesitated, exchanged frightened looks, and then did as they were told. But when the coffin arrived, all was not well. The top of the coffin had partially collapsed. The flowers had been stripped off. It was a mess.
There was a beat of shocked silence. The gravediggers began backing away... then, bedlam.
Theresa let out a shriek and took a swing at the funeral director, striking her in the face. The director collapsed; I lost sight of her as Theresa kept pummeling. De’Andre Perry and two or three of the other pallbearers pounced on the gravediggers, punching wildly. At one point, the gravediggers managed to scramble to their feet, but they were easily caught and trapped against the marble crypts. They disappeared from view in a hail of fists and feet.
The mausoleum filled with screams. This crowd was all too familiar with the physics of violence and its accelerants. In their world, fistfights often become gunfights. Many, I’m sure, thought that there were probably plenty of weapons on hand, and knew that gunfire in that narrow marble space would create a lethal ricochet. The crowd stampeded. Chairs flipped. Women and children went down. The last I saw of the gravediggers, they were awash in blood, being mercilessly beaten.
The melee poured outside. Scuffles broke out among the men, some of the fights dissolving into emotional embraces. Women, dressed in their Sunday best, were running for cars in the bright sunshine.
A few minutes later, De’Andre and the other pallbearers emerged, their clothes disheveled. Theresa charged at them. “You killed my baby!” she screamed, railing at the pointless nihilism of gang life. “You killed him!”
The young men stumbled back, retreating from their aunt’s wrath. The air began to pulse. Everyone looked up. An LAPD helicopter had swooped in and was hovering overhead. Toward the cemetery entrance, LAPD officers were massing, snapping on riot helmets and checking shotguns. They opened the gates, formed a phalanx six across, and started walking calmly and steadily toward the mourners.
The young men in the crowd fled on foot through and over the tombstones, abandoning cars and women and sprinting for the walls. With military precision, the police cleared every crypt and every conceivable hiding space. By the time they reached the mausoleum there was no one left to arrest, and not much to do except stand around bewildered at this strange scene.
Then the damaged coffin came out on a gurney. The pastor and a limousine driver wheeled it back to the hearse. The police lowered their weapons; some took off their helmets, sweating heavily in the heat. Theresa turned to them; her face was a mask of rage and despair. She seemed about to scream again and then just dropped her head. The pastor whispered something into her ear, and gently coaxed her into the limousine. Then he put Devon’s coffin back in the hearse and drove the body away.
A few weeks before his cousin’s funeral, I had met up with De’Andre Perry, known as Little D among his fellow Bounty Hunters. We stood in the entrance to the recreation center in front of the infamous memorial listing those killed in gang violence over the past few years. I asked Perry for the same thing I’d asked other gangbangers caught up in this deadly vendetta — an explanation.
Eventually, like all gangbangers I spoke with, he circled back to gang lore, which defines the gang as a family defending neighborhood pride. “I was born into it,” Perry said. “Doing drug dealing or gangbanging, I was always that in my eyes. The Bounty Hunters are a powerful community wherever we go. Wherever we move you see our prints. Everywhere you go if you ask anybody about Bounty Hunters they have something strong to say.”
I said that’s not the case outside Watts, in, say, wealthy white Santa Monica, where most people have never heard of the Bounty Hunters and would think of them not with respect but disgust.
Perry paused. His eyes moist, he leaned forward and gesticulated with his hands. “If I walk down the street and I see a white dude and he sees the way I look, tattoos and all that, he thinks I am automatic trouble. In a way, that makes me feel good...” He trailed off. Even he wasn’t buying what he was saying. Suddenly, his Bounty Hunter identity dissolved: “I am this way, but not just because I am this way. I am this way because something happened.”
“People walking through are experiencing this violence over and over again,” says Aquila Sherills, a former Grape Street Crip. “So how do we deal with it? We don’t. Alcohol, sex, marijuana. People are totally numb.”
Two years ago, Sherills’ 18-year old son, home on winter break from college, was murdered by gangbangers, shot five times in the back of the head. Through the grapevine, he learned the name of the shooters. His friends offered to kill them. Sherills said no. “I wanted to meet this young man because he is not only the perpetrator of taking my son’s life, he is a victim as well. We kill out of fear. What happened to him? Where did he lose his humanity?”
Sherills told me he became a gangbanger because he was sexually molested. “But that’s taboo,” he said. “You don’t say that. Feeling worthless, like you are an object. In this neighborhood 90 percent of young men have been sexually abused. I will say 99 percent of ladies. Everybody is operating within the cloud. It’s the elephant that is sitting in the room that no one speaks of.”
Gang cops spend their sympathies elsewhere. Their sole purpose is to throw a lifeline to the neighborhood’s innocents, says Sergeant Sean Colomey, head of the LAPD’s Southeast Division gang unit, which patrols Watts, where 47 percent of the children suffer from post-traumatic stress disorder. Gangbangers call the innocents among them “mushrooms” because they pop up in the way of their bullets.
“Second-graders pissing themselves in school without realizing it,” says Mychelle Charters, a social worker in the elementary school that serves Jordan Downs. “They doodle ‘RIP’ but don’t know what it stands for. Just a kid running by is enough for another kid to stick a foot out or throw a punch. Someone running is a threat — that’s all they’re suppose to know.” When children go home their doors are locked and their lights are off, she says. “Playing with your neighbors doesn’t happen. The idea of a family is not even a concept.”
A young woman named Daisy who grew up in Watts told me, “I don’t have words to describe what it’s like to live among the gangs. There was automatic gunfire every day. We never went out. I left for school no later than 6:40 so I didn’t interact with or see anyone. Even the high school kids were gangbangers. After school you came home and locked your doors and locked your windows and entertained yourself inside the house. I spent my childhood washing clothes, cleaning and doing homework.”
Families like Daisy’s have nowhere to turn. Though the projects are federal property, the Bounty Hunter Bloods and Grape Street Crips don’t just live there, they also run them.
“If you want to live in Jordan Downs you do not ask the housing authority or the city for permission, you ask the Grape Street gang,” says civil rights attorney Connie Rice. “When Latino families call the housing authorities to complain, the staff, the housing authorities call the Grape Street Crips.”
Grape Street Crips and Bounty Hunters pay residents $1,000 a month plus rent and moving expenses to use their apartments as crack kitchens and dope shops. “The gangs have control of public property for god’s sake!” says Rice. “And they terrorize everybody in there, family after family after family!”
But Colomey’s unit has only 16 officers on duty at any given time. (One evening last year, three of his officers found themselves in a running gun battle with more than 300 armed gangbangers who had collected in a park.) When I spoke with Chief Bratton, he admitted he had little idea what he was getting into when he took this job. The entire LAPD force has roughly 9,000 officers serving about 3.8 million residents, while New York City has about 38,000 policemen serving a city of 8 million: roughly one cop for every 422 Angelenos * vs. one for every 210 New Yorkers. And astonishingly, much of the time the number of LAPD officers on duty, in patrol cars and prepared to respond to all the city’s problems large and small, is mind-numbingly low — under 450 and often as low as 300. You might find that many police officers in southern Manhattan alone.
Partly for that reason, Colomey’s LAPD gang unit doesn’t see hope in change; they see escape or death. Every year, John Coughlin, one of Colomey’s senior officers, organizes a fund-raiser among the squad. Usually it’s a golf game. The average salary in the unit is $75,000, but Coughlin usually manages to cobble together $100,000 or so. Then he chooses kids from Nickerson Gardens and Jordan Downs who want an education and want to live, and gets them the hell out of Dodge, sending as many of them to private school or college as the money will allow.
Lieutenant Sullivan, the intelligence analyst for the L.A. County Sheriff’s Department, has started to track a demoralizing parallel between the way street gangs are changing in the United States and the inception of home-grown terror cells in Pakistan and the United Kingdom, as well as child soldiers in Africa. “There is debate as to whether gang members are child soldiers because they are not in a declared war. But I think functionally it is the same thing. Whether you declare war or not, we are in a societal conflict.”
Father Boyle, who has watched L.A.’s gangs from the street for 25 years, insists that legal solutions for the “gang problem” miss the point. The key to understanding what we’re really facing, he says, is to be honest about the depth of despair in L.A.’s neighborhoods. “Tough laws are not going to work for kids that don’t believe they have a future. You cannot terrorize a kid into caring. It’s bad math. It won’t work; it has never worked. And when his day is the bleakest, a gangbanger is going to get a gun and go look for his enemy and hope to die.”
{==PAGE_BREAK==}
I asked De’Andre Perry what he’d do if someone gave him a one-way ticket out of Watts and enough money to start a new life. He paused and looked around at the desolate buildings. “I am not going to die for these bricks,” he said. But the gang was more state-of-mind than geography. “Wherever you put me I am still going to be me. I am still going to have Bounty Hunters on my arm, embedded in my brain. Wherever you put me I am going to be hood. Wherever I am at, I am going to make it my hood.”
I asked Andre the same thing.
“You can remove your tattoos, disassociate yourself,” he replied. “But the only thing that everybody knows about you is you are from Bounty Hunters. And the only way out of it is just death.”
Editor's Note: An earlier version of this story incorrectly interpreted the statistic as "one cop for every 42,000 Angelenos." It should have read "one cop for every 422 Angelenos."
Click here for Jervey Tervalon's Slow Death of a Chocolate City
Saturday, February 23, 2008
Avenues Gang Overview
A gang's staying powerEntrenched for years in Northeast L.A., the Avenues continues to defy the forces of law and gentrification.
By Joe Mozingo, Sam Quinones and Richard Winton
Los Angeles Times Staff Writers
February 23, 2008
The young men who rule Drew Street have survived countless convictions, injunctions, evictions and deportations.
Over the years, they have called themselves the Cypress Assassins, the Pee Wee Gangsters, the Brown Crowd Youngsters. They are as much clan as gang, deeply interconnected by family, with decades in their Glassell Park neighborhood.
Police have tried to crush them for years, but for all the law enforcement rained upon the shabby two blocks of wrought-iron fences and stucco apartments, homeboys still command the street, as evidenced by the wild shootout Thursday in Northeast Los Angeles. The gun battle, which followed a drive-by attack near an elementary school, prompted police to shut down dozens of blocks, stranded thousands of residents and left two people dead.
The Drew Street crew is just one clique of the notorious Avenues gang that has tenaciously retained control over a wide swath of Northeast L.A., defying both the forces of gentrification and heavy crackdowns by police and federal agents.
The gang, deriving its name from the avenues that cross Figueroa Street, took root in the 1950s and has wreaked havoc ever since. The insignia tattooed on many members' bodies speaks to their virulent history: a skull with a bullet hole, wearing a fedora.
The city attorney hit the Avenues with a gang injunction in 2002, making it illegal for known members to congregate or ride in cars together throughout much of Highland Park, Glassell Park, Cypress Park and Eagle Rock.
And in 2006, the U.S. attorney in Los Angeles won hate-crime convictions against five members for a murderous campaign to force African Americans out of their turf.
But even though the Avenues' presence in many neighborhoods has diminished in recent years -- currently, there are about 400 members -- it remains one of the most powerful gangs in the city. And it retains strong ties to the Mexican Mafia, known as the Eme -- a dominant force in California prisons.
"They are fully entrenched in the northeast community," said U.S. Atty. Thomas P. O'Brien, who led the hate-crime case and prosecuted members of the gang earlier in his career, as a deputy district attorney. "This is one of those older street gangs that are generational. You have youngsters who are 10 or 11 years old jumped in to the same gang claimed by their grandfathers."
The Drew Street clique is run by five interrelated families, police say. The layout of the small neighborhood -- cut off by San Fernando Road, backed up against Forest Lawn Memorial Park -- serves as a perfect redoubt.
The area has long been a source of income for the Mexican Mafia, as Avenues members have taxed local drug dealers and paid a cut to the prison gang, according to Tony Raphael, author of "The Mexican Mafia." A prominent member of the Eme, Javier "Gangster" Marquez, grew up on Drew Street, and drugs from Mexico would land there before being distributed. Raphael said a recent uptick in violence stems from a renewed push by the Avenues to collect taxes from smaller gangs in Cypress Park and Glassell Park.
Police said the Thursday shootout began when gang members opened fire on 36-year-old Marcos Salas near Aragon Elementary School as he held the hand of his 2-year-old granddaughter. The girl was whisked away, but Salas later died. As the gunmen drove off, several people who apparently knew the victim started firing at them.
Minutes later, police converged on Drew Street, 10 blocks away. They pulled over a white Nissan sedan, and three men jumped out and opened fire, police said. The officers fired back, wounding one man and hitting another, who was wielding an AK-47.
Daniel Leon, 22 -- a heavy in the Drew Street crew -- died on the asphalt he and his brothers ruled. The wounded man, Jose Angel Gomez, was taken to a hospital and is being held on suspicion of killing Salas. Another gunman, Guillermo Ocampo, was later caught by police and booked for investigation of murder. Police identified all three as members of the Avenues.
Leon was one of 13 children of Maria Leon, who lived at 3304 Drew St. until the city shut down the home last year with a narcotics abatement lawsuit. City Atty. Rocky Delgadillo called the home the gang's "mother ship." More than 40 arrests were made there in 2006, and the city attorney was attempting to ban Daniel Leon from the neighborhood before he was killed.
His family is one of the five that control drug sales in the area, LAPD Deputy Chief Sergio Diaz and other sources said.
"This clique is bound by close family ties," said Diaz. "It goes back generations."
Like hundreds of residents in the neighborhood, the Leons originally hailed from the village of Tlalchapa, in Guerrero, Mexico, neighbors said.
That shared history breeds loyalty. Several residents interviewed Friday said they supported the Avenues. "I've been here 25 years and they've never disrespected me," said Modesta Hernandez. "On the contrary, they protect us. They help us."
They depicted the police as hostile and corrupt, and several said the shooting of Daniel Leon was unprovoked, although one neighbor said he clearly saw Leon raise the assault weapon at the officers.
Leon had a history of violence. He was arrested for killing a drug buyer at the house in 2004 and was ultimately convicted of being an accessory to murder. In 2005, he was arrested in a case in which prosecutors alleged "he brutally beat and robbed a 43-year-old man . . . as his wife looked on." The wife would not speak to prosecutors out of fear of retaliation.
This fear is the continuing obstacle in authorities' attempts to break the gang's grip. Witnesses don't believe police will protect them. And gang members who flip on their brethren are instantly "green-lighted" -- marked for execution.
David "Mousie" Cruz testified in 2001 against an Avenues member who was accused of taking part in the killings of two black men. Cruz was then deported to El Salvador, where he was stabbed 22 times in retaliation, but he survived.
FBI Special Agent Jerry Fradella recalled trying to pressure the least culpable defendant in the hate-crime case to testify against his codefendants in exchange for leniency. Fernando "Sneaky" Cazares was known to have been inside a van listening to a police scanner while other defendants carried out a killing outside. But he wouldn't betray them.
"He was loyal to the end," Fradella said. "And he got triple life just like the other guys."
Compounding the problem, potential informants often cannot envision a life after snitching -- no longer safe in their neighborhoods, which are often all they know of the world. And in prison, they would have to be held in protective custody.
"They're just so unfamiliar with whatever else is out there, they want to stick to what they know," Fradella said.
The silence is unbearable for the victims' families. Luisa Prudhomme's son Anthony was shot twice in the head as he lay in bed in his apartment in Highland Park on Nov. 3, 2000. He had no gang affiliation and worked at a Pier 1.
His slaying was part of the hate-crime case that led to the conviction of the five men. But the actual shooter is still at large. Police believe they know his identity, but no one will talk.
"I want the person who murdered my son to be brought to justice," Prudhomme said. "The guy who pulled the trigger. He used a pillow, but he must have gotten some of my son's blood on him. He knows what he did. God knows what he did."
joe.mozingo@latimes.com
sam.quinones@latimes.com
richard.winton@latimes.com
Fears of a Meltdown
America’s economy risks mother of all meltdownsBy Martin Wolf
Published: February 19 2008 18:21 | Last updated: February 19 2008 18:21
“I would tell audiences that we were facing not a bubble but a froth – lots of small, local bubbles that never grew to a scale that could threaten the health of the overall economy.” Alan Greenspan, The Age of Turbulence.
That used to be Mr Greenspan’s view of the US housing bubble. He was wrong, alas. So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor.
Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”**. The characteristics of this scenario are, he argues: “A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.”
Prof Roubini is even fonder of lists than I am. Here are his 12 – yes, 12 – steps to financial disaster.
Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.
Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.
Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.
Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.
Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.
Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.
Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.
Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.
Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.
Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.
Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.
These, then, are 12 steps to meltdown. In all, argues Prof Roubini: “Total losses in the financial system will add up to more than $1,000bn and the economic recession will become deeper more protracted and severe.” This, he suggests, is the “nightmare scenario” keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.
Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about “decoupling”. If it lasts six quarters, as Prof Roubini warns, offsetting policy action in the rest of the world would be too little, too late.
Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.
The risks are indeed high and the ability of the authorities to deal with them more limited than most people hope. This is not to suggest that there are no ways out. Unfortunately, they are poisonous ones. In the last resort, governments resolve financial crises. This is an iron law. Rescues can occur via overt government assumption of bad debt, inflation, or both. Japan chose the first, much to the distaste of its ministry of finance. But Japan is a creditor country whose savers have complete confidence in the solvency of their government. The US, however, is a debtor. It must keep the trust of foreigners. Should it fail to do so, the inflationary solution becomes probable. This is quite enough to explain why gold costs $920 an ounce.
The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable.
*A Coming Recession in the US Economy? July 17 2006, www.rgemonitor.com; **The Rising Risk of a Systemic Financial Meltdown, February 5 2008; ***Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not, February 8 2008
martin.wolf@ft.com
Copyright The Financial Times Limited 2008
Friday, February 22, 2008
Avenues Shoot It Out with SWAT
http://www.latimes.com/news/local/la-me-barricade22feb22,0,2198361.story
Los Angeles Times Staff Writers
February 22, 2008
A drive-by attack followed by a wild shootout between gang members and police shut down dozens of blocks of Northeast Los Angeles for nearly six hours Thursday afternoon, stranding thousands of residents, keeping students locked in their classrooms and leaving two people dead.
Veteran L.A. Police Department officials described the bizarre midday shootings -- and the widespread disruption they caused -- as highly unusual even in an area known for gang activity. It left the neighborhood littered with shell casings and its residents fearful.
Police blamed the incident on the notorious Avenues gang, which has cast a wide shadow over districts north of downtown L.A. for decades and continues to be active despite several high-profile attempts by authorities to shut it down.
The violence began around noon when a 37-year-old man police described as a bystander was shot more than a dozen times by suspected gang members as he held the hand of a 2-year-old girl. He later died. The toddler, apparently picked up by a passerby and carried to safety, was not wounded. As the gunmen drove off, witnesses told police, several pedestrians who apparently knew the victim opened fire on the car.
Minutes later, police attempted to stop suspects driving in a white Nissan sedan about 10 blocks away. Three men jumped out of the car, and at least two of them fired weapons at officers.
A man wielding an AK-47 rifle was killed by police as they returned fire, authorities said.
Another suspect was wounded and later found hiding under a car, where he was still holding a semiautomatic handgun, law enforcement sources said. Police said he is expected to recover.
But it was a massive manhunt for the two remaining suspects that shut down dozens of streets in Cypress Park until police arrested one of the men about 5:30 p.m. The other is believed to have driven out of the area, police said.
As police swept through the neighborhood, parents waited anxiously for word about their schoolchildren and other residents remained either stuck inside their homes or kept back by police barricades.
"My son is trapped over there and I can't get him," said Christine Schmidt, 37, who was inside her home near Drew Street and Avenue 32 when she heard the gunshots. Her son was one of the students locked down at Washington Irving Middle School.
"I want my son," she said.
During the search, SWAT team members took position and patrol deputies went door to door with dogs in a neighborhood Police Chief William J. Bratton called the "heart and soul" of the Avenues street gang, whose roots there date back more than 50 years.
As the search dragged on, Washington Irving Middle School students kept on lockdown were fed lunch, allowed bathroom breaks and kept in touch with parents by cellphone. Also locked down were Fletcher and Aragon elementary schools and Cal Charter.
An automated phone service notified parents of the lockdown status, which was not lifted until about 6:15 p.m.
Hundreds of residents gathered along sidewalks and on freeway bridges, waiting for police to allow them back into the neighborhood.
Juan Soto awoke at home to the sound of helicopters and police cars. His car was in the area blocked by police and he had no way to get to his job.
"My boss is not going to relieve me," said the 31-year-old.
Near the scene of the shootings Thursday, Bratton described a neighborhood terrorized in recent weeks by gang violence.
"Gangs that have been here for generations have been going at each other," Bratton said during a news conference, referring to the Avenues and Cypress Park gangs.
Since the beginning of the year, authorities said Avenues gang members are suspected in at least six homicides. Northeast Division, typically far from the most violent in the city, already has eight homicides this year, more than any other, police said. At that rate, the division would far eclipse last year's total of 18.
Deputy Chief Sergio Diaz said that while the area has gang problems, the level of violence in the last few weeks is "unheard of."
In the last month, police said, about a third of the 60 aggravated assaults in the area this year have been connected to Avenues gang members.
The Avenues gang has cast a long shadow in these poor, largely Latino sections north of downtown L.A.
They gained national attention in 1995 when a 3-year-old Stephanie Kuhen was shot and killed when her family made a wrong turn into a Cypress Park alley.
Two years ago, the gang was again in the news when members were convicted on federal hate crime charges for violently trying to drive black residents from the area, a prosecution authorities hoped would hobble the gang's activities.
But law enforcement officials on Thursday described an active and dangerous enterprise, still operating from its well-known base of operations on Drew Street.
Assistant Chief Jim McDonnell said plainclothes officers in the area had gone to the location Thursday because they believed that possible suspects in the drive-by shooting would soon return.
"There's been a rash, an uptick, of shootings in the past few weeks," McDonnell said of the neighborhood, which is just north of the junction of the 5 and 2 freeways and densely packed with apartment buildings, small bungalows and warehouses.
Within minutes of reports of officers being shot at, a massive police presence had descended on the area. Los Angeles SWAT officers were in position by 1 p.m., authorities said. The location is only a few blocks from the LAPD's Northeast Station on San Fernando Road.
More than four hours after the confrontation began, a body covered by a white sheet was still visible in the street. An AK-47 lay nearby.
Neighbors stood in front yards and looked down from balconies, some snapping photographs.
Neighbors said one home in the area had been a subject of frequent police activity.
On Wednesday night, one neighbor said police officers were at the house.
The 35-year old man, who lives in the apartment building next door and asked not to be identified because of fear of reprisals, said he then heard shots Thursday about noon.
"It's been happening since last night," he said. "It's been getting worse and worse every single day."
The shootout and police activity unnerved others as well. About a dozen residents were evacuated by police and stood waiting for hours in a nearby carport.
Norma Rodriguez, 45, said she was turned back when she tried to pick up her son from Fletcher Elementary School.
"We can't go anywhere," said Rodriguez, who lives in Eagle Rock and works as a private caregiver. "I'm worried. Right now at this point, I know he's inside the school, but I don't want him to be scared. There are police cars everywhere."
richard.winton@latimes.com
andrew.blankstein
@latimes.com
susannah.rosenblatt
@latimes.com
Times staff writers Jack Leonard and Paloma Esquivel contributed to this report.
From the Los Angeles Times
Gang mayhem cripples big area
Thousands stranded, schools locked down as notorious group battles the LAPD after a drive-by killing.
By Richard Winton, Susannah Rosenblatt and Andrew BlanksteinLos Angeles Times Staff Writers
February 22, 2008
A drive-by attack followed by a wild shootout between gang members and police shut down dozens of blocks of Northeast Los Angeles for nearly six hours Thursday afternoon, stranding thousands of residents, keeping students locked in their classrooms and leaving two people dead.
Veteran L.A. Police Department officials described the bizarre midday shootings -- and the widespread disruption they caused -- as highly unusual even in an area known for gang activity. It left the neighborhood littered with shell casings and its residents fearful.
Police blamed the incident on the notorious Avenues gang, which has cast a wide shadow over districts north of downtown L.A. for decades and continues to be active despite several high-profile attempts by authorities to shut it down.
The violence began around noon when a 37-year-old man police described as a bystander was shot more than a dozen times by suspected gang members as he held the hand of a 2-year-old girl. He later died. The toddler, apparently picked up by a passerby and carried to safety, was not wounded. As the gunmen drove off, witnesses told police, several pedestrians who apparently knew the victim opened fire on the car.
Minutes later, police attempted to stop suspects driving in a white Nissan sedan about 10 blocks away. Three men jumped out of the car, and at least two of them fired weapons at officers.
A man wielding an AK-47 rifle was killed by police as they returned fire, authorities said.
Another suspect was wounded and later found hiding under a car, where he was still holding a semiautomatic handgun, law enforcement sources said. Police said he is expected to recover.
But it was a massive manhunt for the two remaining suspects that shut down dozens of streets in Cypress Park until police arrested one of the men about 5:30 p.m. The other is believed to have driven out of the area, police said.
As police swept through the neighborhood, parents waited anxiously for word about their schoolchildren and other residents remained either stuck inside their homes or kept back by police barricades.
"My son is trapped over there and I can't get him," said Christine Schmidt, 37, who was inside her home near Drew Street and Avenue 32 when she heard the gunshots. Her son was one of the students locked down at Washington Irving Middle School.
"I want my son," she said.
During the search, SWAT team members took position and patrol deputies went door to door with dogs in a neighborhood Police Chief William J. Bratton called the "heart and soul" of the Avenues street gang, whose roots there date back more than 50 years.
As the search dragged on, Washington Irving Middle School students kept on lockdown were fed lunch, allowed bathroom breaks and kept in touch with parents by cellphone. Also locked down were Fletcher and Aragon elementary schools and Cal Charter.
An automated phone service notified parents of the lockdown status, which was not lifted until about 6:15 p.m.
Hundreds of residents gathered along sidewalks and on freeway bridges, waiting for police to allow them back into the neighborhood.
Juan Soto awoke at home to the sound of helicopters and police cars. His car was in the area blocked by police and he had no way to get to his job.
"My boss is not going to relieve me," said the 31-year-old.
Near the scene of the shootings Thursday, Bratton described a neighborhood terrorized in recent weeks by gang violence.
"Gangs that have been here for generations have been going at each other," Bratton said during a news conference, referring to the Avenues and Cypress Park gangs.
Since the beginning of the year, authorities said Avenues gang members are suspected in at least six homicides. Northeast Division, typically far from the most violent in the city, already has eight homicides this year, more than any other, police said. At that rate, the division would far eclipse last year's total of 18.
Deputy Chief Sergio Diaz said that while the area has gang problems, the level of violence in the last few weeks is "unheard of."
In the last month, police said, about a third of the 60 aggravated assaults in the area this year have been connected to Avenues gang members.
The Avenues gang has cast a long shadow in these poor, largely Latino sections north of downtown L.A.
They gained national attention in 1995 when a 3-year-old Stephanie Kuhen was shot and killed when her family made a wrong turn into a Cypress Park alley.
Two years ago, the gang was again in the news when members were convicted on federal hate crime charges for violently trying to drive black residents from the area, a prosecution authorities hoped would hobble the gang's activities.
But law enforcement officials on Thursday described an active and dangerous enterprise, still operating from its well-known base of operations on Drew Street.
Assistant Chief Jim McDonnell said plainclothes officers in the area had gone to the location Thursday because they believed that possible suspects in the drive-by shooting would soon return.
"There's been a rash, an uptick, of shootings in the past few weeks," McDonnell said of the neighborhood, which is just north of the junction of the 5 and 2 freeways and densely packed with apartment buildings, small bungalows and warehouses.
Within minutes of reports of officers being shot at, a massive police presence had descended on the area. Los Angeles SWAT officers were in position by 1 p.m., authorities said. The location is only a few blocks from the LAPD's Northeast Station on San Fernando Road.
More than four hours after the confrontation began, a body covered by a white sheet was still visible in the street. An AK-47 lay nearby.
Neighbors stood in front yards and looked down from balconies, some snapping photographs.
Neighbors said one home in the area had been a subject of frequent police activity.
On Wednesday night, one neighbor said police officers were at the house.
The 35-year old man, who lives in the apartment building next door and asked not to be identified because of fear of reprisals, said he then heard shots Thursday about noon.
"It's been happening since last night," he said. "It's been getting worse and worse every single day."
The shootout and police activity unnerved others as well. About a dozen residents were evacuated by police and stood waiting for hours in a nearby carport.
Norma Rodriguez, 45, said she was turned back when she tried to pick up her son from Fletcher Elementary School.
"We can't go anywhere," said Rodriguez, who lives in Eagle Rock and works as a private caregiver. "I'm worried. Right now at this point, I know he's inside the school, but I don't want him to be scared. There are police cars everywhere."
richard.winton@latimes.com
andrew.blankstein
@latimes.com
susannah.rosenblatt
@latimes.com
Times staff writers Jack Leonard and Paloma Esquivel contributed to this report.
Wednesday, February 6, 2008
Lower Prices Are Good!
A fall in prices can often be good news
By John Kay
Financial Times February 5 2008 19:09
We greet our neighbours with the hope that they will experience a good morning, a reflection of the days when we lived by agriculture. John Kenneth Galbraith proposed that the equivalent courtesy in the new industrial state was “low price”. Mostly, falling prices are good news. Better news if you are a buyer than if you are a seller. But if you are a seller in a competitive market, lower prices are usually a consequence of falling costs and the lower price expands the market. In computers and consumer electronics, prices have been falling year by year for decades while sales and profits of most producers have steadily increased. Good news all round.
Warren Buffett, the billionaire investor, has argued that asset markets are no different. He pokes fun at volatile Mr Market, who from time to time is willing to sell him goods at prices that are too low. But Mr Buffett’s is a minority view. Financial markets are spooked by the threat of lower house prices and everyone on CNBC is gloomy when the screen is splashed with red.
But, as usual, the Sage of Omaha has a point. Selling ourselves the same goods at higher prices leaves us neither better nor worse off so long as the goods themselves remain the same. For every house seller, there is a house buyer.
Usually the seller is older than the buyer. Typically, people under 45 are still climbing up the housing ladder while those above that age have reached the top or are easing themselves down. House prices are a transfer of income and wealth between generations. The scale of the transfer is very large. In a modern economy, the value of the housing stock is typically three times national income. That means a 10 per cent rise in house prices can represent a redistribution from young to old of 30 per cent of incomes. The potential burden of the past decade’s rise in house prices on young workers dwarfs the potential burden of pensions or medical care for the elderly that cause such general concern.
These full effects would be realised if existing house owners accessed the whole of their increased wealth through equity release. But they do not. The older generation passes on the balance of its wealth to the next. So the pattern of equity release determines how house prices affect consumption. In the short run, home owners spend more; in the medium term, prospective home owners have less to spend on other consumption; in the long run, the legacies arrive.
Just as a house remains a house, the corporation remains the same collection of tangible and intangible assets whatever is happening in the markets. The businesses, fixed assets, skills and capabilities that are General Electric barely change from week to week or even year to year. When bond prices rise, the interest and principal are unchanged; when oil prices soar, the physical stuff in the ground remains the same.
So what is true of houses is also true of other assets, such as stocks and shares. What changes is not their underlying value, but our perception of their value. Asset prices are a measure less of our wealth than of our propensity for self-congratulation. The net effect is only a transfer between the existing owners and the prospective owners.
Stock prices are also a means of intergenerational redistribution. Falling markets are bad news for the old, good news for the young. And although many people have satisfied their housing needs by middle age, they typically go on acquiring assets until they retire. Most people in work should be pleased when markets fall. That does not seem to be how they feel.
The insight that fundamentals remain the same through market fluctuations is the basis of the only mechanical investment rule that has ever been proved to work: pound or dollar cost averaging. Put the same amount of money into the market month by month, year by year, and you end up with a collection of shares bought for less than the average market price. The greater the volatility, the greater the benefit. In troubled times, every cloud has a silver lining.
johnkay@johnkay.com
By John Kay
Financial Times February 5 2008 19:09
We greet our neighbours with the hope that they will experience a good morning, a reflection of the days when we lived by agriculture. John Kenneth Galbraith proposed that the equivalent courtesy in the new industrial state was “low price”. Mostly, falling prices are good news. Better news if you are a buyer than if you are a seller. But if you are a seller in a competitive market, lower prices are usually a consequence of falling costs and the lower price expands the market. In computers and consumer electronics, prices have been falling year by year for decades while sales and profits of most producers have steadily increased. Good news all round.
Warren Buffett, the billionaire investor, has argued that asset markets are no different. He pokes fun at volatile Mr Market, who from time to time is willing to sell him goods at prices that are too low. But Mr Buffett’s is a minority view. Financial markets are spooked by the threat of lower house prices and everyone on CNBC is gloomy when the screen is splashed with red.
But, as usual, the Sage of Omaha has a point. Selling ourselves the same goods at higher prices leaves us neither better nor worse off so long as the goods themselves remain the same. For every house seller, there is a house buyer.
Usually the seller is older than the buyer. Typically, people under 45 are still climbing up the housing ladder while those above that age have reached the top or are easing themselves down. House prices are a transfer of income and wealth between generations. The scale of the transfer is very large. In a modern economy, the value of the housing stock is typically three times national income. That means a 10 per cent rise in house prices can represent a redistribution from young to old of 30 per cent of incomes. The potential burden of the past decade’s rise in house prices on young workers dwarfs the potential burden of pensions or medical care for the elderly that cause such general concern.
These full effects would be realised if existing house owners accessed the whole of their increased wealth through equity release. But they do not. The older generation passes on the balance of its wealth to the next. So the pattern of equity release determines how house prices affect consumption. In the short run, home owners spend more; in the medium term, prospective home owners have less to spend on other consumption; in the long run, the legacies arrive.
Just as a house remains a house, the corporation remains the same collection of tangible and intangible assets whatever is happening in the markets. The businesses, fixed assets, skills and capabilities that are General Electric barely change from week to week or even year to year. When bond prices rise, the interest and principal are unchanged; when oil prices soar, the physical stuff in the ground remains the same.
So what is true of houses is also true of other assets, such as stocks and shares. What changes is not their underlying value, but our perception of their value. Asset prices are a measure less of our wealth than of our propensity for self-congratulation. The net effect is only a transfer between the existing owners and the prospective owners.
Stock prices are also a means of intergenerational redistribution. Falling markets are bad news for the old, good news for the young. And although many people have satisfied their housing needs by middle age, they typically go on acquiring assets until they retire. Most people in work should be pleased when markets fall. That does not seem to be how they feel.
The insight that fundamentals remain the same through market fluctuations is the basis of the only mechanical investment rule that has ever been proved to work: pound or dollar cost averaging. Put the same amount of money into the market month by month, year by year, and you end up with a collection of shares bought for less than the average market price. The greater the volatility, the greater the benefit. In troubled times, every cloud has a silver lining.
johnkay@johnkay.com
Tuesday, February 5, 2008
Caging Finance
Why it is so hard to keep the financial sector caged
By Martin Wolf
Financial Times February 5 2008 20:06
When will the next financial crisis come? We do not know. Yet of one thing we can be sure: unless we learn from this crisis, another one will put the world economy back on to the rocks in the not too distant future.
The FT has published a number of contributions on the lessons: Charles Goodhart of the London School of Economics and Avinash Persaud of Intelligence Capital offered “a proposal for how to avoid the next crash” (January 31); Francisco González of BBVA discussed “What banks can learn from this credit crisis” (February 4); and Daniel Heller of the Swiss National Bank argued for three ways to reform bank bonuses (February 4). The substance of Mr Heller’s argument was similar to a contribution of my own (“Regulators should intervene in bankers’ pay”, January 15), but without the regulatory coercion.
The big question, indeed, is whether lessons must be embedded in regulation. Optimistic opponents of regulation argue that the banks have learnt their lesson and will behave more responsibly in future. Pessimistic opponents fear that legislators might create a Sarbanes- Oxley squared. The Act passed by the US Congress in 2002, after Enron and other scandals, was bad enough, they say. The banks might now suffer something worse.
“Dream on” is my reply to the optimists. To the pessimists, I respond: yes, the danger of over-regulation is real, but so is that of doing nothing at all.
Two points shine out about the financial system over the past three decades: its ability to generate crises, and the mismatch between public risk and private reward.
It is true, on the first point, that none of the financial crises of this period has gravely damaged the world economy, although some have devastated individual economies. But it is probably just a matter of time. What would be happening now if US inflation were out of control or foreign official support for the US dollar were withdrawn? A deep and prolonged US recession would be probable, with devastating economic and political consequences.
It also true, on the second point, that the banking sector is the recipient of massive explicit and implicit public subsidies: it is largely guaranteed against liquidity risk; many of its liabilities seem to be contingent claims on the state; and central banks create an upward- sloping yield curve whenever banks are decapitalised, thereby offering a direct transfer to any institution able to borrow at the low rate and lend at the higher one.
In addition, banking institutions suffer from massive agency problems – between clients and institutions, shareholders and management and management and other staff. All this is also exacerbated by the difficulty of monitoring the quality of transactions until long after the event.
Consider, for example, the process that brought subprime loans to investors in special investment vehicles (SIVs). In between the ultimate borrowers and the risk-takers were loan-originators, designers and packagers of securitised assets, ratings agencies, sales staff, managers of banks and SIVs and managers of pension – and other – funds. Given the number of agents and the wealth of information asymmetries, it is astounding how little went wrong.
Yet big risks have indeed been run. The US itself looks almost like a giant hedge fund. The profits of financial companies jumped from below 5 per cent of total corporate profits, after tax, in 1982 to 41 per cent in 2007, even though their share of corporate value added only rose from 8 to 16 per cent. Banking profit margins have been strong, until recently. Now, at long last, earnings per share and valuations have collapsed.
Yet can anything effective be done to contain the risk-taking this implies? To answer this, we must distinguish “micro-prudential” controls over institutions from “macro-prudential controls” over the entire system.
On the former, the consensus of regulators seems to be that we need tweaks to the existing system. This could include: greater attention to liquidity management, alongside the focus on capital requirements in Basel II; more stress-testing of “value at risk” models; greater transparency throughout the businesses; and greater independence of ratings agencies from issuers.
I would argue, however, that none of this will make a sufficient difference. Regulators must also pay attention to the incentives – particularly the structure of pay – within the businesses. I would argue, in addition, that regulators would have to take a tougher approach than most did in the past cycle.
The bigger point still, however, concerns macro-prudential regulation. As William White of the Bank for International Settlement has noted, banks almost always get into trouble together.* The most recent cycle of mad lending, followed by panic and revulsion, is a paradigmatic example.
One response would be to raise capital requirements counter-cyclically, in response to the growth of credit, as Profs Goodhart and Persaud suggested. They also suggest a variable maximum loan-to-value ratio for mortgages. Mr White adds the need for tighter monetary policy.
These are all reasonable ideas. Yet, as Mr White also notes, the strength of the pressures against taking “away the punchbowl just as the party gets going”, in former Fed governor William McChesney’s famous phrase, is formidable. In addition to bureaucratic inertia, such action is subject both to unavoidable uncertainty about the dangers of current trends and to resistance from private interests. Furthermore, regulators are in constant danger of losing sight of the systemic wood for the institutional trees. I would add to all this the simple fact that freedom of US monetary policy is constrained by the monetary and exchange-rate policies of others, notably of China.
In the end, we are left with a dilemma. On the one hand, we have a banking sector that has a demonstrated capacity to generate huge crises because of the incentives to take on under-appreciated risks. On the other hand, we lack the will and even the capacity to regulate it.
Yet we have no obvious alternative but to try to do so. A financial sector that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders is, I would argue, politically unacceptable in the long run. Those who want market-led globalisation to prosper will recognise that this is its Achilles heel. Effective action must be taken now, before a still bigger global crisis arrives.
Sources for charts: Smithers and Co; Thomson Datastream
By Martin Wolf
Financial Times February 5 2008 20:06
When will the next financial crisis come? We do not know. Yet of one thing we can be sure: unless we learn from this crisis, another one will put the world economy back on to the rocks in the not too distant future.
The FT has published a number of contributions on the lessons: Charles Goodhart of the London School of Economics and Avinash Persaud of Intelligence Capital offered “a proposal for how to avoid the next crash” (January 31); Francisco González of BBVA discussed “What banks can learn from this credit crisis” (February 4); and Daniel Heller of the Swiss National Bank argued for three ways to reform bank bonuses (February 4). The substance of Mr Heller’s argument was similar to a contribution of my own (“Regulators should intervene in bankers’ pay”, January 15), but without the regulatory coercion.
The big question, indeed, is whether lessons must be embedded in regulation. Optimistic opponents of regulation argue that the banks have learnt their lesson and will behave more responsibly in future. Pessimistic opponents fear that legislators might create a Sarbanes- Oxley squared. The Act passed by the US Congress in 2002, after Enron and other scandals, was bad enough, they say. The banks might now suffer something worse.
“Dream on” is my reply to the optimists. To the pessimists, I respond: yes, the danger of over-regulation is real, but so is that of doing nothing at all.
Two points shine out about the financial system over the past three decades: its ability to generate crises, and the mismatch between public risk and private reward.
It is true, on the first point, that none of the financial crises of this period has gravely damaged the world economy, although some have devastated individual economies. But it is probably just a matter of time. What would be happening now if US inflation were out of control or foreign official support for the US dollar were withdrawn? A deep and prolonged US recession would be probable, with devastating economic and political consequences.
It also true, on the second point, that the banking sector is the recipient of massive explicit and implicit public subsidies: it is largely guaranteed against liquidity risk; many of its liabilities seem to be contingent claims on the state; and central banks create an upward- sloping yield curve whenever banks are decapitalised, thereby offering a direct transfer to any institution able to borrow at the low rate and lend at the higher one.
In addition, banking institutions suffer from massive agency problems – between clients and institutions, shareholders and management and management and other staff. All this is also exacerbated by the difficulty of monitoring the quality of transactions until long after the event.
Consider, for example, the process that brought subprime loans to investors in special investment vehicles (SIVs). In between the ultimate borrowers and the risk-takers were loan-originators, designers and packagers of securitised assets, ratings agencies, sales staff, managers of banks and SIVs and managers of pension – and other – funds. Given the number of agents and the wealth of information asymmetries, it is astounding how little went wrong.
Yet big risks have indeed been run. The US itself looks almost like a giant hedge fund. The profits of financial companies jumped from below 5 per cent of total corporate profits, after tax, in 1982 to 41 per cent in 2007, even though their share of corporate value added only rose from 8 to 16 per cent. Banking profit margins have been strong, until recently. Now, at long last, earnings per share and valuations have collapsed.
Yet can anything effective be done to contain the risk-taking this implies? To answer this, we must distinguish “micro-prudential” controls over institutions from “macro-prudential controls” over the entire system.
On the former, the consensus of regulators seems to be that we need tweaks to the existing system. This could include: greater attention to liquidity management, alongside the focus on capital requirements in Basel II; more stress-testing of “value at risk” models; greater transparency throughout the businesses; and greater independence of ratings agencies from issuers.
I would argue, however, that none of this will make a sufficient difference. Regulators must also pay attention to the incentives – particularly the structure of pay – within the businesses. I would argue, in addition, that regulators would have to take a tougher approach than most did in the past cycle.
The bigger point still, however, concerns macro-prudential regulation. As William White of the Bank for International Settlement has noted, banks almost always get into trouble together.* The most recent cycle of mad lending, followed by panic and revulsion, is a paradigmatic example.
One response would be to raise capital requirements counter-cyclically, in response to the growth of credit, as Profs Goodhart and Persaud suggested. They also suggest a variable maximum loan-to-value ratio for mortgages. Mr White adds the need for tighter monetary policy.
These are all reasonable ideas. Yet, as Mr White also notes, the strength of the pressures against taking “away the punchbowl just as the party gets going”, in former Fed governor William McChesney’s famous phrase, is formidable. In addition to bureaucratic inertia, such action is subject both to unavoidable uncertainty about the dangers of current trends and to resistance from private interests. Furthermore, regulators are in constant danger of losing sight of the systemic wood for the institutional trees. I would add to all this the simple fact that freedom of US monetary policy is constrained by the monetary and exchange-rate policies of others, notably of China.
In the end, we are left with a dilemma. On the one hand, we have a banking sector that has a demonstrated capacity to generate huge crises because of the incentives to take on under-appreciated risks. On the other hand, we lack the will and even the capacity to regulate it.
Yet we have no obvious alternative but to try to do so. A financial sector that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders is, I would argue, politically unacceptable in the long run. Those who want market-led globalisation to prosper will recognise that this is its Achilles heel. Effective action must be taken now, before a still bigger global crisis arrives.
Sources for charts: Smithers and Co; Thomson Datastream
New figures suggest US might be in recession
By Chris Giles in London and James Politi in Washington
Financial Times February 5 2008
The UK, Germany and Japan have rebuffed US calls for a global economic stimulus package even as new figures on Tuesday suggested the US might already be in recession.
The data, showing that the US service sector contracted for the first time in almost five years, provoked sharp falls in shares in Europe, while in the US the S&P500 fell 3.2 per cent – its worst one-day fall in almost a year.
At the close of trading, the Eurofirst 300 index of European equities was down 3.15 per cent to 1,313. The FTSE 100 index of UK shares closed 2.63 per cent lower at 5,868.
The figures came as it emerged that a weekend meeting of the Group of Seven leading economies would not agree on a concerted fiscal stimulus, nor on a regulatory package to address the turmoil in credit markets.
David McCormick, the US Treasury’s undersecretary for international affairs, said it was “especially important” that other countries, “take prudent steps to strengthen their economies’ demand components”.
His call received short-shrift from the finance ministries of Japan, Germany and the UK, which indicated they had no immediate intention of following the US fiscal stimulus package.
There was little consensus among G7 countries on what regulatory steps were needed to address the financial turmoil. Fukishiro Nukaga, Japan’s finance minister, said: “We have learned what such fiscal spending could mean from our experience after the burst of the bubble economy.”
However, signs of softening in big economies were not restricted to the US.
Activity in the US services industry, as measured by the Institute for Supply Management’s non-manufacturing business activity index, appeared to contract in January, adding to gloominess about the economic outlook.
“If the move does stand up on revision, then it suggests a significant and sudden broadening out of the weakness in the US economy,” wrote analysts at Goldman Sachs, reflecting uncertainty over the importance of the ISM index. “In its short history [since 1997] this survey has rarely produced readings below 50 outside recession.”
In the eurozone, the revised service sector purchasing managers’ index for January fell to 50.6 from 53.1 in December, indicating that at the end of last month sentiment deteriorated sharply and activity in the crucial service sector of the 15-member currency zone was barely growing.
Separate figures on Tuesday from the UK show that consumer confidence has fallen to its lowest level since the Nationwide Building Society started the series in 2004.
With the Bank of England expected to cut interest rates on Thursday, the weak eurozone figures suggested Jean Claude Trichet might also soften his language on the possibility of rate cuts.
Financial Times February 5 2008
The UK, Germany and Japan have rebuffed US calls for a global economic stimulus package even as new figures on Tuesday suggested the US might already be in recession.
The data, showing that the US service sector contracted for the first time in almost five years, provoked sharp falls in shares in Europe, while in the US the S&P500 fell 3.2 per cent – its worst one-day fall in almost a year.
At the close of trading, the Eurofirst 300 index of European equities was down 3.15 per cent to 1,313. The FTSE 100 index of UK shares closed 2.63 per cent lower at 5,868.
The figures came as it emerged that a weekend meeting of the Group of Seven leading economies would not agree on a concerted fiscal stimulus, nor on a regulatory package to address the turmoil in credit markets.
David McCormick, the US Treasury’s undersecretary for international affairs, said it was “especially important” that other countries, “take prudent steps to strengthen their economies’ demand components”.
His call received short-shrift from the finance ministries of Japan, Germany and the UK, which indicated they had no immediate intention of following the US fiscal stimulus package.
There was little consensus among G7 countries on what regulatory steps were needed to address the financial turmoil. Fukishiro Nukaga, Japan’s finance minister, said: “We have learned what such fiscal spending could mean from our experience after the burst of the bubble economy.”
However, signs of softening in big economies were not restricted to the US.
Activity in the US services industry, as measured by the Institute for Supply Management’s non-manufacturing business activity index, appeared to contract in January, adding to gloominess about the economic outlook.
“If the move does stand up on revision, then it suggests a significant and sudden broadening out of the weakness in the US economy,” wrote analysts at Goldman Sachs, reflecting uncertainty over the importance of the ISM index. “In its short history [since 1997] this survey has rarely produced readings below 50 outside recession.”
In the eurozone, the revised service sector purchasing managers’ index for January fell to 50.6 from 53.1 in December, indicating that at the end of last month sentiment deteriorated sharply and activity in the crucial service sector of the 15-member currency zone was barely growing.
Separate figures on Tuesday from the UK show that consumer confidence has fallen to its lowest level since the Nationwide Building Society started the series in 2004.
With the Bank of England expected to cut interest rates on Thursday, the weak eurozone figures suggested Jean Claude Trichet might also soften his language on the possibility of rate cuts.
Monday, February 4, 2008
Housing Foreclosures: Some Puzzles
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Last year’s model: stricken US homeowners confound predictions
By Krishna Guha and Gillian Tett
Financial Times January 31 2008
When Ray McDaniel, president of Moody’s, addressed a debate in Davos last week, the mood was so hostile that some speakers joked that he was brave to appear “without a bodyguard”.
No wonder. As the credit squeeze persists, ratings agencies are being forced to downgrade thousands of securities, after failing to foresee the recent wave of defaults, particularly in subprime loans. On Wednesday night alone, Standard & Poor’s downgraded more than 8,000 residential mortgage-related securities worth some $534bn (£268bn, €360bn).
These downgrades have triggered bitter recriminations, amid a wave of losses at asset managers and banks. “Much of the money lost has been held by people who held AAA securities [that were downgraded],” points out Wes Edens, head of Fortress Investment Group, a big hedge fund. “That has caused a tremendous loss of confidence.”
But the downgrades have also left policymakers and analysts scrambling to determine what has gone so badly wrong. As this search intensifies, some economists are starting to suspect that the answer lies in a striking recent change in American household choices – a shift that could have important implications for policymakers and investors alike.
In particular, it seems that mathematical models used to predict future default rates, based on past patterns of losses, have gone wrong because they did not adjust to reflect shifts in household behaviour. Or, to put it another way, financiers have been tripped up because they ignored one of the most basic rules of investment, which is usually found in product literature: the past is not always a guide to the future.
“There has been a failure in some of the key assumptions which supported our analysis and modelling,” Mr McDaniel admits. “The information quality deteriorated in a way that was not appreciated by Moody’s or others.” Mortgage borrowers, in other words, did not behave as expected.
The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first – and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest. That is particularly true of the less creditworthy subprime borrowers. More over, consumers have stopped paying mortgages before they halt payments on their credit cards or automotive loans – turning the traditional delinquency pattern on its head. As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.
“In the past, if a household in America experienced financial problems it tended to go delinquent on its credit cards, but kept on paying its mortgage,” says Malcolm Knight, head of the Bank for International Settlements, the central banks’ bank. “Now what seems to be happening is that people who have outstanding mortgages that are greater than the value of their home, or have negative amortisation mortgages, keep paying off their credit card balances but hand in the keys to their house ... these reactions to financial stress are not taken into account in the credit scoring models that are used to value residential mortgage-backed securities.”
One possible explanation is that it has become culturally more acceptable this decade for people to abandon houses or stop paying in the hope of renegotiating their home loans. The shame that used to be associated with losing a house may, in other words, be ebbing away – particularly among homeowners who took out subprime loans in recent years, as underwriting standards were loosened. Consumers may also be rationally re-evaluating the costs that come with defaulting on different forms of debt, in the light of recent bankruptcy law reforms in America.
But there is a more fundamental economic explanation. In the past, it has usually been assumed that mortgage defaults occurred due to cash flow problems: if a borrower lost a job, for example, he or she would no longer have enough income to service a housing loan. However, if households were actually running out of cash, they might have been expected to stop paying credit card debt too, to a greater degree – implying a change is afoot.
Previously in America, the property market has softened during times of recession and rising unemployment. But this time, house prices have fallen even though unemployment has not risen. Mortgage delinquencies started to surge two years ago, or as soon as house prices stopped rising and then started to fall. That might be because overstretched households with unsuitable loans were no longer able to refinance their way out of trouble, when house prices stopped rising.
But another explanation is that people with high loan-to-value mortgages no longer felt as strong an incentive to maintain payments when house prices started to fall – even if they were able to. This is because of the negative equity phenomenon – where house prices have fallen below the value of the loan or will soon do so.
Thus faced with a choice between keeping their car and maintaining payments on a house in which they had no equity stake, some households apparently chose to keep their wheels. Indeed, International Monetary Fund data that show delinquency rates on prime loans made in 2006 and 2007 – too late to benefit from house price gains – are rising more quickly than delinquencies on prime loans made in 2003 or 2004.
Since the mortgage market is still in flux, it is difficult to tell which explanation is the most accurate. However, if consumer behaviour has shifted, it has potentially crucial policy implications.
In recent months, Washington politicians have devoted a great deal of attention to the problem of “resets”. This refers to the fact that many subprime borrowers took out loans in recent years at initial, ultra-low “teaser” rates, which typically rise (or “reset”) after a couple of years. Around 1m of these subprime loans are due to reset this year, which means that many households could suddenly face sharply higher repayments. That in turn has sparked fears of a looming further rise in delinquencies by increasingly cash-strapped households.
To offset this risk, the administration of President George W. Bush recently brokered a plan to freeze the resets. Yet in private, Treasury officials admit that while the scheme might help at the margins, it is unlikely to be a “silver bullet”. This is because one dirty secret of recent mortgage data is that, thus far, there has been a surprisingly weak correlation between rate resets and delinquencies. That suggests that the reset freeze may have only a limited effect on foreclosures this year.
There is another implication – one that means debt holders may need to rethink their reliance on ratings. In earlier credit cycles, micro-level changes in household behaviour would probably have been spotted by bankers at an early stage, particularly if they had personal knowledge of their clients. But because banks have securitised mortgages in recent years, this contact between lender and borrower has shrivelled. “Nobody has stepped into the gap in terms of monitoring the quality of the loans,” says Walter Kielholz, Credit Suisse chairman. Or as George Soros, the billionaire investor, puts it: “Securitisation had the effect of transferring risk from people who are supposed to know risk and know the borrowers to people who don’t.”
Investors have tried to fill this information gap by turning to ratings agencies. But these agencies have typically predicted defaults by using macroeconomic models that essentially extrapolated past trends into the future. Thus they have been ill-equipped to spot shifts in the fundamental economic drivers of delinquency or that loan underwriting standards had been collapsing to a point where fraud was often creeping into the mortgage chain.
In a sense, then, the securitisation industry has been fighting the last war, tracking the issues that created delinquencies in earlier recessions. Thus mortgage lenders and investors have been filtering loans in recent years on the basis of Fico scores (which measure cash flow management) rather than loan-to-value ratios (which denote exposure to house prices). While some officials inside the ratings agencies have tried to point out these shortcomings, the sheer volume of business that has engulfed the agencies has given them little opportunity to rethink their approach. “Ratings agencies have been very keen to rate things because they got fees,” says Mr Kielholz.
The agencies and Wall Street economists are now scurrying to fix these problems in their models. Treasury and Federal Reserve officials are also conducting micro-level analysis to better understand the shift. But, making the problem doubly pernicious, it remains unclear how stable the current pattern is.
Some economists suspect that if house price declines continue but the US jobs market holds up, the pattern of high mortgage defaults relative to other forms of consumer credit could continue. However, if the US slips into recession or even a protracted period of rising unemployment, delinquencies might rise on a wide range of consumer credits, implying a return to a more traditional pattern. Indeed, some banks are starting to brace themselves for this latter shift. “The problems in the credit markets are spreading to the consumer sector – the next area of concern is auto loans and credit cards,” says John Thain, chief executive of Merrill Lynch.
Nevertheless, one thing is clear: the credit crunch will force many institutions to rethink their reliance on backward-looking models and perhaps put a greater emphasis on behavioural economics. “Simply extrapolating from the past into the future is not good enough,” says one US policymaker. Or as the beleaguered Mr McDaniel at Moody’s adds: “We [in the ratings industry] know we have got to retool our processes.”
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Financial Times FT.com
Last year’s model: stricken US homeowners confound predictions
By Krishna Guha and Gillian Tett
Financial Times January 31 2008
When Ray McDaniel, president of Moody’s, addressed a debate in Davos last week, the mood was so hostile that some speakers joked that he was brave to appear “without a bodyguard”.
No wonder. As the credit squeeze persists, ratings agencies are being forced to downgrade thousands of securities, after failing to foresee the recent wave of defaults, particularly in subprime loans. On Wednesday night alone, Standard & Poor’s downgraded more than 8,000 residential mortgage-related securities worth some $534bn (£268bn, €360bn).
These downgrades have triggered bitter recriminations, amid a wave of losses at asset managers and banks. “Much of the money lost has been held by people who held AAA securities [that were downgraded],” points out Wes Edens, head of Fortress Investment Group, a big hedge fund. “That has caused a tremendous loss of confidence.”
But the downgrades have also left policymakers and analysts scrambling to determine what has gone so badly wrong. As this search intensifies, some economists are starting to suspect that the answer lies in a striking recent change in American household choices – a shift that could have important implications for policymakers and investors alike.
In particular, it seems that mathematical models used to predict future default rates, based on past patterns of losses, have gone wrong because they did not adjust to reflect shifts in household behaviour. Or, to put it another way, financiers have been tripped up because they ignored one of the most basic rules of investment, which is usually found in product literature: the past is not always a guide to the future.
“There has been a failure in some of the key assumptions which supported our analysis and modelling,” Mr McDaniel admits. “The information quality deteriorated in a way that was not appreciated by Moody’s or others.” Mortgage borrowers, in other words, did not behave as expected.
The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first – and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest. That is particularly true of the less creditworthy subprime borrowers. More over, consumers have stopped paying mortgages before they halt payments on their credit cards or automotive loans – turning the traditional delinquency pattern on its head. As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.
“In the past, if a household in America experienced financial problems it tended to go delinquent on its credit cards, but kept on paying its mortgage,” says Malcolm Knight, head of the Bank for International Settlements, the central banks’ bank. “Now what seems to be happening is that people who have outstanding mortgages that are greater than the value of their home, or have negative amortisation mortgages, keep paying off their credit card balances but hand in the keys to their house ... these reactions to financial stress are not taken into account in the credit scoring models that are used to value residential mortgage-backed securities.”
One possible explanation is that it has become culturally more acceptable this decade for people to abandon houses or stop paying in the hope of renegotiating their home loans. The shame that used to be associated with losing a house may, in other words, be ebbing away – particularly among homeowners who took out subprime loans in recent years, as underwriting standards were loosened. Consumers may also be rationally re-evaluating the costs that come with defaulting on different forms of debt, in the light of recent bankruptcy law reforms in America.
But there is a more fundamental economic explanation. In the past, it has usually been assumed that mortgage defaults occurred due to cash flow problems: if a borrower lost a job, for example, he or she would no longer have enough income to service a housing loan. However, if households were actually running out of cash, they might have been expected to stop paying credit card debt too, to a greater degree – implying a change is afoot.
Previously in America, the property market has softened during times of recession and rising unemployment. But this time, house prices have fallen even though unemployment has not risen. Mortgage delinquencies started to surge two years ago, or as soon as house prices stopped rising and then started to fall. That might be because overstretched households with unsuitable loans were no longer able to refinance their way out of trouble, when house prices stopped rising.
But another explanation is that people with high loan-to-value mortgages no longer felt as strong an incentive to maintain payments when house prices started to fall – even if they were able to. This is because of the negative equity phenomenon – where house prices have fallen below the value of the loan or will soon do so.
Thus faced with a choice between keeping their car and maintaining payments on a house in which they had no equity stake, some households apparently chose to keep their wheels. Indeed, International Monetary Fund data that show delinquency rates on prime loans made in 2006 and 2007 – too late to benefit from house price gains – are rising more quickly than delinquencies on prime loans made in 2003 or 2004.
Since the mortgage market is still in flux, it is difficult to tell which explanation is the most accurate. However, if consumer behaviour has shifted, it has potentially crucial policy implications.
In recent months, Washington politicians have devoted a great deal of attention to the problem of “resets”. This refers to the fact that many subprime borrowers took out loans in recent years at initial, ultra-low “teaser” rates, which typically rise (or “reset”) after a couple of years. Around 1m of these subprime loans are due to reset this year, which means that many households could suddenly face sharply higher repayments. That in turn has sparked fears of a looming further rise in delinquencies by increasingly cash-strapped households.
To offset this risk, the administration of President George W. Bush recently brokered a plan to freeze the resets. Yet in private, Treasury officials admit that while the scheme might help at the margins, it is unlikely to be a “silver bullet”. This is because one dirty secret of recent mortgage data is that, thus far, there has been a surprisingly weak correlation between rate resets and delinquencies. That suggests that the reset freeze may have only a limited effect on foreclosures this year.
There is another implication – one that means debt holders may need to rethink their reliance on ratings. In earlier credit cycles, micro-level changes in household behaviour would probably have been spotted by bankers at an early stage, particularly if they had personal knowledge of their clients. But because banks have securitised mortgages in recent years, this contact between lender and borrower has shrivelled. “Nobody has stepped into the gap in terms of monitoring the quality of the loans,” says Walter Kielholz, Credit Suisse chairman. Or as George Soros, the billionaire investor, puts it: “Securitisation had the effect of transferring risk from people who are supposed to know risk and know the borrowers to people who don’t.”
Investors have tried to fill this information gap by turning to ratings agencies. But these agencies have typically predicted defaults by using macroeconomic models that essentially extrapolated past trends into the future. Thus they have been ill-equipped to spot shifts in the fundamental economic drivers of delinquency or that loan underwriting standards had been collapsing to a point where fraud was often creeping into the mortgage chain.
In a sense, then, the securitisation industry has been fighting the last war, tracking the issues that created delinquencies in earlier recessions. Thus mortgage lenders and investors have been filtering loans in recent years on the basis of Fico scores (which measure cash flow management) rather than loan-to-value ratios (which denote exposure to house prices). While some officials inside the ratings agencies have tried to point out these shortcomings, the sheer volume of business that has engulfed the agencies has given them little opportunity to rethink their approach. “Ratings agencies have been very keen to rate things because they got fees,” says Mr Kielholz.
The agencies and Wall Street economists are now scurrying to fix these problems in their models. Treasury and Federal Reserve officials are also conducting micro-level analysis to better understand the shift. But, making the problem doubly pernicious, it remains unclear how stable the current pattern is.
Some economists suspect that if house price declines continue but the US jobs market holds up, the pattern of high mortgage defaults relative to other forms of consumer credit could continue. However, if the US slips into recession or even a protracted period of rising unemployment, delinquencies might rise on a wide range of consumer credits, implying a return to a more traditional pattern. Indeed, some banks are starting to brace themselves for this latter shift. “The problems in the credit markets are spreading to the consumer sector – the next area of concern is auto loans and credit cards,” says John Thain, chief executive of Merrill Lynch.
Nevertheless, one thing is clear: the credit crunch will force many institutions to rethink their reliance on backward-looking models and perhaps put a greater emphasis on behavioural economics. “Simply extrapolating from the past into the future is not good enough,” says one US policymaker. Or as the beleaguered Mr McDaniel at Moody’s adds: “We [in the ratings industry] know we have got to retool our processes.”
Loan Pass-On Problems
Loan market in ‘disarray’ after Harrah’s upset
By Stacy-Marie Ishmael and Henny Sender in New York
Financial Times February 3 2008 22:04
The leveraged loan market begins the week in “disarray” following the collapse of efforts to syndicate $14bn of the debt used to finance the $30bn buy-out of Harrah’s Entertainment, bankers say.
The group of banks backing buyers Apollo Management and Texas Pacific Group are having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss.
The freeze in the debt market means they now face larger potential losses on other big buy-outs, such as BCE and Clear Channel Communications, and will be more desperate to get out of the financing commitments on those deals.
Banks are already saddled with more than $150bn of unsyndicated debt, most of it LBO-related, according to S&P data.
Virtually every loan-backed buy-out deal done in the past few months is trading well below 90 cents on the dollar. With most investors concluding that the bottom is not yet in sight, there is little sense that the current level is a bargain. The prospect of massive losses took its toll on the group of banks arranging the Harrah’s financing.
Credit Suisse, under pressure to get its lending exposures down, sold about $1bn of its share of the debt ahead of the agreed schedule, infuriating the other banks. Credit Suisse informed fellow members of the syndicate of its intention in early January, according to one person familiar with the matter.
“There is no contractual obligation,” this person added. “We cannot concede control over our own capital.”
That may be the pattern in future deals. “The Harrah’s precedent frees other underwriters to deal with situations as they see fit,” noted Standard & Poor’s Weekly Wrap.
“The market is in total disarray,” said the head of debt capital markets at one major Wall Street firm. Another senior banker involved in the deal added: “The last 10 days have been the worst ever. There is a complete buyers’ strike.”
Kingman Penniman, president of KDP Investment Advisors, said: “It’s very hard to see an environment where that overhang of debt is going to be cleared any time soon. But it does look like some of the bigger deals might not get done.”
Ironically, the Federal Reserve’s dramatic 1.25 percentage point cut in interest rates in January contributed to Harrah’s problem, because loans are floating rate and with benchmarks such as Libor dropping, returns to investors fall proportionately.
The Fed rate reduction also meant lower returns on earlier deals to finance the mega buy-outs of the last few months, including the loans on deals such as First Data and Alltel.
The fate of the Harrah’s financing had little to do with the company itself.
Harrah’s has $6bn of equity, making it less highly leveraged than many other buy-outs. That is one reason Goldman Sachs’ mezzanine fund swooped in and bought $1.2bn of Harrah’s bonds.
The head of debt at one private equity firm said: “Technical factors haven’t been fixed and the bad macro outlook has kicked in.
“Even if you are comfortable with the individual credit, why bid when the market is going lower?”
By Stacy-Marie Ishmael and Henny Sender in New York
Financial Times February 3 2008 22:04
The leveraged loan market begins the week in “disarray” following the collapse of efforts to syndicate $14bn of the debt used to finance the $30bn buy-out of Harrah’s Entertainment, bankers say.
The group of banks backing buyers Apollo Management and Texas Pacific Group are having trouble selling on the leveraged buy-out debt to third parties. With the bulk of the debt remaining on their books, the banks are sitting on a sizeable loss.
The freeze in the debt market means they now face larger potential losses on other big buy-outs, such as BCE and Clear Channel Communications, and will be more desperate to get out of the financing commitments on those deals.
Banks are already saddled with more than $150bn of unsyndicated debt, most of it LBO-related, according to S&P data.
Virtually every loan-backed buy-out deal done in the past few months is trading well below 90 cents on the dollar. With most investors concluding that the bottom is not yet in sight, there is little sense that the current level is a bargain. The prospect of massive losses took its toll on the group of banks arranging the Harrah’s financing.
Credit Suisse, under pressure to get its lending exposures down, sold about $1bn of its share of the debt ahead of the agreed schedule, infuriating the other banks. Credit Suisse informed fellow members of the syndicate of its intention in early January, according to one person familiar with the matter.
“There is no contractual obligation,” this person added. “We cannot concede control over our own capital.”
That may be the pattern in future deals. “The Harrah’s precedent frees other underwriters to deal with situations as they see fit,” noted Standard & Poor’s Weekly Wrap.
“The market is in total disarray,” said the head of debt capital markets at one major Wall Street firm. Another senior banker involved in the deal added: “The last 10 days have been the worst ever. There is a complete buyers’ strike.”
Kingman Penniman, president of KDP Investment Advisors, said: “It’s very hard to see an environment where that overhang of debt is going to be cleared any time soon. But it does look like some of the bigger deals might not get done.”
Ironically, the Federal Reserve’s dramatic 1.25 percentage point cut in interest rates in January contributed to Harrah’s problem, because loans are floating rate and with benchmarks such as Libor dropping, returns to investors fall proportionately.
The Fed rate reduction also meant lower returns on earlier deals to finance the mega buy-outs of the last few months, including the loans on deals such as First Data and Alltel.
The fate of the Harrah’s financing had little to do with the company itself.
Harrah’s has $6bn of equity, making it less highly leveraged than many other buy-outs. That is one reason Goldman Sachs’ mezzanine fund swooped in and bought $1.2bn of Harrah’s bonds.
The head of debt at one private equity firm said: “Technical factors haven’t been fixed and the bad macro outlook has kicked in.
“Even if you are comfortable with the individual credit, why bid when the market is going lower?”
Student Loan Company Payouts that Weren't
Sallie Mae Directors to Profit Handsomely
Inside Higher Ed, August 6, 2007
When the directors of Sallie Mae meet next week to consider a $25 billion offer to buy the student loan giant, they will be voting on a transaction that will benefit the company, and also themselves — significantly.
A proxy filing by Sallie Mae with the Securities and Exchange Commission last month shows that the company’s directors will earn a total of about $370 million in profit if the sale of Sallie Mae to J.C. Flowers, Friedman Fleischer & Lowe, Bank of America and JPMorgan Chase goes through on August 15. The bulk of that money — almost $225 million — will go to Sallie Mae’s chairman and former CEO, Albert L. Lord. (A list of the directors and the value of their shares appears below.)
But some current and former higher education officials on the board will benefit handsomely as well, and to some observers, the significant sums going to Sallie Mae directors are symptomatic of larger questions raised by the sale of the mammoth lender, which had its roots as a quasi-governmental entity. Is it appropriate for a company that was built to a large extent through its connection to the federal government profit so enormously as it has slowly shed those ties?
“Sallie Mae was built to serve a public purpose, of providing student loans,” said Robert Shireman, executive director of the Project on Student Debt and a longtime observer of the student loan programs. “It was set free and no one really knew whether the federal government got a good deal or not. This level of profiteering off the corporation suggests that ultimately the deal that was struck may well have undercompensated taxpayers.”
While the funds going to the company’s directors and officers are a tiny portion of the money that will flow to Sallie Mae and its share holders, Shireman said, “those figures are indicative of the nature of the deal that was struck.”
Tom Joyce, a Sallie Mae spokesman, said that it is typical when companies are bought and sold for the men and women who have overseen their success to see personal gain. “It happens in every single transaction,” Joyce said. And while the figures may seem large to many in higher education, Joyce said, that’s because Sallie Mae is an unusually large entity in the college world — at least unusual as a huge and hugely profitable for-profit company.
Joyce rejected the notion that Sallie Mae’s profitability at this point — a decade after it began transitioning away from being a government-sponsored enterprise — can still be attributed to its historic federal ties. “The company has diversified greatly away from being dependent on federal guaranteed student loans, and it has shed its skin a couple times,” Joyce said. “Since 1997, when this board really came into being, it has gone head to head with the major financial institutions in the United States and outperformed them. Should directors be compensated for that? They’re compensated with stock, and now they’re getting rewarded for that.”
Below is a table showing the Sallie Mae directors, their positions (and ties to higher education, if any), and the profit they will see in the sale of their Sallie Mae stock, which is calculated by multiplying the number of shares they own by the amount that the $60 sale price exceeds the “strike price” they would need to pay to exercise their stock options. (All told, the share of officers and directors are worth $750 million at the $60 price.)
Some names familiar to many in higher education appear on the list, including Diane Suitt Gilleland, former director of the Arkansas Department of Higher Education, and Barry A. Munitz, former chancellor of the California State University System.
Name
Title
Net profit from Sallie Mae sale
Non-employee directors
Ann Torre Bates
Strategic and financial consultant
$7,114,311
Charles L. Daley
Director and executive VP, TEB Associates, Inc.
$10,160,011
William M. Diefenderfer III
Partner, Diefenderfer, Hoover & Wood
$4,737,178
Diane Suitt Gilleland
Associate professor of higher education, U. of Arkansas at Little Rock.
$4,595,391
Earl A. Goode
Deputy chief of staff, Indiana Gov. Mitch Daniels
$3,350,189
Ronald F. Hunt
Lawyer
$4,532,269
Benjamin J. Lambert III
State senator, Virginia
$7,280,313
Albert L. Lord
Chairman, Sallie Mae
$225,920,802
Barry A. Munitz
Trustee professor, California State U. at Los Angeles
$609,509
A. Alexander Porter Jr.
Founder and partner, Porter Orlin, Inc.
$25,193,904
Wolfgang Schoellkopf
Managing partner, Lycos Capital Management
$3,874,610
Steven L. Shapiro
CPA
$9,983,250
Barry L. Williams
President, Williams Pacific Ventures
$5,954,446
Sallie Mae Officers
C.E. Andrews
Chief executive officer
$16,116,200
Robert S. Autor
Executive VP, consumer operations
$16,022,128
Robert S. Lavet
Senior VP and general counsel
$9,730,191
Sandra L. Masino
Senior VP, accounting
$666,165
June M. McCormack
Executive VP, servicing, technology and sales marketing
$8,975,958
Kevin F. Moehn
Executive VP, sales and originations
$5,461,750
— Doug Lederman
Inside Higher Ed, August 6, 2007
When the directors of Sallie Mae meet next week to consider a $25 billion offer to buy the student loan giant, they will be voting on a transaction that will benefit the company, and also themselves — significantly.
A proxy filing by Sallie Mae with the Securities and Exchange Commission last month shows that the company’s directors will earn a total of about $370 million in profit if the sale of Sallie Mae to J.C. Flowers, Friedman Fleischer & Lowe, Bank of America and JPMorgan Chase goes through on August 15. The bulk of that money — almost $225 million — will go to Sallie Mae’s chairman and former CEO, Albert L. Lord. (A list of the directors and the value of their shares appears below.)
But some current and former higher education officials on the board will benefit handsomely as well, and to some observers, the significant sums going to Sallie Mae directors are symptomatic of larger questions raised by the sale of the mammoth lender, which had its roots as a quasi-governmental entity. Is it appropriate for a company that was built to a large extent through its connection to the federal government profit so enormously as it has slowly shed those ties?
“Sallie Mae was built to serve a public purpose, of providing student loans,” said Robert Shireman, executive director of the Project on Student Debt and a longtime observer of the student loan programs. “It was set free and no one really knew whether the federal government got a good deal or not. This level of profiteering off the corporation suggests that ultimately the deal that was struck may well have undercompensated taxpayers.”
While the funds going to the company’s directors and officers are a tiny portion of the money that will flow to Sallie Mae and its share holders, Shireman said, “those figures are indicative of the nature of the deal that was struck.”
Tom Joyce, a Sallie Mae spokesman, said that it is typical when companies are bought and sold for the men and women who have overseen their success to see personal gain. “It happens in every single transaction,” Joyce said. And while the figures may seem large to many in higher education, Joyce said, that’s because Sallie Mae is an unusually large entity in the college world — at least unusual as a huge and hugely profitable for-profit company.
Joyce rejected the notion that Sallie Mae’s profitability at this point — a decade after it began transitioning away from being a government-sponsored enterprise — can still be attributed to its historic federal ties. “The company has diversified greatly away from being dependent on federal guaranteed student loans, and it has shed its skin a couple times,” Joyce said. “Since 1997, when this board really came into being, it has gone head to head with the major financial institutions in the United States and outperformed them. Should directors be compensated for that? They’re compensated with stock, and now they’re getting rewarded for that.”
Below is a table showing the Sallie Mae directors, their positions (and ties to higher education, if any), and the profit they will see in the sale of their Sallie Mae stock, which is calculated by multiplying the number of shares they own by the amount that the $60 sale price exceeds the “strike price” they would need to pay to exercise their stock options. (All told, the share of officers and directors are worth $750 million at the $60 price.)
Some names familiar to many in higher education appear on the list, including Diane Suitt Gilleland, former director of the Arkansas Department of Higher Education, and Barry A. Munitz, former chancellor of the California State University System.
Name
Title
Net profit from Sallie Mae sale
Non-employee directors
Ann Torre Bates
Strategic and financial consultant
$7,114,311
Charles L. Daley
Director and executive VP, TEB Associates, Inc.
$10,160,011
William M. Diefenderfer III
Partner, Diefenderfer, Hoover & Wood
$4,737,178
Diane Suitt Gilleland
Associate professor of higher education, U. of Arkansas at Little Rock.
$4,595,391
Earl A. Goode
Deputy chief of staff, Indiana Gov. Mitch Daniels
$3,350,189
Ronald F. Hunt
Lawyer
$4,532,269
Benjamin J. Lambert III
State senator, Virginia
$7,280,313
Albert L. Lord
Chairman, Sallie Mae
$225,920,802
Barry A. Munitz
Trustee professor, California State U. at Los Angeles
$609,509
A. Alexander Porter Jr.
Founder and partner, Porter Orlin, Inc.
$25,193,904
Wolfgang Schoellkopf
Managing partner, Lycos Capital Management
$3,874,610
Steven L. Shapiro
CPA
$9,983,250
Barry L. Williams
President, Williams Pacific Ventures
$5,954,446
Sallie Mae Officers
C.E. Andrews
Chief executive officer
$16,116,200
Robert S. Autor
Executive VP, consumer operations
$16,022,128
Robert S. Lavet
Senior VP and general counsel
$9,730,191
Sandra L. Masino
Senior VP, accounting
$666,165
June M. McCormack
Executive VP, servicing, technology and sales marketing
$8,975,958
Kevin F. Moehn
Executive VP, sales and originations
$5,461,750
— Doug Lederman
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