Monday, February 28, 2011

Today's links

1--Shock Doctrine, U.S.A., Paul Krugman, New York Times

Excerpt: ...Naomi Klein’s best-selling book “The Shock Doctrine” ... argued that ... right-wing ideologues have exploited crises to push through an agenda that has nothing to do with resolving those crises, and everything to do with imposing their vision of a harsher, more unequal, less democratic society.

Which brings us to Wisconsin 2011, where the shock doctrine is on full display.

In recent weeks, Madison has been the scene of large demonstrations against the governor’s budget bill, which would deny collective-bargaining rights to public-sector workers. Gov. Scott Walker claims that he needs to pass his bill to deal with the state’s fiscal problems. But his attack on unions has nothing to do with the budget. In fact, those unions have already indicated their willingness to make substantial financial concessions — an offer the governor has rejected.

What’s happening in Wisconsin is, instead, a power grab — an attempt to exploit the fiscal crisis to destroy the last major counterweight to the political power of corporations and the wealthy. And the power grab goes beyond union-busting. The bill in question is 144 pages long, and there are some extraordinary things hidden deep inside.

For example, the bill includes language that would allow officials appointed by the governor to make sweeping cuts in health coverage for low-income families without having to go through the normal legislative process.

And then there’s this... The state of Wisconsin owns a number of plants supplying heating, cooling, and electricity to state-run facilities (like the University of Wisconsin). The language in the budget bill would, in effect, let the governor privatize any or all of these facilities at whim. Not only that, he could sell them, without taking bids, to anyone he chooses. And note that any such sale would, by definition, be “considered to be in the public interest.”

2--Oil prices and consumer spending, Angry Bear

Key quote: "if oil prices remain high or expand well past $100 we are quite likely to see consumer spending suffer across the board."...

Excerpt: With the recent surge in oil prices I thought it would be useful to look at the potential impact with one set of data I watch. It is energy as a share of personal consumption expenditures or consumer spending. In the 1970s energy consumption rose from about 6% to 9% of spending, or about 50%. In the early 2000s energy rose from about 4% to 7% of consumer spending before it collapsed. As of December energy's share of consumer spending was already back to 6% of spending, about the level it peaked at in the last cycle before the financial panic generated a drop in other consumer spending. If you look at energy consumption this way it appears that oil consumption was already at the point where futher oil price increases would rapidly impact consumer spending on other items.

One area where higher oil prices clearly impacts consumer spending is autos, as consumer spending on new and used autos and energy have a very strong negative correlation. If rising oil prices generate a drop in real income or standard of living one of the easiest way to compensate is to delay buying a new,or used car. What would have been new monthly auto payments can be used to sustain consumption of other items. In this chart you can clearly see that this happened in both the 1970s and the 2000s. You can also see that spending on energy and autos accounted for about 10% of consumer spending in the 1990s and 2000s.

But the chart also shows that auto consumption was only about 3.5% of consumer spending at the end of 2010 as compared to a 5% to 5.5% norm in the 1990s and 2000s economic expansions. So the consumer does not really have the option to cut back on auto consumption like they did in the previous examples of oil price spikes. These charts suggest that if oil prices remain high or expand well past $100 we are quite likely to see consumer spending suffer across the board.

3--Quantitative Easing and America’s Economic Rebound, Martin Feldstein, Project Syndicate

Excerpt: The key driver of the increase in final sales was a strong rise in consumer spending. Real personal consumer spending grew at a robust 4.4% rate, as spending on consumer durables soared by 21%. That meant that the acceleration of growth in consumer spending accounted for nearly 100% of the increase in GDP, with the rise in durable spending accounting for almost half of that increase.

The rise in consumer spending was not, however, due to higher employment or faster income growth. Instead, it reflected a fall in the personal saving rate. Household saving had risen from less than 2% of after-tax incomes in 2007 to 6.3% in the spring of 2010. But then the saving rate fell by a full percentage point, reaching 5.3% in December 2010.

A likely reason for the fall in the saving rate and resulting rise in consumer spending was the sharp increase in the stock market, which rose by 15% between August and the end of the year. That, of course, is what the Fed had been hoping for.

At the annual Fed conference at Jackson Hole, Wyoming in August, Fed Chairman Ben Bernanke explained that he was considering a new round of quantitative easing (dubbed QE2), in which the Fed would buy a substantial volume of long-term Treasury bonds, thereby inducing bondholders to shift their wealth into equities. The resulting rise in equity prices would increase household wealth, providing a boost to consumer spending....

The magnitude of the relationship between the stock-market rise and the jump in consumer spending also fits the data. Since share ownership (including mutual funds) of American households totals approximately $17 trillion, a 15% rise in share prices increased household wealth by about $2.5 trillion. The past relationship between wealth and consumer spending implies that each $100 of additional wealth raises consumer spending by about four dollars, so $2.5 trillion of additional wealth would raise consumer spending by roughly $100 billion.

That figure matches closely the fall in household saving and the resulting increase in consumer spending. Since US households’ after-tax income totals $11.4 trillion, a one-percentage-point fall in the saving rate means a decline of saving and a corresponding rise in consumer spending of $114 billion – very close to the rise in consumer spending implied by the increased wealth that resulted from the gain in share prices.

None of this appears to augur well for 2011. There is no reason to expect the stock market to keep rising at the rapid pace of 2010. Quantitative easing is scheduled to end in June 2011, and the Fed is not expected to continue its massive purchases of Treasury bonds after that.

4--Putting People Back to Work, The New York Times

Excerpt: I mentioned on Wednesday that World War II was the stimulus program that finally ended the Depression. My colleague Alan Schwarz — he of concussion-expose fame — said that the mention reminded him of one of his high school teachers, Werner Feig, who used to tell students that the Depression was ended by the Full Employment Act of Dec. 7, 1941. (Mr. Feig evidently made a big impression: Aaron Sorkin, another former student, wove him into a “West Wing” episode.)

The Depression was obviously far worse than our own Great Recession — and of course the War was vastly worse than either — but there are similar lessons from the 1930s and today. The government can indeed put people back to work after a financial crisis. That’s not happening now because the government is not really trying.

5--Good Inflation, Bad Inflation, Paul Krugman, New York Times

Excerpt: Why does deflation have a depressing effect on the economy? Two reasons. First, it reduces money incomes while debt stays the same, so it worsens balance sheet problems, reducing spending. Second, expectations of future deflation mean that any borrowing now will have to be repaid out of smaller wages (if the borrower is a household) or smaller profits (if the borrower is a firm.) So expected future deflation also reduces spending.

So, does a rise in food and energy prices do anything to alleviate these problems? No. In fact, it makes them worse, by reducing purchasing power. So while the commodity surge may temporarily lead to rising headline prices in Japan, the underlying deflation problem won’t be affected at all.

In a way, this is another illustration of the need to differentiate among inflation measures. It’s not exactly the same as the usual case for focusing on core inflation, but it’s related. And once again, the point is that looking at “the” inflation rate is a bad guide for policy.

6--Smaller Government Can Be a Drag (on Growth), New York Times

Excerpt: Output last quarter grew more slowly than initially reported, according to the Bureau of Economic Analysis: an annual rate of 2.8 percent rather than 3.2 percent. One of the main reasons for the downward revision was that state and local governments cut their spending at a 2.4 percent annual pace.

That was a much sharper decline than the 0.9 percent first estimated. The drop was also faster than what the country had experienced in the previous two quarters, reflecting the fact that state and local budgets are in more trouble than ever.

A decline in state and local spending — and the layoffs that are likely to be involved — can have dangerous reverberations throughout the economy. So would the cut in federal spending that many Congressional Republicans have been threatening. Besides chucking even more workers into the pool of the unemployed, such cutbacks would also take away services supporting the many Americans trying to get back on their feet. This in turn hurts their ability to spend, threatening the bottom lines of the businesses they patronize, potentially leading to even more layoffs in the private sector. And so on.

In other words, government cutbacks during a weak economy affect much more than just government payrolls.

7--Heavy losses at central banks?, naked capitalism

Excerpt: ...The European Central Bank, for example, holds an (ever-swelling) pile of periphery eurozone bonds; the Fed’s balance sheet has more than doubled in size, to $2,500bn, as it has gobbled up mortgage-backed bonds and Treasuries; and the Bank of England also holds a large pile of gilts and mortgage assets....

Now as some readers have noticed, the Fed has also institutionalized an accounting dodge so that it will not have to admit to balance sheet losses. Commentators appear to have missed that this finesse does nothing to solve the underlying reality. The Fed can “print” its way out of balance sheet losses only to the extent that it is not constrained by inflation. If it does run into inflationary constraints, it would need an explicit bailout, irrespective of the accounting treatment. As former central banker Willem Buiter wrote in 2009:

….it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources. Even if it gets the resources, there is likely to be a price tag attached – that is, a commitment to pursue the monetary policy desired by the US Treasury, not the monetary policy deemed most appropriate by the Fed.

Notice that the Fed has quietly established an accounting finesse to circumvent this outcome. Normally, the Fed remits funds to the Treasury annually. The notion is that any Fed position losses (due to credit losses or adverse interest rate movements) would be credited against income earned on Fed assets. If that number still was negative, it would have a credit at the Treasury. In the next profitable year, the Fed would simply retain some of the income it would normally forward to the Treasury to recapitalize the loss. This is what we call “extend and pretend” when private sector banks use flattering accounting to mask balance sheet holes and hope they can earn their way out of trouble....

the dirty secret of the ongoing Eurozone mess is that its banking system has not been cleaned up, and many countries (England, Germany, Switzerland, the Netherlands, for starters) have banking sectors so large relative to the size of their economies that their central banks cannot effectively backstop them. That should mean that the first order of business ought to be to constrain credit growth to increase the safety and stability of the system. But that’s a no-no. We’ve had various financial reform efforts that leave the system still significantly unfettered, when the size and danger it poses says it should be shackled. And the other mechanism for reducing risk, which is to increase capital in the banking system, is being approached in such a cautious and half hearted manner so as to assure it will fall well short of what is needed (witness the attenuated timetable for implementing Basel III)....

The industry nearly blew itself up, was rescued, and in short order was paying itself even higher bonuses than before the crisis. That means it has every reason to go back to piling on risk. The Fed’s accounting finesse means it has slipped one of the mechanisms, having to deal with the consequences of a loss, that might constrain its behavior and hence make it think more carefully about its balance sheet operations. Incentives matter as much for central bankers as they do for banks themselves, and the one at work for the Fed are poor indeed.

8--Accounting tweak could save Fed from losses, Reuters

Excerpt: "Could the Fed go broke? The answer to this question was 'Yes,' but is now 'No,'" said Raymond Stone, managing director at Stone & McCarthy in Princeton, New Jersey. "An accounting methodology change at the central bank will allow the Fed to incur losses, even substantial losses, without eroding its capital."

The change essentially allows the Fed to denote losses by the various regional reserve banks that make up the Fed system as a liability to the Treasury rather than a hit to its capital. It would then simply direct future profits from Fed operations toward that liability.

This enhances transparency by providing clearer, more frequent, snapshots of the central bank's finances, analysts say. The bonus: the number can now turn negative without affecting the central bank's underlying financial condition.

"Any future losses the Fed may incur will now show up as a negative liability as opposed to a reduction in Fed capital, thereby making a negative capital situation technically impossible," said Brian Smedley, a rates strategist at Bank of America-Merrill Lynch and a former New York Fed staffer.

"The timing of the change is not coincidental, as politicians and market participants alike have expressed concerns since the announcement (of a second round of asset buys) about the possibility of Fed 'insolvency' in a scenario where interest rates rise significantly," Smedley and his colleague Priya Misra wrote in a research note....

9--Fannie, Freddie, FHA combined REO Inventory at Record Level, Calculated Risk

Excerpt: The combined REO (Real Estate Owned) inventory for Fannie, Freddie and the FHA increased to a record 295,307 units at the end of Q4, although REO inventory decreased slightly for both Fannie Mae and Freddie Mac in Q4 (compared to Q3). The REO inventory increased 71% compared to Q4 2009 (year-over-year comparison).

The REO inventory for the "Fs" has increased sharply over the last year, from 172,368 at the end of 2009 to a record 295,307 at the end of 2010.

From Fannie Mae: Fannie Mae Reports Fourth-Quarter and Full-Year 2010 Results

Given the large number of seriously delinquent loans in our single-family guaranty book of business and the large current and anticipated supply of single-family homes in the market, we expect it will take years before our REO inventory approaches pre-2008 levels.

Also, this is just a portion of the total REO inventory. Private label securities and banks and thrifts also hold a substantial number of REOs.

10--Washington Wrecks the Economy: More Evidence, Dean Baker, TMPCafe

Excerpt: We now have even more evidence that inept policies from Washington are causing enormous suffering across the country. It is not quite the line that the right-wingers are pushing. The new evidence is that the stimulus worked and was in fact more effective than had been predicted.

The new evidence comes in the form of a study by two Dartmouth professors, James Feyrer and Bruce Sacerdote. Past estimates of the impact of the stimulus on jobs and the economy relied on simply plugging the tax breaks and spending into standard macro models and reporting the predicted effect. In this sense, the impact of the stimulus was actually built into the model. However this new study directly measures the impact of stimulus spending on employment across states, comparing the number of jobs created to the amount of spending.

The study consistently finds significant results over a wide range of specifications. This means that states that got more stimulus money had more jobs. The multipliers varied across specifications and types of spending but the range was 0.5 to 2.0. (The multiplier is the ratio of the change in GDP to the amount of stimulus spending. If the multiplier is 1.5 this means that $1 billion in stimulus increases GDP by $1.5 billion.) While the authors view their multiplier estimates as being somewhat below those predicted by the standard macro models, given the nature of their study their estimates are almost certainly higher than would be expected.

The range of multipliers found in this study suggests that the actual multiplier for stimulus spending is quite likely higher than the 1.5 in most macro models.

This is hugely important for macro policy debates because it suggests that more stimulus would provide a further boost to the economy and reduction in unemployment. This means that the only reason that we are sitting here with 25 million people unemployed and underemployed is that the politicians in Washington are too intimidated by the Wall Street deficit hawks.

The deficit hawks have used their enormous political power and control over the media to shut down any further discussion of stimulus. They have managed to completely dominate public debate with their brand of flat-earth economics. They are using the crisis that was created through their greed and incompetence to reduce hugely valued public benefits, like Social Security and Medicare. And, now they are using the crisis that they have created for state and local governments to destroy public sector unions.

This looks really awful because it is. Our nations' leaders are deliberately inflicting enormous pain on tens of millions of people to advance their political agenda. This new study helps to prove this fact.

11--Corporate Profits Soaring Thanks to Record Unemployment, The Economic Populist

Excerpt: In a January 2009 ABC interview with George Stephanopoulos, then President-elect Barack Obama said fixing the economy required shared sacrifice, "Everybody’s going to have to give. Everybody’s going to have to have some skin in the game."

For the past two years, American workers submitted to the President’s appeal—taking steep pay cuts despite hectic productivity growth. By contrast, corporate executives have extracted record profits by sabotaging the recovery on every front—eliminating employees, repressing wages, withholding investment, and shirking federal taxes.

The global recession increased unemployment in every country, but the American experience is unparalleled. According to a July OECD report, the U.S. accounted for half of all job losses among the 31 richest countries from 2007 to mid-2010. (2) The rise of U.S. unemployment greatly exceeded the fall in economic output. Aside from Canada, U.S. GDP actually declined less than any other rich country, from mid-2008 to mid 2010. (3)

Washington’s embrace of labor market flexibility ensured companies encountered little resistance when they launched their brutal recovery plans. Leading into the recession, the US had the weakest worker protections against individual and collective dismissals in the world, according to a 2008 OECD study. (4) Blackrock’s Robert Doll explains, “When the markets faltered in 2008 and revenue growth stalled, U.S. companies moved decisively to cut costs—unlike their European and Japanese counterparts.” (5) The U.S. now has the highest unemployment rate among the ten major developed countries. (6).

The private sector has not only been the chief source of massive dislocation in the labor market, but it is also a beneficiary. Over the past two years, productivity has soared while unit labor costs have plummeted. By imposing layoffs and wage concessions, U.S. companies are supplying their own demand for a tractable labor market. Private sector union membership is the lowest on record. (7) Deutsche Bank Chief Economist Joseph LaVorgna notes that profits-per-employee are the highest on record, adding, “I think what investors are missing - and even the Federal Reserve - is the phenomenal health of the corporate sector.” (8)

Due to falling tax revenues, state and local government layoffs are accelerating. By contrast, U.S. companies increased their headcount in November at the fastest pace in three years, marking the tenth consecutive month of private sector job creation. The headline numbers conceal a dismal reality; after a lost decade of employment growth, the private sector cannot keep pace with new entrants into the workforce....

The Fed’s Flow of Funds reveals corporate profits represented a near record 11.2% of national income in the second quarter. (13)
Non-financial companies have amassed nearly two-trillion in cash, representing 11% of total assets, a sixty year high. Companies have not deployed the cash on hiring as weak demand and excess capacity plague most industries. Companies have found better use for the cash, as Robert Doll explains, “high cash levels are already generating dividend increases, share buybacks, capital investments and M&A activity—all extremely shareholder friendly.” (5)

Companies invested roughly $262 billion in equipment and software investment in the third quarter. (14) That compares with nearly $80 billion in share buybacks. (15) The paradox of substantial liquid assets accompanying a shortfall in investment validates Keynes’ idea that slumps are caused by excess savings. Three decades of lopsided expansions has hampered demand by clotting the circulation of national income in corporate balance sheets. An article in the July issue of The Economist observes: “business investment is as low as it has ever been as a share of GDP.”...

U.S. tax law allows multinationals to indefinitely defer their tax obligations on foreign earned profits until they ‘repatriate’ (send back) the profits to the U.S. U.S. corporations have increased their overseas stash by 70% in four years, now over $1 trillion—largely by dodging U.S taxes through a practice known as “transfer pricing”. (18)Transfer pricing allows companies to allocate costs in countries with high tax rates and book profits in low-tax jurisdictions and tax havens—regardless of the origin of sale. U.S. companies are using transfer pricing to avoid U.S. tax obligations to the tune of $60 billion dollars annually, according to a study by Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon. (18)

The corporate cash glut has become a point of recurrent contention between the Obama administration and corporate executives. In mid December, a group of 20 corporate executives met with the Obama administration and pleaded for a tax holiday on the $1 trillion stashed overseas, claiming the money will spur jobs and investment. In 2004, corporate executives convinced President Bush and Congress to include a similar amnesty provision in the American Jobs Creation Act; 842 companies participated in the program, repatriating $312 billion back to the U.S. at 5.25% rather than 35%. (19) In 2009, the Congressional Research Service concluded that most of the money went to stock buybacks and dividends—in direct violation of the Act. (20)

The Obama administration and corporate executives saved American capitalism. The U.S. economy may never recover.

12--Janet Yellen on Unconventional Monetary Policy, Grasping reality with both hands

Excerpt: FRB: Speech: February 25, 2011: To assess the macroeconomic effects of the Fed's large-scale asset purchase program, I would like to highlight some findings from a recent study by four Federal Reserve System economists.... The baseline incorporates the first round of asset purchases--which brought the Federal Reserve's securities holdings to a little more than $2 trillion. It embeds an assumption that the FOMC will complete the purchases announced last November so that the balance sheet expands to about $2.6 trillion by the middle of this year.

From that point forward, the authors assume that the overall size of the portfolio will remain unchanged until mid-2012 and then shrink gradually at a rate sufficient to return it to its pre-crisis trend line by mid-2016.... [T]he overall characteristics of this assumed trajectory seem broadly consistent with the sense of the Committee's discussions last spring.... [T]he counterfactual scenario in which the FOMC never conducts any asset purchases.... The pace of recovery under the baseline scenario is expected to be painfully slow. But the counterfactual scenario suggests that conditions would have been even worse in the absence of the Federal Reserve's securities purchases: The unemployment rate would have remained persistently above 10 percent, and core inflation would have fallen below zero this year. Of course, considerable uncertainty surrounds those estimates, but they nonetheless suggest that the benefits of the asset purchase programs probably have been sizeable...

13--Notes on GDP, Econbrowser

Excerpt: The 2nd release for US GDP revealed a downward revision BEA; CR reports the breakdown. What is interesting is that the downward revision is due in part to a greater than previously estimated decline in the state and local government spending contribution. Something useful to keep in mind as state and local governments move to rely solely upon spending cuts instead of revenue increases as means to reduce budget deficits (e.g., as in Wisconsin).

14--G-20 Interim Study Faults Short Supply For Rise in Commodity Prices, Wall Street Journal

Excerpt: A report being conducted for the world’s Group of 20 leading economies points to supply not keeping up with demand as the main factor behind price increases in wheat, sugar, cotton, metals, oil and other commodities.

The Organization for Economic Cooperation and Development’s study–which is being put together ahead of the next G-20 meeting of top finance officials in April in Washington– may lead to increased efforts to boost commodities production around the world. It could also help reduce criticism of the U.S. Federal Reserve’s easy-money policies, which some have blamed for stoking global inflation....

A similar supply and demand argument can be made for oil prices, Padoan said. Oil prices have recently surged above $100 a barrel amid concerns that the recent turmoil in the oil-rich North African and Middle Eastern countries could hit production. The price of Brent oil, considered the best benchmark, is close to $110 a barrel, 15% higher than at the start of the year.

Fed Chairman Ben Bernanke has been making a similar case about commodity prices, following strong criticism that the U.S. central bank’s pumping of dollars has sent floods of cash into China and other developing economies, driving up prices for food and energy. The Fed chief puts the blame on strong growth in developing economies and their inadequate response, including China’s reluctance to let its currency rise.

15--Looking bad in the UK, The Streetlight blog

Excerpt: The fact that a significant reason for the slowdown in economic activity in Britain at the end of last year was the result of a reduction in spending by businesses tells me that companies are deeply worried about the economy in 2011. Based on some conversations that I've had with upper management in a couple of UK companies, as well as plain old common sense, I feel quite certain that this pull-back in spending by businesses is primarily a reaction to the "austerity measures" that the UK's government is implementing. There is a widespread and reasonable concern among businesses that this year's substantial tax increases and cuts in government spending will make a serious dent in the recovery. After all, thanks to the austerity measures, economic forecasts for the UK for 2011 have been revised down in recent months. So naturally, businesses are pulling back on their spending, waiting to see how strong demand for their goods and services really is this year.

And then, as if to kick the British economy while it's down, we learned this week that sentiment on the Monetary Policy Committee ("MPC") of the Bank of England is trending toward higher interest rates, not lower:

More MPC members vote for a rate hike

UK interest rates could rise soon following news that the number of policymakers in favour of a hike increased during the last Bank of England Monetary Policy Committee (MPC) meeting.

Minutes published by the bank show member Spencer Dale joined Andrew Sentance, who has long been voting for a hike, and Martin Weale in pushing for an increase....

I must confess that I am truly mystified by this. Yes, inflation in the UK has risen in recent months. But this is almost completely explained by two very temporary factors: the recent spike in commodity prices (led by the price of oil), and the increase in the VAT in Britain, which feeds through to higher prices for nearly all types of consumer goods. Absent these temporary forces, it seems clear (even to the Bank of England's governor Mervyn King) that underlying inflation in the UK is not a problem.

Alas, I take this as evidence that economists and policy-makers in the UK have forgotten as much about how the macroeconomy works as they have in the US. A Dark Age of Macroeconomics has descended upon both sides of the Atlantic.

Friday, February 25, 2011

Weekend links

1--Sales of New U.S. Homes Fell More Than Forecast in January, Bloomberg

Excerpt: Purchases of new houses in the U.S. fell more than forecast in January, reflecting declines in the West and South that indicate a California tax credit and bad weather may have played a role.

Sales declined 13 percent to a 284,000 annual pace, figures from the Commerce Department showed today in Washington. The median estimate of economists surveyed by Bloomberg News projected a decrease to a 305,000 rate. Demand dropped 37 percent in the West and 13 percent in the South.

Foreclosures will keep depressing prices, making distressed, previously owned properties more attractive to prospective buyers than new houses. Combined with unemployment at 9 percent and tight credit standards, home construction may keep lagging behind the rest of the economy this year...

The supply of homes at the current sales rate rose to 7.9 month’s worth from 7 months in December. There were 188,000 new houses on the market at the end of January, the fewest since December 1967....

Rising borrowing costs represent another hurdle. The average rate on 30-year fixed mortgages matched or exceeded 5 percent for a third period in the week ended Feb. 18, the first time that’s happened since April, the Mortgage Bankers Association said this week. Rates have been rising from a record low of 4.21 percent reached in October.

2--CBO’s Estimates of ARRA’s Impact on Employment and Economic Output, Congressional Budget Office

Looking at recorded spending to date along with estimates of the other effects of ARRA on spending and revenues, CBO has estimated the law’s impact on employment and economic output using evidence about the effects of previous similar policies and drawing on various mathematical models that represent the workings of the economy. Because those sources indicate a wide range of possible effects, CBO provides high and low estimates of the likely impact, aiming to encompass most economists’ views about the effects of different policies. On that basis, CBO estimates that ARRA’s policies had the following effects in the fourth quarter of calendar year 2010:

* They raised real (inflation-adjusted) gross domestic product by between 1.1 percent and 3.5 percent,
* Lowered the unemployment rate by between 0.7 percentage points and 1.9 percentage points,
* Increased the number of people employed by between 1.3 million and 3.5 million, and
* Increased the number of full-time-equivalent (FTE) jobs by 1.8 million to 5.0 million compared with what would have occurred otherwise. (Increases in FTE jobs include shifts from part-time to full-time work or overtime and are thus generally larger than increases in the number of employed workers).

The effects of ARRA on output peaked in the first half of 2010 and are now diminishing, CBO estimates. The effects of ARRA on employment and unemployment are estimated to lag slightly behind the effects on output; they are expected to wane gradually beginning in the fourth quarter. CBO projects that the number of FTE jobs resulting from ARRA will drop sharply during 2011—from between 1.7 million and 4.7 million in the first quarter to less than half that number in the fourth quarter (between 0.8 million and 2.5 million). During 2012, CBO estimates that the impact on employment and economic output of ARRA will be small.

3--Does the U.S. Really Have a Fiscal Crisis?, Simon Johnson, New York Times

Excerpt: The United States faces some serious medium-term fiscal issues, but by any standard measure it does not face an immediate fiscal crisis. Overly indebted countries typically have a hard time financing themselves when the world becomes riskier — yet turmoil in the Middle East is pushing down the interest rates on United States government debt. We are still seen as a safe haven....

The most immediate problem is that our largest banks and closely related parts of the financial system blew themselves up in 2007-8. The ensuing recession and associated loss of tax revenue will end up increasing our government debt, as a percentage of gross domestic product, by around 40 percent. Very little of this debt increase was due to the fiscal stimulus; mostly it was caused by lower tax revenue, because of the slump in output and employment.

The financial system poses a major risk to our fiscal outlook over the next few years. Unless you think that the Dodd-Frank reform bill really ended “too big to fail” and the associated excessive risk-taking culture, you should worry a great deal about the assumption of boom, bust, bailout and fiscal damage that the Bank of England now refers to routinely as the “doom loop.”

4--No Irish Spring: Emerald Isle as Credit Crunch Microcosm, The Big Picture

Excerpt: While the story of the collapse of the Celtic Tiger is not a new story, I did enjoy Theodore Dalrymple’s recent piece in City Journal: How the Irish Bubble Burst.

We are supposed to learn something from this incubator of a pure economic meltdown. I find this amazing:

Some 300,000 new dwellings now stand empty in the Irish Republic, a number whose equivalent in the United States would be approximately 21 million.

And the emigration begins…

Unemployment is now 13 percent in Ireland; it would be higher if 5 percent of the working-age population (principally the young and well-qualified) had not emigrated over the last two years.

A few months ago, I did a podcast interview with a friend of mine from Ireland who described the unsettling change in values during the boom a few years ago while on a family visit.

I observed what I later dubbed the “Irish Carpenter Syndrome” (my label for working and middle class Irish investors who were snapping up condos in Manhattan sight unseen) egged on by the currency imbalance.

The poster child for this phenomenon was The Centria Condo adjacent to Rockefeller Center (faces the famed Christmas Tree directly over the plaza) during the 2007 rush to snap up anything they could. 100% of the buyers in this building were reportedly Irish. The high flying Ireland-based marketing firm that sold these condos to investors, largely sight unseen, imploded along with the investors.

The urgency that permeated this NYT article harkens to another time.

“It’s an Irishman’s dream to be able to go to Manhattan and be able to buy property there,” said Mr. McCann, 36, who added that he hoped to buy more New York apartments.”

Yes, indeed.

5-- Mortgage Fraud Whitewash: $20 Billion “Get Out of Jail Free” Settlement Floated, naked capitalism

Excerpt: ...Even so, the mortgage “settlement” trial balloon floated in the Wall Street Journal this evening is an offense to common sense and decency. Notice how the word “fraud” is pretty much verboten in the MSM; the latest code word for what went awry is “breakdown”. This implies a benign sort of neglect, simply of not doing sufficient maintenance which led fussy machinery to quit working....

The plan involves having servicers give borrowers principal mods, but obviously only to the extent of the fund amount. The WSJ story announces that mortgage investors will suffer no losses. This shows how backwards the logic here is. Investors would LOVE principal mods to qualified borrowers; it’s far better than taking 70%+ losses on foreclosures. So saving RMBS investors any pain should never have been a feature of the plan design. And that means it is really a fig leaf for avoiding writedowns on second liens, which are heavily concentrated in the four biggest TBTF banks....

The servicers, as well as Fannie and Freddie, would be required to provide principal mods. But given the meager settlement amount, this is a complete and utter joke. The mods will be too shallow and too few in number to help either borrowers or the housing market. Both J.C. Flowers and Wilbur Ross, both very tough minded investors, have found deep principal mods work, and research supports their views....

as Marcy Wheeler correctly points out, this program is really HAMP 2.0. When a small group of bloggers visited the Treasury last August, HAMP was such an obvious failure that the staff didn’t even try hard to defend it....The deal wouldn’t create any new government programs to reduce principal. Instead, it would allow banks to devise their own modifications or use existing government programs, people familiar with the matter said. Banks would also have to reduce second-lien mortgages when first mortgages are modified.

6--Austerity’s inauspicious historical precedents, Felix Salmon, Reuters

Excerpt: Macdonald has an economic historian’s view of the current austerity debate, and he was very clear: if you look at the history of countries trying to cut and deflate their way to prosperity while keeping their currencies pegged, it’s pretty grim — all the way back to Napoleonic times. Sometimes, the peg is gold. For a good example of the destructive abilities of that particular peg, look at the UK in the 1920s, which Macdonald says was arguably worse than the US in the 1930s: shallower, to be sure, but substantially longer. The devaluation of the pound, when it finally came, was very long overdue....

So from a historical perspective, the prospects for countries like Portugal, Ireland and Greece are pretty grim. They can cut their budgets drastically and stay pegged to the euro, but most of them would be better off in the position of Iceland, which can and did devalue in a crisis (and allowed its banks to default, too). So far, the Baltic states have stuck to their deflationary guns with the most determination and discipline, but such things work until they don’t: at some point it’s entirely possible that Latvia or Estonia could pull an Argentina and kickstart growth by devaluing.

All of this is relevant for the US states, of course, which are also locked into a currency union and facing very tough fiscal cuts, as Steven Pearlstein says today:

Will the pain come in the form of prolonged high unemployment? Or wage and salary cuts? Or reduction in the value of homes and financial assets? Or loss of ownership of American companies? Or price inflation? Or higher taxes? Or reductions in government services and benefits?

The right answer, of course, is “all of the above.”...

“The historical lesson of postcrisis austerity movements,” writes Leonhardt, “is a rich one,” and also clear: they don’t work, even if they’re “morally satisfying.”

7-- Matt Stoller: The Liquidation of Society versus the Global Labor Revival, naked capitalism

Excerpt: The problem for the elites is that the system of control is breaking down. I noted a week and a half ago that the Egyptian revolution was a labor uprising against Rubinites. So to the extent that global labor arbitrage relies on sweatshops and environmental degradation in poor countries for cheap goods, successful strikes in poor countries undercuts the whole system. The reason to outsource work in the first place is to prevent workers in rich countries from gaining pricing and political power. Now workers in poor countries are getting pricing and political power? It’s actually a fragile system of control, and can be broken through either crackdowns on tax havens and oligarchs in wealthy countries or protests/strikes where the goods are made.

The Egyptian revolution was really a series of protests and highly politicized strikes, which is why people in Madison are taking inspiration from Cairo. In fact, the actions in Egypt may be creating a wave of labor actions worldwide, rippling to Wisconsin, Indiana, and Ohio. All of these strikes are aimed at a collusive set of tight relationships....

Egyptians are trying to throw off the IMF-imposed austerity measures that created such a system for their country. The new government there is proposing raising taxes on oligarchs, increasing food subsidies, and reducing inequality. Their new cabinet is letting more people apply for “monthly portions of sugar, cooking oil, and rice.” The previous cabinet, “which was comprised of businessmen and former corporate executives”, had refused this.

And look at how Egypt is treating public employees: “Temporary workers who have spent at least three years working for the government will now be given permanent contracts that carry higher salaries, and benefits such as pension plans, and health and social insurance.”

Pension plans, health, and social insurance, oh my! How are they planning to pay for this? One member of a left-of-center party made it quite clear:

Confiscating wealth looted by cronies of the former regime, more egalitarian distribution of wealth, gradual taxation, better government oversight, and placing “a reasonable ceiling” on profitability of goods and services sold to the public are among the measures that should restore an economic balance to society, he said.

It is too early to pretend like this is a done deal, but it is certainly the case that the mass exercise of people-power in Egypt made this far more possible than it had been before. Even after Mubarak resigned, and even when the army tried to ban labor gatherings, the Egyptian labor movement continued to strike, gather, and make demands....

As commodity prices shoot up, and become more volatile, the pressure to liquidate America will only increase. These increases take the form of gifting public assets to oligarchs, taxing the middle class and poor, slashing social service budgets, and cutting wages through inflation and outright demotions (like the NYC sanitation workers that were demoted right before a giant blizzard). But civil unrest is intensifying it its most basic forms: protests and strikes, and in advanced forms, like the blowback at the national security state embodied in the HB Gary and WIkileaks fiasco.

What we are seeing is two political and economic systems, increasingly at odds – high trust and cooperative, or dominance-based and lowest common denominator. This is not, fundamentally, a debate about economics. It is true that neoclassical economics doesn’t work, leads to corruption, and is intellectually dishonest. But that’s why this isn’t a question of economics, because the dishonesty is part of a system of corrupted values.

8--From inflation to stagflation, FT Alphaville

Excerpt: (wonkish) Some grumbling from the belly of the US Treasury curve.

US Treasuries had a rollercoaster day on Wednesday as soaring crude sent the 10-year yield lower by 6 basis points. UST gains then reversed within a couple of hours. Meanwhile five-year breakeven rates (the spread between inflation-linked and regular US debt notes) rose to the highest since July 2008 on inflation concerns.

And indeed there’s been some active movement in the TIPS market — with short-end inflation expectations (as implied by two-year TIPS) rallying as much as 35 basis points over the past week as they react to those commodity prices.

So — inflation expectations for sure. But maybe something else too.

Here’s Bank of America Merrill Lynch analysts on recent UST moves:

The market contributes the [10-year] move as dealers getting ready for the supply of US$29bn 7y, but a detailed scrutiny reveals that the move follows a stagflation concern which is clear from the 5y bond: almost the entire rally came from the real yield (RY), and the sell-off, from breakeven inflation (BEI). Beginning to end, the 5y RY (USGGT05Y) and BEI (USGGBE05) were respectively (-0.32%, 2.14%) and (-0.42%, 2.2%). The lower real yield is one reason that the USD traded weak.

The spread between five-year real yields and five-year breakeven inflation also looks to have completely reversed its 2008 (deflationary) relationship.

Salutations, stagflation expectations.

9--Eurozone bond buybacks, unmoored, FT Alphaville

Excerpt: Portugal’s 10-year bonds now yield 7.5 per cent. Quite unmoored.

Long-term plans to resolve the eurozone crisis — joining them there, increasingly.

Everyone still seems to be digesting the results from a state election in Germany, in which Angela Merkel’s party was roundly trounced. Likely not for its European policies, but there’s still been a legislative backlash against eurozone bailout proposals all the same.

In particular, against allowing the European Stability Mechanism to buy debt of distressed sovereigns, or indeed lending to governments to allow it to buy it back themselves.

Not only that — but Merkel’s coalition partners also want a ’special’ deal on Greek debt buybacks to be ruled out before the ESM comes online in 2013, the FT reports.

Given their implications, we’re not sure these two objections have been digested nearly enough yet.

10--Why Stocks Tanked (It's Not Just Libya) , Wall Street Journal

Excerpt: It's not just about Libya. There's another reason the stock market just took a hit. Everyone had become way too bullish and way too complacent.

Pride, as they say, goeth before a fall. When everyone's bullish, who is left to come in?

We're slap-bang in the middle of another mania.

A few days ago, while everyone was watching events unfold across the Arab world, an intriguing document came across my desk. It was the monthly Bank of America/Merrill Lynch survey of the world's top investment managers.

Bank of America spoke to 270 institutional investment managers—with a thumping $773 billion in assets—around the world and asked them for their views on the markets.

In a nutshell? They were about as euphoric as they have been since the late 1990s. "Institutions have record equity and commodity overweights, very low cash levels and the strongest risk appetite since Jan '06," reports Bank of America. Cash had fallen to 3.5% of assets—a dangerously low level. BofA research says that in the past, when it has fallen that low a stock market "correction" has usually followed in a matter of weeks.

Our old friends the hedge funds are back to where they were before the crash. According to the BofA report, hedge funds are betting as heavily on booming share prices as they were in July 2007, and the last time they were playing with this much borrowed money was in March 2008. Ah, the happy memories ...

It isn't just the institutions, either. The individual American investor, who has been selling stocks for most of the past couple of years, has suddenly turned tail and started buying again. Portfolio managers will tell you their clients have been back on the phone since the start of the year, eager to get in on the action. The Investment Company Institute, a trade organization for mutual funds, reports big inflows of new money into stock-market funds since early January. Indeed, inflows into U.S. stock funds have been running at levels not seen—but for a single brief spike in 2009—since well before the crash.

Sentiment is one thing. Valuation is another. And Wall Street is frankly expensive by most measures. The dividend yield on the overall market, according to FactSet, is a measly 1.5%. The last time it was this low for any length of time was during the great bubble years of 1997 to 2001. According to data tracked by Yale University economics professor Robert Shiller, the market overall is priced at about 24 times cyclically-adjusted corporate earnings. That is very high; the average is about 16. Last week I screened the stock market for good dividend stocks: blue-chip companies whose shares are selling cheaply and which offer decent yields. The ranks are pretty thin these days. Everything has boomed.

11--Germany’s Economic Fortress Could Come Toppling Down, Marshall Auerback, New deal 2.0

Excerpt: There is a long way to go before the private sector will have adequately restructured their balance sheets so that they will be prepared to spend freely again. Unless some other sector is willing to reduce its net saving (such as the external sector via trade) or increase its deficit spending (as with the federal budget balance of late), then the mere attempt by the domestic private sector to net save out of income flows, given the existing private debt overhang, can prove very disruptive.

Would that our officials recognized this. Instead, we have the spectacle of governments across the world engaged in significant fiscal retrenchment at a time when the private sector is demonstrating a strong predisposition to save. That’s understandable. Given prevailing high levels of unemployment, low capacity utilization ratios, and relatively sluggish aggregate demand, a greater predisposition by the private sector to save makes greater sense.

Who, then, can fill that gap? If it doesn’t come from exports (and it’s impossible for all nations to run current surpluses), then only the government can fill that gap. A lack of jobs is the result of a lack of spending. The government has the capacity to provide that extra aggregate demand, and could do so easily by directly creating the necessary work. Instead, we appear more focused on union-busting and rewarding the figures most responsible for creating this crisis in the first place.

12--Liquidations Coming: Hedge Fund Margin Debt Surges - Total Free Cash Lowest Since July 2007, Just Prior To Quant Wipe Out, zero hedge

Excerpt: The NYSE has released its January margin debt data. Not surprisingly, total margin debt hit a peak of $290 billion, the highest since September 2008, but the one category that shows just how much purchasing is occurring on margin is total Free Credit less Total Margin Debt drops to the lowest since the all time credit bubble peak in July of 2007! At ($45.9 billion) this number is just below the ($52.8) billion last seen just before the August 2007 quant wipe out which blew up Goldman's quant desk, and arguably was the catalyst for the beginning of the end. In other words, as we have shown, everyone is now purchasing on margin and the level of investor net worth is the lowest in over 3 years. Which means that should the market decline from this week persist and the Fed be unable to stop it, the margin calls will start coming in fast and furious, and unwinds in otherwise stable products like gold and silver are increasingly possible as hedge funds proceed to outright liquidations.

13--Household deleveraging and consumer-led growth, FT Alphaville

Excerpt: Back in October and November of last year, one of the reasons that cautious optimism returned to the US economy was the possibility that household deleveraging was far enough along that it could continue, perhaps at a slower pace, even while consumers felt comfortable spending again.

With government’s contribution to the economy declining and corporates continuing mostly to sit on their cash piles, consumption would have to carry a heavy burden for pushing the economy forward....Thus far, it seems, consumers are playing their part — increasing spending and continuing to deleverage. Greg Ip wrote in November that the ratio of household debt to disposable income had declined from its 2007 peak of 135 per cent to 123 per cent in the middle of last year. And since then it has fallen further to 118 per cent...

At the same time, if you look at a breakdown (via EconomPic Data) of last week’s GDP numbers, it’s clear that personal consumption is indeed what largely drove the economy in the fourth quarter...

(Yes, there was also a big contribution from declining imports, but James Hamilton explains that this positive contribution should be interpreted as having been offset by declining inventories, as these two variables have tended to move inversely of late, which is likely not a coincidence.)

This seems exactly like the scenario everybody was hoping for: a recovery that’s driven by rising income and demand, taking place even as households keep deleveraging.

In other words, the recovery can’t be just a consumer story forever. That spending is outpacing income is a welcome boost to the economy for now, but certainly nobody would think it healthy for the savings rate to fall again to the absurd, sub-1% levels it reached in 2005.

At some point, the recovery will need help from business investment (including higher employment) to be sustainable. And surely Tim Duy has a point when he writes that an element of global rebalancing needs to play a big role as well — a higher savings rate would help the US reduce its current account deficit and allow net exports to pull more weight.

As you may have guessed, there are additional complications.

One is that much of the deleveraging is happening through defaults on mortgages and consumer loans.

Thursday, February 24, 2011

Today's links

1--Fed’s Hoenig: Easy Money And Too-Big-To-Fail Must End, Wall Street Journal

Excerpt: Federal Reserve Bank of Kansas City President Thomas Hoenig on Wednesday said the U.S. central bank was risking a new financial crisis with its easy-money policies and urged regulators to break up the biggest banks.

Hoenig, one of the Fed’s most outspoken internal critics, warned monetary policy should be tailored “so you don’t overshoot and cause the next crisis.”

The maverick Fed official was also sharply critical of the regulatory overhaul passed last July, saying the risks to the U.S. economy from the largest financial institutions are even worse following the approval of the Dodd-Frank law.

Hoenig’s remarks are likely to fall on deaf ears. Fed Chairman Ben Bernanke believes the fragile U.S. economy still needs support from the central bank’s low-interest-rate policy. And last week, Bernanke told Congress regulation has made great steps forward thanks to Dodd-Frank.

Speaking at a Women in Housing and Finance lunch in Washington, Hoenig said he voted against the Fed’s easy-money policies throughout 2010 for fear it would lead to excessive speculation and risk-taking. Hoenig is concerned low rates will harm the economy by causing prices to rise suddenly or by creating speculative asset bubbles, like the housing bubble behind the 2008 financial crisis.

Most Fed officials, including Bernanke, disagree, arguing that low interest rates are needed because unemployment remains so high more than 18 months after the recession ended, while inflation is still low.

Asked how he could advocate tighter policy when unemployment is still so high, Hoenig said the Fed should think about the long-term implications of its actions. Monetary policy is a “powerful tool” that can have “unintended consequences.” He pointed out the recent crisis came about following a period of very low rates.

In his prepared remarks, Hoenig said the U.S. must end its implicit “too-big-to-fail” guarantee for the biggest financial institutions, or is doomed once again to face a crisis.

The Fed official said the country’s largest financial institutions enjoy insulation from normal market forces that would otherwise force them to make more prudent choices. That insulation, in the form of U.S. bailouts, needs to end, he said.

“I am convinced that the existence of too-big-to-fail financial institutions poses the greatest risk to the U.S. economy,” Hoenig said.

The largest banks must be broken apart, Hoenig said, by splitting apart their lines of business and limiting the activities–and risk–of commercial banks operating under the public safety net.

“We must expand the Volcker Rule and carve out business lines that are not essential to the basic business of commercial banking or consistent with public safety nets and then require that these lines be spun off into separate firms,” he said.

The Volcker rule, named for former Fed Chairman Paul Volcker, is designed to discourage banks from entering into risky trades with their own money. It forces banks to scale back their proprietary-trading desks and curtail relationships with hedge funds and private-equity funds.

Elements of the Glass-Steagall Act, which separated commercial and investment banking, also should be reinstated, Hoenig said. Banks should also be forced to adhere to more strict capital standards, he said.

The implicit guarantee given to the country’s largest institutions, Hoenig said, distorts the quality of their credit ratings. That’s exhibited, he said, through credit-ratings agencies’ distinction between standalone ratings–those based on the institution’s profile without a government guarantee–and support ratings, based on how much government aid an institution would be expected to receive.

“The difference in these two ratings thus provides one measure of the funding advantages that too-big-to-fail organizations have over others,” he said.

2--Why Budget Cuts Don’t Bring Prosperity, New York Times

Excerpt: Remember the German economic boom of 2010?

Germany’s economic growth surged in the middle of last year, causing commentators both there and here to proclaim that American stimulus had failed and German austerity had worked. Germany’s announced budget cuts, the commentators said, had given private companies enough confidence in the government to begin spending their own money again.

Well, it turns out the German boom didn’t last long. With its modest stimulus winding down, Germany’s growth slowed sharply late last year, and its economic output still has not recovered to its prerecession peak. Output in the United States — where the stimulus program has been bigger and longer lasting — has recovered. This country would now need to suffer through a double-dip recession for its gross domestic product to be in the same condition as Germany’s.

Yet many members of Congress continue to insist that budget cuts are the path to prosperity. The only question in Washington seems to be how deeply to cut federal spending this year....

The fundamental problem after a financial crisis is that businesses and households stop spending money, and they remain skittish for years afterward. Consider that new-vehicle sales, which peaked at 17 million in 2005, recovered to only 12 million last year. Single-family home sales, which peaked at 7.5 million in 2005, continued falling last year, to 4.6 million. No wonder so many businesses are uncertain about the future.

Without the government spending of the last two years — including tax cuts — the economy would be in vastly worse shape. Likewise, if the federal government begins laying off tens of thousands of workers now, the economy will clearly suffer.

That’s the historical lesson of postcrisis austerity movements.

3---Geithner's Gamble, Simon Johnson, Project Syndicate

Excerpt: In a recent interview, United States Treasury Secretary Tim Geithner laid out his view of the nature of world economic growth and the role of the US financial sector. It is a deeply disturbing vision, one that amounts to a huge, uninformed gamble with the future of the American economy – and that suggests that Geithner remains the senior public official worldwide who is most in thrall to the self-serving ideology of big banks.

Geithner argues that the world will now experience a major “financial deepening,” owing to growing demand in emerging markets for financial products and services. He is thinking, of course, of “middle-income” countries like India, China, and Brazil. And he is right to emphasize that all have made terrific progress and now offer great opportunities for the rising middle class, which wants to accumulate savings, borrow more easily (for productive investment, home purchases, education, etc), and, more generally, smooth out consumption.

But then Geithner takes a leap. He wants US banks to take the lead in these countries’ financial development. His words are worth quoting at length:

“I don’t have any enthusiasm for…trying to shrink the relative importance of the financial system in our economy as a test of reform, because we have to think about the fact that we operate in the broader world…It’s the same thing for Microsoft or anything else. We want US firms to benefit from that…Now, financial firms are different because of the risk, but you can contain that through regulation.”...

our largest banks are now undoubtedly too big to fail, they have even more incentive to increase their debt levels relative to their equity. Higher leverage increases their payoffs when times are good – as executives and traders are paid based on their “return on equity.” And when times are bad, for example in a crisis episode, losses are transferred to creditors. If those creditor losses are large and spread so as to undermine the broader financial system, pressure for a government bailout will mount. Bankers get the upside and taxpayers (and people laid off as credit is disrupted) get the downside....

In Switzerland, the two largest banks (UBS and Credit Suisse) had a combined balance sheet in fall 2008 of around 8 times Swiss GDP – mostly based on their global activities. Mortgage traders in London – not many of whom were Swiss – took on enormous risks that almost brought down UBS. The Swiss government could afford the bailout, just. And now the Swiss National Bank is moving in the exact opposite direction to Geithner – they are pushing these big banks to become smaller and to finance more of their activities with equity, rather than debt.

Geithner is a very smart and experienced public servant. His views concerning the future of finance will help shape what happens. And that is why we are headed for trouble.

4--Existing Home Inventory increases 3.1% Year over Year, Calculated Risk

Excerpt: Although inventory decreased from December to January, inventory increased 3.1% YoY in January. This is the sixth consecutive month of year-over-year increases in inventory, although the increase in January was lower than the previous months. But any increase is bad news with the high level of inventory.

Inventory should increase in February and March, and this is something to watch closely over the next few months...

Sales NSA were about the same level as the last three years. January is usually the weakest month of the year for existing home sales (followed by February). The real key is what happens in the spring and summer.

The bottom line: Sales increased slightly in January (using the old method to estimate sales), apparently due to an increase in investor purchases of distressed properties at the low end. The NAR noted "Investors accounted for 23 percent of purchases in January, up from 20 percent in December and 17 percent in January 2010 ... Distressed homes edged up to a 37 percent market share in January from 36 percent in December"

Inventory remains very high, and the year-over-year increase in inventory is very concerning.

5---Oil May Surge to $220 If Libya, Algeria Halt, Nomura Says, Bloomberg

Excerpt: Oil prices may surge to $220 a barrel if political unrest in North Africa halts exports from Libya and Algeria, Nomura Holdings Inc. said.

Crude futures rose to $97.97 in New York today, the highest in more than two years, as the violence in Libya threatened to disrupt exports from Africa’s third-biggest supplier. Libyan leader Muammar Qaddafi vowed yesterday to fight a growing rebellion until his “last drop of blood.” Protests in Algeria led to the ending of a 19-year state of emergency.

“If Libya and Algeria were to halt oil production together, prices could peak above $220 a barrel and OPEC spare capacity will be reduced to 2.1 million barrels a day, similar to levels seen during the Gulf war and when prices hit $147 in 2008,” the Tokyo-based bank said in a note today.

6--Real House Prices fall to 2000 Levels, Update on NAR Overstating Sales, Calculated Risk

Excerpt: The real key is the level of inventory and months-of-supply. Prices were boosted in 2009 and early 2010 by a combination of policies, including the housing tax credits, foreclosure moratoriums (reducing supply), and low mortgage rates. Prices are now falling again, and if the months-of-supply is substantially higher than originally thought (the NAR reported 8.1 months in December), then prices will probably fall further than many analysts expect.....

• The real price indexes are at post-bubble lows. The National index is at a post-bubble low in nominal terms too (not inflation adjusted), and is now back to Q1 2003 prices. Those who argued prices bottomed some time ago are already wrong - and prices are still falling.....

In real terms, the National index is back to Q1 2000 levels, the Composite 20 index is back to January 2001, and the CoreLogic index back to October 2000. ....

• I don't expect real prices to fall to '98 levels. In many areas - if the population is increasing - house prices increase slightly faster than inflation over time, so there is an upward slope in real prices.

• Real prices are still too high, but they are much closer to the eventual bottom than the top in 2005. This isn't like in 2005 when prices were way out of the normal range.

• Prices will probably fall some more and my forecast is for a decline of 5% to 10% from the October 2010 levels for the national price indexes. However we need to watch inventory (and months-of-supply) closely over the next few months - and it doesn't help that the NAR data is questionable.

7---Consumer Stress Continues to Rise While DC Goes into “Mission Enough Accomplished” Mode, naked capitalsim

Excerpt: ...the latest report from the not-for-profit credit counseling agency CreditAbility. Its latest report (hat tip Doug Smith) shows that, contrary to media cheerleading, consumer conditions deteriorated in the fourth quarter of 2010. That means not only did conditions worsen during all of last year, but the standing of household budgets is at its worst level since the first quarter of 2010.

And Mark Cole, who is oversees the credit index, does not see reports of improved economic conditions translating into healthier consumer finances:

“Improved stock prices have increased the value of 401(k) and other investment accounts in the average US household, but high unemployment continues to stifle income growth, causing many homeowners to miss mortgage payments,” Cole said. “While an increase in consumer spending helped the economy in the fourth quarter, the index showed that an increasing number of people failed to prudently manage their household budgets. This lack of savings could cause financial problems if they need to rely on their savings in the future.”

Cole does note that households with stable and unimpaired incomes are beginning to spend more freely, but distress is becoming more acute for those whose cash flow has not recovered. And the number of people in the latter category is large enough to call the happy talk about the state of the economy into question.

8---The deflationary shock, Pragmatic Capitalism

Excerpt: David Rosenberg makes some interesting comments in his morning note regarding the price action in US Treasuries. He cites the rally as a sign that the world is concerned about the deflationary shocks from rising oil prices:

“It is also interesting to see how government bond markets are reacting to the oil price surge — by rallying, not selling off. In other words, bond market investors are treating this latest series of events overseas as a deflationary shock.”

I think Rosey has this one spot on. The risk of rising oil is not a hyperinflationary spiral, but rather a deflationary spiral. Oil price increases are cost push inflation of the worst kind and for a country still mired in a balance sheet recession that means spending gets diverted which only gives the appearance of inflation in (highly visible) gas prices while creating deflationary trends in most (less visible) other assets (have a look at today’s Case Shiller housing report for instance).

The environment is not really so different from what we were experiencing in 2008. What we have in the USA is an underlying balance sheet recession being papered over by government deficit spending and very easy monetary policy. The math behind our economic plight is quite simple. Since we are running a -3% current account deficit the government must spend to the tune of 3%+ of GDP if the private sector desires to save. And that’s exactly what is occurring. In fact, the 10% deficit is allowing the private sector to save quite a bit (roughly 7%). Make no mistake, the deficit spending of the last 2 years is what has generated recovery. This is far from organic growth, but as we learned in Japan and during the Great Depression, the alternative is to risk something worse. Unfortunately, our implementation of the recovery plan has been mangled at several steps along the way so it is primarily Wall Street that has benefited while Main Street continues to suffer. I attribute this lopsided recovery in large part to the actions of the Fed.

The Fed’s dual mandate has them tinkering in the markets far more than they should and the repercussions are disastrous psychological impacts. They manipulate rates, bailout the banks, and generally implement policy that is based around creating a healthy banking system. After all, that’s really all their tool set can do anyhow. Not surprisingly, their policies over the last 20 years have helped in significantly financializing the US economy. The results of that world speak for themselves.

Today, in a misguided attempt to create a “wealth effect” via equities it appears as though Ben Bernanke has helped to generate a speculative boom in many commodities. This is not the direct cause of the unrest abroad, but it’s certainly not helping. But perhaps more importantly, the environment that Ben Bernanke is creating (commodity bubbles) actually increases the risk that we will relapse into a deflationary spiral (the very thing he is attempting to combat). After all, if the global economy slows once again it is highly likely that we will see price action that was very similar to 2008 – a flight to safety in US Treasuries, USD, commodities get crushed and equities sell-off. Today’s action is a small example of that sort of fear trade. And make no mistake – this is not hyperinflationary price action. This is deflationary price action.

9----The Secret US War in Pakistan, Jeremy Scahill, The Nation

Excerpt: At a covert forward operating base run by the US Joint Special Operations Command (JSOC) in the Pakistani port city of Karachi, members of an elite division of Blackwater are at the center of a secret program in which they plan targeted assassinations of suspected Taliban and Al Qaeda operatives, "snatch and grabs" of high-value targets and other sensitive action inside and outside Pakistan, an investigation by The Nation has found. The Blackwater operatives also assist in gathering intelligence and help direct a secret US military drone bombing campaign that runs parallel to the well-documented CIA predator strikes, according to a well-placed source within the US military intelligence apparatus. ...

Who is Behind the Drone Attacks?...

The military intelligence source says that the CIA operations are subject to Congressional oversight, unlike the parallel JSOC bombings. "Targeted killings are not the most popular thing in town right now and the CIA knows that," he says. "Contractors and especially JSOC personnel working under a classified mandate are not [overseen by Congress], so they just don't care. If there's one person they're going after and there's thirty-four people in the building, thirty-five people are going to die. That's the mentality." He added, "They're not accountable to anybody and they know that. It's an open secret, but what are you going to do, shut down JSOC?"...

"The immediate question is, How do you define the active pursuit of military objectives in a country with which not only have you not declared war but that is supposedly a front-line non-NATO ally in the US struggle to contain extremist violence coming out of Afghanistan and the border regions of Afghanistan and Pakistan?" asks Zaidi, who is currently a columnist for The News, the biggest English-language daily in Pakistan. "Let's forget Blackwater for a second. What this is confirming is that there are US military operations in Pakistan that aren't about logistics or getting food to Bagram; that are actually about the exercise of physical violence, physical force inside of Pakistani territory."...

JSOC performs strike operations, reconnaissance in denied areas and special intelligence missions. Blackwater, which was founded by former Navy SEALs, employs scores of veteran Special Forces operators--which several former military officials pointed to as the basis for Blackwater's alleged contracts with JSOC....

Wilkerson said that almost immediately after assuming his role at the State Department under Colin Powell, he saw JSOC being politicized and developing a close relationship with the executive branch. He saw this begin, he said, after his first Delta Force briefing at Fort Bragg. "I think Cheney and Rumsfeld went directly into JSOC. I think they went into JSOC at times, perhaps most frequently, without the SOCOM [Special Operations] commander at the time even knowing it. The receptivity in JSOC was quite good," says Wilkerson. "I think Cheney was actually giving McChrystal instructions, and McChrystal was asking him for instructions." He said the relationship between JSOC and Cheney and Rumsfeld "built up initially because Rumsfeld didn't get the responsiveness. He didn't get the can-do kind of attitude out of the SOCOM commander, and so as Rumsfeld was wont to do, he cut him out and went straight to the horse's mouth. At that point you had JSOC operating as an extension of the [administration] doing things the executive branch--read: Cheney and Rumsfeld--wanted it to do. This would be more or less carte blanche. You need to do it, do it. It was very alarming for me as a conventional soldier."

Wilkerson said the JSOC teams caused diplomatic problems for the United States across the globe. "When these teams started hitting capital cities and other places all around the world, [Rumsfeld] didn't tell the State Department either. The only way we found out about it is our ambassadors started to call us and say, 'Who the hell are these six-foot-four white males with eighteen-inch biceps walking around our capital cities?' So we discovered this, we discovered one in South America, for example, because he actually murdered a taxi driver, and we had to get him out of there real quick. We rendered him--we rendered him home."...

The use of private companies like Blackwater for sensitive operations such as drone strikes or other covert work undoubtedly comes with the benefit of plausible deniability that places an additional barrier in an already deeply flawed system of accountability. When things go wrong, it's the contractors' fault, not the government's. But the widespread use of contractors also raises serious legal questions, particularly when they are a part of lethal, covert actions. "We are using contractors for things that in the past might have been considered to be a violation of the Geneva Convention," said Lt. Col. Addicott, who now runs the Center for Terrorism Law at St. Mary's University School of Law in San Antonio, Texas. "In my opinion, we have pressed the envelope to the breaking limit, and it's almost a fiction that these guys are not in offensive military operations." Addicott added, "If we were subjected to the International Criminal Court, some of these guys could easily be picked up, charged with war crimes and put on trial. That's one of the reasons we're not members of the International Criminal Court."

Wednesday, February 23, 2011

Today's links

1--$100 oil, Calculated Risk

Excerpt: From Reuters: Brent Hits 2-1/2 Year High on Libya Export Concerns

Clashes in oil producer Libya sent benchmark Brent crude to 2-1/2-year highs on Monday above $105 a barrel on fears that supplies to Western countries could be disrupted, while U.S. prices rallied by more than $4.

• From the WSJ: The Stealth Return of $100 Oil

The days of $100 oil are back—and not just in Europe, where the Brent crude benchmark vaulted past $108 a barrel on Monday.

While U.S. prices haven't scaled such heights ... many U.S. oil refiners and consumers are finding their costs have already escalated.

2--Home Prices Slid in December in Most U.S. Cities, New York Times

Excerpt: Mr. Shiller, noting the unrest in the Middle East, a large backlog of foreclosed houses, the uncertain future of the mortgage holding companies Fannie Mae and Freddie Mac and proposals to reduce the mortgage tax deduction, saw “a substantial risk” of declines of “15 percent, 20 percent, 25 percent.”

3---Richard Koo: QE2 is undermining US economic policy, pragmatic capitalism

Excerpt: Richard Koo, likely the foremost expert in quantitative easing brings us a global perspective on the Fed’s QE2 policy and he believes it is having a strictly negative impact on the USA’s ability to manage its economy. In his latest economic note Koo writes that QE is undermining the USA’s attempts to generate stability:

“Given the extreme instability and fluidity characterizing the global political and economic situation, I think anything could happen next.

Adding to the instability is the absence of a decision-making body—the G20 is now jokingly described as the G0. Under ordinary circumstances the US would play a leadership role in this organization, but now it finds itself almost isolated as a result of the Fed’s QE2 program, which sparked a heavy backlash from many emerging nations.

To make the matter worse, Western countries are shifting their focus at the G20 meeting and other international summits from economic recovery—both in their own countries and the global economy—to the correction of imbalances. From the standpoint of the emerging economies that are currently driving global economic growth, this appears as little more than a thinly disguised effort to pass the buck.

Emerging countries have continued to post robust growth based on solid economic management without adopting US-style financial capitalism. Their first question is why they should have to participate in the cleanup of a global mess created by the issue of fraudulent Western financial instruments sold with fraudulent ratings.

Blaming China’s foreign exchange policy for the recent financial crisis is neither reasonable nor persuasive. Yet lately the US focus at G20 meetings has been the Chinese currency, and I think that is increasingly undermining US leadership within the organization.”

It’s difficult to reject anything that Koo says with regards to QE. After all, he has been right about this policy and its effects for almost 20 years running….

The 20-city composite is currently off 31.2 percent from its peak. Many economists expect the market to fall another 5 to 10 percent in the next few months....

Also released Tuesday was the Case-Shiller quarterly index that covers all homes in the country. It showed prices fell 3.9 percent in the fourth quarter and 4.1 percent for all of 2010....

“Every place is pretty much getting hit a second time for essentially the same reasons,” said Andrew LePage, an analyst with DataQuick Information Systems. “Slow economic recovery, little job growth, still-tight credit, no more government stimulus, a pervasive and gnawing sense that prices could fall more, too few people getting jobs and too many worrying about losing the one they have.”

4--Housing data may have understated extent of collapse: report, Reuters

Excerpt: A housing trade association is examining the possibility that the data it releases underestimated the collapse of the housing industry, the Wall Street Journal reported on Monday.

The National Association of Realtors, which issues the monthly existing home sales report that is closely watched by economists and financial markets, may have over-counted home sales dating as far back as 2007, the newspaper said in an article posted to its web site.

NAR's home sales count was at odds with calculations by CoreLogic, a California real estate analysis firm, according to the report. CoreLogic says NAR could have overstated home sales by as much as 20 percent.

An over-count of home sales may mean that there is a bigger backlog of unsold homes and that it will take longer for the U.S. housing sector to climb out of the deep hole it is already in, dragging on the broader economic recovery.

5---Oil price shock: Pandora's Box is opened, The Telegraph

Excerpt: The last time the oil price lost all sense of gravity, as it threatens to again with the price of Brent crude now well north of $100 a barrel, it helped tip the world economy into the deepest recession since the 1930s.

Is history about to repeat itself? Much depends on developments in the Middle East, but things are once more looking perilous.

By adding to energy costs, the effect of high oil prices is to reduce the amount of money for spending on other things, thereby undermining aggregate demand in the wider economy. Eventually a tipping point is reached where confidence collapses. Given what happened as recently as 2008, you would expect OPEC to be acting quickly to prevent the same thing recurring. By raising quotas with dispatch, OPEC might limit any further explosive increase in prices....

An unduly elevated price will eventually destroy demand, which in turn will undermine sustainable investment in new capacity to meet future demand growth. These cycles are a major influence on the ups and downs of the broader business environment.

6---US housing market is in suspended animation, The Economist

Excerpt: The role of the FHA, which is to guarantee mortgages with low downpayments to families of modest means in return for a fee, is relatively uncontroversial. The big debate is to what extent the federal government should also guarantee mortgages to middle-class families. The Treasury’s options will include doing so through a stand-alone federal agency—perhaps a nationalised version of Fannie or Freddie—or by selling an explicit government guarantee for a fee to any lender, much as the Federal Deposit Insurance Corporation charges banks to insure their deposits....

The Treasury can start to trim back the firms’ role in other ways. Fannie and Freddie are allowed to guarantee mortgages as big as $729,750, but in October that limit should start to drop, leaving more of the market to private firms. The fees they charge for their guarantee can also be raised, crowding in private insurance.

But the Treasury’s power over the pair is limited as long as they remain under the control of the Federal Housing Finance Agency, an independent agency. The Treasury cannot, for example, force them to write down mortgage principal to mitigate defaults, even though taxpayers rather than shareholders would bear any associated costs. That is a pity, given the government’s flailing foreclosure strategy.

When Barack Obama first unveiled the Home Affordable Modification Programme (HAMP) in March 2009, the hope was to modify 3m-4m mortgages by subsidising payment reductions through the Troubled Asset Relief Programme (TARP), a bail-out fund. But by the end of last year, only 522,000 loans had been permanently modified. Of the $50 billion originally allocated to the programme, just $1 billion had been spent, according to Neil Barofsky, the TARP’s watchdog. “It’s remarkably dispiriting,” he told Congress on January 26th...

Still, the lack of progress means foreclosures are likely to be higher this year than last. That will maintain downward pressure on home prices, which have resumed their fall after the expiry of a tax credit last year. The home-ownership rate fell to 66.5% at the end of 2010, its lowest level since 1998, as many former and would-be home-owners rent (see chart). Long after the crisis and the recession, the housing bust that caused them lingers on.

7--Mortgages in foreclosure process hit record, SF Gate

Excerpt: A record share of U.S. mortgages were in the foreclosure process at the end of 2010, matching the all-time high, as lenders and servicers delayed home seizures to investigate charges of improper documentation.

About 4.63 percent of loans were in foreclosure in the fourth quarter, up from 4.39 percent in the previous three months, the Mortgage Bankers Association said in a report Thursday. The combined share of foreclosures and loans with overdue payments was 14 percent, or about one in every seven mortgages.

Property seizures plunged at the end of 2010 as lenders such as Bank of America Corp. and JPMorgan Chase & Co. temporarily halted proceedings to review their handling of court documents. That left more homes in the foreclosure process with their status unresolved. Repossessions tumbled 32 percent in the fourth quarter from the prior period, according to data from RealtyTrac Inc. in Irvine.

"It's clear that the process issues were driving the increase," said Jay Brinkmann, chief economist of the Mortgage Bankers Association. "We would expect the foreclosure inventory to start coming down as that gets resolved and the court situations get cleared up."

8--Survey: Sales of Distressed Homes increased in January, Calculated Risk

Excerpt: From Campbell/Inside Mortgage Finance HousingPulse: HousingPulse Distressed Property Index Hits 49.6% in January

Perhaps the biggest news in the January data was a sharp rise in the HousingPulse Distressed Property Index or DPI, a key indicator of the health of the housing market. The DPI, or share of total transactions involving distressed properties, climbed from 47.2% in December to 49.6% in January. The increase was a continuation of a trend as the DPI registered just 44.5% back in November.

Already, in the key state of California, distressed property transactions account for 66% of the market. In Florida, distressed property transactions account for 63% of the market. And in the combined area of Arizona and Nevada, distressed property transactions are a stunning 72% of home sales.

The increase in distressed properties, combined with a reduction in first-time homebuyers, is causing downward pricing pressure to build in the market, especially for the categories of damaged REO and move-in ready REO.

This fits with other recent reports suggesting the percent of distressed sales was very high in January. The Case-Shiller house price data, to be released this morning, will be for last year (October, November and December) - and this survey suggests the repeat transaction house price indexes will show further weakness in 2011.

9---Case-Shiller: National Home Prices Are Close to the 2009Q1 Trough, Calculated Risk

Excerpt: From S&P: National Home Prices Are Close to the 2009Q1 Trough

Data through December 2010, released today by Standard & Poor’s for its S&P/Case-Shiller Home Price Indices ... show that the U.S. National Home Price Index declined by 3.9% during the fourth quarter of 2010. The National Index is down 4.1% versus the fourth quarter of 2009, which is the lowest annual growth rate since the third quarter of 2009, when prices were falling at an 8.6% annual rate. As of December 2010, 18 of the 20 MSAs covered by S&P/Case-Shiller Home Price Indices and both monthly composites were down compared to December 2009....

The Composite 10 index is off 31.2% from the peak, and down 0.4% in December(SA). The Composite 10 is still 2.4% above the May 2009 post-bubble bottom.

The Composite 20 index is also off 31.2% from the peak, and down 0.4% in December (SA). The Composite 20 is only 0.8% above the May 2009 post-bubble bottom and will probably be at a new post-bubble low in January....

Prices in Las Vegas are off 58% from the peak, and prices in Dallas only off 8% from the peak.

From S&P:

Eleven MSAs posted new index level lows in December 2010, since their 2006/2007 peaks. These cities are Atlanta, Charlotte, Chicago, Detroit, Las Vegas, Miami, New York, Phoenix, Portland (OR), Seattle and Tampa. Nine of these cities had also posted lows with November’s report as well. New York and Phoenix are the new entrants to this group with December’s data.

Prices are now falling just about everywhere, and more cities are hitting new post-bubble lows. Both composite indices are still slightly above the post-bubble low, but the indexes will probably be at new lows in early 2011.

10---Stocks Tumble as Mideast Unrest Intensifies, Bloomberg

Excerpt: Oil climbed to a two-year high while stocks fell the most in three weeks and Treasuries and the Swiss franc gained as anti-government violence escalated in Libya.

Oil for March delivery rose as much as 9.6 percent to $94.49 a barrel and traded 6.8 percent higher at 9:36 a.m. in New York.... The Standard & Poor’s 500 Index lost 1.3 percent, the most since Jan. 28. Ten-year Treasury yields slid six basis points....

Protests in the Middle East are driving oil prices higher, stoking concern inflation will accelerate. At least 250 people died in the Libyan capital Tripoli overnight as violence spread in the nation with Africa’s largest oil reserves, al-Jazeera reported. China told banks to recalculate capital levels to account for higher risk weightings on some loans as it seeks to curb lending, two people with knowledge of the matter said.

“If oil continues to rise and the dots get connected beyond Libya, then you can set yourself up for a setback in stocks,” said David Sowerby, a Bloomfield Hills, Michigan-based money manager at Loomis Sayles & Co., which oversees $150 billion. “People are going to wait and see what type of unrest there is in the largest producing oil countries. Risk aversion is going to be everybody’s assessment.”...

The S&P 500 retreated from its highest level since June 2008 as trading resumed today after the Presidents’ Day holiday. Wal-Mart Stores Inc. declined 4.1 percent after posting a seventh straight quarterly sales decline at its U.S. stores, trailing its own projections....U.S. equities also declined after the S&P/Case-Shiller index of home values in 20 cities fell 2.4 percent in December from the same month in 2009, the biggest 12-month decrease in a year.