Wednesday, January 26, 2011

Today's links

1--Structural Causes of the Global Financial Crisis: A Critical Assessment of the ‘New Financial Architecture’, By James Crotty, PERI, U of Mass. Amherst

Abstract: The main thesis of this paper is that the ultimate cause of the current global financial crisis is to be found in the deeply flawed institutions and practices of what is often referred to as the New Financial Architecture (NFA) – a globally integrated system of giant bank conglomerates and the so-called ‘shadow banking system’ of investment banks, hedge funds and bank-created Special Investment Vehicles. The institutions are either lightly and badly regulated or not regulated at all, an arrangement defended by and celebrated in the dominant financial economics theoretical paradigm – the theory of efficient capital markets. The NFA has generated a series of ever-bigger financial crises that have been met by larger and larger government bailouts. After a brief review of the historical evolution of the NFA, the paper analyses its structural flaws. The problems discussed in order are: 1) the theoretical foundation of the NFA – the theory of efficient capital markets – is very weak and the celebratory narrative of the NFA accepted by regulators is seriously misleading; 2) widespread perverse incentives embedded in the NFA generated excessive risk-taking throughout financial markets; 3) mortgage-backed securities central to the boom were so complex and nontransparent that they could not possibly be priced correctly; their prices were bound to collapse once the excessive optimism of the boom faded; 4) contrary to the narrative, excessive risk built up in giant banks during the boom; and 5) the NFA generated high leverage and high systemic risk, with channels of contagion that transmitted problems in the US subprime mortgage market around the world. Understanding the profound problems of the NFA is a necessary step toward the creation of a new and improved set of financial institutions and practices likely to achieve core policy objectives such as faster real sector growth with lower inequality.

2--Financial Crisis Was Avoidable, Inquiry Finds, New York Times

Excerpt: The 2008 financial crisis was an “avoidable” disaster caused by widespread failures in government regulation, corporate mismanagement and heedless risk-taking by Wall Street, according to the conclusions of a federal inquiry.

The commission that investigated the crisis casts a wide net of blame, faulting two administrations, the Federal Reserve and other regulators for permitting a calamitous concoction: shoddy mortgage lending, the excessive packaging and sale of loans to investors and risky bets on securities backed by the loans.

“The greatest tragedy would be to accept the refrain that no one could have seen this coming and thus nothing could have been done,” the panel wrote in the report’s conclusions, which were read by The New York Times. “If we accept this notion, it will happen again.”...

The majority report finds fault with two Fed chairmen: Alan Greenspan, who led the central bank as the housing bubble expanded, and his successor, Ben S. Bernanke, who did not foresee the crisis but played a crucial role in the response. It criticizes Mr. Greenspan for advocating deregulation and cites a “pivotal failure to stem the flow of toxic mortgages” under his leadership as a “prime example” of negligence.

It also criticizes the Bush administration’s “inconsistent response” to the crisis — allowing Lehman Brothers to collapse in September 2008 after earlier bailing out another bank, Bear Stearns, with Fed help — as having “added to the uncertainty and panic in the financial markets.” ...The financial industry spent $2.7 billion on lobbying from 1999 to 2008, while individuals and committees affiliated with it made more than $1 billion in campaign contributions.

The report does knock down — at least partly — several early theories for the financial crisis. It says the low interest rates brought about by the Fed after the 2001 recession; Fannie Mae and Freddie Mac, the mortgage finance giants; and the “aggressive homeownership goals” set by the government as part of a “philosophy of opportunity” were not major culprits.

By one measure, for about every $40 in assets, the nation’s five largest investment banks had only $1 in capital to cover losses, meaning that a 3 percent drop in asset values could have wiped out the firm. The banks hid their excessive leverage using derivatives, off-balance-sheet entities and other devices, the report found. The speculative binge was abetted by a giant “shadow banking system” in which the banks relied heavily on short-term debt.

3--U.S. Home Prices Slump Again, Hitting New Lows, New York Times

Excerpt: A new slide in housing prices has begun in earnest, with averages in major cities across the country falling to their lowest point in many years.

Prices in 20 major metropolitan areas slid 1 percent in November from October, according to the Standard & Poor’s Case-Shiller Home Price Index released Tuesday. The index has fallen 1.6 percent from a year ago.

Nine of the 20 cities in the index sank in November to new lows for this economic cycle: Chicago; Las Vegas; Detroit; Atlanta; Seattle; Charlotte, N.C.; Miami; Tampa; Fla.; and Portland, Ore. Only a handful of places — essentially, California and the District of Columbia — went counter to the trend and had rising prices over the last year.

Whether the long-predicted double dip is looming or has already arrived is a quibble of semantics.....analysts said the declines would continue, even if not as sharply as in 2007 and 2008. “The enormous supply overhang of existing homes — particularly factoring in all those in foreclosure or soon to be — promises to keep pressure on prices for some time,” said Joshua Shapiro, the chief United States economist of MFR Inc.

4--Richard Koo On The Weakest Links In The Bernank's QEasy Logic, zero hedge

Excerpt: Richard Koo--"The Beige Book also noted that US households and businesses continue to deleverage, creating a situation in which banks’ preferred customers are not interested in borrowing. This is also identical to the situation in Japan more than a decade ago.

Banks hurt by the crash in commercial real estate are naturally reluctant to lend more to the sector, but potential borrowers in other sectors are not interested in borrowing despite current low interest rates. This has arrested growth in banks’ loan books—including consumer loans.

The implication is that during the Christmas shopping season consumers paid for their purchases with cash instead of credit. This reflects changes in the US credit card market and also suggests that US households are beginning to emerge from their dependence on debt.

If US households were to begin consuming only what they can afford without relying on debt, it would represent a sea change and would also be a first step on the path to a sounder US economy.

However, in that case, GDP and demand for commercial real estate would be unlikely to grow substantially amid modest growth in employment and incomes. Continued private sector deleveraging also means the government will need to continue generating demand for some time."....

The Fed’s zero-interest-rate policy and quantitative easing will have almost no effect as long as the private sector continues to deleverage and demand for loans remains weak. No matter how much the monetary authorities ease policy, money will not start flowing and the money supply will not increase without private-sector borrowers.

5--Fed to Pursue QE Even as Business Lending Gains, Bloomberg

Excerpt: The Federal Reserve will probably push forward with $600 billion in securities purchases even as the biggest jump in business loans in more than two years adds to signs the U.S. economy is gaining strength.

Commercial and industrial loans increased at an annual rate of 7.6 percent last month, the largest gain since October 2008, according to Fed data. Total bank credit has risen in three of the past six months as business loans cushioned against declines in real estate and consumer credit.

Fed Chairman Ben S. Bernanke and his fellow policy makers will probably note improvements in the economy such as higher consumer spending in a statement to be released tomorrow, former Fed governor Lyle Gramley said. Encouraging signs like firmer bank credit are unlikely to prompt a reduction in stimulus so long as growth remains weak and unemployment persists near 10 percent, he said.

“The Fed is not ready to let up on its accelerator,” said Gramley, senior economic adviser for Potomac Research Group in Washington. “They are going to be impressed with the fact the economy has gained some momentum, but there are still strong headwinds to growth, and bank lending is quite modest.”...

Since reducing its target federal funds rate to near zero in December 2008, the central bank has used its balance sheet as a monetary policy tool. Its assets have tripled to $2.43 trillion from $873 billion in February 2008.... Treasury yields have risen amid signs of a stronger economy. The yield on the 10-year note increased to 3.36 percent at 1:11 p.m. today in New York from 2.57 percent after the Nov. 3 FOMC meeting, when the asset purchases were announced.

Yields have increased because of “a stronger economy and better expectations,” Bernanke said at a forum in Arlington, Virginia on Jan. 13.

Jim Comiskey, a senior market strategist at Lind-Waldock in Chicago, disputed that view, saying yields have risen on concern that Fed bond purchases will stoke inflation.

“The market is scared about the inflationary impact of what the Fed is currently doing,” Comiskey said.

6--Shadow inventory threatens housing recovery, CNN Money via patrick.net

Excerpt: There is a growing glut of foreclosed homes threatening to hit the market over the next couple of years, potentially delaying any recovery.

There were 1.7 million homes either owned by the bank or in some stage of foreclosure at the end of the third quarter of 2010, according to a recent report by Standard & Poor's. It would take 44 months, at the current rate of sales, to sell them off -- a 25% increase from the beginning of 2010. (S&P does not count home loans backed by Fannie Mae and Freddie Mac.)...

Data through Sept. 30 from the Mortgage Bankers Association, which tracks about 80% of the market, suggests there are more than 2 million Americans seriously delinquent on their mortgages and another 2 million bank-owned homes. Plus, RealtyTrac reported last week that a million homes were repossessed in 2010

Westerback said the biggest contributor to the longer shadow inventory is that banks are taking far longer to foreclose on homes than they once did.

7--FBI looks into bid rigging at courthouse auctions, SFGate via patrick.net

Excerpt: Foreclosure auctions take place every weekday on the steps of courthouses throughout California. Now the FBI is investigating whether some real estate speculators are illegally rigging bids for these sales.

"Last week, the FBI conducted interviews and executed search warrants through the entire Bay Area as part of a long-term investigation of anti-competitive practices at trustee sales of foreclosed homes," said bureau spokeswoman Julie Sohn.

The probe is shaking up the tight-knit world of investors who bid at these auctions. The issue, sources say, is that some participants allegedly pay others to refrain from bidding on certain properties to keep their prices low....

"If you start to bid, there are about five guys who work together and who box you in," said the man, who asked not to be named for fear of retribution. "One guy came up to bid who clearly was not part of that crew. The guys were bidding. At some point, (their ringleader) turned to (the outsider) and said, 'You must really like this property. It must be really important to you.' He had a piece of paper in his hand; he showed it to the guy. The guy nodded OK and then disappeared into the building."

The man said he was positive that the outsider was being paid off not to bid, although he did not witness money changing hands.

8--Case-Shiller: U.S. Home Prices Keep Weakening as Eight Cities Reach New Lows in November, Calculated Risk

Excerpt: From S&P: U.S. Home Prices Keep Weakening as Eight Cities Reach New Lows

Data through November 2010, released today by Standard & Poor’s for its S&P/Case-Shiller1 Home Price Indices, the leading measure of U.S. home prices, show a deceleration in the annual growth rates in 17 of the 20 MSAs and the 10- and 20-City Composites compared to what was reported for October 2010. The 10-City Composite was down 0.4% and the 20-City Composite fell 1.6% from their November 2009 levels. Home prices fell in 19 of 20 MSAs and both Composites in November from their October levels. In November, only four MSAs – Los Angeles, San Diego, San Francisco and Washington DC – showed year-over-year gains. The Composite indices remain above their spring 2009 lows; however, eight markets – Atlanta, Charlotte, Detroit, Las Vegas, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices peaked in 2006 and 2007, meaning that average home prices in those markets have fallen even further than the lows set in the spring of 2009....

The Composite 20 index is off 30.9% from the peak, and down 0.5% in November (SA)....Prices are now falling - and falling just about everywhere. As S&P noted "eight markets – Atlanta, Charlotte, Detroit, Las Vegas, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices peaked in 2006 and 2007". Both composite indices are still slightly above the post-bubble low.

9--MBA: Mortgage Purchase Applications lowest since last October, Calculated risk

Excerpt: The MBA reports: Mortgage Applications Decrease in Latest MBA Weekly Survey

The Refinance Index decreased 15.3 percent from the previous week and reached its lowest level since January 2010. The seasonally adjusted Purchase Index decreased 8.7 percent from one week earlier. The Purchase Index is at its lowest level since October 2010....

The four-week moving average of the purchase index suggests weak existing home sales through the first few months of 2011.

10--19--Treasurys Throw the Recovery a Curve, Kelly Evans, Wall Street Journal

Excerpt: Treasurys may be signaling trouble....The market is behaving in ways that suggest investors are starting to fret over the potential for stagflation in the U.S....Consider the Treasury "yield curve." It refers to the difference between short-term and long-term interest rates on U.S. Treasury debt.

Typically, as the economy is expanding, this curve has an upward slope, and is usually at its steepest during the earliest stages of a recovery.

Eventually, investors anticipate the Fed will begin raising interest rates to stave off inflation. That tends to lift short-term rates, compress long-term ones, and generally flatten the curve, or even invert it if investors expect the outcome could be recession....Lately, with the U.S. growth outlook improving, the slope of the curve hasn't started flattening, as might be expected at this point in the recovery. Instead, it has gotten steeper.

Earlier this week, the spread between two-year and 30-year Treasury yields hit a record-wide four percentage points, notes RBS Securities. At the same time, the implied annual inflation rate over a five-to-10 year horizon, based on Treasury yields, has moved up above 3% and towards levels last seen before the Fed's previous rate-rise cycle began in mid-2004.

Investors, in other words, don't expect the Fed to be as aggressive as in the past in raising rates—even as they see inflation on the rise.

"I think the Fed's credibility is in question here," says Priya Misra, head of rates strategy at Bank of America Merrill Lynch.

Or perhaps investors simply realize the Fed has put itself between a rock and a hard place. The U.S. unemployment rate is currently 9.4%, after all. It was at 5.6% in June 2004.

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