Friday, November 5, 2010

Today's Best Reads

1--"A complete collapse of the financial system is not out of the question", Randall Wray, Credit Writedowns

Excerpt: Where are we now? Many governments reacted with fiscal stimulus packages as well as bail-outs of financial systems. While many have proclaimed that the worst is behind, by all objective measures, nearing the end of 2010 the financial system is probably in worse shape than it was at the end of 2007 when it collapsed. Debt ratios have not come down appreciably. Defaults and delinquencies are up by huge amounts. In the US foreclosures have come to a virtual standstill as it has been recognized that many or perhaps most foreclosures that have taken place were almost certainly illegal. Holders of securitized products like MBSs and CDOs have begun to sue banks for fraud, demanding they take them back. While banks have reported strong earnings, almost all of these have been in trading activity or have resulted from reducing loss reserves (ironically, as defaults rise). In other words, none of the normal bank activity is generating revenue—all profits are accounting profits where it is easy to “cook the books”. Where it will all end is unknown but a complete collapse of the financial system is not out of the question.

This time around, it is not clear that governments will save the banks–having been burned last time around, voters are not sympathetic. Especially in the US the feeling is that Main Street’s needs have been ignored while Wall Street has been favored. And in most nations, government has adopted austerity policies to reduce spending and where possible to raise taxes. In some countries this appears to be necessary—such as the so-called “PIIGS” (Portugal, Ireland, Italy, Greece, Spain) that are heavily indebted with hands tied due to constraints imposed by the currency union. In others, such as the UK and the US it is mostly political—a reaction against the bail-outs of financial institutions. How this will all turn-out I do not know, but another crash and even deeper downturn seems likely.

2--The Many Faces Of Deleveraging, contrary

Excerpt: We think the summation messages are very clear and certainly have implications for at least a domestic economy that is suffering primarily from a lack of aggregate demand, let alone a global economy in part suffering from the same. As hard as this may be to hear, deleveraging is still barely out of the total cycle starting gates. At the household level we have not yet even seen organic deleveraging, but rather deleverageing through defaults. Jobs and income growth are the keys to the deleveraging process at the household level, but they are for all intents and purposes missing in action in the current cycle. And that speaks to time. Time for true balance sheet healing and ultimately a recovery in aggregate demand. The very means for households to delever independent of default are not visible. Not yet. And so we need to expect 1) a stop-start real world domestic economic recovery, 2) Fed QE that does nothing to reinvigorate the real economy, but has the real potential to create yet more unproductive asset bubbles, 3) continued volatility in financial asset and commodity prices based on investor perceptions of Fed and global central banker sponsored liquidity and the effectiveness or not of liquidity injections at any point in time. In reality, this is nothing we have not already been dealing with up to this point. But for our investment activities specifically, we believe it all comes down to just how far the Fed and their global central banking brethren are willing to push the envelope in terms of money printing, currency intervention, etc. For now, investors still view these activities as virtuous. But at some point unless we do indeed see true real world economic reinvigoration, we believe the markets will come to view further Fed and global central banker monetary "experiments" quite negatively. All part of the psychology of a financial market and economic cycle.

3--Hooters Shows Why Deflation May Never Go Away: William Pesek, Bloomberg

Excerpt: Japan used to be an automated-teller machine for brands like Prada, Gucci and Louis Vuitton. Women thought little of plopping down $2,000 for the latest fashions from Milan and Paris. Men didn’t blink at paying $200 for a tie. That’s all fashion-industry history now. Sliding wages and rising job insecurity brought budget-shopping into vogue.

No matter how much yen the Bank of Japan pumps into the economy, deflation deepens. It’s all about confidence, of which there is virtually none. Companies don’t trust that growth will return and so they avoid investing and hiring and trim salaries. Households fret about the future....

Getting households to spend more of the roughly $15 trillion of savings sitting under tatami mats is the key to ending deflation. That’s not going to happen with workers increasingly referring to themselves as “precariats” -- a word combining precarious and proletariat....

shifts in the underlying dynamics of Japan Inc. undermined households’ sense of security and caused greater disparities in a society that once viewed itself as egalitarian. Among the most troubling side effects is a slumping birthrate...

Deflation is deepening because no one believes it will be defeated over the next several years. That mindset has morphed the once free-spending Japanese into yen-pinchers. It also has many a politician, corporate executive and investor needing a drink. Perhaps even at Hooters.

4--Justice for some, Joseph Stiglitz, Project Syndicate

Excerpt: It was widely known that banks and mortgage companies were engaged in predatory lending practices, taking advantage of the least educated and most financially uninformed... But banks used all their political muscle to stop states from enacting laws to curtail predatory lending. When it became clear that people could not pay back what was owed, the rules of the game changed. Bankruptcy laws were amended...

With one out of four mortgages in the US under water ... there is a growing consensus that the only way to deal with the mess is to write down the value of the principal... America has a special procedure for corporate bankruptcy, called Chapter 11, which allows a speedy restructuring by writing down debt... It is important to keep enterprises alive ... in order to preserve jobs and growth. But it is also important to keep families and communities intact. So America needs a “homeowners’ Chapter 11.” .....

In today’s America, the proud claim of “justice for all” is being replaced by the more modest claim of “justice for those who can afford it.” And the number of people who can afford it is rapidly diminishing.

5--Was That a Plea From Bernanke?, New York Times

Excerpt: Laurence H. Meyer, a former Federal Reserve governor, said the following in today’s Times:

Bernanke has said that fiscal stimulus, accommodated by the Fed, is the single most powerful action the government can take for lowering the unemployment rate, when short-term rates are already at zero… He has nearly pleaded with Congress for fiscal stimulus, but he can’t count on it.

(Bernanke) made a deliberate choice to avoid making that point strongly or clearly.... Mr. Bernanke had perhaps more ability to influence this debate than anyone else. Imagine if he had given a speech earlier this year, as the economy started to falter, that included something along the lines of:

Last year’s stimulus program was not perfect, and we will never know its precise effect on the economy. But the available evidence — including the Fed’s own analytical tools and those of the Congressional Budget Office and private economists, as well the timing and pattern of spending by consumers, businesses and governments — suggests that the program made a major difference. It appears that more than one million jobs, and perhaps substantially more, would not exist now had the program not been enacted. Similarly, additional fiscal stimulus today, in the form of government spending or tax cuts, could play an important role in helping the economy to continue to recover from the recent financial crisis, especially if this short-term stimulus were paired with policies to reduce the deficit in future years.”

An argument like this would have made national headlines and cut through some of the more frivolous criticism of the stimulus. It may even have affected the debate as much as Alan Greenspan’s endorsement of the Bush tax cuts did in 2001. We’ll never know because Mr. Bernanke opted not to use his bully pulpit. That’s certainly his right as Fed chairman, but I don’t think he deserves credit today for trying.

6--ECB Rejects Request for Greek Swap Files, Citing `Acute' Risks, Bloomberg

Excerpt: The European Central Bank refused to disclose internal documents showing how Greece used derivatives to hide its government debt because of the “acute” risk of roiling markets, President Jean-Claude Trichet said.

The ECB is withholding the information six months after the European Union and International Monetary Fund led a 110 billion-euro bailout ($154 billion) for Greece. The government didn’t originally disclose the swaps, which were designed to help it comply with the deficit and debt rules it agreed to meet when it joined the euro in 2001. Eurostat, the EU’s statistics agency, is still trying to work out how Greece hid the deficit.

The Greek swaps fueled a financial crisis that threatened the breakup of the region’s currency. The government now says the swaps, some of which were arranged by Goldman Sachs Group Inc., may have caused “long-term damage” for taxpayers.

“There’s only one solution to resolving the current uncertainty: full disclosure,” said Gustavo Piga, author of “Derivatives and Public Debt Management,” and a professor at Tor Vergata University in Rome.

Greece’s fiscal crisis turned attention to off-market swaps arranged by Goldman Sachs that allowed the country to hide the extent of its debt from 2000 onwards. The Goldman Sachs swaps, signed in 2000 and 2001, reduced the country’s foreign- denominated debt in euro terms by 2.37 billion euros and lowered debt as a proportion of GDP to 103.7 percent from 105.3 percent, according to a Feb. 21 statement by Goldman Sachs.

7-- Fed's QE policy causing 'distortions' and 'problems', Reuters

Excerpt: The head of Brazil's central bank said on Thursday that the U.S. Federal Reserve's latest plan to lower domestic borrowing costs and jumpstart the ailing economy would cause further "distortions" in world markets and complicate his country's efforts to stem the rise of its currency....

Speaking to reporters after an event at the University of Chicago's Booth School of Business, Henrique Meirelles said the Fed's effort to drive interest rates lower through a policy of quantitative easing -- or "QE" for short -- was having "negative consequences for other countries," including his own.

"QE creates excessive liquidity that flows over to countries like Brazil," Meirelles said. "Definitely, for Brazil it does create a problem and Brazil will present proposals in that regard to several countries -- the U.S. and China -- to reach a different agreement not to generate so many distortions."

8--QE2 is about asset prices, not the economy, Gavyn Davies, FT

Excerpt: Clearly, the fuss is mostly about asset prices. The announcement of QE2 has broken new ground not so much in its initial quantum, but in the fact that the Fed is willing to embark on this unconventional programme in the absence of any obvious financial or economic emergency. In fact, it has been willing to do so in the face of recent economic data which are definitely not indicative of a double dip in the economy. The ISM figures released in the past few days suggest that the economy may re-accelerate in the current quarter, despite the Fed’s insistence that the recovery remains disappointingly slow....

commodity and equity prices have risen sharply, by 16 per cent and 11 per cent respectively. These developments are all consistent with a belief that the Fed is intent on reflating the US economy, and that it will succeed in doing so.

Probably the oldest piece of advice in asset management is “don’t fight the Fed”. It usually works. If the economy grows moderately in coming months, while the Fed steadily injects money into the financial system, risk assets could benefit further.

9--Bank of America Edges Closer to Tipping Point, Jonathan Weil, Bloomberg

Excerpt: It was only last April that Bank of America Corp. was making fools out of the doomsayers who had called for its nationalization a year earlier. Taxpayers had gotten their bailout cash back. Investors who bought its shares at the bottom were making a killing. Government leaders lauded the company’s rescues, both of them, as a great success.

Now the bank may be on the verge of trouble again. Its stock has fallen 41 percent since April 15. Mortgage-bond investors are demanding untold billions of dollars in refunds. The foreclosure fiasco is metastasizing...

Judging by its shrinking stock price, though, investors are acting as if Bank of America is near a tipping point.... the market is saying there’s a $96.8 billion hole in Bank of America’s balance sheet....

The only certainty is there is none, aside from the knowledge that Bank of America’s top executives have no idea what goes on inside the bowels of their company. For all we know the stock could double, or be a donut. The fate of the financial system hangs in the balance. Once again, we’re all on the hook.

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