Tuesday, May 15, 2007

Fed Saw Risks of Inflation Falling Too Low, Transcripts Show (Bloomberg)

By Craig Torres

May 15 (Bloomberg) -- Federal Reserve officials raised concerns about deflation as early as November 2001, about a year-and-a-half before they disclosed to the public that interest-rate policy was responding to ``an unwelcome'' fall in inflation.

``I think we are moving gradually from a disinflationary process toward a situation where we could experience outright deflation,'' then-Chairman Alan Greenspan told the Federal Open Market Committee meeting that month, according to transcripts released today in Washington.

The comments by Greenspan and others marked a turning point in U.S. monetary history. For years, Fed officials had aimed at squeezing inflation lower over time. Now, they were concerned about inflation falling too low, a condition that could hamper policy operations, disrupt money markets, and compress corporate profits as inventory values fell.

``Economic slack could reduce inflation and inflation expectations so far that it became impossible for the Federal Reserve to drive real interest rates far enough in negative territory to counteract continuing weakness,'' Donald Kohn, then a senior policy adviser, told the committee. Kohn is now the Fed's vice chairman.

During 2001, the FOMC engaged in the most aggressive monetary easing in Greenspan's 18-year tenure, slashing the benchmark lending rate from 6.50 percent to 1.75 percent. Adjusted for inflation, minus food and energy, the benchmark rate fell below zero in November and remained around zero or below until 2005.

Half-Point Steps

Eight of the 11 rate cuts were in half-point moves, and three of those were conducted between meetings as officials received fresh reports of the economy deteriorating more rapidly than they expected. The economic outlook was complicated by the Sept. 11 terrorist attacks on New York and Washington.

The unemployment rate rose 1.5 percentage points during the year as non-farm payrolls shrank for 10 consecutive months after a gain of 80,000 jobs in February. Inventories were flat or negative for 10 months during the year. By the end of the year, factory use rates fell to the lowest levels since 1983.

Fed officials had Japan as a reference point for their worries. The Bank of Japan had cut its benchmark lending rate to zero in 1998 to ward off disinflation. Still, Japan's consumer price index was negative for five consecutive years starting in 1999.

By August 2001, Fed officials had seen the core personal consumption expenditures index fall below 1 percent on a three- month annualized basis for two consecutive months. Their concerns about the deflationary risks resulted in another half- point cut in the federal funds rate in November, the tenth reduction of the year, to 2 percent.

Broaddus's Alarm

Richmond Fed President J. Alfred Broaddus Jr., whose dissents in favor of higher borrowing costs in 1997 defined him as one of the committee's leading inflation hawks, became an unlikely siren on prices falling too low.

``What we need to do now is to pre-empt disinflation -- as novel as it is to think in those terms -- and do so fairly aggressively to guard against potential problems of the zero bound,'' Broaddus said at the November meeting, referring to the possibility that the benchmark rate would have to be cut to zero if a downward price spiral intensified.

Broaddus was joined in his arguments by Greenspan, Governor Edward Gramlich and Vice Chairman Roger Ferguson Jr., and they were also effective in changing other members' votes.

McDonough's Pond

New York Fed President William McDonough said he walked into the meeting preferring a quarter-point rate cut. Telling a story about how the fish pond in his backyard was routinely raided by neighborhood hawks, he said: ``One of the hawks miraculously turned into a beautiful white dove. I was very confused until I realized that what was even more miraculous was that the dove spoke with a southern accent.''

McDonough changed his vote in support of a 50 basis-point cut. A basis point is 0.01 percentage point.

Two years later, Governor Ben S. Bernanke gave a speech titled: ``Deflation: Making Sure `It' Doesn't Happen Here,'' that described the risks of deflation and the cures a central bank could pursue.

By May 2003, the FOMC cited in its statement ``the probability of an unwelcome substantial fall in inflation'' as the largest risk then shaping monetary policy. The federal funds rate had been cut to 1.25 percent, and would drop to 1 percent the next month with San Francisco Fed President Robert Parry dissenting in favor of a 50-basis point cut.

The monetary stimulus in 2001 helped keep the recession shallow. The National Bureau of Economic Research in Cambridge, Mass., the arbiter of U.S. business cycles, says the 2001 recession lasted eight months from March to November.

U.S. Economy: Consumer Prices Rose Less Than Forecast (Bloomberg)

By Joe Richter

May 15 (Bloomberg) -- Prices paid by U.S. consumers rose less than forecast in April, a sign that inflation is abating as the economy cools.

The consumer price index increased 0.4 percent after climbing 0.6 percent in March, the Labor Department said today in Washington. Economists surveyed by Bloomberg News projected a 0.5 percent gain. Core prices, which exclude food and energy, rose 0.2 percent.

The 2.3 percent annual increase in core prices, also less than forecast, suggests that surging fuel costs aren't triggering a broader jump in the cost of living. The report may reassure Federal Reserve officials, who are counting on slower growth to ease inflation.

``It's consistent with a gradual unwinding of inflation pressures,'' said Brian Bethune, an economist at Global Insight Inc. in Lexington, Massachusetts. ``There's nothing in here to push the Fed one way or the other.'' Policy makers have kept their benchmark rate unchanged at 5.25 percent since August.

Other reports today showed manufacturing was improving and home builders were more pessimistic. The New York Fed said manufacturing in the state expanded at a faster pace for the second straight month in May. The main index in the Empire State Manufacturing Survey rose to 8.0 from 3.8 in April. Readings greater than zero signal expansion.

Builder Index

The National Association of Home Builders/Wells Fargo sentiment index fell to 30 from 33 in April. The reading matched September's figure as the lowest since 1991. Readings below 50 mean most respondents view conditions as poor.

Treasury notes rose after the inflation figures were released before giving up gains later in the day. Stocks rallied. The Dow Jones Industrial Average was up 37 points at 4:15 p.m. in New York.

Core prices were projected to rise 0.2 percent, according to the survey median. The increase in the 12 months ended in April, the smallest in a year, was forecast at 2.4 percent.

``Things are moving gradually toward lower inflation, which is what the Fed expects,'' said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. ``It leaves them on hold for the time being.''

Overall prices were up 2.6 percent from the same time last year, compared with a 2.8 percent gain in March.

The CPI is the government's broadest gauge of costs because it includes goods and services. Other inflation reports last week showed core wholesale prices were unchanged in April, while prices of U.S. imports rose for a third month.

Fuel Prices

Today's report showed energy prices rose 2.4 percent after jumping 5.9 percent in March. Fuel oil costs rose 2.1 percent and natural gas prices fell 1 percent. Gasoline prices jumped 4.7 percent.

Prices at the pump for regular gasoline averaged $2.83 a gallon in April, up from $2.56 in March, according to the American Automobile Association. The price rose throughout the month, ending at $2.97 on April 30, just shy of the record $3.06 reached in Sept. 5, 2005, in the aftermath of Hurricane Katrina. The record was eclipsed this month as the price reached $3.09 a gallon yesterday.

Food prices, which account for about a fifth of the CPI, rose 0.4 percent after a 0.3 percent increase in March.

Procter & Gamble Co., the largest U.S. consumer-goods maker, raised prices last quarter as raw-material costs increased, Chief Financial Officer Clayton Daley said May 1. Green coffee, pulp used in paper products and zinc for batteries were all more expensive, he said.

Housing, Rent

Housing costs, which include some energy costs and account for one-third of the total consumer price index, rose 0.2 percent for a second month. Owner's equivalent rent, which makes up 30 percent of the core CPI, increased 0.2 percent after rising 0.3 percent. The cost of hotel stays jumped 1.9 percent.

Higher medical care costs and hotel rates were offset by lower prices for clothing and cheaper airline fares, the report also showed. Auto prices were unchanged.

The Fed's preferred measure, the Commerce Department's price figures tied to consumer spending patterns, was up 2.1 percent in March from a year earlier. Some Fed policy makers have said they want to see the measure within a 1 percent to 2 percent range.

`Somewhat Elevated'

Central bankers last week left their interest-rate target unchanged and said core inflation remains ``somewhat elevated.'' The risk that inflation won't moderate as expected is the central bank's ``predominant concern,'' they also said.

The economy grew 2.1 percent in the 12 months ended March, the smallest year-over-year gain since June 2003, a government report last month showed. Economists forecast growth of 2.1 percent for all of 2007, the least in five years, based on the median estimate in a Bloomberg survey April 30 to May 8.

Reports last week raised hopes that price pressures won't increase much more. While higher costs for food and fuel pushed wholesale prices up last month, core prices were unchanged for a second month. The last time core costs went two months without an increase was the end of 2005.

A separate report showed prices for imported capital goods fell and those for foreign-made consumer products rose just 0.1 percent.

In addition, wage growth slowed last month and the unemployment rate rose, providing some relief to central bankers who have voiced concern that a tight labor market would stoke inflation.

Costs ``are beginning to plateau,'' P&G's Daley said in an interview. ``We are hoping we don't have to raise prices anymore.''

Chrysler CEO Finds Assurance (Wall Street Journal)


DETROIT -- Chrysler Chief Executive Tom LaSorda said Tuesday he is looking forward to running the U.S. auto maker as a privately held enterprise that doesn't have to disclose quarterly financial reports or chase short-term targets.

Mr. LaSorda, speaking to reporters at Chrysler headquarters one day after DaimlerChrysler AG announced a deal to sell Chrysler to Cerberus Capital Management LP, said he is convinced Cerberus sees Chrysler as a "long-term" investment. He said the U.S. auto maker needs a patient approach in order to strike sustainable levels of profitability.

The Chrysler executive said, "Daimler looked long and hard for the right partner [and] we're confident that this transaction will create a Chrysler that is financially stronger."

Chrysler posted a $2 billion loss in the first quarter due to heavy restructuring charges. The company bled $1.5 billion in 2006 and is looking to cut 13,000 jobs and return to black ink by 2008.

"We're on our way to a standalone company, and guess what? I won't have to divulge quarterly corporate earnings," Mr. LaSorda said "We'll run [the business] the way we want to run it."

The executive, who has been at the Chrysler helm since September 2005, said he expects Cerberus to be a part of Chrysler five years from now, even though there is a perception that private-equity players are looking for a quick buck.

Focus On Labor Costs

Still, Mr. LaSorda preached a sense of urgency when it comes to turning around money-losing Chrysler. "They have deep pockets, but we've go to deliver. We've got to deliver. It's not an endless bank.

One of the first areas Chrysler plans to attack is what Mr. LaSorda refers to as a labor-cost "gap" that it carries -- not only compared to foreign rivals, but also against General Motors Corp. and Ford Motor Co. "We need to close the gap beyond the other two [domestic] companies," he said.

In 2005, the United Auto Workers granted health-care concessions to GM and Ford, but refused to extend those cost cuts to Chrysler.

Mr. LaSorda said Chrysler officials who are already in place will negotiate the next master labor contract with the UAW this summer. There has been speculation that Cerberus will take a heavy hand in labor negotiations, but Mr. LaSorda insisted "all negotiations will go through us."

He declined to discuss specific negotiating points related to labor talks, other than to agree that the company needs to cut its long-term health-care cost obligations.

Cerberus Calms Fears

Cerberus, which is a leading U.S. private-equity firm, has in recent days made attempts to relieve fear that it is going to chop up Chrysler and sell it for a quick profit. The normally private Cerberus founder Stephen Feinberg met with Chrysler executives Monday night and made remarks that Mr. LaSorda said "calmed people down."

Mr. Feinberg and other Cerberus officials met Tuesday with labor unions in order to assure them that no additional job cuts will result directly from Chrysler's new ownership structure.

DaimlerChrysler's supervisory board will meet Wednesday to discuss the Cerberus transaction and it is expected to affirm the deal. Winning labor support was essential for DaimlerChrysler and Cerberus given that 10 of the 20 DaimlerChrysler supervisory board members are from unions.

While there are several governance issues still to be decided on, Mr. LaSorda insisted Chrysler will remain close with Daimler after the two companies separate in the third quarter. He said the auto makers will share vehicle technology and purchasing activities, for instance.

One thing that is certain, at least according to Mr. LaSorda, is that longtime DaimlerChrysler executive Wolfgang Bernhard will not be on his executive team, even though Mr. Bernhard currently works as a Cerberus consultant specifically for the purposes of shaping the Chrysler investment.

Mr. LaSorda also said he will be meeting with Mr. Bernhard on Tuesday, but he insisted Mr. Bernhard -- a former chief operating officer at Chrysler -- "will not be on the executive team." Mr. LaSorda added that Mr. Bernhard "is a great guy," and that they are "close friends."

In addition, Mr. LaSorda said the company will not break up its three brands -- Chrysler, Dodge and Jeep -- under any circumstances. He said the company will not use Cerberus's money to buy out dealers, but said the company will press forward with a plan to reduce its U.S. dealer count.

Limited Slashes 1Q, Year View (AP)

Apparel retailer Limited Brands Inc. on Tuesday slashed its earnings forecast for the fiscal first quarter and full year, citing lower-than-expected sales and merchandise margins at its brands, particularly at its Victoria's Secret stores. Limited now expects first-quarter earnings of 12 cents to 14 cents per share, compared with an earlier estimate of 25 cents to 28 cents per share. In the year-ago first quarter, earnings were 25 cents per share. Analysts polled by Thomson Financial, on average, were expecting profit of 22 cents per share for the latest quarter. For the second quarter, Limited projects earnings of 20 cents to 24 cents per share, down from 28 cents per share in the year-earlier quarter. Wall Street expected 29 cents per share. For 2007, Limited now forecasts earnings of $1.55 to $1.65 per share, down from earlier expectations of $1.75 to $1.90 per share. Analysts projected earnings of $1.78 per share for the year. The company expects trends will continue to be challenging in the second quarter, especially at Victoria's Secret. Limited Brands also said Tuesay it will sell a majority interest in its underperforming Express apparel brand and is mulling options for its Limited Stores chain. Limited shares rose 7 cents to $26.25 in the extended session, after losing $1.23, or 4.5 percent, to close at $26.18 in the regular session.

Bloomberg poised for third-party campaign (Washington Times)

By Ralph Z. Hallow

New York Mayor Michael R. Bloomberg is prepared to spend an unprecedented $1 billion of his own $5.5 billion personal fortune for a third-party presidential campaign, personal friends of the mayor tell The Washington Times.
"He has set aside $1 billion to go for it," confided a long-time business adviser to the Republican mayor. "The thinking about where it will come from and do we have it is over, and the answer is yes, we can do it."
Another personal friend and fellow Republican said in recent days that Mr. Bloomberg, who is a social liberal and fiscal conservative, has "lowered the bar" and upped the ante for a final decision on making a run.
The mayor has told close associates he will make a third-party run if he thinks he can influence the national debate and has said he will spend up to $1 billion. Earlier, he told friends he would make a run only if he thought he could win a plurality in a three-way race and would spend $500 million -- or less than 10 percent of his personal fortune.
A $1 billion campaign budget would wipe out many of the common obstacles faced by third-party candidates seeking the White House.
"Bloomberg is H. Ross Perot on steroids," said former Federal Election Commission Chairman Michael Toner. "He could turn the political landscape of this election upside down, spend as much money as he wanted and proceed directly to the general election. He would have resources to hire an army of petition-gatherers in those states where thousands of petitions are required to qualify a third-party presidential candidate to be on the ballot."
Senior Republican officials -- including those supporting declared Republican presidential nomination contenders -- and several top Democrats told The Times they take the possibility of a Bloomberg candidacy as a serious threat in November 2008.
The Bloomberg team is studying the strategies of Mr. Perot, the Texas billionaire whose 1992 presidential campaign helped President Clinton to win the White House with 43 percent of the popular vote.
"Mike has been meeting with Ross Perot's most senior people about how they did an independent run in 1992," the Bloomberg business adviser said on condition of anonymity so as to avoid appearing to speak for Mr. Bloomberg.
Talk of Mr. Bloomberg as a third-party candidate comes as Republican voters are deeply divided over their top-three declared candidates -- Arizona Sen. John McCain, former New York Mayor Rudolph W. Giuliani and former Massachusetts Gov. Mitt Romney -- and are casting longing glances at former Tennessee Sen. Fred Thompson and former House Speaker Newt Gingrich.
"Some of the people on McCain's [presidential campaign] staff have been calling me to see if Mike is running because they are ready to leave the McCain campaign, which is a biplane on fire and spiraling down," the Bloomberg adviser said.
Nebraska Sen. Chuck Hagel, another independent-minded Republican, dined recently with Mr. Bloomberg and suggested on CBS' "Face the Nation" over the weekend that he and Mr. Bloomberg might make an independent run for the presidency.
But in Albany, N.Y., yesterday, Mr. Bloomberg downplayed that suggestion.
"I think he was probably joking," the mayor told reporters. Mr. Hagel "speaks his mind. ... He's not happy with the same things that I'm not happy about."
Republicans who say they are girding for a Bloomberg entry note Mr. Bloomberg has a 68 percent share of his privately owned company, Bloomberg LP. The company is worth $20 billion (and about $30 billion if put on the block for public bidding) and earns $1.5 billion annually in after-tax profits.
"If Bloomberg runs, he could have more money on hand than either of the two major party nominees," said Mr. Toner, the former FEC chairman. "It would be the first time that happened in the modern era."
A New York Daily News poll of the city's voters finds that Mr. Bloomberg, twice elected mayor as a moderate Republican, is far more popular than Mr. Giuliani, the former mayor who leads in most polls for the Republican presidential nomination.
Mr. Bloomberg said yesterday he was flattered by that result but downplayed it at his Albany press conference, saying, "The current mayor always has a real advantage."
Social conservative leaders have told The Times they are determined to block Mr. Giuliani from becoming the Republican presidential candidate but that they can't stop Mr. Bloomberg from making a third-party run.
"This much I know, if Giuliani gets the Republican nomination, that is the ticket for the Democrats to get the White House in 2008," said Tony Perkins, president of the socially conservative Family Research Council. "Many pro-life voters who have been voting Republican will not vote for the top of the ticket if it's Giuliani."
Other top social and religious conservative leaders, in separate interviews and discussions last week, told The Times their movement has decided to support Mr. Thompson for the Republican nomination. They said he has satisfied them that he is reliably supportive of religious-conservative positions on key issues.
"A third-party candidacy is almost inevitable" in 2008, said former Virginia Democratic Party Chairman Paul Goldman, who pointed out that third-party candidacies have affected the outcome of five of the past 10 presidential elections -- including George Wallace in 1968, John Anderson in 1980, Mr. Perot in 1992 and '96, and Green Party candidate Ralph Nader in 2000.
"If the Republicans nominate someone the press can tag as a pro-war social conservative and the Democrats pick an anti-war liberal, Bloomberg will run up the center," Mr. Goldman said. "If conservatives don't rally to stop Giuliani they will get a third party socially conservative candidate who will only help elect the Democrat."

Freed from Chrysler, Daimler could boost payouts (Reuters)

By Michael Shields

FRANKFURT (Reuters) - DaimlerChrysler may give shareholders excess cash freed up by its sale of Chrysler, the automaker said on Tuesday after one-off gains and a profit rebound at Mercedes helped first-quarter profit rise 73 percent.

Earnings before interest and tax (EBIT) at the world's fifth-biggest carmaker advanced to 2.04 billion euros ($2.76 billion), it said, handily beating market expectations even as ailing Chrysler Group lost nearly 1.5 billion euros.

Chrysler, the U.S. arm it is selling, is set to lose more than $2 billion this year after restructuring charges, it added.

"We clearly state today we have excess liquidity in our hands, also for the shareholder, which is a good issue. It is something that shareholders should enjoy," Chief Financial Officer Bodo Uebber told a results conference call.

Unburdened of the $17.5 billion in unfunded staff healthcare obligations on Chrysler's books at the end of last year, the German group to be called Daimler AG will propose by February at the latest how to share the wealth with investors, he said.

He declined to be more specific.

In its first detailed outlook for the year, the group forecast 2007 EBIT would rise to 7 billion euros excluding the impact from selling Chrysler, a deal that breaks up a failed transatlantic car merger struck in 1998.

The results drove home just why DaimlerChrysler announced on Monday it was in effect paying private equity group Cerberus Capital Management to take Chrysler off its hands after nine years of roller-coaster results at its North American arm.

Chrysler is keeping the healthcare liabilities and faces tough negotiations with the U.S. United Auto Workers union on cost cuts. The current UAW contract expires in September.


Chrysler Group's loss in the quarter was twice as bad as expected and included restructuring costs of 914 million.

Chrysler, which is in the process of cutting 13,000 jobs, expects a 2007 EBIT loss of 1.6 billion euros even though its car sales will rise, especially outside North America, it said.

Mercedes Car Group -- which includes the premium Mercedes-Benz, luxury Maybach and Smart minicar brands -- swung to a better-than-expected quarterly EBIT of 792 million euros.

Mercedes reiterated its forecast of generating an operating margin of at least 7 percent this year, up from just 6.6 percent in the quarter, which Mercedes had signaled would be weak.

DaimlerChrysler stock, which has outperformed the German blue-chip index by nearly a fifth this year, rose as much as 4.4 percent and was up 2.4 percent at 63.20 euros by 1505 GMT while the DAX index <.GDAXI> rose 0.4 percent.

"It's difficult today, a day after the Cerberus news, for the first-quarter numbers to have any effect," said Heinz-Gerd Sonnenschein, equity markets strategist at Germany's Postbank.

Overall, group net profit rose 152 percent to 1.97 billion euros, helped by a gain from selling shares in aerospace group


It reported under IFRS accounting rules for the first time.

Boosted by a global boom in freight transport by road that is poised to fall off sharply in the United States this year, its market-leading truck group had operating profit of 528 million euros, up by a quarter and ahead of market expectations.

The group said the forecast for 7 billion euros in 2007 EBIT included a gain of 1.6 billion from selling EADS shares.

It will also book charges of 1.0 billion for reorganizing Chrysler and 600 million for cutting white-collar jobs.

-- Additional reporting by Peter Starck

Treasurys Gain on Benign CPI Data (Wall Street Journal)

May 15, 2007 1:24 p.m.

Treasury prices rose Tuesday, driving yields lower, after a government report showed U.S. consumer prices rose less than expected last month.

The benchmark 10-year Treasury note was last up 4/32, or $1.25 per $1,000 invested, at 98 18/32 with a yield of 4.683%. The 30-year Treasury bond was up 8/32 to 98 12/32 to yield 4.854%. The two-year note was flat at 99 18/32 with a 4.731% yield. Prices and yields move inversely.

The moderate core inflation in April could take some pressure off the Federal Reserve to raise interest rates. But at its meeting last week, Fed officials looked past the benign core inflation figures for March, and said inflationary pressures are elevated and remain the greatest risk to a stable economy.

"The market seems relieved at the absence of a feared CPI core overshoot," said Mike Englund, chief economist at research firm Action Economics.

U.S. consumer prices increased 0.4% in April, boosted by increases for energy and groceries, the Labor Department said Tuesday. Economists surveyed by MarketWatch had expected a 0.5% gain.

Excluding food and energy, the core consumer price index rose 0.2%, as expected, cutting the annual gain in the core down to a one-year low of 2.3%.

The fixed-income market abhors inflation because it eats into the investment return of bonds.

Daniel Jester, economist at Moody's Economy.com, said "today's report continues a string of good inflation reports which have shown moderating core price pressure since the start of the year."

That said, "the sharp gains in food, and more importantly, energy prices in the past three months -- both more robust than was experienced this time last year -- will keep the Fed on guard about the risk of potential price pass-through," he said.

This could eventually temper the deceleration in core inflation later this year, especially if the economy begins to reaccelerate," he said. "As such, we are still comfortable with the Fed remaining on the sidelines for the duration of 2007, so long as fallout from the housing recession proceeds as expected."

Separately, the Federal Reserve Bank of New York said its Empire State Manufacturing index rose to 8.0 in May from 3.8 in April. Readings over zero indicate expansion.

This is the highest level of the index since February, and was in line with expectations of Wall Street economists.

Also on Tuesday, the Treasury Department said foreign purchases of long-term U.S. securities jumped in March, led by private investors' purchases of Treasury bonds and notes as well as by official institutions buying government agency bonds.

Net foreign purchases of long-term securities rose to $107.9 billion in the month, up from February's $77.9 billion. Private investors boosted the March total by buying $30.7 billion in Treasury bonds and notes, more than double the amount purchased in February.

At 1 p.m. Eastern time, the National Association of Home Builders and Wells Fargo will released the housing market index for May.

Thomson Wins Over Reuters Board (Forbes)

By Parmy Olson

LONDON - The folks behind the Bloomberg boxes could be forgiven for have fretted a little on Tuesday morning. Thomson and Reuters Group had just announced their agreement to a takeover that will create one of the world's largest financial news providers, one which would just trump about the market share of the rival founded by New York City Mayor Michael Bloomberg.

The cash and stock deal sees Reuters shareholders getting 352.5 pence ($6.97) per share in cash, plus 0.16 shares in Thomson. That effectively values each Reuters share at 692 pence ($13.68) and Reuters Group at about £9.7 billion ($19.2 billion), based on Thomson (nyse: TOC - news - people )'s price of $42 (£21.24) on the New York Stock Exchange on Tuesday morning.

Shares in Reuters were up 21.75 pence (43 cents), or 3.6%, at 627.25 pence ($12.39), in Tuesday morning trading in London, still well below the bid price as investors continued to mull the regulatory outcome of the deal. Thomson-Reuters will keep dual listings in Toronto and London, and Tom Glocer, the well-regarded chief executive of Reuters, will head the combined company.

Just last week Thomson was able to free up the cash for its bid when it sold its educational division for $7.8 billion. (See: "Thomson Holds A Book Sale")

Though the combination still needs to squeeze past regulators in order to become official, Thomson appears to have, crucially, won the approval of Reuters Group's (nasdaq: RTRSY - news - people ) trustees, who have the power the veto any takeover of the 156-year-old company.

That's despite the fact that Canada's wealthy Thomson family will own about 53% of Thomson-Reuters. Traditionally the directors of the Reuters Founders Share Company must ensure that no party owns more than 15% of Reuters shares, so it appears that the Thomson, together with Reuters management and the trustees, have agreed to alter that limit.

The 18 "guardians" of the Reuter Trust Principles said in a statement on Tuesday that they had worked closely with Thomson and Reuters over the last week to ensure the company's code of editorial independence would be upheld after the takeover. The combined business will adopt the Trust Principles, Thomson and Reuters said, and the Thomson family, represented by holding company Woodbridge, would "use its voting control to support the Reuter Trust Principles."

Thomson's historical connections to the British newspaper establishment -- it once owned the Times of London -- and reputation for hands-off stewardship will no doubt have helped Thomson in negotiations. As well as being the world's 10th-richest person, Chairman David Thomson is also the third Baron Thomson of Fleet Street, that being the famous road in London on which many of the U.K.'s biggest newspapers, along with Reuters, used to be based. The title was created for his grandfather, company founder Roy Thomson.

Thomson, Reuters and Bloomberg have been competing to sell data terminals to large banks, brokerages and hedge funds. But the new alliance will now put significant pressure on market leader Bloomberg.

That company has a 33% market share for financial-information terminals, according to Inside Market Data Reference, but the Thomson-Reuters combination should put it just ahead with 34% of the market. Regulators might not like that, since the market will in effect be divided into three parts and limit the choice for buyers to two media powerhouses and a cluster of small companies.

It's perhaps worth noting, though, that Thomson has managed to shimmy past regulators before. Just prior to its $3.4 billion takeover of legal information provider West Publishing in 1996, Thomson and West had been the two largest legal publishers in the U.S.

Stocks Surge on Inflation Figures (AP)

By JOE BEL BRUNO AP Business Writer

NEW YORK — Wall Street bounded higher Tuesday, propelling the Dow Jones industrials past 13,400 for the first time, after mild inflation figures raised hopes the Federal Reserve might cut interest rates later this year.

Investors were encouraged to extend the market's months-long rally after the Labor Department reported prices paid by consumers rose less than expected in April, and indicated that inflation may be easing as the economy continues to cool. The consumer price index rose 0.4 percent after rising 0.6 percent in March, while core prices _ which exclude food and energy _ rose 0.2 percent after a 0.1 percent gain.

"It's certainly a good reaction to a lower-than-expected headline inflation number and that gives the Fed some will room if it needs to cut rates," said Nick Raich director of research at National City Private Client Group, referring to the Federal Reserve's next move on short-term interest rates.

Dow components Home Depot Inc. and Wal-Mart Stores Inc. handed Wall Street disappointing first-quarter results. Both companies are considered to be proxies for consumer spending, and weaker sales were translated as another sign the economy continues to moderate.

In midmorning trading, the Dow rose 91.42, or 0.68 percent, to 13,438.20 after rising to a new trading high of 13,452.75.

Broader stock indicators also advanced. The Standard & Poor's 500 index was up 8.85, or 0.59 percent, at 1,512.00, while the Nasdaq composite index recovered from an earlier loss and rose 10.67, or 0.42 percent, to 2,557.11.

Bonds rose as fixed-income investors reacted to the economic reports, with the yield on the benchmark 10-year Treasury note falling to 4.68 percent from 4.69 percent late Monday. The dollar was mixed against other major currencies, while gold prices advanced.

A barrel of light sweet crude declined 26 cents to $62.72 on the New York Mercantile Exchange. There remained looming concerns in the commodities market about refinery problems and uncertainties over whether U.S. gasoline inventories can meet summer driving demand.

Investors were awaiting the National Association of Home Builders housing market index, which was being released later in the session. It could show whether the housing sector is showing any signs of recovery.

On Wednesday, the Commerce Department will report housing starts and building permits that might provide more clues about the housing market. Builders broke ground on 1.52 million homes in March, and results for last month are expected to show a slight decline.

The reports come after a government report last week that indicated moderating inflation at the wholesale level. That data also lifted hopes that the Federal Reserve might not need to raise rates, and might consider a cut later this year.

Fed Chairman Ben Bernanke gave the market no new insights into his views on the economy and inflation. He addressed the growth of credit derivatives and other financial instruments during a speech before a financial markets conference in Georgia.

Home Depot, the nation's largest home improvement chain, posted lower quarterly profit as a sluggish U.S. housing market dented sales. Sales at stores open at least a year, an important measure of how retailers fared, slumped 7.6 percent.

Wal-Mart Stores, the world's largest retailer, missed Wall Street projections and warned second-quarter results might be disappointing. Last week, it reported April same-store sales were the weakest its history for April.

Shares of Wal-Mart fell 19 cents to $47.65, while Home Depot shed 89 cents, or 2.3 percent, to $38.12. Lowe's Cos., the second-largest home improvement chain, fell 23 cents to $30.76.

Sales figures reported by dozens of retailers last week raised concerns on Wall Street about consumer spending, which accounts for two-thirds of total economic activity.

Reuters Group PLC agreed Tuesday to a $17.2 billion takeover by Thomson that would vault the combined entity ahead of Bloomberg to become the world's largest financial data and news provider. Shares of Reuters rose $2.62, or 3.7 percent, to $74.24; Thomson fell 9 cents to $41.91.

Advancing issues outnumbered decliners by about 3 to 1 on the New York Stock Exchange, where volume came to 311.1 million shares.

The Russell 2000 index of smaller companies rose 4.42, or 0.54 percent, at 826.75.

Overseas, Japan's Nikkei stock average fell 0.93 percent. In afternoon trading, Britain's FTSE 100 was down 0.04 percent, Germany's DAX index rose 0.17 percent, and France's CAC-40 added 0.05 percent.

Microsoft says open-source violates 235 patents (Reuters)

NEW YORK - Microsoft Corp.

Research said on Tuesday that open-source software, including the rival Linux operating systems, violates 235 of its patents, making its most detailed intellectual property challenge to open source.

The maker of the Windows operating system said it wants to work out licensing deals with open source companies instead of fighting out the patent disputes in court.

The world's largest software maker contends open-source software violates its patents related to graphical user interface, e-mail programs and other technology.

Linux is a rival to Windows and is distributed by Novell and dozens of competitors. It is the most popular version open-source software, which users can obtain at no cost and which developers can download and modify as long as they share changes with the public.

Microsoft heralded last year's partnership with Novell Inc. (NOVL.O: Quote, Profile, Research as an example of the type of licensing agreement it wants to replicate with other open-source vendors. The partnership also made the technology interoperable.

That agreement, which includes a clause that Microsoft will not sue Novell's Linux customers, which incensed the community of open-source software developers, because they say it implied Microsoft holds patents that apply to cooperatively-developed technology.

"The real question is not whether there exist substantial patent infringement issues, but what to do about them," said Horacio Gutierrez, Microsoft Vice President of Intellectual Property and Licensing in an e-mail statement.

Microsoft's challenge to open-source comes at a time when the Free Software Foundation is discussing the draft of a new version of its General Public License, which allows access to the software code at the heart of the Linux operating system.

The nonprofit software group has said it may ban Novell from using new versions of its computer code. Novell is one of two companies that have made profitable businesses out of selling their own versions of Linux bundled with technical support, maintenance and other services.

Family Holds Discussion of Dow Bid by Murdoch (NYTimes)


The far-flung family that controls Dow Jones & Company met by phone yesterday to discuss a pledge by Rupert Murdoch to give them a seat on the board of his News Corporation if it buys Dow Jones, and to guard the independence of the Dow Jones trophy property, The Wall Street Journal.

Members of the Bancroft family declined to comment on the meeting. But people close to the family said they saw little new in Mr. Murdoch’s missive and nothing that would soften family members’ initial opposition to the deal.

In a letter to the Bancrofts, who own a controlling interest in Dow Jones and initially rejected his $5 billion offer, Mr. Murdoch asked to meet with them, to continue making his case for a takeover in person. The text of the letter, dated May 11, was made public yesterday by the Web site of The Journal and confirmed by the News Corporation.

Many Bancroft family members, according to people who know them, object to Mr. Murdoch’s brand of journalism, arguing that he might bend The Journal’s news coverage to suit his business interests and conservative political views.

Mr. Murdoch addressed such concerns directly in his letter, as he did in an earlier missive to the family, presenting himself and the family as products of the same newspaper traditions. “Much has been written about me, my family and our company, some flattering, some not; some accurate, most not,” he wrote.

He said that he would give the family a seat on the News Corporation board, and would establish an editorial board to oversee The Journal, as he did at The Times of London, to protect its top editors from capricious dismissal and to mediate disputes between the newspaper and the corporation. He had made the same commitments already in the two weeks since the takeover offer became public knowledge.

“It seems like he’s just repeating the things he’s already expressed publicly in interviews and in his original letter,” said James H. Ottaway Jr., a former Dow Jones board member who worked with the Bancrofts for more than three decades. Mr. Ottaway, whose family owns 5.2 percent of the voting power in the company’s stock, has publicly stated his reluctance to sell to anyone, and his adamant opposition to a takeover by Mr. Murdoch.

“I don’t see that it advanced his case particularly, and I would doubt that it would change the Bancrofts’ position,” he said of the letter.

But the fact that the family conferred yesterday could indicate that some of its members do not want to let the matter drop. Mr. Murdoch’s $60-a-share offer was a steep premium for a stock that had recently traded around $35 to $36, and word of it caused the price to soar. Shares of Dow Jones closed yesterday at $53.77.

Perhaps as important as his promise to protect Dow Jones’s integrity was Mr. Murdoch’s promise to invest in the company, which increasingly must compete against much larger providers of news and financial information.

“We believe that News Corporation could bring substantial resources to bear in a combined enterprise, providing the additional capital and scale that will preserve Dow Jones’s leadership and growth for generations to come,” he wrote.

Separately, a group of Journal reporters based in China urged the Bancroft family in a letter to reject Mr. Murdoch’s bid.

The letter, written May 10, said the Journal’s integrity could be compromised because Mr. Murdoch is well-known for making editorial decisions in China to serve News Corporation’s business interests there.

The letter was signed by seven reporters, including many who were members of a team that won the Pulitzer Prize for international reporting this year for the paper’s coverage of the consequences of China’s aggressive economic growth.

Good Life of Boomers Tied to Better Life for Immigrants (Wall Street Journal)

The quality of life for some 80 million graying baby boomers in the U.S. may depend in large part on the fortunes of another high-profile demographic group: millions of mostly Hispanic immigrants and their children.

With a major part of the nation's population entering its retirement years and birth rates falling domestically, the shortfall in the work force will be filled by immigrants and their offspring, experts say. How that group fares economically in the years ahead could have a big impact on everything from the kind of medical services baby boomers receive to the prices they can get for their homes.

Immigrants and baby boomers are two groups whose destinies are converging in the next 20 years," says Dowell Myers, a demographer at the University of Southern California. "Baby boomers will surrender their economic role to this generation of immigrants and their children," who will evolve into a critical pool of laborers and taxpayers, he says.

Prof. Myers, author of the recent book "Immigrants and Boomers: Forging a New Social Contract for the Future of America," is among a crop of academics studying the link between the giant generation born between 1946 and 1964 and newcomers to the U.S., mainly Latin American immigrants.

The U.S. is undergoing a seismic demographic change that will kick in over the next decade or so. In California, for example, there were 9.7 million baby boomers between the ages of 40 and 49 in 2005, who accounted for 51% of the prime working-age population. By 2020, they will be 55 to 74 years old, with most boomers on the brink of retirement or about to plunge into it.

The weight of this aging population will swell relative to the pool of working-age people. The ratio of senior citizens to prime-working-age people, 25 to 64 years old, will jump 30% in the decade between 2010 and 2020 and an additional 29% in the following decade, according to Prof. Myers. All told, the ratio of seniors to working-age residents, including immigrants, will grow from 250 seniors per 1,000 working-age people in 2010 to 411 per 1,000 in 2030, he calculates.

This hefty burden will be hard for the economy to absorb, and will require some difficult choices. Those may include tax increases, benefit cuts for seniors, increases in the taxable income of working-age residents, as well as efforts to attract more immigrants to fill out the work force.

At a hearing on New York's Ellis Island last month, Prof. Myers told congressional leaders that the current influx of immigrants, about 1.5 million annually, is softening the impact of the bulging population of seniors relative to working-age adults by about a quarter from what it would be without immigration. Boosting immigration would relieve more pressure, he and other experts say.

But given the nation's polarizing debate over illegal immigration, the U.S. is unlikely to implement policies to attract many newcomers in the near future. That suggests that one of the country's most pressing tasks may be improving the earnings prospects of its youngsters, especially Latino youth, who will have to carry much of the financial burden for the supersize boomer generation.

One of the challenges is that Americans don't seem to be aware of the vital role the next generation will play. The predominantly white senior citizens and boomers, who account for the majority of the nation's decision makers, often vote against measures to boost services or raise taxes for schools increasingly populated by Hispanics. That's a problem, because better education is the ticket to prosperity for those on whose tax dollars boomers will rely.

Ron Crouch, director of Kentucky's State Data Center at the University of Louisville, makes about 150 presentations a year to groups including educators, high-tech industry leaders and government officials to paint a picture of what the U.S. will look like as an aging white population converges with a growing population of immigrants and minority youth.

"If I'm an old white person, I better be interested in how these young, Hispanic kids are doing," Mr. Crouch told an audience attending the National School Board Association conference in San Francisco last month.

Between 1990 and 2005, blacks and Hispanics, including immigrants, accounted for 80% of all population growth in the U.S. They accounted for all the population growth among those 45 and younger, according to the Census Bureau. That represents both the younger end of the current work force and the nation's future labor pool.

This maturing younger population will need to be ready for opportunities far beyond the fields, construction sites and nursing homes that employed many of their parents, Mr. Crouch says. They will also need to be "architects, business owners, doctors and scientists," he says.

More broadly, the U.S. economy needs enough skilled workers to stay competitive. But current statistics bode ill for the future of the country's youth -- and the aging generation whose fate is tied to theirs.

In Georgia, for example, minorities accounted for two-thirds of the population growth between 1990 and 2000. Between 2000 and 2005, they represented 80% of that growth. Yet, only 12% of black fourth-grade students and 17% of Hispanic fourth-graders are proficient in reading, compared with 38% of whites, according to a report by the Center for American Progress, a public policy think tank.

In California, already a majority minority state, 11% of African-American and 9% of Hispanic fourth-graders are proficient in reading, compared with 36% of their white peers.

The achievement gap seen in elementary school is unlikely to close by the time most students enter high school. Down the road, only slightly more than half of all blacks and Hispanics graduate from high school in four years, compared with 78% of whites.

For baby boomers, the economic status of the new generation will affect more than the kind of quality of services the government available. It will also affect the value of a major asset for many boomers: their homes.

Prof. Myers's studies show a pattern of upward mobility into homeownership by immigrants and their children. By 2005, four of the top 10 surnames among home buyers nationwide were Spanish, up from only two in 2000. But young Latinos will become the largest market for the homes of white boomers as the latter seek to downsize or cash out in the near future.

A less-advantaged younger generation is less likely to be able to afford to pay top dollar for retirees' homes. "We need to cultivate new home buyers; it requires moving more Latino kids through high school and college," says Prof. Myers. "It's not for the good of Latinos. It's for the good of the nation."

Angry Wolfowitz in four-letter tirade (Guardian Unlimited)

Richard Adams in Washington
Tuesday May 15, 2007

An angry and bitter Paul Wolfowitz poured abuse and threatened retaliations on senior World Bank staff if his orders for pay rises and promotions for his partner were revealed, according to new details published last night.

Under fire for the lavish package given to Shaha Riza, a World Bank employee and Mr Wolfowitz's girlfriend when he became president, an official investigation into the controversy has found that Mr Wolfowitz broke bank rules and violated his own contract – setting off a struggle between US and European governments over Mr Wolfowitz's future.

Sounding more like a cast member of the Sopranos than an international leader, in testimony by one key witness Mr Wolfowitz declares: "If they fuck with me or Shaha, I have enough on them to fuck them too."

The remarks were published in a report detailing the controversy that erupted last month after the size of Ms Riza's pay rises was revealed. The report slates Mr Wolfowitz for his "questionable judgment and a preoccupation with self-interest", saying: "Mr Wolfowitz saw himself as the outsider to whom the established rules and standards did not apply."

The report brushed off Mr Wolfowitz's defence that he thought he had been asked to arrange Ms Riza's pay package, observing that "the interpretation given by Mr Wolfowitz ... simply turns logic on its head".

The investigators have sent their completed report to the bank's governing board, containing a string of withering criticisms of Mr Wolfowitz's behaviour and casting doubt on his ability to continue running the bank, a multibillion-pound international agency with 12,000 staff based in Washington.

According to the report, Mr Wolfowitz's actions "had a dramatic negative effect on the reputation and credibility" of the bank.

It concluded that "the damage done to the reputation of the World Bank group" should lead the bank's board to "consider whether Mr Wolfowitz will be able to provide the leadership needed to ensure that the bank continues to operate to the fullest extent possible".

It also said: "Mr Wolfowitz's contract requiring that he adhere to the code of conduct for board officials and that he avoid any conflict of interest, real or apparent, [was] violated."

Despite the weeks of turmoil within the bank, Mr Wolfowitz may still keep his job if the US government is prepared to stick by him.

Mr Wolfowitz still enjoys support from the Bush administration, where he served as deputy defence secretary at the Pentagon during the invasion of Iraq.

Yesterday vice president Dick Cheney defended Mr Wolfowitz, saying: "Paul is one of the most able public servants I've ever known .... I think he's a very good president of the World Bank, and I hope he will be able to continue."

The US treasury secretary, Hank Paulson, was yesterday said to also be drumming up support for Mr Wolfowitz, while European governments increasingly despair of US intransigence in allowing Mr Wolfowitz to hang on.

The angry comments attributed to Mr Wolfowitz came from damning testimony by Xavier Coll, head of human resources at the bank, who provided investigators with his notes of a meeting with Mr Wolfowitz last year. The notes directly contradict Mr Wolfowitz's assertions that the details of Ms Riza's treatment were properly shared with senior bank officials.

In March last year, when a mention of Ms Riza's secondment outside the bank to avoid rules about partners was first published in the magazine US News & World Report, an angry Mr Wolfowitz accused Mr Coll of leaking the information.

According to Mr Coll's notes: "At the end of the conversation Mr Wolfowitz became increasingly agitated and said that he was 'tired of people ... attacking him' and 'you should get your friends to stop it'. Mr Wolfowitz said, 'If they fuck me or Shaha, I have enough on them to fuck them too'," naming several senior bank staff he felt were vulnerable.

Mr Wolfowitz appears before the bank's executive board today to make a final defence of his actions, with the board meeting tomorrow to consider the report and make a statement later in the week.

With Mr Wolfowitz so far refusing to step down, the board may need to take radical action to break the stalemate. Members have discussed a range of options, including sacking Mr Wolfowitz, issuing a vote of no confidence or reprimanding him. Some board members argue that a vote of no confidence would make it impossible for him to stay in the job.

EU Expects Faster Economic Growth (NY Post)

AP Business Writer

BRUSSELS, Belgium (AP) -- The European Commission on Monday forecast faster economic growth than expected this year for nations using the euro and for the full European Union, with unemployment dropping to the lowest levels in 15 years.

It estimated 2.6 percent growth in 2007 for the 13 nations using the euro - up from an earlier forecast of 2.4 percent - and 2.9 percent growth for the entire 27-nation, rather than the previously expected 2.7 percent, due to a boost in investment and household spending.

The 10.9 trillion euro ($14.78 trillion) EU economy should add another 5.5 million new jobs in 2007 and 2008, cutting unemployment rates to levels not seen since the early 1990s, the European Commission said in its spring economic forecast.

Most are expected in the euro area where the two biggest nations, Germany and France, still have large numbers of jobseekers. The EU's overall unemployment rate should fall to 7.2 percent this year and 6.7 percent next year, with the rate in the euro zone down to 7.3 percent in 2007 and 6.9 percent in 2008.

"This shows that the strength of the recovery has been transmitted to the employment figures. That is very, very good news," said EU Economic and Monetary Affairs Commissioner Joaquin Almunia.

Last year, the euro-area economy grew 2.7 percent and the economies of the 27 EU countries expanded by 3 percent - the fastest since 2000 as exports boomed and countries started to enjoy the effects of labor market reforms.

This recent growth spurt will slow this year and next year, with the euro nations' economies growing by 2.5 percent and the EU overall by 2.7 percent, the European Commission said.

EU economists expect wages to increase but to stay moderate over the next two years, keeping inflation close to 2 percent - adhering to the European Central Bank guideline and undermining one of its reasons to raise interest rates.

But prices will edge up in 2008 in line with higher spending, the commission said.

It warned that the sunny forecasts could be shadowed by a sharper downturn in the U.S. housing market, any sudden shift in worldwide deficits and new oil price hikes. It estimated that oil prices would average $66.20 a barrel this year and $70.30 next year.

However, they said stronger growth in Asia - and better labor market performance in Europe, which would increase spending - could lift its predictions again.

The commission predicted that the region's largest economy, Germany, would grow strongly at 2.5 percent this year and 2.4 percent in 2008, bringing its unemployment down to 7.3 percent in 2007 and 6.5 percent the year after.

France's economy should expand 2.4 percent in 2007 and 2.3 percent in 2008, it said. Unemployment is likely to remain high at 8.9 percent this year and 8.5 percent next year.

British growth is forecast at 2.8 percent this year and 2.5 percent next year, with unemployment staying stable - and higher than last year - at 4.4 percent for 2007 and 2008.

Italy, however, will grow more slowly: 1.9 percent this year and 1.7 percent in 2008.

Portugal's budget deficit will still break the EU limit of 3 percent next year unless Lisbon takes action, he warned. Four other nations using the euro also will surpass that maximum by the end of this year: the Czech Republic, Hungary, Poland and Romania.

Poland will come under EU scrutiny in September to see if it has obeyed recommendations to cut its deficit, targeted to hit 3.4 percent this year and 3.3 percent next year. Its unemployment rate - the EU's highest - is likely to fall to 11 percent this year and 9 percent next year as the economy grows at more than twice the EU average.

Commodities Broker Hits Geysers Of Trouble (NYPost)


Once-highflying commodities broker Optionable is crashing back to earth.

On Friday its CEO abruptly resigned following the bombshell revelation that he has a prison record and failed to disclose it. And now the Nymex has ordered its representative off of Optionable's board as it reviews its $27 million investment in the firm.

Both blows hit as the firm reels from word that the Bank of Montreal is severing its ties to the broker following a $400 million loss that BMO took on bad natural gas bets placed through Optionable.

CEO Kevin Cassidy triggered the latest turmoil when he resigned after questions surfaced about his role in a payment scam that defrauded the government out of import duties in the 1990s. Cassidy served a six-month stretch in federal prison in connection with the crime.

None of Optionable's federal filings or its marketing materials noted his incarceration. Nor were investors - including Nymex, which last month closed on a 19 percent stake in the broker - informed.

A failure to disclose Cassidy's legal problems violates numerous securities laws.

Cassidy and his father are owners of A-1 International Importing Enterprises, which imports ceramic figurines and coin sets. The firm once did a brisk business with the Home Shopping Network.

Both Cassidys were convicted of using money that should have been sent to the IRS for personal expenditures.

According to the federal prosecutors' docket, Cassidy was sentenced on Nov. 17, 1993, and might have received a stiffer sentence had the prosecutors not requested the judge depart from the guidelines.

A call to Cassidy's house was not returned, and a spokesman for Optionable declined to comment. Ex-Chairman Mark Nordlicht, who resigned May 1, declined to comment.

In Deal, a Test for the U.A.W. (New York Times)

These are the most pressing questions to arise from the deal announced Monday for Cerberus Capital Management, which specializes in restructuring troubled companies, to pay a total of $7.4 billion to take control of Chrysler, with most of that money to be invested in the newly independent company.

By unwinding a nine-year-old merger between Chrysler and Daimler-Benz of Germany, Cerberus is also taking on Chrysler’s $18 billion obligation for health care and pensions for employees and retirees.

Any efforts to sharply reduce those perks — which Chrysler can afford but says represent a cost burden of $1,500 a vehicle — will probably put it at odds with the U.A.W.

The issue will take on added importance in two months, when the union and Detroit automakers open talks on a new national contract. The union’s position on Chrysler may influence talks with General Motors and the Ford Motor Company, with the outcome representing the latest chapter in the wholesale restructuring of the American auto industry.

For now, the U.A.W. is supporting the deal. Its stance represents a reversal from only a month ago, when Ron Gettelfinger, the union president, warned that an equity player might “strip and flip” Chrysler, selling off its most valuable parts for a quick profit.

But based on what the union was told of Cerberus’s plans, Mr. Gettelfinger said Monday that the U.A.W. was “confident enough to say that we support this transaction.”

That support may dwindle as the company and the union start discussing specifics. The most obvious way for Cerberus to make money off its investment is to cut costs — especially by reducing the benefits that workers hold sacred, including medical benefits for workers and their immediate families for life, with only modest co-payments or deductibles.

“They’re going to want us to give something up,” Tim Preston, 50, a tradesman at Chrysler’s Jefferson Avenue North assembly plant in Detroit, said Monday.

Chrysler, in fact, has already tried. Last year, the U.A.W. refused to give Chrysler the same concessions on medical costs that it granted G.M. and Ford, which it deemed in far worse shape.

The union also refused to grant deep wage and benefit cuts to the Delphi Corporation, G.M.’s former parts subsidiary, which had reached agreement to sell itself to Cerberus if a labor deal could be reached. Company and union leaders say those talks are not dead, however.

Except for the early 1980s, when the union granted concessions at all three car companies, labor talks have been fruitful for the U.A.W. in recent decades, as it has continued to make gains in wages and benefits even as tens of thousands of jobs have been eliminated.

That trend was broken in the last couple of years when the union agreed to buyouts and retirement incentives for workers and agreed to concessions at G.M. and Ford.

By showing their support Monday for the Cerberus deal, U.A.W. leaders may have been trying to set the tricky groundwork of making the prospect of concessions palatable to union members as a way to keep Chrysler competitive.

“It does promise some creative and maybe not-business-as-usual solutions,” said John Paul MacDuffie, co-director of the International Motor Vehicle Program at the Massachusetts Institute of Technology.

No requests have been made of the union yet, but both Mr. Gettelfinger and senior Chrysler executives say there seems to be a meeting of minds.

“We have been led to believe that they are very concerned about the American automobile industry,” said Mr. Gettelfinger, who spent four hours with Chrysler executives this weekend being briefed.

His reaction was clearly a relief to the Cerberus chairman, John W. Snow, the former Treasury secretary, who joined DaimlerChrysler officials in Stuttgart, Germany, at a news conference on Monday.

“We’re going to work to make sure this company succeeds, and as the company succeeds, it will maximize opportunities for workers,” Mr. Snow said. “Our objective is a successful Chrysler and a successful Chrysler creates opportunities.”

Some workers, however, were skeptical. “It makes me real nervous,” said Anthony Watson, 36, a chassis assembly worker at Chrysler’s truck plant in Warren, Mich.

Richard Burns, 39, an assembly line worker at the Warren plant, just north of Detroit, said he and many of his colleagues did not know much about Cerberus. “We’re scared they’re going to break us up,” he said.

Cerberus officials insisted Monday that was not the case. Under the complicated deal, Cerberus will take an 80.1 percent stake in the new company, to be known as Chrysler Holding. Of the $7.4 billion, Cerberus agreed to invest $5 billion in the new Chrysler and $1.05 billion in Chrysler’s financial arm. The remaining $1.35 billion will go to the former German parent company.

In turn, DaimlerChrysler has agreed to lend Chrysler Holding $400 million and will absorb $1.6 billion in costs related to a restructuring program under way at Chrysler, which said in February that it would cut 13,000 jobs and close all or part of four factories. Investors in DaimlerChrysler showed their support for the deal Monday by bidding up the shares $2.12, to $84.12. The Cerberus deal will have little impact on shareholders of the German parent company, other than the financial impact of shedding Chrysler.

All told, DaimlerChrysler will spend $677 million in cash on the transaction. Daimler-Benz paid $36 billion for Chrysler in 1998 in what was portrayed as a merger of equals but ended up being a German takeover of the American company.

In hindsight, the merger’s early days were its best. At the time, Chrysler was rolling in profit, from the popularity of its big Jeeps and minivans, while Mercedes-Benz was enjoying a comeback for its cars, especially the E-class sedan and the M-class, its first S.U.V.

The architects of that earlier merger, Jürgen E. Schrempp, the former chief executive at Daimler-Benz, and Robert J. Eaton, who ran Chrysler, envisioned a company that married the mass-market success of Chrysler and the luxury appeal of Mercedes. But Chrysler did not consistently deliver on its promise.

Indeed, for the last 30 years, Chrysler has acted like what might be described as a split-personality car company, with wide and fast swings from highs to lows.

The same big vehicles, for example, that generated big profits in the late 1990s put Chrysler out of step with changing consumer tastes when gas prices soared.

Last summer, as many as 100,000 unsold Chryslers piled up on storage lots, a big factor in Chrysler’s $1.5 billion loss for 2006. Last year, it fell to fourth place in the American market, behind Toyota.

In February, Mr. Schrempp’s successor, Dieter Zetsche, who ran Chrysler from 2000 to 2005, said the company would eliminate 13,000 jobs, or 16 percent of the total staff, and close all or part of four plants in its second restructuring in seven years.

Mr. Zetsche also put Chrysler up for sale, attracting a series of bidders, including Cerberus as well as two other equity players, the Blackstone Group and Centerbridge Partners.

The billionaire Kirk Kerkorian, who had often tangled with Chrysler management, also put in a bid, as did Magna International, the Canadian auto parts supplier.

The Cerberus deal represents a sea change in Detroit, where there has not been a major privately held company in over half a century (the Ford Motor Company, in which the Ford family still has a controlling stake, went public in 1956; G.M. has been public for nearly a century.)

As a private company, Chrysler may be able to better explore, with less public scrutiny, ways to lower health care costs with its workers.

One idea may come from the Goodyear Tire and Rubber Company, which is giving the United Steelworkers union $1 billion to take over a health care plan covering 30,000 retired workers.

Executives from all of Detroit’s companies have studied the plan, which would probably cost the auto industry tens of billions of dollars to carry out in the United States. But if the U.A.W. did agree, it would mean removing the liability from the car companies.

Whatever the answer, many industry experts predict that Chrysler will find some way to resurrect itself.

“This history of coming back from near death over and over — the nine lives of Chrysler — does have a powerful hold within the company, and with their suppliers and with the union workers,” Professor MacDuffie said.

Nick Bunkley contributed reporting.

HSBC dips after U.S. mortgage bad debts rise (Reuters)

LONDON (Reuters) - HSBC (HSBA.L: Quote, Profile, Research shares drifted lower on Tuesday after Europe's biggest bank reported another big jump in bad debts at its U.S.-based consumer finance arm, although it saw the value of its stake in a Chinese bank soar.

HSBC Finance said in a regulatory filing late on Monday its net income was $541 million in the first quarter, down 39 percent from a year earlier. The unit set aside $1.7 billion for credit losses, almost double a year ago.

Dozens of lenders to the U.S. subprime mortgage market were hit hard by a sharp downturn last year, forcing HSBC -- one of the biggest players in the segment -- to write off bad debts of $10.6 billion, compared to $7.8 billion in 2005.

On Monday, HSBC Finance said quarterly mortgage credit performance was "in line" with expectations, and that delinquencies are rising more slowly than in prior quarters.

Home Depot First-Quarter Profit Falls 30% on Housing Slowdown (Bloomberg)

By Mark Clothier

May 15 (Bloomberg) -- Home Depot Inc., the world's largest home-improvement retailer, said first-quarter profit fell more than analysts' estimates after a slump in U.S. home sales lowered demand for kitchen cabinets and discouraged remodeling.

First-quarter net income fell 30 percent to $1.05 billion, or 53 cents a share, from $1.48 billion, or 70 cents, a year earlier. Sales rose 0.6 percent to $21.6 billion, the smallest gain in about four years, Home Depot said today in a statement.

Sales at the company's retail stores declined 4.3 percent. Chief Executive Officer Frank Blake, who took over in January after Robert Nardelli was ousted over compensation, tried to boost store sales by adding staff and hiring skilled trades people at about $30 an hour.

``There is not a heck of a lot of upside at this point,'' said Patricia Edwards, a Seattle-based money manager at Wentworth, Hauser & Violich. The firm holds $9.6 billion in assets including Home Depot shares. ``I don't expect sentiment to change until we see the whites of the uptick's eyes. That's going to take a while.''

Home Depot shares rose 15 cents to $39.01 in New York Stock Exchange composite trading yesterday. The stock declined 2.9 percent between Blake's appointment Jan. 3 and yesterday.

Analysts surveyed by Bloomberg estimated profit of 59 cents a share on sales of $21.8 billion.

Unit Sale

Home Depot is considering selling its HD Supply unit, which caters to professional builders, after expanding it with 34 acquisitions since 2004. Some investors said the expansion of the division, which makes up about 13 percent of sales, took Home Depot's focus off its retail stores.

Home Depot sales have grown an average of 12 percent the past three years, trailing 18 percent growth at Lowe's Cos., the second-biggest home-improvement retailer.

``We remain concerned with prospects for Home Depot and Lowe's,'' Brian Nagel, an analyst at UBS Securities LLC, wrote in a research note May 9. ``Continued weakness in the U.S. housing market is apt to have a more pronounced impact upon sales and earnings per share at the chains.''

Nagel, who has a ``reduce'' rating on the company, is the only analyst who recommends selling Home Depot stock. Twelve have it at ``buy,'' and nine say ``hold.''


AP, Bloomberg, Reuters, N.Y. Post

May 14, 2007 -- Generics Mylan Laboratories said yesterday it agreed to buy Merck's generic- drug unit for $6.7 billion in cash to become the world's third-largest ge neric drug maker. Mylan is paying more than its own market value to buy a unit with annual sales almost double its own. Mylan beat out Teva Pharmaceuticals Indus tries Ltd. of Israel, the world's largest maker of generic drugs, in a four- month battle. Dine in Macy's plans to test bistros, gourmet restau rants and Starbucks cof fee shops at some stores in an effort to draw cus tomers and keep them shopping longer. The new in-store restaurants and cafes, featuring such famed chefs as Wolfgang Puck and Todd English, come as Federated De partment Stores focuses on building Macy's as a national brand. Feder ated will change its name to Macy's Inc. if shareholders approve the switch at this Fri day's annual meeting. Skype hype Wal-Mart is adding an array of Skype phone gear to the electronics section in 1,800 stores, bringing the renegade provider of cheap calling over the Internet to a huge mainstream audi ence. The dedicated Skype section will fea ture handsets, headsets and Webcams designed to work with Skype, a provider of free and cheap long-distance calls, including to phone numbers abroad. Wal- Mart will also sell the first prepaid cards for Skype calls to be sold in this country, the compa nies will announce today. Yahoo Green Yahoo! is to introduce today Yahoo Green, an online education pro gram that will offer users the latest environmental news, consumer tips and ways to be socially ac tive in combating cli mate change.

Bush orders agencies to draft environmental regulations (Chicago Tribune)

By Mark Silva

WASHINGTON - President Bush ordered federal agencies Monday to start drafting regulations to cut U.S. gas consumption by 20 percent in the next 10 years and to cut emissions of greenhouse gases. But the president's critics were quick to say that the call lacked any real heft and would result in neither lower gas prices nor reduced pollution for years to come, if then.

"America has a clear national interest in reducing our dependence on oil," Bush said in a Rose Garden appearance. "When it comes to energy and the environment, the American people expect common sense, and they expect action."

The president directed Cabinet officers to fashion new regulations by this fall, though some of those officials questioned whether their review would result in new fleet mileage standards for American auto manufacturers. The president also conceded that action will take time. "This is a complicated legal and technical matter," he said, "and it's going to take time to fully resolve."

Some in Congress, including an influential member of Bush's own party, called this inadequate. One Democrat called it a "stall tactic" following a recent Supreme Court ruling that the administration must act on greenhouse gas emissions.

And the president's directive, experts say, won't have any short-term bearing on the rising price of gasoline, which averages $3.05 per gallon for regular gas in the latest U.S. Department of Energy survey, up from just above $2 per gallon on Election Day 2004. The average national price of a gallon of gas hit a record $3.073 on Monday, according to AAA and the Oil Price Information Service.

Since Bush's State of the Union address in January 2006, when he declared that "America is addicted to oil," he has set goals for lowering energy consumption. In that address, Bush said the U.S. should replace more than 75 percent of its oil imports from the Middle East by 2025.

And with his State of Union address in January of this year, the president set a goal of cutting U.S. gas consumption by 20 percent over 10 years - a "20-in-10" plan that he now is ordering federal agencies to begin implementing with new regulations.

The president now has a stronger hand in the matter, with a recent Supreme Court ruling that the federal government has authority to regulate greenhouse gas emissions under the Clean Air Act.

"The Bush administration is taking the first regulatory step to decrease greenhouse gas emissions from cars," said Steve Johnson, administrator of the Environmental Protection Agency. "We have not reached any conclusion about what the final regulation will look like."

Yet even as the president's executive order directs the EPA and Departments of Transportation, Energy and Agriculture to develop regulations that will put his plan into effect, the administrators of these agencies cannot say what, if any, specific new automobile fleet standards for fuel economy might emerge.

"The agencies are putting the building blocks in place," said Agriculture Secretary Mike Johanns, backing a farm bill proposing $1.6 billion in funding for renewable energy, with a focus on cellulosic ethanol.

Yet, experts say the availability of alternative sources of energy such as ethanol or bio-diesel fuel is unlikely to achieve the sort of savings in gas that the president is seeking within 10 years. And short of making a dramatic increase in domestic oil production - including the controversial tapping of Alaskan or Gulf Coast oil reserves now off-limits to drilling - the U.S. will remain dependent on foreign oil, experts say.

Sen. Richard Lugar, an Indiana Republican, delivered a critical assessment of the president's leadership on energy in a speech Monday. "The president's energy activities are barely registering in the American consciousness," Lugar told the Deloitte Energy Conference.

"In large part, this is because there is no energy campaign upon which he has visibly and repeatedly staked his reputation and legacy," Lugar said. "With the possible exception of drilling in the Arctic National Wildlife Refuge, there is nothing in the Bush domestic energy program that a well-informed American would identify with this administration."

What's needed, the influential farm-state senator said, is a national policy of making "competitively-priced bio-fuels available to every motorist." This would include ensuring that virtually every new car sold is capable of running on an 85 percent ethanol fuel mix and that at least one quarter of all filling stations have "E-85" pumps.

The government should also "radically" increase the standards for fuel efficiency of the nation's auto fleets, Lugar said.

Nonetheless, administration officials don't guarantee that this will lead to new regulations for automobile fleet fuel efficiency, known as Corporate Average Fuel Economy. The EPA's Johnson says this is only one of the clear options.

"Goals are great in soccer and hockey," said Rep. Ed Markey, D-Mass., chairman of the Select House Committee on Energy Independence and Global Warming, calling the president's plan a "stall tactic."

With an auto industry already facing multibillion-dollar losses, talk of higher CAFE standards for cars like those already imposed for light trucks invites a new political problem.

"It's time to move beyond what has become a stale and sterile debate over Corporate Average Fuel Economy standards," Rep. John Dingell, D-Mich., chairman of the House Energy Committee, said at the Detroit Economic Club.

"As the needs of the nation and the technology of vehicles and fuels have evolved, it is becoming clear that regulating miles per gallon is no longer adequate," Dingell said. "The auto industry today is the only industry in the country with a carbon constraint. ... Rather than ratchet down only on cars and light trucks, I propose that we spread the burden evenly and equally."

The nation's leading automakers have pledged to double production of vehicles that can run on an 85 percent ethanol mix by 2010 and ensure that half of their new fleets will run on flexible fuels by 2012. But they say infrastructure remains a problem, with only about 1,100 E-85 pumps now operating at gas stations.

"The `20 in 10' is a nice sound-bite goal, but at the end of the day doesn't solve the problems that President Bush has identified," said Max Schulz, a senior fellow at the Manhattan Institute who served as a senior policy adviser in the Bush administration's Energy Department from 2001 through 2005.

Airline customer satisfaction falls (AP)

By Associated Press | May 15, 2007

ATLANTA -- Bankruptcy can be a wake-up call for airlines about the need to run their operations more efficiently, but it also can shine a light on a more basic challenge like making customers happy.

United Airlines and Delta Air Lines Inc., both of which restructured under Chapter 11 in recent years, ranked last and next-to-last, respectively, among airlines in terms of customer satisfaction in a survey to be released today by the University of Michigan.

Marks were only slightly better for AMR Corp.'s American Airlines, which teetered on the verge of bankruptcy before winning employee concessions in 2003, and Northwest Airlines Corp., which is currently in bankruptcy.

There were some bright spots for a few airlines in the survey. Dallas-based Southwest Airlines Co. ranked first, and was one of only two airlines mentioned by name in the survey that improved in terms of customer satisfaction this year compared with last year. Houston-based Continental Airlines Inc. was the other.

"We've done as well as we have up to date by making sure our customers have a rich experience, and that's largely due to our people," said Beth Harbin, a spokeswoman for Southwest, which also is one of the few consistently profitable airlines.

About 20,000 people were asked during the first quarter of this year to rate their level of satisfaction as customers of companies in a variety of industries, including the airlines.

"The same problems that have pulled airline passenger satisfaction down the past few years -- disenchanted employees, increasing fuel costs, bankruptcy, and now also record levels of lost, delayed, and damaged luggage -- cause it to drop again," the researchers said in their analysis.

Verizon Grabs Cybertrust

Tim Wilson, Site Editor, Dark Reading

Any lingering questions about large service providers' intentions in the security market got put to rest today with Verizon's acquisition of Cybertrust, one of the best known independent security service providers.

Financial terms of the deal for privately-held Cybertrust weren't disclosed.

Verizon, the former regional Bell which also operates the former MCI, already had a 300-person security services operation, but was looking to expand its reach and range of services, according to Nancy Gofus, senior vice president and chief marketing officer for Verizon Business.

"We didn't have the global reach some of our customers were asking for, particularly in Asia and Europe," said Gofus in a press briefing this morning. "We also didn't have some of Cybertrust's capabilities, such as forensics and identity management."

The acquisition follows BT's acquisition of managed security service provider Counterpane last year, as well as IBM's acquisition of Internet Security Systems, which was immediately placed into the IBM Global Services unit. (See BT Buys Counterpane and IBM Up-Ends Security Services Market.)

"This shows that consolidation in the broad security market will continue for those services that are already highly commoditized," said Gary McGraw, CTO of Cigital. "The idea now is to 'turn the crank' to build the business into something global." But he also warned that "some dilution in the effectiveness of the services" is part of this market dynamic.

Jim Ivers, senior vice president of corporate marketing at Cybertrust, said the newly-combined company will seek offer customized security services. "If a service provider thinks they can take a cookie-cutter approach to this market, they are going to have some issues," he said. "A service provider can't just go out and buy any security company and do what Verizon Business can do."

The Verizon and Cybertrust executives said the combined company will target large enterprises and government agencies, adding security capabilities such as computer forensics and identity management to Verizon's current range of firewall, antivirus, and anti-spam services. "We can do more than Counterpane, which was strictly limited to managed security services," Ivers said.

But Bruce Schneier, CTO at BT Counterpane, pointed out that BT already has identity management. "They do it for the UK government, for heavens sake, and forensics as well. They already have a far greater global reach than Verizon can even dream of," Schneier wrote in an email today.

"The key to judge the two companies is not to look at Counterpane and Cybertrust as stand-alone companies, but to look at the combined strength of BT plus Counterpane vs Verizon plus Cybertrust," he added.

Some analysts speculated that the acquisition might lead to other services from Verizon as well.

"Every small and medium business requires secure communications services," notes Eric Ogren, principal analyst and founder of the Ogren Group. "Verizon can use this acquisition to enhance the security of its own infrastructure, but the real prize will be in bundling security services for SMBs that do not have in-house security expertise. Picture an SMB package for IP data and voice communications with annual PCI audits.".

"The next big race is to use cellphones as a replacement for credit cards, and Cybertrust suddenly looks very strategic with regard to where the market is going," says Rob Enderle, president of the Enderle Group. "If the merger is successful -- and remember, some are not -- the end result could be that Verizon is favored for cellphone based transactions, and Verizon customers will be the first to benefit broadly from them."

Phoenix firm claims price-fixing by 5 freight railroads (kvoa.com)

NEWARK, N.J. -- Five major freight railroads conspired to fix prices by adding fuel surcharges, according to an antitrust lawsuit filed Monday in U.S. District Court.

The lawsuit, which seeks class-action status, was filed by Phoenix-based Dust Pro Inc. on behalf of other parties who shipped goods on one or more of the railroads since July 2003.

The suit seeks unspecified monetary damages from the five railroads: CSX Transportation Inc., of Jacksonville, Fla., Norfolk Southern Railway Co., of Norfolk, Va.; BNSF Railway Co., a subsidiary of Burlington Northern Santa Fe Corp., of Fort Worth, Texas; Union Pacific Railroad Co., of Omaha, Neb.; and Kansas City Southern Railway Co., of Kansas City.

The lawsuit alleges the five engaged in an "unreasonable restraint of trade or commerce" in violation of the Sherman Act, a federal antitrust law. It said the companies control more than 90 percent of the rail freight traffic.

CSX spokesman Bob Sullivan said the railroad could not yet discuss specific allegations, but that it "believes strongly that its fuel surcharge practices comply with all applicable laws and regulations."

Kansas City Southern said the allegations are "without merit," but did not elaborate.

Officials at the other railroads had no immediate comment.

The lawsuit charged that the railroads "moved in uniform lockstep" to fix prices for the fuel surcharges, which it said had no relationship to actual fuel costs.

As a result, the railroads "restrained competition in the market for unregulated rail freight transportation services" and "realized billions of dollars in revenues ... in excess of their actual increase in fuel costs from the specific customers on whom they imposed the surcharge."

The lawsuit cited a decision by the U.S. Surface Transportation Board, which in January banned excessive fuel surcharges by railroads and imposed strict rules on the fees that many companies had credited with bolstering profits.

That ruling, however, applied only to rate-regulated shipping. The lawsuit said the majority of shipments are unregulated.

The board said it did not have jurisdiction over unregulated shipping, said Stephen Neuwirth, a lawyer for Dust Pro, which ships liquids used for large-scale dust control.

Neuwirth said the lawsuit was filed in Newark because the region is one of the nation's freight centers.

Freight is considered "unregulated" when a shipper has choices on how to transport its goods, said Robert G. Szabo, executive director of Consumers United for Rail Equity _ a nonprofit lobbying group representing freight rail customers seeking changes in federal law and policy.

Shippers who require rail to move their goods and only have one rail company to choose from can petition the Surface Transportation Board for lower rates, a process that Szabo called expensive and rarely successful.

His group is not involved in the lawsuit, although Szabo said, "I agree with it totally."

The lawsuit said much of the freight rail industry was deregulated in 1980, but that the number of carriers has declined from 35 at the time to seven.

As a result, "Rail freight shippers across the nation are being subjected to an endless string of rate increases by railroads made possible by a concentrated market structure, tight capacity, and coordinated pricing," the lawsuit said.

The suit was filed in the U.S. District Court for New Jersey.

Spending plan has welfare cuts (Whittier Daily News)

By Mike Zapler and Kate Folmar Sacramento Bureau

Gov. Arnold Schwarzenegger on Monday fine-tuned his budget proposal for next year with a plan that would cut welfare programs, siphon $1.3 billion of public transit money for other state programs, and sell off a quasi-public agency that guarantees student loans.

The Republican governor's plan would leave the state with a $1.4 billion "net operating deficit" for the fiscal year starting in July. But Schwarzenegger said he was proud of paring a $16.5 billion deficit he inherited in 2003, without raising taxes.

The release of the governor's revised budget triggers the annual money debate in the Legislature, and Democrats were quick to criticize Schwarzenegger's welfare proposal. It calls for denying cost-of-living increases to welfare recipients and halting payments to poor families with children after five years. Democrats said it targets those who can least afford it: poor families, seniors and the disabled.

"It looks like, once again, the most vulnerable Californians are in the free-fire zone," said Senate President pro tem Don Perata, D-Oakland, referring to proposed social service cuts.

Schwarzenegger called the plan a matter of necessity.

"I think that a lot of people deserve this money," Schwarzenegger said, "but I have an obligation, which is I promised the people of California that I will bring down the structural deficit to zero, and that we will be fiscally responsible."
Schwarzenegger relies on several one-time fixes to help balance the budget. He wants to shift $600 million from a tobacco settlement reserve fund into the state's general fund. And he would generate nearly $1 billion by auctioning off the state's EdFund program, which guarantees student loans. The governor also reiterated his interest in privatizing the state lottery, portraying it as a pain-free way to generate billions of extra dollars to pay off debt and finance state programs.

"We've got to find new ways of creating the revenues," Schwarzenegger said.

Overall, general fund spending would grow from

$102.3 billion in the current fiscal year to $103.8 billion next year, a 1.5 percent increase. Reflecting his confidence in California's economy despite a cooling housing market, the governor's finance team expects tax revenues to surge 5.8 percent - from $95.7 billion to $101.3 billion.

Among Schwarzenegger's proposals to find more than

$5 billion to balance the budget, his changes to welfare could be the most contentious. The governor wants to end state welfare payments to families with children after five years, and to deny cost-of-living increases to recipients of both CalWorks and a cash assistance program for the elderly, blind and disabled.

Raquel Cardenas, 30, said she receives a monthly welfare check of $650, plus $130 in food stamps, to support her 2- and 12-year-old daughters. Cardenas, who is divorced and rents a room in San Francisco, said she was trained as a graphic designer but can't work because child care for her younger daughter is too expensive. The governor's welfare plan will hurt, Cardenas said.

"Rent goes up, the cost of milk goes up, everything goes up except for" help from the state, she said.

Some social services fared better. Because of last winter's crop freeze, local food banks and a state agency that stores food for emergencies will see their total grant nearly double, to about $9 million.

And health advocates said there was little to praise or complain about in the state's health and human services budget, but they did approve of efforts to enroll more children in the Healthy Families subsidized health insurance program.

Transportation also looks to be a hot topic as lawmakers try to pass a budget by the June 15 Constitutional deadline. Schwarzenegger wants to move $1.3 billion in gas tax funds - which have surged recently because of spiking prices at the pump - into the general fund. Public transit advocates say the proposal will force public transit agencies to raise bus and rail fares and cut service.

Democrats are also upset that the governor wants to take hundreds of millions of dollars extra to make early payments on loans taken out during the dot-com bust.

Critics say the idea is like making an extra mortgage payment while ignoring the electricity bill.

Republicans, however, welcomed the move. The GOP wields more power over the budget than just about any other issue, because some Republican votes are needed to secure a required two-thirds vote.

"We have to bring expenditures in line with revenues, and we need to do it now," said Assemblyman Roger Neillo, R-Sacramento, the ranking Republican on the lower house's budget committee. "As painful as it is now, it will be even more painful if we delay it to subsequent years."

Republicans, however, weren't so pleased with another Schwarzenegger proposal that would eliminate the state's contribution - $40 million - toward a farmland preservation program known as the Williamson Act. Many of the state's rural areas are represented by Republicans.

Critics say the state subsidy is misguided, but the four-decade-old program remains popular with many farmers and environmentalists for reducing sprawl.

While many social services suffered, some areas of the budget still see increases - including spending on the governor's own office. Schwarzenegger proposes a 5 percent increase to pay for upgrading technology. He is expected to offer raises to his 185-member staff later this year, but those would come from existing budgets.

Even though the $1 million increase on governor's office spending is a tiny speck in the whole budget picture, it rankles some lawmakers, who could ax it from the budget.

There's no cost-of-living increase in grants to the aged, blind and disabled, noted Assembly Budget Committee Chairman John Laird, D-Santa Cruz, "but he says his office needs one. I think that would doom his proposal."

One powerful constituency - public schools - seemed to do particularly well under Schwarzenegger's budget plan. Per-pupil spending would increase more than $300, to $11,562.

But there was other good news - from funding to expand nutrition programs to a one-time $100 million block grant for school safety programs.