European Stocks Advance as Ministers Set Rescue Limit

By Tom Stoukas - Mar 30, 2012 7:36 PM GMT+0700

European stocks rose, extending the best first-quarter rally for the Stoxx Europe 600 Index (SXXP) since 2006, as euro-area finance ministers set the overall ceiling for the rescue of the region’s indebted nations at $1.1 trillion. U.S. index futures and Asian shares also climbed.

Daimler AG rallied after Bank of America Corp. recommended buying the shares. Credit Agricole SA (ACA) advanced 2.2 percent as it began talks with China’s Citic Securities Co. to sell its CLSA brokerage unit. HeidelbergCement AG (HEI) jumped 5.5 percent after HSBC Holdings Plc raised its rating on the stock.

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March 30 (Bloomberg) -- Richard Koo, chief economist at Nomura Research Institute, discusses the economic outlook for Spain. He speaks with David Tweed in Cernobbio, Italy, on Bloomberg Television's "Countdown." (Source: Bloomberg)

The Stoxx Europe 600 Index (SXXP) gained 0.8 percent to 262.73 at 1:34 p.m. in London. The benchmark gauge has gained 7.5 percent so far this year as Greece obtained a second bailout and U.S. economic data beat forecasts. Futures on the Standard & Poor’s 500 Index expiring in June added 0.4 percent today. The MSCI Asia Pacific Index rose 0.3 percent.

“The U.S. recovery is now sustainable and, of course, Europe is still at pains but northern Europe remains one of the stronger areas in terms of growth,” said Larry Hatheway, a London-based economist and asset-allocation strategist at UBS AG. He spoke to Linda Yueh and Mark Barton in a Bloomberg Television interview.

The volume of shares changing hands on the companies listed on the Stoxx 600 was 7.8 percent higher than the average of the last 30 days, data compiled by Bloomberg show.

Financial Firewall

Euro-area ministers, meeting in Copenhagen today, set the maximum lending volume of the proposed European Stability Mechanism at 500 billion euros ($667 billion) and the combined lending ceiling of the ESM and the temporary fund -- the European Financial Stability Facility -- at 700 billion euros.

This, in addition to the 102 billion euros already paid to support current rescue programs, takes the total size of the firewall to 800 billion euros, the Eurogroup said in a statement.

“Finally, Robust firewalls have been established,” the ministers said in the statement. “This comprehensive strategy has paid off and led to a significant improvement in market conditions.”

In the U.S., consumer spending rose in February by the most in seven months, showing the biggest part of the economy is strengthening.

Purchases climbed 0.8 percent, the largest gain since July, Commerce Department figures showed.. The median estimate of economists surveyed by Bloomberg News called for a 0.6 percent increase. Incomes advanced less than projected, sending the saving rate down to the lowest level in more than two years.

Consumer Sentiment

Another report may show the Thomson Reuters/University of Michigan final March confidence index fell to 74.5 from 75.3 the previous month, according to the median forecast in a Bloomberg survey. That would be the first monthly decline since August.

Daimler rose 2.9 percent to 45.53 euros as a gauge of European carmakers was the best-performing group in the Stoxx 600. Bank of America recommended buying Daimler’s shares, saying the company “is finally cutting out costs, reducing complexity, simplifying engineering and refreshing the product portfolio.”

Bayerische Motoren Werke AG (BMW) advanced 3 percent to 67.80 euros. Preferred shares of Volkswagen, Europe’s largest maker of automobiles, gained 2.2 percent to 132.55 euros.

Michelin & Cie, the world’s second-largest tiremaker, climbed 2.6 percent to 55.98 euros and Continental AG (SXXP) rallied 5.1 percent to 72.16 euros.

CLSA Brokerage Stake

Credit Agricole rose 2.2 percent to 4.72 euros after its corporate and investment banking unit entered exclusive talks with Citic Securities Co., China’s largest broker by market value, to sell the remaining 80.1 percent stake in its CLSA brokerage unit.

BHP Billiton, the world’s biggest mining company, added 2.4 percent to 1,922.5 pence as a gauge of mining shares rose 2.6 percent. Rio Tinto Group, the world’s third-largest mining company, gained 3.1 percent to 3,481.5 pence.

HeidelbergCement jumped 5.5 percent to 45.92 euros after HSBC upgraded the stock to overweight from neutral, meaning that investors should hold more shares than is represented in benchmark indexes. Lafarge SA (LG), the world’s biggest cement maker, advanced 5.3 percent to 36.05 euros.

Meyer Burger Technology gained 2.4 percent to 14.95 Swiss francs after HSBC raised its recommendation on the shares to neutral, the equivalent of hold, from underweight, the equivalent of sell.

Bad Bank

Commerzbank AG (CBK) added 3.2 percent to 1.92 euros. Germany’s second-largest bank plans to set up a so-called bad bank to liquidate its Eurohypo AG public-finance and commercial-property unit over the coming years, Handelsblatt reported, citing unidentified people in the finance industry.

Vestas Wind Systems A/S, the world’s largest wind-turbine maker, surged 5 percent to 58.40 kroner. The stock was raised to neutral from sell at UBS AG, which said the company could be a target for acquisition.

Subsea 7 SA added 2.7 percent to 150.4 kroner. The oilfield-services provider won a $175 million contract for work at the Cheviot Oil Field.

Telecom Italia SpA fell 2.3 percent to 88 euro cents. Italy’s biggest phone company posted a bigger-than-estimated loss in 2011 after Italy’s largest phone company wrote down goodwill for 7.3 billion euros ($9.68 billion).

Shire Plc dropped 3.5 percent to 2,044 pence after saying the experimental drug SPD476 to treat diverticulitis failed to meet the main goal of an investigational study and that the company won’t pursue a regulatory filing.

To contact the reporter on this story: Tom Stoukas in Athens at astoukas@bloomberg.net

To contact the editor responsible for this story: Andrew Rummer at arummer@bloomberg.net

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U.S. Stock Futures Rise; S&P 500 Heads for Weekly Advance

By Rita Nazareth - Mar 30, 2012 8:32 PM GMT+0700

U.S. stocks rose, extending the Standard & Poor’s 500 Index’s biggest first-quarter advance since 1998, as larger-than-forecast growth in consumer spending bolstered optimism in the economy.

The S&P 500 increased 0.3 percent to 1,408.12 at 9:30 a.m. New York time. The benchmark gauge has rallied 12 percent since the beginning of 2012, gaining for a second straight quarter. The Dow Jones Industrial Average advanced 42.76 points, or 0.3 percent, to 13,188.58 today.

“Things are not going gangbusters, but they are more positive,” Ann Miletti, senior portfolio manager for Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said in a telephone interview. Her firm manages $213 billion. “The tail risk of Europe seems to have gone away. In an environment where you have stocks trading at discounts to their historical levels, it does create a sweet spot.”

More than $3.6 trillion was restored to U.S. equity values since the S&P 500 reached last year’s low in October as better- than-estimated economic and corporate data bolstered demand for stocks. The index climbed 28 percent from Oct. 3 through yesterday. The rally sent the S&P 500 to 14.5 times reported earnings, the highest valuation since July while below the average since 1954 of 16.4.

The S&P 500 has increased 3.2 percent in March (SPX), rallying for a fourth straight month. The Dow has climbed 1.9 percent since the end of February and is poised to cap a sixth month of gains. Both gauges are headed for the longest stretches of monthly gains since 2009.

Dow History

Over the last 100 years, the Dow has advanced 1.3 percent on average in April (INDU) and gained 57 percent of the time, according to data compiled by Bespoke Investment Group. The index has risen an average 2.1 percent in April over the last 50 years and 2.9 percent in the past 20 years, the data showed, marking the best month for the Dow in both time frames.

Stocks rose today as government data showed U.S. consumer spending increased 0.8 percent in February, the most in seven months and more than the median economist estimate of 0.6 percent, signaling the biggest part of the economy is strengthening. Another report may show consumer sentiment held near a one-year high.

Investors also watched the latest attempts in taming Europe’s debt crisis. Adding the 300 billion euros already committed to Greece, Ireland and Portugal, euro-area finance ministers put the overall size of the firewall at 800 billion euros. Finance ministers ruled out using the 240 billion euros left in the temporary rescue fund to go beyond that.

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net

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Foxconn Auditor Finds ‘Serious’ Violations of Chinese Law

By Stanley James - Mar 30, 2012 11:08 AM GMT+0700

An audit of Foxconn Technology Group (2354) found “serious and pressing” violations of Chinese labor laws, prompting the biggest maker of Apple Inc. (AAPL) devices to pledge to cut working hours and give employees more oversight.

Inspectors found at least 50 breaches of Chinese regulations as well as the code of conduct Apple signed when it joined the Fair Labor Association in January after deaths of workers at suppliers, the monitoring group said today. Foxconn will bring hours in line with legal limits by July 2013 and compensate its more than 1.2 million employees for overtime lost due to the shorter work week, it said.

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Employees of Hon Hai Precision Industry Co. Ltd. work along a production line in the Longhua Science and Technology Park, also known as Foxconn City, in Shenzhen, China. Photographer: Thomas Lee/Bloomberg

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March 30 (Bloomberg) -- Fair Labor Association Chief Executive Officer Auret van Heerden talks about the group's audit of Foxconn Technology Group. The audit found “serious and pressing” violations of Chinese labor laws, prompting the biggest maker of Apple Inc. devices to pledge to cut working hours and give employees more oversight. Van Heerden speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

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March 29 (Bloomberg) -- Auret van Heerden, president and chief executive officer of the Fair Labor Association, talks about the group's audit of Foxconn Technology Group that found "serious and pressing" violations of Chinese labor laws, prompting the biggest maker of Apple Inc. iPads to pledge to cut working hours and give employees more oversight. Van Heerden speaks with Trish Regan on Bloomberg Television's "Street Smart." (Source: Bloomberg)

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March 29 (Bloomberg) -- Brian Blair, an analyst at Wedge Partners Corp., and Bloomberg's Jon Erlichman talk about an audit of the labor practices of Foxconn Technology Group, the biggest maker of Apple Inc.'s iPads. They speak with Trish Regan on Bloomberg Television's "Street Smart." TKNG Capital Partners' Neil Grossman also speaks. (Source: Bloomberg)

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March 29 (Bloomberg) -- Gene Munster, an analyst at Piper Jaffray Cos., talks about an audit of labor practices of Foxconn Technology Group, the biggest maker of Apple Inc.'s iPads. He speaks with Emily Chang on Bloomberg Television's "Bloomberg West." (Source: Bloomberg)

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March 30 (Bloomberg) -- Bloomberg's Dominic Chu reports on the impact on Apple from an audit of Foxconn Technology Group that found “serious and pressing” violations of Chinese labor laws. He speaks on Bloomberg Television's "Inside Track." (Source: Bloomberg)

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Workers are seen inside a Foxconn factory in the township of Longhua in the southern Guangdong province May 26, 2010. Employee deaths at global contract electronics manufacturer Foxconn, Apple's main supplier, has cast a spotlight on some of the harsher aspects of blue-collar life on the Chinese factory floor. Photographer: Bobby Yip/Landov

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Workers at Foxconn City, in Shenzhen, China. Photographer: Thomas Lee/Bloomberg

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Employees at Hon Hai's Foxconn plant in Shenzhen. Photographer: Qilai Shen/Bloomberg

“The eyes of the world are on them and there’s just no way they can’t deliver,” FLA President Auret van Heerden said. “It’s a real showstopper.”

Assessors found cases of employees working longer hours and more days in a row than allowed by FLA standards and Chinese law. They uncovered inconsistent health and safety policies and instances of unfair pay for overtime work. To meet its commitments, Foxconn must hire, train and house tens of thousands of workers to assemble products for Apple, Dell Inc. (DELL), Hewlett-Packard Co. (HPQ) and other customers, the FLA said.

Foxconn Response

“We are committed to work with Apple to carry out the remediation program, developed by both our companies,” Foxconn said in an e-mailed statement today. “Our success will be judged by future FLA audits and the monitoring of the implementation of the remediation program, by reviews carried out by Apple and other customers and by future employee surveys.”

Shares in Hon Hai Precision Industry Co., Foxconn’s flagship, dropped 2.1 percent to NT$113.5 as of 11:54 a.m. in Taipei after dropping as much 3 percent, the largest decline since Feb. 21. Apple fell after the report was released, dropping 1.3 percent to $609.86 at the close in New York.

Apple said it appreciated the work FLA has done to assess conditions at Foxconn.

“We fully support their recommendations,” Cupertino, California-based Apple said in an e-mailed statement. “Empowering workers and helping them understand their rights is essential.”

Costs for Consumers

Apple, the world’s most-valuable company, will have to cut profit margins or pass the resulting costs on to consumers, said Alberto Moel, an analyst at Sanford C. Bernstein & Co. in Hong Kong.

“The benefit we, the consumers, and Apple extract from these products at the expense of Foxconn and its workforce is completely unequal,” Moel said in an interview earlier this week. “Foxconn will also have to meet these requirements for all its customers -- Apple, Dell, HP -- because it is at risk of being audited at any production line.”

Foxconn’s pledges will leave more money in the pocketbooks of workers and give them more time to spend it, dovetailing with government plans to rebalance the economy away from exports and toward domestic consumption. Chinese Vice Premier Li Keqiang told Apple Chief Executive Officer Tim Cook during a March 27 meeting in Beijing that multinational companies should pay more attention to caring for workers and share development opportunities, the official Xinhua News Agency reported.

Profit Margins

Apple’s operating margin rose to 31 percent last year, from 12 percent in 2005, according to data compiled by Bloomberg. At Foxconn’s flagship company, Taiwan-listed Hon Hai Precision Industry Co. (2317), the measure fell to 1.1 percent from 3.2 percent.

Apple built computers in the U.S. for much of its 36-year history. As the manufacturing capabilities in Asia improved, it joined other electronics companies in moving assembly lines to China to take advantage of less expensive labor. Now Apple products, including the iPhone and iPad, read on the back: “Designed by Apple in California. Assembled in China.”

The conditions at those facilities have been under scrutiny in recent years, particularly after at least 10 workers committed suicide at plants owned by Foxconn. Three employees died last year and more than 70 were hurt in blasts at two iPad facilities, one owned by Foxconn.

Responding to the criticism, Apple agreed to FLA audits. After surveying more than 35,000 workers and logging over 3,000 hours on site, inspectors found long hours and a failure to engage workers in management decisions.

Inland Expansion

As Foxconn grows, it’s expanding to inland Chinese cities such as Chengdu in the southwestern province of Sichuan and Zhengzhou in the central province of Henan -- where Cook visited yesterday -- to be closer to workers’ hometowns.

When most employees are migrant workers from other areas of the country, businesses can end up with a lot of dissatisfaction and turnover, the cost of which is “humongous,” Moel said.

“If you bring the factories to the workers, they can go home at night,” Moel said.

At two factories in Shenzhen in southern China and at a third in Chengdu, inspectors found the average working week exceeded both the FLA’s 60-hour cap and China’s 49-hour maximum.

Workers were excluded from decision making on health and safety issues, with management nominees dominating the company’s labor union, the FLA said. “Factories’ communications are almost entirely top down,” the report said. Fewer than 1 in 1,000 employees at three business units making Apple products were managers, it found.

Less Than Big Mac

Foxconn pledged to allow workers to elect representatives to union positions and other workplace committees, in line with government rules that are rarely followed in China.

The FLA auditors found no issues related to child or forced labor, according to the report. The average age of workers was 23, they found.

While Foxconn scored well for paying wages on time and at rates higher than the local minimum, more than 64 percent of employees said the basic wage was insufficient.

Foxconn workers in Shenzhen start on 1,800 yuan ($285) a month, rising to about 2,200 yuan after probation, the report said. The average wage in one of the Shenzhen plants was 2,687 yuan and in the other it was 2,872 yuan.

The minimum wage set by the government is 1,500 yuan a month, and 13.3 yuan an hour for part-time employees -- or less than the 15.5 yuan price of a Big Mac.

Updates Coming

More than 80 percent of workers surveyed said they were either content with their hours or wanted more overtime to earn extra money, the report said. Still, employees who worked shorter weeks were more content and expressed a higher level of loyalty to the company, it said.

Today’s report isn’t the first time worker violations have been highlighted. Apple’s own annual audits have cited excessive working hours as a problem since 2006.

The companies haven’t made adequate changes in the intervening years, said Scott Nova, executive director of the Worker Rights Consortium, a labor group in Washington.

“Apple and Foxconn don’t deserve the benefit of the doubt at this point,” Nova said. “The burden is now on Apple and Foxconn to demonstrate that these promises are real by actually implementing these changes.”

To monitor Foxconn’s compliance, the FLA will give regular updates on its website, the new report said.

“We’ve set milestones and concrete deliverables for them to give workers a say,” said Van Heerden, a former South African activist who was imprisoned and tortured under the apartheid regime, exiled in 1987 and later appointed under Nelson Mandela as labor attache to the United Nations.

Companies working with the FLA must agree to disclose their suppliers and have them submit to inspections. The FLA audits about 5 percent of its members’ supply chains each year.

Apple’s membership in the independent FLA will increase scrutiny of its other suppliers, including Seoul-based Samsung Electronics Co. (005930) and Inchon, South Korea-based Hynix Semiconductor Inc. (000660)

“Apple is the most valuable company on the planet and Foxconn the biggest producer of electronics,” Van Heerden said. “This could set the bar for the electronics industry as a whole.”

To contact the reporter on this story: Stanley James in Hong Kong at sjames8@bloomberg.net

To contact the editor responsible for this story: Ben Richardson at brichardson8@bloomberg.net

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Sun Hung Kai Loses $4.9 Billion as Kwoks Arrested

By Kelvin Wong - Mar 30, 2012 4:41 PM GMT+0700

Sun Hung Kai Properties Ltd. (16) plunged the most in 14 years and lost $4.9 billion of market value after anti-graft investigators arrested the billionaire brothers who run Hong Kong’s biggest developer.

Co-chairmen Thomas and Raymond Kwok were detained by the Independent Commission Against Corruption, Sun Hung Kai said late yesterday. Rafael Hui, a former No. 2 official in the government, was also arrested, according to a person with knowledge of the matter who asked not to be identified because of the ongoing probe.

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Raymond Kwok, joint chairman of Sun Hung Kai Properties Ltd., left, and Thomas Kwok, joint chairman, talk after the company's annual general meeting in Hong Kong, China, on Thursday, Dec. 8, 2011. Photographer: Jerome Favre/Bloomberg

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March 30 (Bloomberg) -- Andrew Sullivan, principal sales trader at Piper Jaffray Asia Securities Ltd., discusses investment strategy and the arrest of the billionaire co-chairmen of Hong Kong's biggest developer Sun Hung Kai Properties Ltd. He speaks from Hong Kong with Mark Barton on Bloomberg Television's "First Look." (Source: Bloomberg)

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March 30 (Bloomberg) -- Francis Lun, managing director at Hong Kong-based Lyncean Holdings Ltd., talks about the arrest of Sun Hung Kai Properties Ltd. co-chairmen Thomas and Raymond Kwok and the implications for the company. Hong Kong anti-graft investigators arrested the billionaire co-chairmen of Sun Hung Kai, the city’s biggest developer, in one of the former British colony’s highest-profile corruption cases in decades. Lun speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

The arrests mark one of the highest-level investigations in the ICAC’s 38-year history and come four days after a Hong Kong leadership election in which close ties between government and business emerged as a key campaign theme. Current Chief Executive Donald Tsang is being probed separately by the ICAC for accepting trips on the yachts and planes of tycoons.

“This will no doubt further strengthen the impression among the public that there is a collusion between business and government,” said Shiu Lik-king, a lecturer of public policy at the Chinese University of Hong Kong. “Politics is all about perception. Once the public think you’ve done it, it won’t matter even if you’re not convicted at the end.”

Sun Hung Kai plunged 13 percent, the most since January 1998, to close at HK$96.50 in Hong Kong after a suspension yesterday. The stock has dropped 17 percent since the company said March 19 Executive Director Thomas Chan Kui-Yuen was arrested by the ICAC.

Stocks, Bonds

Citigroup Inc. and Barclays Plc cut their ratings on the developer’s stock, while Goldman Sachs Group Inc. suspended the rating.

“Investor short-term concern on corporate governance is unavoidable,” Oscar Choi and Ken Yeung, analysts at Citigroup, wrote in a note to clients today. Citigroup said it downgraded the shares citing it expects the difference between the market value and the value of the developer’s assets to widen following the news of the arrests.

Sun Hung Kai’s $500 million of 4.5 percent bonds due February 2022 dropped to 95.6 cents on the dollar to yield 5.07 percent, as of 10:07 a.m. in Hong Kong, according to BNP Paribas SA prices. That’s the lowest price since the bonds were sold on Feb. 6. The company has the equivalent of $10.6 billion of bonds and loan facilities outstanding, according to data compiled by Bloomberg.

Standard & Poor’s lowered the outlook on the developer’s A+ credit rating to negative, saying that ICAC’s probe “may weaken the stability of its management and reputation of the company.” S&P said it aimed to resolve the “CreditWatch negative” in the next three months. Moody’s Investors Service is assessing whether the incident has any impact on Sun Hung Kai’s rating, said Sydney-based spokesman Hector Lim.

Eight People Arrested

Thomas and Raymond Kwok, and Hui were released by the ICAC late yesterday, Radio Television Hong Kong reported today. Thomas and Raymond were detained in connection with a probe into offenses suspected to have been committed under the Prevention of Bribery Ordinance, the company said. They will keep running the developer, and the arrests won’t affect the normal business operations, Sun Hung Kai said.

Hui, 64, who was chief secretary from 2005 to 2007, resigned as an independent director of AIA Group Ltd. (1299) “to attend to other commitments,” the insurance company said in a statement yesterday. In his more than three decades in government, Hui served as secretary for financial services and set up the city’s public pension fund before being appointed as the city’s No. 2 official.

The ICAC said it arrested two executives and a former senior government official for suspected corruption, without identifying anybody. Five other people were arrested earlier for their alleged role in the case, it said yesterday.

Family Business

Raymond Kwok was shown entering the ICAC headquarters in footage broadcasted by Cable TV yesterday. Margaret Ng, a spokeswoman for Sun Hung Kai, declined to comment, as did Alan Tse, a spokesman for the ICAC.

Sun Hung Kai has been run by Thomas Kwok, 59, and Raymond Kwok, 58, since the ouster as chairman in 2008 of their elder brother Walter. Walter is still a non-executive director of the company.

Walter Kwok applied to the High Court in 2008 to prevent the board from removing him from office, alleging that his brothers opposed his inquiries into impropriety in the way the company awarded construction contracts, and other corporate governance issues. Their ages are cited in the company’s latest annual report.

Hong Kong Election

The two Kwok brothers and their mother lost almost $2 billion on paper today, according to data compiled by Bloomberg. The shares, a 42.9 percent stake in Sun Hung Kai, are in a family trust held by HSBC Holdings Plc and are worth $13.9 billion.

Sun Hung Kai built and runs the 118-floor International Commerce Centre, which at 484 meters (1,588 feet) is Hong Kong’s tallest building, as well as the International Finance Centre complexes in Hong Kong and Shanghai.

In the election for the city’s next chief executive, candidate and former chief secretary Henry Tang lost public support after admitting knowledge of a basement built without planning permission under a luxury home his wife owns. Thousands of people took to the streets in early March to demand that Chief Executive Tsang quit after it emerged he had taken trips on yachts and planes of his tycoon friends.

Chief Executive-elect Leung Chun-ying, chosen by a panel of 1,193 on March 25, has promised measures to close the wealth gap and reduce home prices. Savills Plc said the price of an apartment in Hong Kong is almost two times higher than in London, which placed second on the property broker’s list of most expensive places to buy a home.

1970s Corruption

The ICAC was formed in 1974 after protests erupted in the city when a chief police superintendent fled while under investigation for possessing HK$4.3 million of assets. The officer, Peter Godber, was extradited from England in 1975, and was sent to jail for four years for conspiracy and accepting bribes, according to the commission’s website.

The agency also uncovered corruption among senior officials in the city’s legal department and the government property agency since its formation. It prosecuted 275 people last year, with 235 convicted according to its website.

Chan, an executive director for Sun Hung Kai since 1987, was arrested by the ICAC, the company said in a March 19 statement. Chan, 65, according to the developer’s annual report, is responsible for land acquisitions and project planning.

To contact the reporter on this story: Kelvin Wong in Hong Kong at kwong40@bloomberg.net

To contact the editors responsible for this story: Andreea Papuc at apapuc1@bloomberg.net; Hwee Ann Tan at hatan@bloomberg.net

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Foxconn Auditor Finds ‘Serious’ Violations of Chinese Law

By Stanley James - Mar 30, 2012 4:29 AM GMT+0700

An audit of Foxconn Technology Group (2354) found “serious and pressing” violations of Chinese labor laws, prompting the biggest maker of Apple Inc. (AAPL) devices to pledge to cut working hours and give employees more oversight.

Inspectors found at least 50 breaches of Chinese regulations as well as the code of conduct Apple signed when it joined the Fair Labor Association in January after deaths of workers at suppliers, the monitoring group said today. Foxconn will bring hours in line with legal limits by July 2013 and compensate its more than 1.2 million employees for overtime lost due to the shorter work week, it said.

Enlarge image

Workers are seen inside a Foxconn factory in the township of Longhua in the southern Guangdong province May 26, 2010. Employee deaths at global contract electronics manufacturer Foxconn, Apple's main supplier, has cast a spotlight on some of the harsher aspects of blue-collar life on the Chinese factory floor. Photographer: Bobby Yip/Landov

Play Video

March 30 (Bloomberg) -- Fair Labor Association Chief Executive Officer Auret van Heerden talks about the group's audit of Foxconn Technology Group. The audit found “serious and pressing” violations of Chinese labor laws, prompting the biggest maker of Apple Inc. devices to pledge to cut working hours and give employees more oversight. Van Heerden speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

Play Video

March 30 (Bloomberg) -- An audit of Foxconn Technology Group found “serious and pressing” violations of Chinese labor laws, prompting the biggest maker of Apple Inc. devices to pledge to cut working hours and give employees more oversight. Bloomberg’s Emily Chang and Jon Erlichman report on Bloomberg Television’s “Bloomberg West.” (Source: Bloomberg)

Play Video

March 29 (Bloomberg) -- Auret van Heerden, president and chief executive officer of the Fair Labor Association, talks about the group's audit of Foxconn Technology Group that found "serious and pressing" violations of Chinese labor laws, prompting the biggest maker of Apple Inc. iPads to pledge to cut working hours and give employees more oversight. Van Heerden speaks with Trish Regan on Bloomberg Television's "Street Smart." (Source: Bloomberg)

Play Video

March 29 (Bloomberg) -- Brian Blair, an analyst at Wedge Partners Corp., and Bloomberg's Jon Erlichman talk about an audit of the labor practices of Foxconn Technology Group, the biggest maker of Apple Inc.'s iPads. They speak with Trish Regan on Bloomberg Television's "Street Smart." TKNG Capital Partners' Neil Grossman also speaks. (Source: Bloomberg)

Play Video

March 29 (Bloomberg) -- Gene Munster, an analyst at Piper Jaffray Cos., talks about an audit of labor practices of Foxconn Technology Group, the biggest maker of Apple Inc.'s iPads. He speaks with Emily Chang on Bloomberg Television's "Bloomberg West." (Source: Bloomberg)

Enlarge image

Workers at Foxconn City, in Shenzhen, China. Photographer: Thomas Lee/Bloomberg

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Employees at Hon Hai's Foxconn plant in Shenzhen. Photographer: Qilai Shen/Bloomberg

“The eyes of the world are on them and there’s just no way they can’t deliver,” said FLA President Auret van Heerden. “It’s a real showstopper.”

Assessors found cases of employees working longer hours and more days in a row than allowed by FLA standards and Chinese law. They uncovered inconsistent health and safety policies and instances of unfair pay for overtime work. To meet its commitments, Foxconn must hire, train and house tens of thousands of workers to assemble products for Apple, Dell Inc. (DELL), Hewlett-Packard Co. (HPQ) and other customers, the FLA said.

‘Essential’ Move

“We appreciate the work the FLA has done to assess conditions at Foxconn and we fully support their recommendations,” Cupertino, California-based Apple said in an e-mailed statement. “Empowering workers and helping them understand their rights is essential.”

Apple fell after the report was released, dropping 1.3 percent to $609.86 at the close in New York. Apple, the world’s most valuable company, will have to cut profit margins or pass resulting costs on to consumers, said Alberto Moel, an analyst at Sanford C. Bernstein & Co. in Hong Kong.

“The benefit we, the consumers, and Apple extract from these products at the expense of Foxconn and its workforce is completely unequal,” Moel said in an interview earlier this week. “Foxconn will also have to meet these requirements for all its customers -- Apple, Dell, HP -- because it is at risk of being audited at any production line.”

Foxconn’s pledges will leave more money in the pocketbooks of workers and give them more time to spend it, dovetailing with government aims to rebalance the economy away from exports and toward domestic consumption. Chinese Vice Premier Li Keqiang told Apple Chief Executive Officer Tim Cook during a March 27 meeting in Beijing that multinational companies should pay more attention to caring for workers and share development opportunities, the official Xinhua News Agency reported.

Profit Margins

Apple’s operating margin rose to 31 percent last year, from 12 percent in 2005, according to data compiled by Bloomberg. At Foxconn’s flagship company, Taiwan-listed Hon Hai Precision Industry Co. (2317), the measure fell to 1.1 percent from 3.2 percent.

Apple built computers in the U.S. for much of its 36-year history. As the manufacturing capabilities in Asia improved, it joined other electronics companies in moving assembly lines to China to take advantage of less expensive labor. Now Apple products, including the iPhone and iPad, read on the back: “Designed by Apple in California. Assembled in China.”

The conditions at those facilities have been under scrutiny in recent years, particularly after at least 10 workers committed suicide at plants owned by Foxconn. Three employees died last year and more than 70 were hurt in blasts at two iPad facilities, one owned by Foxconn.

Long Hours

Responding to the criticism, Apple agreed to FLA audits. After surveying more than 35,000 workers and logging over 3,000 hours on site, inspectors found long hours and a failure to engage workers in management decisions.

As Foxconn grows, it’s expanding to inland Chinese cities such as Chengdu in the southwestern province of Sichuan and Zhengzhou in the central province of Henan -- where Cook visited yesterday -- to be closer to workers’ hometowns.

When most employees are migrant workers from other areas of the country, businesses can end up with a lot of dissatisfaction and turnover, the cost of which is “humongous,” Moel said.

“If you bring the factories to the workers, they can go home at night,” Moel said.

At two factories in Shenzhen in southern China and at a third in Chengdu, inspectors found the average working week exceeded both the FLA’s 60-hour cap and China’s 49-hour maximum.

Decision Making

Workers were excluded from decision making on health and safety issues, with management nominees dominating the company’s labor union, the FLA said. “Factories’ communications are almost entirely top down,” the report said. Fewer than 1 in 1,000 employees at three business units making Apple products were managers, it found.

Foxconn pledged to allow workers to elect representatives to union positions and other workplace committees, in line with government rules that are rarely followed in China.

The FLA auditors found no issues related to child or forced labor, according to the report. The average age of workers was 23, they found.

While Foxconn scored well for paying wages on time and at rates higher than the local minimum, more than 64 percent of employees said the basic wage was insufficient.

Foxconn workers in Shenzhen start on 1,800 yuan ($285) a month, rising to about 2,200 yuan after probation, the report said. The average wage in one of the Shenzhen plants was 2,687 yuan and 2,872 yuan at the other.

Less Than Big Mac

The minimum wage set by the government is 1,500 yuan a month, and 13.3 yuan an hour for part-time employees -- or less than the 15.5 yuan price of a Big Mac.

More than 80 percent of workers surveyed said they were either content with their hours or wanted more overtime to earn extra money, the report said. Still, employees who worked shorter weeks were more content and expressed a higher level of loyalty to the company, it said.

Today’s report isn’t the first time worker violations have been highlighted. Apple’s own annual audits have cited excessive working hours as a problem since 2006.

The companies haven’t made adequate changes in the intervening years, said Scott Nova, executive director of the Worker Rights Consortium, a labor group in Washington.

“Apple and Foxconn don’t deserve the benefit of the doubt at this point,” Nova said. “The burden is now on Apple and Foxconn to demonstrate that these promises are real by actually implementing these changes.”

Updates Coming

To monitor Foxconn’s compliance, the FLA will give regular updates on its website, the new report said.

“We’ve set milestones and concrete deliverables for them to give workers a say,” said Van Heerden, a former South African activist who was imprisoned and tortured under the apartheid regime, exiled in 1987 and later appointed under Nelson Mandela as labor attache to the United Nations.

Companies working with the FLA must agree to disclose their suppliers and have them submit to inspections. The FLA audits about 5 percent of its members’ supply chains each year.

Apple’s membership in the independent FLA will increase scrutiny of its other suppliers, including Seoul-based Samsung Electronics Co. (005930) and Inchon, South Korea-based Hynix Semiconductor Inc. (000660)

“Apple is the most valuable company on the planet and Foxconn the biggest producer of electronics,” Van Heerden said. “This could set the bar for the electronics industry as a whole.”

To contact the reporter on this story: Stanley James in Hong Kong at sjames8@bloomberg.net

To contact the editor responsible for this story: Ben Richardson at brichardson8@bloomberg.net

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Toshiba May Bid Against Micron for Elpida, Nikkei Reports

By Naoko Fujimura and Takashi Amano - Mar 30, 2012 7:19 AM GMT+0700

Toshiba Corp. (6502), the world’s second- largest maker of flash memory, will bid against Micron Technology Inc. (MU) to become the sponsor of Japan’s failed chipmaker Elpida Memory Inc. (6665), the Nikkei newspaper said.

Toshiba may seek assistance from the government-backed Enterprise Turnaround Initiative Corp. of Japan, the Nikkei reported, without saying where it got the information.

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A Toshiba Corp. 24 nanometer (nm) NAND flash wafer sits on display in Las Vegas, Nevada, U.S. Toshiba announced its withdrawal from making DRAM in 2001 to focus more on making NAND flash memory chips. Photographer: Andrew Harrer/Bloomberg

Elpida, which filed for bankruptcy protection last month, will choose a sponsor in early May after two rounds of bids, the report said. Boise, Idaho-based Micron has been in talks with Tokyo-based Elpida since the end of last year and is considered a leading candidate, the report said.

Elpida, the last Japanese maker of dynamic random access memory, or DRAM, filed for bankruptcy with liabilities of 448 billion yen ($5.4 billion) on Feb. 27. Falling prices and a stronger yen exacerbated the company’s troubles after it received financial support from the government and lenders in 2009. The chipmaker, whose customers include Apple Inc. (AAPL), was delisted from the Tokyo Stock Exchange on March 28.

Toshiba wasn’t the source of the Nikkei report, the Tokyo- based electronics maker said in a statement to the Tokyo Stock Exchange today. Kaori Hiraki, a spokeswoman for Toshiba, declined to elaborate beyond the statement. Calls to Elpida’s public relations staff weren’t immediately answered.

Toshiba announced its withdrawal from making DRAM in 2001 to focus more on making NAND flash memory chips. Elpida was formed through the 1999 merger of NEC Corp. (6701)’s and Hitachi Ltd. (6501)’s memory businesses.

To contact the reporters on this story: Naoko Fujimura in Tokyo at nfujimura@bloomberg.net; Takashi Amano in Tokyo at tamano6@bloomberg.net

To contact the editor responsible for this story: Michael Tighe at mtighe4@bloomberg.net

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Elevation’s McNamee Says Apple Is Winning All Profit in Mobile

By Ari Levy - Mar 30, 2012 6:30 AM GMT+0700

Technology investor Roger McNamee said all of the profit in mobile right now is being gobbled up by Apple Inc. (AAPL), while Google Inc. (GOOG) and Microsoft Corp. (MSFT) are losing money in the business trying to keep up.

“There is no profitability at either Microsoft or Google from these devices,” McNamee said in an interview yesterday with Bloomberg Television’s Margaret Brennan. “I don’t think these guys are going to roll over and let Apple own things forever.”

In order for other companies to compete with Apple’s iPad and iPhone, they have to go outside of the application model and use the HTML5 programming language to “create a new Web,” said McNamee, co-founder of Elevation Partners in Menlo Park, California. Elevation is an investor in Facebook Inc., (FB) another company that McNamee said has failed to make money in mobile.

The advantage Facebook has is that so many other websites are signing on users through the social-networking service, and that will eventually gravitate to mobile devices, McNamee said. Another advantage is that Facebook’s founder, Mark Zuckerberg, is the “best I’ve ever known” as far as entrepreneurs go, McNamee said. That includes the late Steve Jobs, Apple’s co- founder, and Microsoft’s Bill Gates, he said.

To contact the reporter on this story: Ari Levy in San Francisco at alevy5@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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S&P 500 Trims Loss on Speculation Selloff Was Overdone

By Rita Nazareth - Mar 30, 2012 4:01 AM GMT+0700

The Standard & Poor’s 500 Index (SPX) trimmed losses in the final two hours of trading ahead of data forecast to show growth in consumer confidence and spending tomorrow, the final day of the best first quarter since 1998.

The S&P 500 retreated 0.2 percent to 1,403.28 at 4 p.m. New York time, paring a loss of as much as 1 percent. The Dow Jones Industrial Average (INDU) rose 19.61 points, or 0.2 percent, to 13,145.82 after reversing a drop of as much as 94 points to halt a two-day decline.

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March 30 (Bloomberg) -- Brian Jacobsen, chief portfolio strategist at Wells Fargo Advantage Funds, talks about the outlook for U.S. stocks and investment strategy. Jacobsen also discusses China's growth outlook. He speaks with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg)

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March 29 (Bloomberg) -- Michael Darda, chief economist and chief market strategist at MKM Partners LP, talks about the outlook for financial markets and investor sentiment. Darda speaks with Betty Liu, Julie Hyman and Josh Lipton on Bloomberg Television's "In the Loop." (Source: Bloomberg)

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March 29 (Bloomberg) -- Joseph Quinlan, chief market strategist at U.S. Trust, Bank of America Private Wealth Management, talks about risk in emerging markets and investment opportunities in U.S. large-capitalization stocks. He speaks with Tom Keene on Bloomberg Television's "Surveillance Midday." (Source: Bloomberg)

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March 29 (Bloomberg) -- Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC, talks about U.S. weekly jobless claims data and fourth-quarter gross domestic product released today. LeBas, speaking with Betty Liu and Julie Hyman on Bloomberg Television's "In the Loop," also discusses Federal Reserve policy. (Source: Bloomberg)

“It’s buying on weakness,” Tim Ghriskey, who oversees $2 billion as chief investment officer of Solaris Group in Bedford Hills, New York, said in a phone interview. “The corrections seem to be very short lived because money just seems to be flowing right in. The end of the quarter is imminent. Given that it’s been a positive quarter for stocks, many managers don’t want to show any cash in their client portfolios.”

The S&P 500 has risen 12 percent since the beginning of 2012 amid better-than-estimated economic data and expectations Europe would tame its crisis. The index has gained 2.8 percent in March, rallying for a fourth straight month and poised for the longest streak of monthly gains since September 2009.

Alcoa Inc. (AA), Caterpillar Inc. (CAT) and Coca-Cola Co. climbed more than 1.5 percent for the biggest gains in the Dow today. Red Hat Inc. (RHT) surged 20 percent after profit and sales topped projections. Bank of America Corp. and Citigroup Inc. fell more than 1.4 percent to pace losses in financial companies. Best Buy (BBY) Co., the largest consumer-electronics retailer, slumped 7 percent on plans to close 50 stores as sales missed forecasts.

‘Down the Road’

Benchmark equity indexes slumped earlier as S&P said Greece may have to restructure its debt again. There may be “down the road, I’m not predicting today when, another restructuring of the outstanding debt,” said Moritz Kraemer, head of sovereign ratings at S&P. In the U.S., claims for unemployment benefits fell to the lowest since April 2008. The economy grew at a 3 percent annual rate from October through December, separate data showed.

“People are taking some chips off the table,” said Matt McCormick, who helps oversee $5.8 billion at Bahl & Gaynor Inc. in Cincinnati. “It’s been a good run and people are questioning: is that sustainable? The measures taken by European authorities have put those issues in the back burner. If that narrative changes, it makes people address something that they thought was already taken care of.”

Gauges of utility and health-care companies in the S&P 500 gained, while financial shares slumped. Alcoa added 2 percent to $10.03. Caterpillar rose 1.7 percent to $106.02. Coca-Cola advanced 1.6 percent to $73.81.

Corporate Demand

Red Hat surged 20 percent, the most in the S&P 500, to a 12-year high of $61.43. The company was surprised by demand for its Red Hat Enterprise Linux software from corporations preparing to move more applications to the so-called cloud, where they can be delivered to users over the Internet, Chief Executive Officer Jim Whitehurst said in an interview. Profit for the current fiscal year will be as much as $1.20 a share, the company projected, exceeding estimates.

Health maintenance organizations rose. Investors speculated the Supreme Court will overturn aspects of the Affordable Care Act, benefiting managed care companies, according to Dave Shove, an analyst at BMO Capital Markets. Aetna Inc. (AET) added 6.5 percent to $49.56. UnitedHealth Group Inc. (UNH) rallied 4.8 percent to $58.11.

Illumina Inc. (ILMN) climbed 5.1 percent to $52.40. Roche Holding AG raised its hostile takeover offer for Illumina by 15 percent to about $6.7 billion, yielding to demands for a higher price from shareholders of the U.S. maker of gene-mapping tools.

Collective Brands

Collective Brands Inc. (PSS) jumped 8.4 percent to $19.99. South Korean clothing company E-Land Group said it will bid for the retailer, which owns the Payless ShoeSource chain.

Global dealmaking slumped for a third straight quarter as chief executive officers funneled cash into share buybacks and new products, a trend that may reverse in the coming months as the economic recovery gains momentum. Mergers and acquisitions so far this quarter fell 14 percent from the fourth quarter to $418 billion, making it the slowest three-month period in 2 1/2 years, according to data compiled by Bloomberg.

“I still think big cash surpluses will lead to more M&A because companies fundamentally want to grow,” said Peter Tague, who started as co-head of global M&A at Citigroup (C) in New York this month.

The KBW Bank Index (BKX) slumped 1.1 percent as 23 of its 24 stocks declined. A measure of European lenders dropped 2.9 percent. Bank of America lost 2.3 percent to $9.53. Citigroup slid 1.5 percent to $36.51.

Best Buy

Best Buy tumbled 7 percent to $24.77. Chief Executive Officer Brian Dunn trimmed discounts after the holiday shopping season, sacrificing sales to maintain profitability. The retailer is closing big-box stores and cutting jobs to reduce costs while boosting online sales and opening smaller locations.

Mosaic Co. (MOS) slid 5.1 percent to $55.27. The largest U.S. potash producer said earnings fell to 64 cents a share in the quarter ended Feb. 29 from $1.21 a year earlier. That missed the 69-cent average estimate of 19 analysts compiled by Bloomberg.

Big Lots Inc. (BIG) sank 4.8 percent to $43.42. The discount retailer’s sales trends are “not as good as we’d hoped,” Charles Grom, an analyst with Deutsche Bank AG, wrote in a note after meeting with the company’s management.

The S&P 500 will likely remain stuck in the 500-point range where it’s been four-fifths of the time since 2000 until the Federal Reserve allows interest rates to rise, according to Piper Jaffray Cos.

Trading Range

The benchmark measure fell in the previous two days after reaching 1,416.51, the highest level since May 2008 and 9.5 percent below its record high of 1,565.15 from 2007. The index has traded between 1,000 and 1,500 for about 80 percent of the time since 2000, according to data compiled by Bloomberg.

Equity gains stalled in the past 12 years as the economy suffered from the bursting of bubbles in technology and real estate, forcing the central bank to cut its benchmark interest rate to near zero from 6.5 percent to spur growth. Fed Chairman Ben S. Bernanke has pledged to keep borrowing costs low through at least late 2014.

“The S&P 500 is approaching the upper end of the secular trading range,” Craig W. Johnson, a Minneapolis-based technical market strategist with Piper Jaffray, wrote in a note yesterday. “This resistance will likely remain intact until 2014-2015, and will correspond with a secular change in bond yields.”

To contact the reporter on this story: Rita Nazareth in New York at rnazareth@bloomberg.net

To contact the editor responsible for this story: Michael P. Regan at mregan12@bloomberg.net

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Apple’s Tim Cook Visits Foxconn IPhone Plant in China

By Bloomberg News - Mar 29, 2012 10:49 AM GMT+0700

Apple Inc. (AAPL) Chief Executive Officer Tim Cook visited Foxconn Technology Group’s newly built manufacturing facility for the iPhone in Zhengzhou, China, as the U.S. company seeks to improve working conditions.

The iPhone production line is at the new Foxconn Zhengzhou Technology Park, which employs 120,000 people, Carolyn Wu, a Beijing-based Apple spokeswoman, said in an e-mail today. She didn’t provide other details on Cook’s visit or say how much longer he’ll be in China after having held high-level talks in Beijing earlier this week.

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A handout photo shows Tim Cook, chief executive officer of Apple Inc., center, visiting the iPhone production line at the Foxconn Technology Group facility in Zhengzhou, yesterday. Photographer: Bowen Liu/Apple Inc. via Bloomberg

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March 29 (Bloomberg) -- Bloomberg's Cory Johnson reports on Apple Inc. Chief Executive Officer Tim Cook's visit to China, which included a meeting with Vice Premier Li Keqiang. (Source: Bloomberg)

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March 28 (Bloomberg) -- Pelham Smithers, managing director of Pelham Smithers Associates, discusses Foxconn Technology Group's 133 billion yen ($1.6 billion) investment in Sharp Corp. He speaks with Mark Barton on Bloomberg Television's "Countdown." (Source: Bloomberg)

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A handout photo shows Tim Cook, chief executive officer of Apple Inc., left, visiting the iPhone production line at the Foxconn Technology Group facility in Zhengzhou, yesterday. Photographer: Bowen Liu/Apple Inc. via Bloomberg

Apple, which contracts Foxconn to make its iPhones and iPads, became the first technology company to join the Fair Labor Association in January, opening up suppliers’ factories to inspections by the Washington-based group after complaints by human rights organizations. The group found “tons of issues,” while also seeing “dramatic” improvements, FLA Chief Executive Officer Auret van Heerden said last month.

“Apple has had a string of negative publicity this year with Foxconn factory issues,” said Mark Natkin, managing director of Marbridge Consulting Ltd., a Beijing-based market research firm. “Apple is trying to demonstrate how seriously they take these issues, and how strong their commitment is to China.”

Cupertino, California-based Apple has been criticized by organizations including China Labor Watch for conditions at its suppliers, and the company has found infractions including excessive overtime and environmental violations. It didn’t specify which companies breached its supplier code of conduct.

Foxconn, founded by Chairman Terry Gou in 1974, raised the base pay for junior workers by as much as 25 percent last month and said its wages exceed government mandates.

‘Great’ Meetings

Cook’s trip to Zhengzhou followed a meeting with Beijing Mayor Guo Jinlong on March 26 and with Chinese Vice Premier Li Keqiang on March 27. Apple’s Wu said earlier those meetings were “great,” without providing details on their content.

Vice Premier Li told Cook China will strengthen intellectual property rights, according to the official Xinhua news agency. He also told Cook multinational companies should pay more attention to caring for workers and share development opportunities with the Chinese side, Xinhua reported.

Cook told Li Apple “will strengthen comprehensive cooperation with the Chinese side and conduct business in a law- abiding and honest manner,” Xinhua reported.

To contact the reporter on this story: Edmond Lococo in Beijing at elococo@bloomberg.net

To contact the editor responsible for this story: Michael Tighe at mtighe4@bloomberg.net

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Geithner’s Math Puzzle Beyond Numbers for DeMarco: Mortgages

By Clea Benson, Dan Levy and Jody Shenn - Mar 29, 2012 9:27 PM GMT+0700

Mark Wilson/Getty Images

Treasury Secretary Timothy Geithner testifies during a Senate Appropriations Committee hearing on Capitol Hill, on March 28, 2012.

Timothy F. Geithner is giving Edward J. DeMarco, Fannie Mae and Freddie Mac’s overseer, some math homework. For DeMarco, it’s more of a psychology question.

Geithner, the U.S. Treasury secretary, is offering new incentive payments to the two government-supported mortgage financiers if DeMarco drops his opposition to principal reductions for homeowners whose loans are backed by the companies. Geithner told Congress yesterday he was sure the economics would work in favor of debt reductions “in some circumstances.” The Treasury would pay a maximum of 63 cents for each dollar of loan forgiveness as part of its expanded Home Affordable Modification Program.

It’s not just a question of whether the numbers add up, DeMarco said in an interview at Bloomberg’s headquarters in New York yesterday. The Federal Housing Finance Agency also is examining for the first time whether forgiveness would encourage defaults among borrowers who have kept making payments on mortgages that exceed the values of their homes, he said. The analysis may be finished by mid-April.

“The principal forgiveness debate for FHFA is not a question of should we forgive principal versus should we be foreclosing on borrowers that stop making mortgage payments,” DeMarco said. “We’ve got to consider all of the ramifications of principal forgiveness relative to other tools.”

DeMarco faces mounting pressure as President Barack Obama’s administration, Congress and the Federal Reserve seek to turn around a housing market that’s lost 34 percent since the 2006 peak, and wiped out $7 trillion of household wealth. Proponents from Martin Feldstein, a chief economic adviser to the late President Ronald Reagan, to activist groups such as MoveOn.org have called on DeMarco to allow writedowns. Congressional Democrats including Rep. Elijah Cummings of Maryland have accused him of blocking a recovery and called on him to resign.

FHFA Unconvinced

Last month, the five largest U.S. banks agreed to offer mortgage forgiveness as part of a $25 billion accord with federal regulators and state attorneys general that settled charges of abusive foreclosure practices by lenders.

FHFA is not yet convinced principal reductions are the best answer, DeMarco said, in part because the agency still must examine how offering loan writedowns would affect the behavior of underwater borrowers who are still making their payments on time. Until now, the agency hasn’t specifically focused on the issue of whether loan forgiveness would create a moral hazard by providing an incentive for borrowers to default. That’s because without the extra incentives offered by the government this year, debt forgiveness was more costly than forbearance as most underwater borrowers would stay in their homes if given a low enough payment, according to its analysis.

Negative Equity

About 12 million borrowers are weighed down by $700 billion in aggregate negative equity, according to a report the Federal Reserve sent to Congress on Jan. 4.

Fannie Mae (FNMA) and Freddie Mac guarantee almost 3 million mortgages that are underwater. Of those, most are not delinquent, DeMarco said.

“Three out of every four underwater homeowners with mortgages by Fannie and Freddie are current,” DeMarco said in an interview on Bloomberg Television’s “Street Smart” with Trish Regan. “These borrowers are making their monthly mortgage payments by honoring their obligations.”

In a January analysis sent to Congress, FHFA said it would cost Fannie Mae and Freddie Mac an additional $100 billion to write down all 3 million loans to the value of the homes securing them.

Violating Legal Responsibility

The U.S. government has spent $190 billion to shore up the companies since they were taken into federal conservatorship in 2008 after their investments in risky loans soured. DeMarco said adding to the firms’ costs would be a violation of his legal responsibility to restore them to financial health.

Using principal forbearance instead of forgiveness so far has been better for taxpayers, DeMarco said. Forbearance reduces monthly payments while requiring borrowers to pay back the full amount of the loan when they sell the house.

“If the borrower is successful on the modification, allows them to stay in their house and they stay in their house and start making mortgage payments, the taxpayer gets to share in the upside of that borrower’s success,” DeMarco said in the Bloomberg Television interview. “If we forgive the principal up front and the borrower is successful, that upside all goes to the borrower and is not shared with the taxpayer.”

No Slam Dunk

Paul Willen, senior economist at the Federal Reserve Bank of Boston, offered evidence in a 2008 study that suggests DeMarco’s concerns about principal reductions may be right.

He found only 5.2 percent of borrowers underwater by 20 percent or more during the 1990s in Massachusetts (DFARMA) lost their homes. Two-thirds of those still in homes in 1994 would have had positive equity if they avoided foreclosure until 2000.

“The idea that there’s a slam-dunk case for principal reductions isn’t true,” Willen said in an interview.

That hasn’t stopped forgiveness from becoming increasingly popular among banks and servicers of securities without government backing, according to new data released yesterday by the Office of the Comptroller of the Currency.

Principal reductions were granted in 8.5 percent of the 116,153 delinquent mortgages that received permanent modifications in the fourth quarter, according to a report by the regulator. That’s up from 8.1 percent in the prior three- month period. Debt forgiveness was included in 16 percent of loans held by private investors and 25 percent of loans held in bank portfolios.

PIMCO, Lippmann Support

Pacific Investment Management Co. (PTTRX), manager of the world’s biggest bond fund, hedge-fund manager Greg Lippmann and analyst Laurie Goodman at Amherst Securities Group LP also have voiced support for the idea of loan forgiveness.

“We’ve been behind responsible, intelligent principal modifications for two-plus years,” Scott Simon, managing director at Newport Beach, California-based Pimco, said in a telephone interview. Banks and bondholders can be best served by balance reductions that allow borrowers to refinance into new government-backed loans, he said. At the same time, Simon said that DeMarco must follow his congressional mandate to make sure Fannie Mae and Freddie Mac are sound.

DeMarco said he hasn’t seen evidence that homeowners re- default much less after getting principal reductions, so long as they’re offered an affordable payment. Analysts such as those at Credit Suisse Group AG agree with DeMarco’s assessment, while Amherst comes to the opposite conclusion.

Taxpayer Risk

Michael Barr, assistant Treasury secretary for financial institutions from 2009 to 2010, said that homeowners with “significantly high levels” of negative equity have been shown to stop paying their mortgages more frequently than those with lower levels of negative equity. Reducing defaults among them will help the real-estate market, and hence Fannie Mae and Freddie Mac, he said.

“If you’re not able to stabilize the housing market, taxpayers are further at risk,” said Barr, now a professor at the University of Michigan’s law school in Ann Arbor. “So, there are benefits to taxpayers in the medium-term in taking steps that in the short-term may cost taxpayers some funds.”

Homeowners who said they knew someone who strategically defaulted were 51 percent more likely to say they would in surveys done for a June 2011 paper by Luigi Guiso of the European University Institute, Northwestern University’s Paola Sapienza, and Luigi Zingales of the University of Chicago.

‘Social Contagion’

That underscores the risk of “social contagion” as the stigma of walking away from properties decreases or borrower understanding of the often minimal consequences grows, the researchers wrote.

Many homeowners don’t even realize they are underwater, according to the paper. The 2009 surveys found that between 9 percent and 16 percent of respondents estimated they have negative equity, compared with national rates calculated by CoreLogic Inc. during the period between 21 percent and 35 percent. Adjusting borrowers’ views of their home prices downward by 20 percent brought the ratios more in line.

Data that Credit Suisse analysts led by Dale Westhoff examined show essentially no difference in re-default rates among delinquent borrowers given only payment reductions and those also offered smaller mortgages.

Based on loans in mortgage bonds without government backing, about 40 percent of borrowers whose payments were cut between 20 percent and 40 percent defaulted again after 12 months, regardless of whether they were more than 60 percent underwater or had home equity between zero and 20 percent, according to Credit Suisse.

‘Unprecedented Times’

A December report by Goodman’s team at Amherst shows that among subprime borrowers who received payment reductions of more than 40 percent in 2010, 19 percent defaulted after 12 months if their reworked loans included a lower balance, while 27 percent fell behind again if they only received a lower rate.

How borrowers will react over time is difficult to know.

“The fact of the matter is we’re in unprecedented times,” said Scott Theobald, the chief risk officer for Philadelphia- based Radian Group Inc., the top U.S. mortgage insurer by new business. “If I had the numbers for that, I’d be a wealthy man.”

To contact the reporters on this story: Clea Benson in Washington at Cbenson20@bloomberg.net.

To contact the reporter on this story: Dan Levy in San Francisco at dlevy13@bloomberg.net Jody Shenn in New York at jshenn@bloomberg.net

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