Friday, December 30, 2011

Weekend links

1---Keynes Was Right, Paul Krugman, NY Times via economist's view

Excerpt: “The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as FDR was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.

Unfortunately, in late 2010 and early 2011, politicians and policy makers in much of the Western world believed that they knew better, that we should focus on deficits, not jobs, even though our economies had barely begun to recover... And by acting on that anti-Keynesian belief, they ended up proving Keynes right all over again.

In declaring Keynesian economics vindicated ... the real test ... hasn’t come from the half-hearted efforts of the U.S. federal government to boost the economy, which were largely offset by cuts at the state and local levels. It has, instead, come from European nations like Greece and Ireland that had to impose savage fiscal austerity as a condition for receiving emergency loans — and have suffered Depression-level economic slumps, with real GDP in both countries down by double digits.

This wasn’t supposed to happen, according to ... the Republican staff of Congress’s Joint Economic Committee ... report titled “Spend Less, Owe Less, Grow the Economy.” It ridiculed concerns that cutting spending in a slump would worsen that slump, arguing that spending cuts would improve consumer and business confidence, and that this might well lead to faster, not slower, growth.

They should have known better...

Now, you could argue that Greece and Ireland had no choice about imposing austerity ... other than defaulting on their debts and leaving the euro. But another lesson of 2011 was that America did and does have a choice; Washington may be obsessed with the deficit, but financial markets are, if anything, signaling that we should borrow more. ...

The bottom line is that 2011 was a year in which our political elite obsessed over short-term deficits that aren’t actually a problem and, in the process, made the real problem — a depressed economy and mass unemployment — worse.

The good news, such as it is, is that President Obama has finally gone back to fighting against premature austerity — and he seems to be winning the political battle. And one of these years we might actually end up taking Keynes’s advice, which is every bit as valid now as it was 75 years ago.

2--The Over-Valued Dollar as Class War, CEPR

Excerpt: ....The article shows clearly how the over-valued dollar that was deliberately engineered by Robert Rubin in the late 90s has put downward pressure on wages of large segments of the U.S. workforce. With the dollar having reversed most of its gains from the 90s, U.S. manufacturing wages can again be competitive with wages in China and other developing countries. Further declines in the dollar will allow manufacturing workers to get higher wages and create more jobs.

Most professionals (doctors, lawyers, economists etc.) are largely protected (by policy) from the sort of competition that manufacturing workers face. For this reason they are likely to benefit from a higher valued dollar since it means that they can get cheaper manufacturing goods and pay less for overseas vacations.

3--Weekly Initial Unemployment Claims increase to 381,000, CalculatedRisk

Excerpt: The DOL reports:

In the week ending December 24, the advance figure for seasonally adjusted initial claims was 381,000, an increase of 15,000 from the previous week's revised figure of 366,000. The 4-week moving average was 375,000, a decrease of 5,750 from the previous week's revised average of 380,750.

4--Overnight Borrowing From ECB Highest Since Feb, Nasdaq

Excerpt: Euro-zone banks' overnight borrowing from the European Central Bank jumped Thursday to a level unseen since early this year, while their deposits remained close to the record levels hit earlier this week.

Banks borrowed EUR17.307 billion from the ECB Thursday, up sharply from EUR4.321 billion Wednesday, the ECB said Friday. The last time their borrowing exceeded the EUR17 billion mark was in late February.

Banks, meanwhile, deposited EUR445.683 billion with the ECB, the ECB said Friday, up from EUR436.583 billion Thursday. Deposits hit an all-time high of EUR452.034 billion earlier this week after the ECB's first ever offer of a three-year refinancing operation last week.

The ECB's Governing Council embarked on several liquidity boosting measures at its last rate meeting in December to prevent a liquidity crunch from developing into a credit crunch. Money supply data that the ECB published Thursday showed that lending growth to the private sector slowed sharply in November from a year earlier and the amount lent fell from the previous month for the first time since January 2010.

The time of year may also be a reason for banks relying heavily on the ECB's overnight facilities as they need to meet certain capital requirements at the end of the year.

5--NY Fed: New Dollar Swap Facility Borrowings Total $42.359 Bln, WSJ

Excerpt: New foreign central-bank borrowings from the Federal Reserve surged again in the latest week, rising by $42.359 billion.

The Federal Reserve Bank of New York said Thursday that total borrowing from its dollar liquidity swap facility stood at $99.823 billion in the week ended Wednesday, compared to $62.599 billion the week before.

The Fed's lending facility provides dollar loans to the European Central Bank, as well as the Bank of Canada, Bank of England, Bank of Japan and the Swiss National Bank.

As it has been in weeks past, the ECB was the main driver for the increase. It borrowed an additional $33.004 billion, leaving it with $85.437 billion borrowed.

The Bank of Japan borrowed $9.035 billion in new money, and the Swiss National Bank took $320 million in new loans.

The dollar swap facility was brought back last year as tensions began to rise in Europe due to the government debt crisis holding sway over that region. Over recent weeks, dollar borrowing from the Fed has been rising. The Fed brought the facility back to ensure the global financial system doesn't run short of dollar liquidity.

6--Libor Gap Hints at Debt Crisis Money-Market Freeze: Euro Credit, SF Gate

Excerpt: The gap between the highest and the lowest rates that banks say they can borrow from each other in dollars is close to a 2 ½-year high, a sign Europe's failure to end the debt crisis is straining the financial industry.

The divergence from reported fixings by the 18 banks contributing to the three-month London interbank offered rate reached 28 basis points yesterday, within two basis points of the widest since May 2009. Libor for three-month loans climbed to 0.579 percent yesterday, the most since July 2009, even as central banks injected cash into the market.

"The interbank market remains broken," said Richard McGuire, a senior fixed-income strategist at Rabobank International in London. "We used to say during the financial crisis a few years ago that interbank rates are rates at which banks won't lend to each other, and sadly that's still the case today. The amount of peripheral government debt banks hold raises questions about counterparty risks."....

"The main problem in the interbank market is not a lack of liquidity, but a lack of trust," said Christoph Rieger, the head of fixed-income strategy at Commerzbank AG in Frankfurt. "There are no central bank tools that would force banks to extend credit lines among themselves. The euro-area sovereign crisis has deepened concern about bank balance sheets."

Six central banks, led by the Federal Reserve, agreed on Nov. 30 to make it cheaper for banks to borrow dollars in emergencies. They also created temporary programs to provide funds in any major currency. The European Central Bank started offering banks unlimited cash for three years on Dec. 22.

The ECB lent 523 banks a record 489 billion euros ($633 billion) last week under the program to keep credit flowing to the 17-nation euro economy during the sovereign debt crisis. The money was lent at the ECB's 1 percent benchmark rate.

The central bank's balance sheet soared to a record 2.73 trillion euros after it lent financial institutions more money last week to keep credit flowing during the debt crisis, it said in a statement yesterday....

Even with the ECB steps, there are few signs that banks are lending to each other.

The ECB said yesterday euro-area banks parked 452 billion euros with the Frankfurt-based central bank on Dec. 27 on an overnight basis, the most since the euro was introduced in 1999 and up from the previous record of 412 billion euros. With an overnight rate of 0.25 percent, it means banks would rather incur a loss than lend it for more elsewhere....

European leaders have held 15 summits in two years and produced five plans that so far have failed to convince investors the sovereign-debt crisis begun in 2009 will not be a risk to global financial markets. Falling prices for European sovereign debt led to the breakup of Franco-Belgian Dexia SA, once the world's largest municipal lender, and the failure of New York-based futures brokerage MF Global Holdings Ltd.

Fresh Capital

The European Banking Authority demanded this month that the region's banks raise 114.7 billion euros of fresh capital to withstand writedowns on Greek bonds and other sovereign debt.

"The intensification of the euro-area sovereign debt crisis went hand in hand with banking-sector weakness," said the BIS Quarterly Review published on Dec. 11. "While bank funding problems had manifested themselves throughout the year, policy makers and market participants increasingly turned their attention to issues of bank solvency."

7--Financial market credit tightened at year end: Fed, Reuters

Excerpt: Banks tightened the screws on lending to major financial market participants in recent months, the U.S. Federal Reserve said on Thursday, reflecting concerns about Europe's banking crisis.

The central bank's survey of senior credit officers did not mention Europe directly, but indicated a "broad but moderate tightening of credit terms applicable to important classes of counterparties over the past three months."

Large financial firms have been under pressure from worries that Europe's political deadlock may eventually lead to some type of sovereign debt default, saddling institutions with massive losses.

The Fed said tighter credit terms were especially evident for hedge funds, real estate investment trusts and non-financial corporations.

"These responses reflect an apparent continuation and intensification of developments already in evidence in the last survey in September," the report said.

Since then, Europe's crisis has engulfed financial markets in a fear of a possible repeat of the fall of 2008, when massive investment bank failures sent an already weak economy into a nose dive.

The European Central Bank's latest attempt to stem the crisis, a 489-billion-euro program of cheap three-year loans for banks, has managed to bring down interbank borrowing costs for now. But few analysts see the situation as sustainable.

"I expect (banks) to keep the money in deposits ... because they fear they can run short of liquidity and that they cannot face a bond redemption, (while) deposits are shrinking so they need higher liquidity buffers," ING rate strategist Alessandro Giansanti said.

Indeed, despite being awash with liquidity, banks still appear distrustful and prefer to deposit their money at the ECB's overnight facility rather than lend to each other.

8--(From the archives) A Short History of Bubblenomics, Mike Whitney, Counterpunch

Excerpt: The Fed can induce spending by lowering interest rates, easing credit or buying bonds, but the banks do the heavy lifting. That’s where the zillions in leverage are created via off-balance sheets operations, repo transactions and derivatives contracts. These asset-pumping operations remain largely concealed from the public, so no one really knows what’s going on. That’s why the connection between money supply and financial asset prices is so tenuous and misleading, because the banks create money that doesn’t appear in the data. That’s what off-balance sheets operations are all about. They generate unknown amounts of credit which stimulates activity, but remains invisible. The printing presses have essentially been handed over to private industry. Here’s how it all works according to Independent Strategy’s David Roche

"The reason for the exponential growth in credit, but not in broad money, was simply that banks didn’t keep their loans on their books any more ? and only loans on bank balance sheets get counted as money. Now, as soon as banks made a loan, they "securitized" it and moved it off their balance sheet.

There were two ways of doing this. One was to sell the securitized loan as a bond. The other was "synthetic" securitization: for example, using derivatives to get rid of the default risk (with credit default swaps) and lock in the interest rate due on the loan (with interest-rate swaps). Both forms of securitization meant that the lending bank was free to make new loans without using up any of its lending capacity once its existing loans had been "securitized."

So, to redefine liquidity under what I call New Monetarism, one must add, to the traditional definition of broad money, all the credit being created and moved off banks’ balance sheets and onto the balance sheets of nonbank financial intermediaries. This new form of liquidity changed the very nature of the credit beast. What now determined credit growth was risk appetite: the readiness of companies and individuals to run their businesses with higher levels of debt." ("The Global Money Machine", David Roche, Wall Street Journal)

The Fed is not the main culprit in this new paradigm where banks and shadow banks stealthily add to the money supply without any oversight. The problem is the lack of regulation. There needs to be strictly enforced guidelines on the amount of leverage a bank can use and–more importantly–any financial institution that acts like a bank must be regulated like a bank. (Dodd-Frank reforms don’t fix this problem.)

9--Spain to Cut Spending, Boost Taxes, Bloomberg

Excerpt: Spanish Prime Minister Mariano Rajoy announced 14.9 billion euros ($19.3 billion) of deficit cuts, with the government’s finances in worse shape than expected and the budget shortfall exceeding European Union forecasts.

The deficit this year will reach 8 percent of gross domestic product, requiring tax increases of 6 billion euros and spending reductions of 8.9 billion euros, spokeswoman Soraya Saenz de Santamaria said at a press conference in Madrid. Spain will finish the year with a budget gap twice that forecast for Italy and more than four times Germany’s shortfall.

The stepped up austerity to avoid a bailout may derail Rajoy’s aim of trimming the country’s rising debt while spurring a shrinking economy that’s being choked by Europe’s highest unemployment rate. Joblessness of 22 percent helped drive former Prime Minister Jose Luis Rodriguez Zapatero’s Socialist Party from power in the Nov. 20 elections, when Rajoy won the biggest parliamentary majority in three decades....

Higher Taxes

The government plans to raise tax on income, interest on savings and on high-value homes and maintain a freeze on civil servant wages. Pensioners will receive a 1 percent increase, a move that will cost 1.4 billion euros, and the government will also maintain a special 400-euro a month unemployment benefit, a popular measures in a country where almost one in four people is jobless.

10--The Big Lie is the gift that keeps giving, The Big Picture

Excerpt: No. 1. Big Whopper--- “The financial crisis was caused not by Wall Street but by the federal government, namely Fannie Mae (FNMA) and Freddie Mac.”

This is a convenient argument made by conservatives trying to gut regulation of Wall Street (or attack Freddie “consultant” Newt Gingrich), one that draws its force from Fannie and Freddie’s role as a piggy bank for ex-officials from both parties over the last 20 years. The two institutions performed abominably and attempted to conceal their mistakes and thwart regulators; so far, six of their former executives have been sued by the Securities and Exchange Commission.

But the abuses of Fannie and Freddie did not cause our woes. David Min of the Center for American Progress makes mincemeat of Peter Wallison, a lonely dissenter on the Financial Crisis Inquiry Commission who has loudly and fallaciously insisted that the government’s affordable housing policies lie at the root of the entire financial crisis. Min points out that bubbles in commercial real estate and consumer credit developed independent of housing, and that the crisis extended around the globe to regions and institutions with no U.S. residential housing exposure. Besides, mortgages from private lenders defaulted at higher rates than those from Fannie and Freddie, which got into the securitization racket much later and at lower levels than Wall Street, the true source of the mess. This week’s $335 million settlement in the Countrywide case, where private lenders preyed on blacks and Hispanics, is a reminder that Fannie and Freddie were hardly the only miscreants and shouldn’t be immortalized as the direct cause of the crisis.

Economics is now divided into two camps: Those who see the world as it is, and those who see the world as they want it to be.

11--Liquidity Returns To Flood The ECB Basement, WSJ

Excerpt: The European Central Bank turned the fire hose on the euro-zone banking system last week. The fire is still burning, but the liquidity has simply returned to flood the ECB’s basement — at least for the time being.

The amount of money parked by euro-zone banks in the ECB’s 0.25% deposit facility surged to another new record of €452.03 billion Tuesday, up from €411.81 billion over the Christmas break and well above the previous record high of €384 billion.

Use of the deposit facility is frequently seen as an indicator of stress in the financial system, but the latest surge probably doesn’t reflect any deterioration in the situation since last week. “This is just a mirror image of the liquidity that the ECB is pushing into the system,” said Jacques Cailloux, chief euro-zone economist at Royal Bank of Scotland in London.

Last week, banks had taken a massive €489 billion from the ECB’s first-ever three-year lending operation. In an interview with the German magazine Stern, published Wednesday, Deutsche Bundesbank President Jens Weidmann described the operation as a sort of bridging loan for banks “who will only be on a sound footing again when the sovereign debt crisis is overcome.”

Mr. Weidmann again ruled out an expansion of outright government bond purchases by the ECB to tackle the debt crisis, saying that, “Over time, financing public debts with the money printing press would burden the modest saver and the person with low income.”

12--America’s Financial Leviathan, Bradford DeLong, Project Syndicate

Excerpt: In 1950, finance and insurance in the United States accounted for 2.8% of GDP, according to US Department of Commerce estimates. By 1960, that share had grown to 3.8% of GDP, and reached 6% of GDP in 1990. Today, it is 8.4% of GDP, and it is not shrinking. The Wall Street Journal’s Justin Lahart reports that the 2010 share was higher than the previous peak share in 2006.

Lahart goes on to say that growth in the finance-and-insurance share of the economy has “not, by and large, been a bad thing....Deploying capital to the places where it can be best used helps the economy grow...”

But if the US were getting good value from the extra 5.6% of GDP that it is now spending on finance and insurance – the extra $750 billion diverted annually from paying people who make directly useful goods and provide directly useful services – it would be obvious in the statistics. At a typical 5% annual real interest rate for risky cash flows, diverting that large a share of resources away from goods and services directly useful this year is a good bargain only if it boosts overall annual economic growth by 0.3% – or 6% per 25-year generation.

....well-functioning financial systems match large, illiquid investment projects with the relatively small pools of money contributed by individual savers who value liquidity highly. There has been one important innovation over the past two generations: businesses can now issue high-yield bonds. But, given the costs of the bankruptcy process, it has never been clear why a business would rather issue high-yield bonds (besides gaming the tax system), or why investors would rather buy them than take an equity stake.

Third, improved opportunities to borrow allow one to spend more now, when one is poor, and save more later, when one is rich. Households are certainly much more able to borrow, thanks to home-equity loans, credit-card balances, and payday loans. But what are they really buying? Many are not buying the ability to spend when they are poor and save when they are rich, but instead appear to be buying postponement of the “unpleasant financial retrenchment” talk with the other members of their household. And that is not something you want to buy.....

Overall, however, it remains disturbing that we do not see the obvious large benefits, at either the micro or macro level, in the US economy’s efficiency that would justify spending an extra 5.6% of GDP every year on finance and insurance. Lahart cites the conclusion of New York University’s Thomas Philippon that today’s US financial sector is outsized by two percentage points of GDP. And it is very possible that Philippon’s estimate of the size of the US financial sector’s hypertrophy is too small.

Why has the devotion of a great deal of skill and enterprise to finance and insurance sector not paid obvious economic dividends? There are two sustainable ways to make money in finance: find people with risks that need to be carried and match them with people with unused risk-bearing capacity, or find people with such risks and match them with people who are clueless but who have money. Are we sure that most of the growth in finance stems from a rising share of financial professionals who undertake the former rather than the latter?

13--Iraq’s tragic encounter with US imperialism, James Cogan, WSWS

Excerpt: The withdrawal of American combat troops from Iraq after nearly nine years of military occupation has been accompanied by a surge in sectarian tensions and violence that threatens to escalate into civil war. Following the explosions that ravaged Baghdad last week, there have been further attacks on government buildings in the capital and bombings and killings in the volatile cities of Fallujah, Mosul and Kirkuk.

The national unity government made up of rival sectarian- and ethnic-based factions has collapsed. Prime Minister Nouri al-Maliki, the representative of the dominant Shiite political bloc, has issued an arrest warrant against Sunni Vice President Tariq al-Hashemi, accusing him of directing sectarian terrorism. Sunni parties are boycotting the parliament and their ministers have walked out of the cabinet. They have accused Maliki of seeking to establish a dictatorship, and their leader, Iyad Allawi, has called for intervention by the US, Turkey and the Arab League.

There can be no doubt that the US State Department, the CIA and other intelligence agencies, operating from the massive American embassy in central Baghdad, are active participants in the political crisis. The Obama administration and the US military agreed to remove all combat troops, as stipulated in the Status of Forces agreement reached in 2008, only after they failed to bully the Iraqi regime into allowing thousands of troops to remain under a blanket exemption from prosecution under Iraqi law. None of the Iraqi parties could support such a demand because of massive popular hostility toward the US occupation.

Events are now beginning to spiral out of control. Hashemi has taken refuge in the autonomous Kurdish region in the north and the Kurdish establishment have rejected Maliki’s demands that they hand over the Sunni official. The Sunni leadership of Anbar province, where Fallujah is located, has joined with the majority Sunni provinces of Diyala and Salahaddin in announcing that it wants the same autonomous status as the Kurdish region.

Maliki declared Saturday that he would oppose the autonomy moves, warning that it would lead to “dividing Iraq and to rivers of blood.” Troops and militias loyal to the Shiite parties have deployed across Baghdad and are massing near other major cities such as Mosul. There is little doubt that Sunni militias are mobilising and that the Kurdish armed forces have been placed on alert.

Just two weeks ago, US President Barack Obama declared Iraq to be a country “that is self-governing, that is inclusive, and that has enormous potential.” In reality, a war fought on the most reactionary communalist lines is looming, potentially providing the pretext for some form of new US-led intervention in Iraq. The conspiracies, assassinations and bombings taking place all have the character of black operations intended to destabilise the country.

At least 40,000 American troops, backed by an array of aircraft, are currently based in Kuwait, Bahrain and elsewhere in the Middle East.

From the beginning, the US intervention in Iraq has had one primary aim: to ensure that its large oil and natural gas reserves were brought under US corporate domination and American military control. To achieve that end, the American occupation regime ruthlessly stoked sectarian and ethnic divisions to prevent the emergence of a unified movement among the Iraqi people against US imperialism.

The disbandment of the entire Iraqi Army and the illegalisation of Saddam Hussein’s Baath Party in the first weeks of the occupation were intended to disempower the largely Sunni Muslim ruling elite. Despite their close links to Iran, Shiite religious parties were elevated in place of their Sunni counterparts, providing they helped repress Iraqi Shiites who were organising to resist. The north of the country was handed over to a venal Kurdish elite as a private fiefdom in exchange for their provision of Kurdish forces to assist the US military.

At every point, sectarian violence was used to weaken the anti-occupation insurgency. The February 2006 bombing of the Shiite Askiriya shrine by unknown assailants was blamed on Sunni extremists and seized upon by the Shiite-dominated government and security forces to unleash a frenzy of killings throughout the suburbs of Baghdad. The US military stood by as thousands of Sunni men and boys were hideously tortured and their bodies dumped in the streets.....

The US occupation of the country has amounted to a conscious policy of sociocide—the destruction of the very fabric of a society. Formerly mixed suburbs have been transformed into sectarian enclaves, and the people have been traumatised by bitter memories of communal violence. The Iraqi population as a whole has been left to endure radioactive and other forms of contamination, dysfunctional water and electricity supplies, a ruined health and education system, and the loss of a large proportion of an entire generation of men. Well over one million people were killed, with millions more wounded and still more millions turned into refugees.

Thursday, December 29, 2011

Today's links

Today's quote:  "Getting worse more slowly is not the same as getting better", Bradford DeLong UC Berkeley

Excerpt: The European Central Bank said overnight deposits from the region’s financial institutions increased to an all-time high.

Euro-area banks parked 452 billion euros ($591 billion) with the Frankfurt-based ECB yesterday, the most since the euro’s introduction in 1999 and up from the previous record of 412 billion euros a day earlier.

The ECB last week lent 523 banks a record 489 billion euros for three years to keep credit flowing to the 17-nation euro economy during the sovereign debt crisis. It lent the money at its benchmark rate of 1 percent. Banks are depositing excess cash back with the ECB at the overnight rate of 0.25 percent, incurring a loss rather than lending it at a better rate.

Barclays Capital estimates the three-year loans injected 193 billion euros of new money into the system, with 296 billion euros accounted for by maturing loans. Since the three-year loans started on Dec. 22, overnight deposits have jumped by 187 billion euros, suggesting banks are parking almost all the additional liquidity back with the ECB.

Excerpt: From the WSJ:

The Federal Reserve's Covert Bailout of Europe 

America's central bank, the Federal Reserve, is engaged in a bailout of European banks. Surprisingly, its operation is largely unnoticed here.

The Fed is using what is termed a "temporary U.S. dollar liquidity swap arrangement" with the European Central Bank (ECB). There are similar arrangements with the central banks of Canada, England, Switzerland and Japan. Simply put, the Fed trades or "swaps" dollars for euros. The Fed is compensated by payment of an interest rate (currently 50 basis points, or one-half of 1%) above the overnight index swap rate. The ECB, which guarantees to return the dollars at an exchange rate fixed at the time the original swap is made, then lends the dollars to European banks of its choosing.

Why are the Fed and the ECB doing this? The Fed could, after all, lend directly to U.S. branches of foreign banks. It did a great deal of lending to foreign banks under various special credit facilities in the aftermath of Lehman's collapse in the fall of 2008. Or, the ECB could lend euros to banks and they could purchase dollars in foreign-exchange markets. The world is, after all, awash in dollars.

The two central banks are engaging in this roundabout procedure because each needs a fig leaf. The Fed was embarrassed by the revelations of its prior largess with foreign banks. It does not want the debt of foreign banks on its books. A currency swap with the ECB is not technically a loan.

The ECB is entangled in an even bigger legal and political mess. What the heads of many European governments want is for the ECB to bail them out. The central bank and some European governments say that it cannot constitutionally do that. The ECB would also prefer not to create boatloads of new euros, since it wants to keep its reputation as an inflation-fighter intact. To mitigate its euro lending, it borrows dollars to lend them to its banks. That keeps the supply of new euros down. This lending replaces dollar funding from U.S. banks and money-market institutions that are curtailing their lending to European banks—which need the dollars to finance trade, among other activities. Meanwhile, European governments pressure the banks to purchase still more sovereign debt.

This Byzantine financial arrangement could hardly be better designed to confuse observers, and it has largely succeeded on this side of the Atlantic, where press coverage has been light. Reporting in Europe is on the mark. On Dec. 21 the Frankfurter Allgemeine Zeitung noted on its website that European banks took three-month credits worth $33 billion, which was financed by a swap between the ECB and the Fed. When it first came out in 2009 that the Greek government was much more heavily indebted than previously known, currency swaps reportedly arranged by Goldman Sachs were one subterfuge employed to hide its debts.

The Fed had more than $600 billion of currency swaps on its books in the fall of 2008. Those draws were largely paid down by January 2010. As recently as a few weeks ago, the amount under the swap renewal agreement announced last summer was $2.4 billion. For the week ending Dec. 14, however, the amount jumped to $54 billion. For the week ending Dec. 21, the total went up by a little more than $8 billion. The aforementioned $33 billion three-month loan was not picked up because it was only booked by the ECB on Dec. 22, falling outside the Fed's reporting week. Notably, the Bank of Japan drew almost $5 billion in the most recent week. Could a bailout of Japanese banks be afoot? (All data come from the Federal Reserve Board H.4.1. release, the New York Fed's Swap Operations report, and the ECB website.)

No matter the legalistic interpretation, the Fed is, working through the ECB, bailing out European banks and, indirectly, spendthrift European governments. It is difficult to count the number of things wrong with this arrangement.

First, the Fed has no authority for a bailout of Europe. My source for that judgment? Fed Chairman Ben Bernanke met with Republican senators on Dec. 14 to brief them on the European situation. After the meeting, Sen. Lindsey Graham told reporters that Mr. Bernanke himself said the Fed did not have "the intention or the authority" to bail out Europe. The week Mr. Bernanke promised no bailout, however, the size of the swap lines to the ECB ballooned by around $52 billion.

Second, these Federal Reserve swap arrangements foster the moral hazards and distortions that government credit allocation entails. Allowing the ECB to do the initial credit allocation—to favored banks and then, some hope, through further lending to spendthrift EU governments—does not make the problem better.

Third, the nontransparency of the swap arrangements is troublesome in a democracy. To his credit, Mr. Bernanke has promised more openness and better communication of the Fed's monetary policy goals. The swap arrangements are at odds with his promise. It is time for the Fed chairman to provide an honest accounting to Congress of what is going on.

Excerpt: Even after the European Central Bank doled out nearly half a trillion euros of loans to cash-strapped banks last week, fears about potential financial problems are still stalking the sector. One big reason: concerns about collateral.

The only way European banks can now convince anyone—institutional investors, fellow banks or the ECB—to lend them money is if they pledge high-quality assets as collateral.

Now some regulators and bankers are becoming nervous that some lenders' supplies of such assets, which include European government bonds and investment-grade non-government debt, are running low.

If banks exhaust their stockpiles of assets that are eligible to serve as collateral, they potentially could encounter liquidity problems. That is what happened this fall to Franco-Belgian lender Dexia SA, which ran out of money and required a government bailout.

"Over time it is certainly a risk," said Graham Neilson, chief investment strategist for Cairn Capital Ltd. in London. "If banks don't have assets good enough to pledge as collateral, they will not be able to tap as much liquidity...and this could be the end-game path for a weaker bank."

The ECB earlier this month moved to address the collateral shortages; Mario Draghi, the central bank's new president, announced it would accept a wider range of assets as collateral for ECB loans, which have become a primary source of funding for many European banks.

The looser rules, which will allow some corporate bonds to be used, kick in early next year, in time for banks to pledge the assets in exchange for three-year loans that the ECB will offer on Feb. 29.

Some bank executives, regulatory officials and other experts are optimistic that will largely solve the problem.

"The ECB is being much more generous. We think there's enough [collateral] to exceed European banks' funding needs for the next year," said Jacques Cailloux, chief European economist at the Royal Bank of Scotland Group.

In one sign that the ECB move has eased market strains, even if only modestly, Italian borrowing costs dropped sharply Wednesday as the country successfully auctioned more than €10 billion, or $13 billion, of short-term debt. Average yields on six-month bills were 3.251%, half that of an auction a month ago and even below those in October, although yields on 10-year benchmark bonds worryingly remained just below 7%. Last week, Italian banks borrowed more than €110 billion of the three-year ECB funds, some of which might have been used to purchase the country's sovereign bonds.

Other market watchers, however, remain concerned. In addition to fears that the banks might simply run out of eligible collateral, some bankers and regulators worry that the banks' growing reliance on "secured lending" will make it harder for the industry to return to its past practice of funding itself by issuing unsecured bonds. That could result in a permanent funding scarcity.

It is tough to tell how big a problem this is. European banks generally don't disclose how many assets they have on their balance sheets that would be eligible as collateral, either to pledge with the ECB or to package into "covered bonds," another increasingly popular type of secured lending, and aren't already earmarked for other purposes.

The Bank of England is among those ringing alarm bells. Officials are worried that the growing reliance on secured lending like "covered bonds," which are secured by mortgages or, in some cases, municipal loans that remain parked on the banks' balance sheets, has left increasing portions of bank assets "encumbered," or otherwise committed. That means they wouldn't be available to unsecured creditors if the bank collapsed.

"There are already market concerns about the degree to which banks' assets are 'encumbered'," the Bank wrote in its Financial Stability Report in December. "Higher levels of, or greater uncertainty about, encumbrance increase the probability of a creditor run, making the institution more vulnerable to liquidity risk.... It can lead to the emergence of adverse feedback loops, whereby funding-constrained banks seek to tap secured markets only to see their access to unsecured funding markets reduced further."

Officials also are nervous that some banks, particularly smaller ones, could exhaust their supplies of collateral that can be used for covered bonds or with the ECB, according to people familiar with the matter.

"Recent market intelligence suggests this is a growing concern for investors," partly because of the dearth of publicly available data, one person said.

The U.K.'s Financial Services Authority recently conducted a confidential survey of British banks to gauge the degree to which their assets are encumbered. The Bank of England is in the early stages of reviewing the data and hasn't yet reached any firm conclusions, said the people familiar with the matter.

Since this summer, it has been virtually impossible for banks to issue unsecured bonds, because investors view European banks as risky investments.

In the second half of 2011, European banks issued a total of about $80 billion of senior unsecured bonds, according to data provider Dealogic. That compares to $240 billion in the same period last year and $257 billion in 2009.

Banks have had to turn to other sources for funding. Banks in Spain, Italy and France, among others, have borrowed hundreds of billions of euros from the ECB on a short-term basis, posting items including government bonds—often from financially weak countries such as Greece and Ireland that helped precipitate the crisis—as collateral.

For longer-term financing, banks have been issuing covered bonds. European banks have issued about $334 billion of these bonds this year, up 8% from last year and 24% from 2009, according to Dealogic.

But there is a finite supply of mortgages and municipal loans that banks can bundle together for such bonds—and there are signs that it is running thin.

In some cases, banks are weighing new types of collateral to back covered bonds. Some smaller German banks, which are burning through their supplies of high-quality mortgages to use as collateral, are looking at using loans to small and medium-sized businesses to back their bonds instead.

"You are basically taking an asset class known as being plain vanilla and going back to more complex products," said a London-based bond executive at a major international bank.

Some banks have been engaging in financial gymnastics to come up with scarce collateral. A group of Italian banks, for example, last week got the Italian government to guarantee about €38 billion of newly created bonds, thereby making them eligible to serve as collateral for ECB loans.

Instead of selling the bonds to investors, however, the banks simply stashed the bonds on their own balance sheets.

The reason, according to multiple Italian bank executives: They were running out of normal collateral.

"The collateral of the Italian banks is very limited right at the moment," said an executive at an Italian bank, who added that he is optimistic that the ECB's looser collateral requirements will ease the problem in 2012.

Excerpt: Italy faces a crucial test tomorrow as the technocrat government of Mario Monti launches its first big auction of long-term bonds since a disastrous upset a month ago.

The outcome will set the tone for a string of debt sales through early 2012 that risk stretching the eurozone bond markets to breaking point.

The EU authorities are hoping commercial lenders will use last week’s flood of cheap liquidity from the European Central Bank to soak up southern European debt and bring yields back under control, starting with Italy’s €8.5bn (£7.1bn) sale of 10-year bonds today. The country must raise €440bn in debt in 2012, beyond the current fire-fighting power of Europe’s bail-out machinery.

The flight to safety exceeds the most extreme moments of the Lehman crisis in 2008. Although the picture may have been distorted by the Christmas holiday, it is clear large parts of Europe’s financial system remain under acute stress.

Excerpt: The dollar reasserted itself as the global reserve currency of choice in 2011, despite concerns about US debt.

Worries over borrowing in recent years have seen the dollar weakening, despite successive Treasury Secretaries repeating their mantra that the country has a "strong dollar policy". However, as a lack of safe-haven alternatives and a liquidation of risky assets unfolded, the US currency rallied sharply in the last few months of the year. The dollar index, which tracks the greenback against a basket of currencies, jumped by about 9pc from its lows earlier in the year.

Worries over eurozone sovereign debt prompted the dollar gains, as did the removal of the Swiss franc as an alternative safe haven currency in September....

The Japanese central bank was also forced to intervene this year, selling yen to protect its exporters. At the end of October, the bank sold $100bn (£64bn) worth of yen. However, dollar strength at the end of the year meant that the Japanese currency weakened against the dollar. As we enter 2012, City strategist expects the dollar and yen to continue to strengthen.

Excerpt: European banks are making great use of the ECB’s overnight deposit facility. Last night they parked $590 billion at the ECB breaking the record they had set the night before. They are clearly unwilling to lend to other European banks, highlighting the distrust and fear in the interbank marketplace. While the ECB’s lending initiative calmed the markets somewhat, it apparently has done nothing to free up the logjam blocking interbank lending.

The distrust on the streets is said to be growing also. Barroom gossip says that safe-deposit boxes are in a demand that borders on frenzy. They allow you to take your Euros and covert them into something of value (gold, Swiss Francs, etc.) and sock it away in a safe place.

Others are said to be buying property in London and elsewhere lest you awake one day and discover that your Euros have reverted to drachmas or lira.

Savvy bankers are said to be setting up personal and communal trusts domiciled in places like the Bahamas, the Caymans or the Isle of Jersey. Some banks are offering depository accounts denominated (and repayable) in alternate currencies like the dollar or the yen.

We think a Lehman-like event would most likely be triggered by a run on a bank or a series of banks. The scramble for currency (value) protection among the public could turn into that bank run in the same way that a crowd can instantly turn into a mob. Watch the money flows out of Greece and Italy very carefully. The pot continues to bubble

Excerpt:  I already wrote a big post about yesterday's SOPA markup day one. While we're moving forward on day two, I wanted to call out one key point that was really made clear by an amendment offered by Rep. Jared Polis late in the day yesterday, which hasn't received nearly enough attention. As you may recall, with the "manager's amendment" version of SOPA (i.e., SOPA 2.0), the "notice-and-shut off funding" section of the private right of action in Section 103 was removed. This was good, because we've seen how the notice-and-takedown provision of the DMCA has been widely abused. 

However, what most people missed was that the bill effectively sneaks this back into the bill in a much worse form in Section 105, which supposedly grants "immunity" to service providers for taking voluntary action to stop infringement. The true impact of this section was only made clear by Rep. Polis' attempt to limit it, as he highlighted how this broad immunity would likely lead to abuse. That's because this section says that anyone who takes voluntary action "based on credible evidence": basically gets full immunity. Think about what that means in practice. If someone sends a service provider a notice claiming infringement on the site under this bill, the first thing every lawyer will tell them is "quick, take voluntary action to cut them off, so you get immunity." Even worse, since this is just about immunity, there are no counternotice rules or anything requiring any process for those cut off to be able to have any redress whatsoever. 

This is scary. 

Excerpt: Key euro zone bank-to-bank lending rates fell for the fifth session running on
Wednesday, pushed down by a funding glut after banks took almost
half a trillion euros at the European Central Bank's first-ever
injection of 3-year cut-price loans.
    Euro zone banks received 489 billion euros last Friday in
the first of two opportunities to access this longer-term money
- operations the ECB hopes will encourage banks to unclog
lending to each other and then onto customers in spite of the
region's debt crisis.
    But despite being awash with liquidity, banks still appear
distrustful and prefer to deposit their money at the ECB's
overnight facility rather than lend to each other.
    Latest figures show banks deposited 452 billion euros at the
central bank -- a record high. Emergency overnight borrowing
also remained high at above 6 billion euros.
    The intensification of the euro zone debt crisis has left a
growing pack of banks virtually locked out of open funding
markets and reliant on the ECB. In response the ECB has already
reinstated some of its most potent crisis-fighting tools.
    Last week's bumper liquidity boost was the ECB's latest and
most dramatic effort to bolster banks' finances, while ECB
Governing Council member Ignazio Visco hinted in a weekend
newspaper interview that the bank could cut interest rates
further if the euro zone economy continues to decline.

Wednesday, December 28, 2011

Today's links

Excerpt: Use of the European Central Bank's overnight deposit facility reached a new, all-time high Monday, as euro-zone banks increasingly turned to the ECB as a safe-haven for extra funds.

Banks deposited EUR411.813 billion overnight Monday, up from EUR346.994 billion deposited overnight Thursday ahead of the Christmas holiday, ECB data showed Tuesday.

Monday night's deposit figure surpasses the previous all-time high record of EUR384.3 billion reached in June 2010.

The high level reflects ongoing distrust in inter-bank lending markets, where banks prefer using the low-risk ECB facility for excess funds rather than lending them to other banks.

The high deposit level also suggests markets aren't fully convinced that the ECB's massive long-term loan allotment last week is enough to fortify the currency bloc's banking sector. The central bank extended nearly half a trillion euros in long-term loans to euro-zone banks last week, hoping to ease fears of a new credit crunch as banks struggle to borrow from markets.

The ECB further said banks borrowed EUR6.131 billion from the ECB's overnight lending facility, compared to EUR6.341 billion borrowed Thursday.

When markets are functioning properly, banks only use the facility to the tune of a few hundred million euros overnight.

Excerpt: Consumer spending was tepid in November and a gauge of business investment fell for a second straight month, suggesting the economy lost some of its recent momentum.

Some analysts trimmed fourth-quarter growth forecasts after the weak consumption and factory data on Friday. But many still expected output to expand at an annual pace of more than 3 percent, faster than the 1.8 percent in the July-September period.

"The economy got off to a solid start this quarter, but it seems to have cooled a little bit in November. Growth is still going to be strong this quarter, but it's going to slow in the first half of 2012 because of Europe," said Ryan Sweet, a senior economist at Moody's Analytics in West Chester, Pennsylvania....

n another report, the department said non-defense capital goods orders excluding aircraft, a closely watched proxy for business spending, fell 1.2 percent last month after declining 0.9 percent in October.

Shipments of these so-called core capital goods, which go into calculations of U.S. gross domestic product, dropped for a third straight month.

This suggests that business spending, which has been robust since the start of the recovery in mid-2009, could slow considerably from the third-quarter's 15.7 growth percent pace.

Economists said uncertainty about fiscal policy at home and the debt crisis in Europe were causing businesses to becoming more cautious about spending.

The ability of U.S. consumers to keep on spending while incomes remain weak is also a potential drag on growth in early 2012.

"No one is putting themselves out there in terms of business expansion and capital equipment because it's a dangerous world out there and there are still a lot of risks in terms of Europe and China," said Steve Blitz, senior economist at ITG Investment Research in New York....

Income ticked up 0.1 percent, the weakest reading since August, as wages and salaries fell. Disposable income was flat.

A strengthening in the labor market has offered some hope income growth will quicken, but analysts said the report augured poorly for consumer spending at the start of the new year.

"The lack of real income growth really raises questions as to what is going to happen to the economy in the first quarter," said Mark Vitner, senior economist at Wells Fargo Securities in Charlotte, North Carolina....

On the bright side, the report confirmed an easing in inflation, which should help to support spending. Further help should also come from the temporary extension of payroll tax cut and benefits for the long-term unemployed.

A price index for personal spending was flat last month after falling 0.1 percent in October. In the 12 months through November, the PCE price index was up 2.5 percent, the smallest rise since April.

A core inflation measure, which strips out food and energy costs, edged up 0.1 percent last month after a similar gain in October. In the 12 months through November, it was up 1.7 percent after increasing 1.7 percent in October.

Excerpt: With U.S. unemployment at a lofty 8.6 percent, home foreclosures rising and property prices under pressure, more and more Americans have given up the dream of owning, opting instead to rent, a shift that is remaking the face of the U.S. housing industry.

The percentage of Americans who own their home dropped from a peak of 69.2 percent in late 2004 to a 13-year low of 65.9 percent in the second quarter. It edged up to 66.3 percent in the third quarter of this year.

On the flip side, the percentage of rental properties that are empty fell to 9.8 percent in the third quarter from 10.3 percent a year earlier.
In a recent report, Oliver Chang, an analyst at Morgan Stanley, dubbed 2012 "The Year of the Landlord."

Groundbreaking for new housing jumped 9.3 percent in November to the highest level in 19 months, fueling optimism that the battered housing market was regaining its footing.....The gains, however, were almost solely in multifamily housing

"Rents are rising, vacancies are falling, household formations are growing and rental supply is limited," the Morgan Stanley report stated. "We believe the demand for rental properties will continue to grow." 

Excerpt: Falling Commodities, Easing Price Rises Give Central Bank Room to Spur Growth...

U.S. inflation is slowing after a surge early in the year.

This is good news for Americans, as it means the money in their pockets goes further. It also is welcome at the Federal Reserve, which has been counting on an inflation slowdown. It gives the Fed some maneuvering room in 2012 if central-bank officials want to take steps to bolster economic growth.

The slowdown has been apparent for months in some commodities. The price of copper is down 21% from a year earlier. Cotton is down 45%. Natural-gas prices continue to fall, and crude oil has retreated from peaks hit in April, though not as sharply as other commodities.

Now, more broadly, the Commerce Department's measure of consumer prices for November, released Friday, stood 2.5% above year-ago levels in November, down from year-over-year increases of 2.7% in October and 2.9% in September. A less volatile measure excluding food and energy, watched closely by the Fed, rose 1.7% from a year earlier....

Another closely tracked measure, the Labor Department's consumer-price index, has risen at a 0.8% annual rate in the past three months....

The Fed has been considering new steps to spur growth. Two ideas are on the table: commit to keep short-term interest rates near zero for even longer than through mid-2013, and restart a bond-buying program aimed at driving already-low long-term interest rates lower. Before taking either step, though, Fed officials would want to have some comfort that they wouldn't be creating undesired inflation.

"This inflation news would open the door for Fed action if the unemployment rate is drifting higher in the first half of the year," said Mr. Kasman....

Inflation is retreating as a concern in bond markets, too. Yields on inflation-sensitive 10-year Treasury notes have fallen from 3.7% in February to about 2%.

Excerpt: When on Friday we penned "And This Is Where The LTRO Money Went" we said that the final nail in the "Carry Trade" theory was that instead of using the LTRO "Bazooka" cash to collect meaningless pennies in front of a steamroller, Europe's banks turned around and deposited it right back with the ECB after the bank's deposit facility soared to a 2011 record €347 billion, €82 billion more than the day before. Today, any residual doubt of where the LTRO cash proceeds went is eliminated, as the ECB has just confirmed that what goes out of one pocket comes back in the other, as the ECB's deposit facility has just exploded to not a 2011 record, but an all time record high €412 billion, a €65 billion increase overnight, and €167 billion higher in the past two days alone, which effectively accounts for practically all of the LTRO's free €210 billion.

And to those who foolishly claim this is a seasonal year end cash parking, we present the full history of the ECB's facility usage since it exploded on the scene in 2008. P;ease go ahead and show us when in 2008, 2009 and 2010 there was a spike in year end facility usage. We have all day. But wait: there's more! In another independent confirmation that all hell is about to break loose, we just saw the 1 Year Bund drop sub zero again. As a reminder, the last time it was there was in the last days of November, just before the global central bank cartel had to come in and provide a global liquidity bailout for Europe's banks. So: back to square minus one ladies and gentlemen of an insolvent Europe?

But the biggest slap in the face of Sarkozy is that instead of banks pocketing the "guaranteed" 2-3% in carry trade between the 1% LTRO rate and the soveriegn bond yield, banks are losing 75 basis point on this inverse carry trade, where they take LTRO cash and deposit it with the ECB where it yields... 0.25%!

6--A New Force in Latin America, MARK WEISBROT, counterpunch

Excerpt:  Although most Americans have not heard about it, a historic step toward changing this hemisphere was taken three weeks ago.  A new organization for the region was formed, and everyone was invited except the U.S. and Canada. The new organization is called the Community of Latin American and Caribbean States (CELAC).

There was a reason for the exclusion of the two richest countries, including the world’s largest economy. In fact there were many reasons, but they went mostly unnoticed in the major media.  The existing regional grouping, the Organization of American States (OAS), is too often controlled by the U.S. State Department, with Canada as junior partner.

In 2009, there was a big eye-opener for the rest of the hemisphere, especially those governments that thought President Obama would break with tradition and support democracy in the hemisphere.  The democratic government of Honduras was overthrown in a military coup in June of that year. Although the U.S. role in the coup itself is still unclear, there is no doubt that Washington did quite a bit to help the coup government succeed and establish itself. And one of the things that the Obama administration did was to block the OAS from taking more effective action against the coup government.

The OAS was also used by Washington to overturn election results in the first round of Haiti’s presidential election of last year.  An OAS “expert verification mission” changed the results without even so much as a recount or any statistical basis for its actions, and the U.S. and its allies threatened Haiti’s government until it accepted the result....

it is no coincidence that Latin America’s worst long-term growth failure in more than a century – from 1980-2000 – took place during the era of the “Washington Consensus,” when economic policy in the region was heavily influenced by Washington-based institutions such as the International Monetary Fund (IMF).  In fact, the Latin American spring was mainly driven by this economic failure and a desire for alternatives.

The new CELAC reflects this new reality – Latin America has become politically independent of the United States, there have been many changes in economic policy as a result, and these changes have brought higher living standards.

Excerpt: With neither exports nor private consumption able to pull the economy the state has been under constant pressure to offer support via deficit spending, leading to the accumulation of an unsustainable quantity of government debt. This deficit spending is about to come to an end (permanently according to the latest EU agreement), and under these circumstances the economy is likely to remain in or near contraction for as long as it takes to recover competitiveness. The question is, how long is that going to be, and what will happen to the debt dynamics in the meantime....

Poised On A Knife-edge

But given everything it is clear that Italian debt, and with it the future of the Euro, now sits poised on a knife edge, as is illustrated in the chart below (which comes from Barclay’s Capital). If you take a neutral scenario where Italy has a balanced budget and a sum total of zero nominal GDP growth (ie growth+inflation = 0) debt stays put at 120% of GDP out to infinity....

But then imagine the average finance cost of Italian debt rises, and stays high. In this case the only way to compensate is by running a larger primary surplus (ie more spending cuts, or revenue increases to compensate for the extra interest cost). The net effect of this would either be to generate deflation or a more sustained economic contraction, in which case debt to GDP would start to rise indefinitely. Think of it like this, either prices fall by one percent and GDP (via exports) rises by 0.5% (for example), in which case nominal GDP falls 0.5% a year (the Japan type case), or prices rise by 0.5%, exports lose more competitiveness, and so growth falls by 1%. I mean, this example is only illustrative, but it is meant to give some sort of feel for what “knife edge dynamics” really mean....

t’s All About Structural Reforms, Or Is It?

So basically, what the whole argument about whether or not Italy can make a final burst and reach the finishing line is all about structural reforms, and whether the country can get enough growth (quickly enough) to turn the “knife edge trap” around. Personally I am extremely doubtful that it can, which is why I placed so much emphasis on the growth performance in the first section. The turnaround needed here is massive. It is a 30 year decline we are talking about, and I doubt short of outright default and substantial devaluation we have historical examples of anyone doing this. The adjustment made in Germany between 1999 and 2005 was much smaller in comparison....

The bottom line is that Italy is both too big to fail and too big to be bailed out, which is why it is still hanging dangerously in limbo-land. Since, as I argue in this article, some sort of restructuring or other is well nigh inevitable in the Italian case, the sooner Europe’s leaders work up a credible plan on how to achieve this, the better. Otherwise it will not only be Italy’s citizens who are subjected to the Full Monti, Europe’s leaders may also find themselves with their credibility stripped naked.

Excerpt: Data through October 2011, released today by S&P Indices for its S&P/Case-Shiller1 Home Price Indices ... showed decreases of 1.1% and 1.2% for the 10- and 20-City Composites in October vs. September. Nineteen of the 20 cities covered by the indices also saw home prices decrease over the month. The 10- and 20-City Composites posted annual returns of -3.0% and -3.4% versus October 2010, respectively.

“There was weakness in the monthly statistics, as 19 of the cities posted price declines in October over September,” says David M. Blitzer, Chairman of the Index Committee at S&P Indices. “Eleven of the cities and both composites fell by 1.0% or more during the month.

9--Restoring European Growth, Project Syndicate

Since the crisis began, the need for economic growth in Europe’s debt-distressed countries has been portrayed as their problem. For creditors, especially German lenders, the main priority has been to impose austerity and discipline on the eurozone’s profligate south. Because German banks hold much of the debt owed by peripheral banks and governments, officials have focused on this financial link between Germany’s economy and those of troubled eurozone members. But German Chancellor Angela Merkel’s understandable desire to discipline the spendthrifts entails sawing away at the last remaining branch on which Germany’s bankers and taxpayers are perched....

Until the crisis hit, Germany benefited immensely from the stable environment created by the eurozone. Peripheral eurozone countries ran large current-account deficits, which subsidized German growth. If these markets now contract – and austerity has thus far led to severe recessions in Greece and Ireland, with Portugal expected to follow next year – so will the German economy. The highly indebted southern countries are far from being the sole stakeholders in their own economic growth.

Any viable strategy to resolve the crisis must address both links between core and peripheral economies. This means finding the right policy mix between austerity and growth. Only a solution that balances the two will guarantee the long-term growth of both peripheral and core eurozone economies, reassuring debt markets of their solvency and stemming the contagion that threatens to sweep the continent. The agreement reached at the recent EU summit to institutionalize austerity needs to be supplemented by a growth policy....

This requires a two-pronged approach. First, highly indebted countries should be allowed to swap existing debt for new bonds issued at a heavy discount. The discount is essential for reducing sovereign debt in the periphery to manageable levels and lowering immediate debt payments, thereby freeing resources for the investment and consumption that make growth possible.

But if creditors must share in the downside of the current crisis, they should also share in the future economic growth of peripheral eurozone economies. This requires a second step: linking the new bonds to warrants tied to debtor countries’ GDP growth. Converting existing sovereign debt into new bonds attached to GDP warrants would work like a debt/equity swap in a corporate bankruptcy. It would guarantee that creditors share in the upside of the reforms that the eurozone must implement to guarantee its own viability.

There is a precedent for this. Following its debt default in 2002, Argentina successfully implemented a similar program. In exchange for a reduction of its existing debt, the Argentinean government issued new bonds linked to GDP warrants and committed 5% of future annual GDP growth above 3.3% to a pool shared among creditors.

These Argentinean GDP warrants soon became tradable separately from the bonds to which they were initially linked, allowing their holders to cash in. Once growth resumed in Argentina, its GDP warrants became some of the best investments in the developing world, generating a total return of more than 500% over the last five years.

Without economic growth, there will be no lasting solution to the eurozone crisis. For the troubled economies to revive, the recent agreements on austerity must be supplemented by significant debt haircuts. Such haircuts, however, are hard to sell to the German electorate. GDP warrants would be a good way to close the deal.

Tuesday, December 27, 2011

Today's links

Excerpt: Europe faces another year of dismal economic performance in 2012 that will weigh on global growth, but emerging markets and the United States should at least keep the world economy moving in the right direction.

There are several reasons why next year may be nothing to look forward to, according to Reuters polls from the last few months.

Many of the world's biggest developed economies are heading into recession, global stock markets look set to recoup only a fraction of their heavy losses in 2011, oil prices will head lower, and asset managers are unsure where best to invest.

And these could be the best-case scenarios.

Most economists base their assumptions on the hope that the euro zone's sovereign debt crisis will not boil over into a new global economic crisis, having already dented growth in major exporters to Europe....


The severe uncertainty surrounding 2012 is perhaps best reflected by Reuters' asset allocation poll of more than 50 leading investment houses in the United States, Europe and Japan.

Investors raised their cash balance to the highest in a year in December as they prepared for a jittery 2012, although they also moved back into cheap equities, Reuters polls showed on Monday...

, the Chinese economy is now growing at its weakest pace since 2009. In an effort to support it the central bank cut reserve requirements at the end of last month for the first time in three years.

Economists polled by Reuters after this move, however, said the People's Bank of China will refrain from more aggressive stimulative policies unless growth falls sharply to below 8 percent.

Similarly, India has been suffering from a pronounced slowdown in growth and Reuters polls suggest its central bank will also slacken monetary policy by mid-2012 to counter this, despite stubbornly high inflation. It could be in for a difficult year.

"Looking ahead, the economy faces the lagged effects of monetary tightening," said Leif Eskesen, economist HSBC in Singapore.

Excerpt: A new study has concluded that the FDA severely underrated the risk of contaminants in seafood following the BP oil spill of 2010, according to Environmental Health Perspectives (via Alternet).

The report, conducted by non-governmental scientists, says that 53 percent of Gulf shrimp samples tested revealed "levels above concern" of carcinogenic polycyclic aromatic hydrocarbons (PAHs).

Some cases showed carcinogenic levels up to 10,000 times more than what is considered safe.

This leaves pregnant women, children and big seafood eaters at risk to develop issues stemming from the consumption of these chemicals. Prenatal exposure to PAHs has been shown to lower IQs and increase the risk of asthma, heart malformations and low birth weight.

Excerpt: The European Central Bank's (ECB) unprecedented provision of a €489bn (£407.5bn) in cheap loans will "buy valuable time" for eurozone banks but has not improved their credit outlook, a director of Standard & Poor's (S&P) has warned.

He said the action did not "change the fundamental picture but it does buy valuable time". He added: "The move in itself will not lead to any improvement in (banks') credit ratings."

Earlier this month S&P put 15 of the 17 eurozone countries and some of their biggest banks on credit downgrade watch. The agency is expected to deliver a verdict on the credit watch in January....

Bondmarkets again showed the signs of stress. The yield on Italian 10-year bonds rose to 6.8pc - dangerously close to the 7pc bail-out level. While UK gilts benefited, the yield on Spanish and French bonds were pushed up too.

Excerpt: Venezuela has launched its energy assistance program for the seventh consecutive year, which helps poor Americans to pay for their home heating oil during the winter, Press TV reports.

The aid, which is provided by Citgo, a branch of the Venezuelan state oil company, PDVSA, will be received by more than 400,000 poor Americans next year, a Press TV correspondent reported on Thursday. 

Citgo's president, Alejandro Granado, has said that rising energy costs continue to affect millions of Americans, impairing their quality of life. 

Granado added that his company does not want the US families to be forced to choose between keeping their homes heated, and paying for other basic needs like food or medicines. 

“United States is not all roses like people think there are lots of people under poverty, below their standards” Oil industry analyst, Elio Ohep says. 

The heating oil program began in 2005, following the aftermath of hurricanes Rita and Katrina. The PDVSA's subsidiary has so far invested over 400 million dollars in energy assistance for US citizens facing economic hardship. 

Excerpt: The wealth of today’s super-rich is bound up with the destruction, not the development, of the productive forces. The riches of these few depend on the impoverishment of hundreds of millions. In fact, the Financial Times reported last week that “the share of US national income that goes to workers as wages rather than to investors as profits and interest” has fallen to its lowest level since the end of World War II. The precipitous fall of the workers’ share of the national income below the post-war average translates into an annual collective wage loss in 2011 of $740 billion—approximately $5,000 per worker. That staggering amount has been funneled into the salaries and investment accounts of the super-rich.

Despite this fact, the indignant rich argue that it would make no economic sense to disturb their wealth. But every day, in the United States and throughout the world, the media they own and the politicians they bribe demand and implement cuts in wages and the slashing of budgets that fund essential social services.

The economic and social crisis in the United States and throughout the world cannot be addressed by reforms, such as a change in tax rates, which seek within the framework of capitalism a less irrational distribution of the national income. However justified such a measure would be, if only as an initial step toward more fundamental change, the lords of Wall Street and the corporate conglomerates will not accept any reform that threatens their domination of economic life and pursuit of limitless personal riches. Like all ruling classes whose interests are antagonistic to the needs of society as a whole, they will defend what they perceive to be their interests without restraint and without mercy. This is the social instinct that underlies the lowering of workers’ living standards, the systematic erosion of democratic rights, and the ever-more reckless resort to war as a means of securing the ruling elite’s global economic interests.

Excerpt: Fortunately, there has been a great deal of new research that sheds light on the effects of fiscal policy in settings where monetary policy does not respond aggressively. Some of it uses evidence from the crisis itself, but much does not; some focuses on a particular country, usually the United States, but some uses larger samples; and a considerable body of the work looks at evidence from different regions within a country, again usually the United States. One particularly appealing aspect of this last set of studies is that because monetary policy is conducted at the national level, it is inherently being held constant when one is looking at within-country variation.

Collectively, this research points very strongly (though, I should say, not unanimously) to the conclusion that when monetary policy does not respond, conventional fiscal stimulus is effective.3 And a careful examination of the evidence gives no support to the view that when monetary policy is constrained, fiscal contractions are expansionary (International Monetary Fund, 2010).  Even so, I find two types of evidence that predate the crisis even more compelling. The first comes from wars. The fact that the major increases in government purchases in the two world wars and the Korean War were associated with booms in economic activity, and that those booms occurred despite very large tax increases and extensive microeconomic interventions whose purpose was to restrict private demand, seems to me overwhelming evidence that fiscal stimulus matters.

The other type of evidence is more general evidence about the functioning of the macroeconomy. We know that monetary policy has powerful real effects, which means that aggregate demand matters. We know that current disposable income is important to consumption. And we know that cash flow and sales have strong effects on investment. It would take a strange combination of circumstances for those things to be true but for fiscal policy, which one would expect to work through those channels, not to be effective.

Given this wide range of evidence—not to mention the large body of pre-crisis work on the effects of fiscal policy that I have not even touched on—I think we should view the question of whether fiscal stimulus is effective as settled.

7--EZ credit update, macronomyblogspot

Excerpt: My good credit friend and I discussed the following in relation to the latest IMF involvement or the rescue funds:

"To repeat what we discussed in our last conversation, neither the IMF nor the rescue funds can sort the solvency problem out. France is about to be downgraded, bringing down the EFSF structure. So anyone who thinks that the EFSF and the ESM will run in parallel has it wrong. Of course the ESM will remain, but its firepower will be far less than the Euro 500 billions earmarked, not enough to rescue all the peripheral countries under pressure. Of course, the IMF may help sovereigns funding issues but, it will do in accordance with specific rules: liquidity issues will be faced, solvency one will not. While we do not foresee major problems right now for the core European countries, the environment could change very quickly."

As the Head of the Canadian Central Bank just declared, “developed economies have regularly increased their debt leverage over dozens of years. But this period is now over. If the deleveraging trend is now clear, the speed and size of the process are not. This process could last and be done in an orderly way, or be abrupt and disorderly.”

Simon Johnson, who served as chief economist at the International Monetary Fund in 2007 and 2008, and is now a professor at the MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics, had an interesting column in Bloomberg relating to the IMF involvement in the European Sovereign debt crisis on the 19th of December - IMF Bazooka Is Between Meaningless and Dangerous:

"Today’s proposed bazookas are about providing enough financial firepower so that troubled European governments do not necessarily have to fund themselves in panicked private markets. The reasoning is that if an official backstop is at hand, investors’ fears would abate and governments would be able to sell bonds at reasonable interest rates again. 

This idea is just as dubious as Paulson’s original notion. Markets are so thoroughly rattled that if a financial backstop is put in place, it would need to be used -- probably to the tune of trillions of euros of European debt purchases from sovereigns and banks in coming months. Whether or not it is used, a plausible bazooka would need to be huge."

Simon Johnson also adding:
"Even if the IMF went all in for troubled Europe -- an idea with little support in emerging markets -- it wouldn’t make much difference. Italy’s outstanding public debt of 1.9 trillion euros is bigger than that of Greece, Ireland, Portugal and Spain combined. The country faces about 200 billion euros in bond maturities in 2012 and an additional 108 billion euros of bills, according to Bloomberg News. The euro area’s 2012 sovereign funding needs are estimated at more than $1 trillion next year alone, and any credible financing plan needs to fully cover 2012 and 2013 at a minimum. It remains unclear who is willing to fund European banks in this stress scenario. 

The idea that the IMF could tap emerging markets for additional capital to lend to Europe is met with polite public demurrals. Behind closed doors, it’s not so polite....

"Eighty years ago, most prominent officials and private financiers were confident that the gold standard should and would remain in place. Starting in 1931, the gold standard failed as a global financing system, with unpleasant consequences for many. 

As 2011 draws to a close, the age of the global bailout also seems to be fading. Perhaps the Europeans will find a way to scale up their own rescues using their own money. Perhaps they will manage to protect creditors fully, and convince investors to lend to Italy again. More realistically, the bazooka standard is about to collapse."...

In addition to being a political symbol, the Euro was supposed to offer two irresistible benefits to its members: (1) the Deutsche Mark’s low interest rates for everyone and (2) no more exchange rate volatility within the Eurozone.

Until 2008, the first benefit (lower interest rates) kept its promises. Italy’s yield spread against Germany went from 12% in 1982 to a mere 20bp in 2007. It actually worked so well for some countries that it led to huge housing bubbles, consumer credit bubbles and fiscal largesses, as deficits were easy to finance. Unfortunately, as we can see nowadays, these were all sources of phantom growth, i.e. growth that resulted from stealing from the future and not from increasing productivity. The debt crisis in the Eurozone is a direct result of this unchecked debt bubble.

The Euro’s second “benefit” (no more currency volatility) created another imbalance that will probably be even more painful to resolve than the first one. Since the last competitive devaluations of the early nineties, we have witnessed a huge divergence of Eurozone members’ unit labor costs

Interestingly, we can notice that the five countries whose unit labor costs grew the most are the PIIGS. This is probably not a coincidence. Low labor competitiveness hurts the economy, thus lowering tax revenues, while public spending is used to hide the underlying decline of the economy. This leads to a degradation of the fiscal situation.

In a nutshell, labor forces in many Eurozone countries are now getting paid in a currency that is vastly overvalued compared to their productivity (this can also be seen in the degradation of the trade balance of many European countries including France).

To restore to competitiveness of PIIGS (and to a lesser extent France and Belgium), labor costs will therefore have to decrease significantly....

The ECB could crash the Euro. Monetizing huge amounts of sovereign debt would contribute to this (in addition to solving the liquidity situation of PIIGS). However, Germany and other countries that are already competitive will oppose this. Additionally, it would not solve the structural problem of unit labor cost divergence, which would inevitably lead to new crises further down the road.

It is difficult to predict what path (or combination of paths) will be chosen by politicians. The one thing we strongly believe is that, whatever the path, real aggregate demand is going to crash a lot further in large parts of the Eurozone. Growth expectations remain way too optimistic.

This is why we consider that Europe’s P/Es of 8 are not cheap by any standards, and that the Euro is poised to fall against other currencies."