Saturday, November 13, 2010

Weekend Links

1--Greece, Ireland and Portugal have "virtually lost access to capital markets, Bloomberg

Excerpt: European Central Bank President Jean-Claude Trichet is the buyer of only resort as the euro area’s bond market melts down.

Just six months after he threw out his rule book to prevent Greece’s debt crisis from splintering the euro area, the 67-year old Frenchman may again be the only policy maker able to prevent the collapse in Irish and Portuguese bonds from spreading. That may require him to ignore opposition from Bundesbank President Axel Weber to the ECB’s bond-buying program and expand purchases of sovereign assets, according to Citigroup Inc. and Royal Bank of Scotland Group Plc.

The pressure on the Frankfurt-based ECB reflects its status as the only institution in the 27-nation European Union able to act fast enough to placate bondholders. The premium investors charge to hold Irish and Portuguese debt over German bunds reached records yesterday and the euro today fell to a six-week low against the dollar....

With Greece, Ireland and Portugal “now having virtually lost access to capital markets,” Cailloux said the ECB must “extend dramatically” its bond purchases. He called on it to buy Spanish assets to limit contagion and spend an additional 100 billion euros by the beginning of next year. So far, the ECB has spent a total of 64 billion euros.

2--Home Values Near Unprecedented Decline as Hints of Stabilization Wane in Third Quarter,

Excerpt: Percentage of Homeowners Underwater Reaches New Peak; Length and Depth of Housing Downturn Approach Depression-Era Declines According to Q3 2010 Zillow® Real Estate Market Reports.

The United States housing market continued its long decline in the third quarter with home values falling for the 17th consecutive quarter, according to Zillow Real Estate Market Reports(1). With home values 25 percent below their June 2006 peak, the current housing downturn is approaching Great Depression-era declines, when home values fell 25.9 percent in five years.

3--Government campaigns to avoid EU financial bailout, Irish Times

Excerpt: THE GOVERNMENT is campaigning to avert the threat of being forced to seek emergency fiscal aid from the EU authorities as it battles a drastic loss in investor confidence.

Market pressure eased slightly yesterday in response to an attempt by five EU finance ministers to boost the confidence of euro zone investors, but Irish and European officials remain very apprehensive about a record spike in the Government’s borrowing costs.

Three sources familiar with ongoing European scrutiny of Ireland’s plans said there is concern to ensure the Government manages to pass the budget and demonstrate to the markets it is executing the promised measures. They also acknowledged worries that the €45 billion bank bailout bill might rise....

Two well-placed sources told The Irish Times , however, that Irish officials have been involved in ‘‘technical’’ discussions about the procedures to be followed in the event of any aid application being made to the European Financial Stability Facility (EFSF). Such discussions have come amid informal contact between Brussels, Berlin and other capitals to assess their readiness to activate the €750 billion rescue fund.

4--Axis of Deflation, Paul Krugman, New York times

Excerpt: The basic situation in today’s world isn’t mysterious: we’re in the midst of a deleveraging crisis, in which those who ran up large debts during the Great Moderation are being forced to pay them down, rapidly. The trouble with this situation is that someone has to make up for the decline in debtors’ spending, or the world will be pushed into a deflationary slump. Fiscal expansion could do the job – and no, it’s not absurd to say that the solution to a problem caused by some actors taking on too much debt involves having other actors take on debt. Monetary policy can also help; but conventional monetary policy is at its limit, so expansion has to take unconventional forms.

But almost the whole world has turned against doing anything that might actually help. Fiscal policy has been killed by the Pain Caucus; and now they’re coming for monetary policy. China’s predatory policies are hurting everyone else — but somehow Ben Bernanke has become global enemy #1.

5--Ireland Stirs Specter of EU Default, Wall Street Journal

Excerpt: European leaders' pledge that current bondholders will be spared bailout costs briefly eased fears that Ireland's financial malaise will soon spread to the continent's other weak economies, but the reassurance underscored the fact that Europe's debt crisis is still smoldering months after it was believed to be contained....

As officials seek to calm nerves about Ireland, investors are anxious about what lies ahead. While Greece, Ireland and Portugal represent about 5% of the euro-zone economy, policy makers worry that the crisis could spread to Italy and Spain, the euro-zone's third- and fourth-biggest economies after Germany and France. Such a scenario would pose serious challenges for the euro zone and raise questions about the durability of the common currency.

"It is the contagion that is the most worrying," says Nick Matthews, senior European economist at Royal Bank of Scotland Group PLC in London. "There are some signs the problems are beginning to affect Europe's larger economies."

Ireland's descent into crisis comes after markets believed early this year that the country had made the right moves to meet its fiscal challenges even as Greece slid deeper into trouble. But the scale of Ireland's banking problem—now at as much as €50 billion ($69 billion)—has surged in the past few months, sharply changing investor perceptions....Mr. Lenihan earned praise a year ago for making the right fiscal moves early in the crisis, but the markets have grown more doubtful about Ireland's ability to fund itself. The country's deficit, at 32% of gross domestic product, is more than 10 times the euro-zone ceiling.

6--The GOP's Plan to Dismantle Wall Street Reform, Mother Jones

Excerpt: Already a power struggle has broken out between two GOP congressmen, Spencer Bachus of Alabama and Ed Royce of California, to claim the chairman's gavel when the Republicans assume control of the House in January. That Royce is challenging Bachus at all shows the jostling underway to take power in the upcoming 112th Congress. Bachus, of course, is the obvious choice to become chairman, having served as the financial services committee's ranking member. Royce, meanwhile, ranks fourth among Republicans on the committee.

While both men have downplayed the drama for winning the gavel, there's plenty at stake here. For Bachus, dumped unceremoniously from the GOP team that took part in crucial bailout negotiations in 2008, winning the chairmanship would mark a return to the top financial seat in his party. A Royce victory, leapfrogging as he would two other Republicans on the committee, would swiftly launch him into upper rungs of House Republican leadership.

For consumer advocates and pro-reform types, there's no favorite in the Bachus-Royce race. Both are freemarket-loving lawmakers who want to dismantle, if not wipe out altogether, the new financial regulatory reform bill before it's even drawn first breath.

7--Neoliberal Economists Agonistes, Grasping reality with both hands, Bradford Delong

Excerpt: What we did believe? We believed that the Federal Reserve could handle whatever financial crisis the markets could throw at it. We believed that the Federal Reserve had the policy tools, the risk management skills, and the incentives to firewall the real economy from financial dislocations, and to clean up whatever financial messes were left behind. There were solid reasons for these beliefs: they were called 1987, 1991, 1997, 1998, and 2001. In all of those episodes--some of them involving financial losses much greater than those of the initial subprime mortgage crisis--the Federal Reserve had successfully firewalled the real economy off from financial turmoil.

Once we had concluded that the Federal Reserve had the tools and the competence to absorb financial shocks, the jaws of the trap snap shut. Leverage then appears to be a positive good rather than a danger. Why? Because if the past two centuries of financial market history prove anything, it is that the markets are woefully short of patent capital willing to bear risks. The financial rich are overwhelmingly the patient risk-bearers. The financial poor are those who sought safety, or who were unwilling or unable to hold their positions and wait for fundamentals to reassert themselves. Leverage then becomes a way of taking the money of the risk-averse of whom the market has too many--for that is what low long-term returns on "safe" portfolios tell us--and putting it too work in the hands of the too-few who will use it to take the long-term risks that the market, historically, has always handsomely rewarded. And financial sophistication becomes a way of concentrating and amplifying the rewards of risk-bearing to call forth additional risk-bearing capital to bolster the numbers of the too-few.

The argument is bullet-proof and correct--as long as Greenspanism is true doctrine, as long as the Federal Reserve does in fact have the policy tools, the risk management skills, and the incentives to firewall the real economy from financial dislocations, and to clean up whatever financial messes were left behind.....But "captured" is the wrong word. "Trapped" is much better. And not trapped by the efficient market hypothesis. Trapped, instead, by confidence in modern central banking.

8--Fix the Economy or Else ...Mark Weisbrot,

Excerpt: By now it is clear to most analysts of the United States’ midterm election that the economy played a huge role in the Democrats’ losses. It is also pretty clear that the vote was a protest vote by people reacting to economic troubles, rather than an attitudinal change in the electorate towards a conservative political agenda.

This can be seen from both pre-election polling data and exit polling. For example, 58 percent of voters said that they were “trying to send a message about how dissatisfied they are with things in Washington.” But voters were more likely to agree with Democratic positions on Social Security, trade policy and other issues. This is despite the fact that an “enthusiasm gap” lowered Democratic turnout....

Barring unforeseen circumstances such as a steep decline in the dollar (which would boost the U.S. economy by reducing imports and increasing exports), the next two years of the U.S. economy do not look good. Even the White House is projecting more than 8 percent unemployment in 2012. If President Obama and the Democrats decide to find common ground with the Republicans on deficit reduction, it would likely make the economy even weaker....

The latest conventional wisdom is that another, more adequate stimulus package is off the table now that the Republicans control the House. But the President and his party had better find a way around that. At the very least they would have to fight very hard for what is needed – as they did not do in the last two years – and make it extremely clear that Republican obstruction is the obstacle to economic recovery. Otherwise, the most likely result in 2012 will be a repeat of what we just saw – only with more losses for the Democrats, possibly including the presidency.

9--CFR Report Urges Major Afghanistan Drawdown,

Excerpt: While admitting their previous support for President Obama’s massive December 2009 escalation of the Afghan War, the Council on Foreign Relations today released a report calling for a major scaling back on the conflict, citing the lack of progress, enormous costs and political unpopularity of the nearly decade-long war.

The report, penned by a task force headed by former Deputy Secretary of State Richard Armitage, urged the president to take a clear picture of the war in his December review and, barring unforseen progress, should start removing large numbers of troops from the nation.

“We ought to not wait until July 2011 to change directions,” warned Armitage, citing the promised drawdown date that the administration has already disavowed on several occasions, adding that “absent a much better situation in Pakistan, we cannot prevail in Afghanistan.”

10--Municipal Bond Market Shudders, New York Times

Excerpt: Concern over the increasingly strained finances of states and cities and a growing backlog of new bonds for sale overwhelmed the market last week. After performing so well for so long, munis and funds that invest in them fell hard. One big muni fund, the Pimco Municipal Income Fund II, for instance, lost 7.5 percent. The fund is still up 6.75 percent so far this year.

While the declines were relatively small given the remarkable gains in these bonds over the last two years, the slump was swift enough to leave investors wondering if this was a brief setback or the start of something worse. For months, some on Wall Street have warned that indebted states and cities might face a crisis akin to the one that brought Greece to its knees.

But the big question confronting this market is how state and local governments will manage their debts. Many are staggering under huge pension and health care obligations that seem unsustainable...

California, for example, will have to sell nearly $14 billion of debt into the falling market this month, because of its record delay in getting a budget signed this year. The warnings keep coming. On Friday, Fitch, the credit ratings agency, issued a report saying that ratings downgrades for municipal bonds outnumbered upgrades for the seventh consecutive quarter....

The reason for scarcity of tax-exempt bonds has been, in part, the Build America Bonds program, created as part of the fiscal stimulus program. That federally subsidized program is scheduled to expire at the end of this year, so states and cities have been rushing to take advantage of it.

11--Will the Fed Scale Up QE2?, Tim Duy, Fed Watch

Excerpt:...households are still fundamentally challenged relative to five years ago. Housing markets remain a mess, net worth has been shredded, etc. And these events appear to have made something of a permanent mark on consumer psychology. Witness as retailers rush to get the jump on the holiday shopping season, ratcheting up discounts amid worries that consumers remain frugal and more discerning about their spending.... is importance to recognize that the relative challenges still facing households - namely a loss of asset values and the access to credit those values provided - is more a story of why spending did not quickly revert to trend, not a reason to believe that spending cannot be maintained along its current anemic trend...

...the recent flow of data does little to convince me that the US economy is set to grow much faster than potential....the US economy did not experience a V-shaped recovery, not even close. And I don't see h ow you get a V-shaped anything at this point. Traditionally, employment would rocket up on the back of inventory correction - which would fuel factory rehires - and housing. But, like in the wake of the 2000 recession, the lost manufacturing jobs appear to be permanent, and housing is...well, that story has been told a thousand times at this juncture.

In this narrative, we simply need dramatically faster growth to relieve the stress on the labor market, not to mention to stave off deflationary pressures....

But we shouldn't kid ourselves. Flooding the market with money is dangerous business. It risks distorting prices and capital allocations. We simply don't know where the money will wash up. I know that is in vogue to believe there is a nice, obvious story that links an increase in the money supply to an increase in nominal GDP, but that only works on paper. In the real world, the paths between money and output and prices are complicated. The ultimate composition of aggregate demand matters. It matters a lot - distortions have consequences.(Duy is always a "must read")

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