Wednesday, February 2, 2011

Today's links

1--The Great Stagnation, Low-Hanging Fruit and America’s ‘Sputnik Moment’, Kelly Evans, Wall Street Journal

Excerpt: His essential point is that economic development and technological innovation have reached a plateau, and unfortunately we in America are only now just realizing it: “Political discourse and behavior have become highly polarized, and what I like to call the ‘honest middle’ cannot be heard above the din. People often blame the economic policies of ‘the other side’ or they belligerently snipe at foreign competition. But we are failing to understand why we are failing. All of these problems have a single, little-noticed root cause: We have been living off low-hanging fruit for at least three hundred years. We have built social and economic institutions on the expectation of a lot of low-hanging fruit, but that fruit is mostly gone.”

What does he mean by low-hanging fruit? He lists three major forms — free land, technological breakthroughs (specifically during the 1880-1940 period), and smart, uneducated kids — and two minor ones, cheap fossil fuels and the U.S. Constitution. In other words, these preconditions gave rise to rapid growth and incredible prosperity over the last couple of centuries, but we have now exhausted their dividends. The most obvious measure of this is the stagnation of median household wages in the U.S. for several decades now. “If median income had continued to grow at its earlier postwar rate, the median family income today would be over $90,000,” he notes — about 50% higher than where it currently is....

2--Fed’s Lockhart: Economy Still Needs Support of Stimulative Fed, Wall Street Journal

Excerpt: The U.S. economic recovery, while ongoing, still needs the support of supportive monetary policy, a Federal Reserve official said Monday.

“There are definitely hopeful signs of sustained recovery in 2011,” and “much of the strength in the fourth quarter of last year has carried over into 2011,” and will prove sustainable, Federal Reserve Bank of Atlanta President Dennis Lockhart said. “Progress is real, but fitful, and support of accommodative Fed policy is still required,” he said....

Lockhart said inflation is at “lower than desired rates.” But when it comes to the threat of deflation, “this concern has abated and the rate of inflation seems to have stabilized.” He noted worries about higher prices are being fueled by rising commodity and gasoline prices, even though these gains have not moved into underlying price trends. “Through 2011 and 2012, I expect gradual firming of underlying inflation pressures from current very low levels to healthier levels,” the official said.

The main threats to growth as the year moves forward are continued house price weakness, which “could reemerge as a major drag on consumer spending over and above the direct effect of slow construction activity.” Troubled state and local government finance remains an issue, as could new troubles in European government finance.

3--More on the bank business lending recovery, FT Alphaville

Excerpt: We mentioned last week that bank business lending in the US had finally begun to recover, if weakly, after precipitous double-digit declines during and after the recession....

Banks mainly pointed to a more favorable or less uncertain economic outlook and increased competition from other banks or nonbank lenders as reasons for easing. …

Of the banks reporting stronger demand, about 75 percent indicated that the increased demand was partly due to funding needs for merger and acquisition activity, and more than half noted reduced borrowing from other banks or nonbank sources. Somewhat less than half of the banks also noted increased financing needs for inventories, accounts receivable, and investment in plant and equipment. Foreign institutions also reported a moderate net increase in demand and in inquiries regarding lines of credit, in line with the previous survey.

We’ve noted many times that businesses have capitalised on easy credit conditions to fund M&A, increase dividends, and buy back shares. This has been a boon for asset markets — but the effects on the broader economy are less salutary than if businesses were using their cash hoards and access to cheap financing to invest more in capital and labour.

4--Only one US bank was safe from collapse during financial crisis, says Fed's Ben Bernanke, Richard Blackden, Telegraph

Excerpt: Only one of America's major financial institutions was not at risk of collapse during the financial crisis that swept Wall Street in 2008, according to previously private remarks the chairman of the Federal Reserve made to a panel investigating the crisis. The Financial Crisis Inquiry Commission released comments Ben Bernanke made in a private interview alongside its final report on Thursday. "If you look at the firms that came under pressure in that period... only one... was not at serious risk of failure," Mr Bernanke told the commission. "Even Goldman Sachs, we thought there was a real chance that they would go under."

The material disclosed by the commission did not identity which bank the Fed chairman believed could have withstood the turmoil. The commission was established by Congress in May 2009 to provide an authoritative explanation of what caused the country's worst financial crisis since the Great Depression. However, the commission has been marred by political infighting among its members, and only the six Democratic members endorsed the final report. The report concluded that the crisis was avoidable and laid much of the blame at the feet of regulators, including the Federal Reserve. "We do not accept the view that regulators lacked the power to protect the financial system," the report argues. "They had ample power in many arenas and they chose not to use it."

Alan Greenspan, Mr Benanke's predecessor, came in for particular criticism for championing less regulation. "The government permitted financial firms to pick their preferred regulators in what became a race to be the weakest supervisor," the report said. Meanwhile, Moody’s said its timeframe for possibly placing a negative outlook on the Aaa rating of US Treasury bonds is shortening as the country’s deficit widens. The outcome of the November elections, the extension of tax cuts and the chance that Congress will not address deficit reduction have increased Moody’s uncertainty over the willingness and ability of the US to reduce its debt, the credit-rating company said in a report on Thursday.

5--Ireland, Land of Thieves, Charlatans and Sodomites, Angry Bear

Excerpt: Our crisis. As of this month, the CSO (Central Statistics Office) quotes the unemployment rate at 14.1%, that’s over 400,000 people out of work. Those people will be on the dole or getting some version of welfare, which starts at €197 per week and rises according to number of dependents.

The CSO’s figures are frightening. They say that of the over 800,000 mortgages in the country, worth €120 billion, 40,000 are in arrears and that figure will rise to 70,000 in the coming year: the banks will be forced to repossess these houses. But the banks don’t want all that property. What good is it to them? They especially don’t want to be shackled with toxic real estate when so many are already in negative equity. Every town and village in the country sports its token ghost estate, the relic of the boom years, a reminder of the savage greed that swiftly plunged us into ruin. More on that in a bit. The ESB [Electricity Supply Board] are shutting off service to 50 homes per month for non-payment of bills.

Health Care in Ireland is totally banjaxed: My father who is 80 spent three nights on a trolley in a hallway last year because there were no beds available. He is no longer able to regulate his body temperature because he suffers from leukemia and other complications, so he nearly shivered to death in the one place he went to for care. My sister is a doctor but she could do nothing. Our Health Care system was dismantled and then rebuilt in order to centralize it, hospitals were closed all over the country and acute services scaled back or abandoned altogether. A moratorium on hiring nurses and doctors was instituted and all administrative staff downsized. ...

It’s not helpful to speak about the criminal behavior that got our country into this debacle. We’re not allowed to focus on the deranged and delusional freak-show that was the hybrid known as the Celtic Tiger. Our attention is quickly diverted if we mention how local councils all over the country used their zoning powers to wheedle dirty money from developers [this being their only way to raise money] in order to line the pockets of avaricious landowners and bankers. Many of these useless developments were erected on flood plains or dangerously unsuitable terrain. It didn’t matter so long as the bonanza was in full tilt.

6--Fed's Easy Money Helps European Banks Refinance, Bloomberg

Excerpt: Federal Reserve Chairman Ben S. Bernanke’s easy money policies are allowing European banks to sell a record amount of dollar-denominated bonds to refinance about $1 trillion of debt maturing this year....

Bernanke’s pledge to inject cash into the financial system by purchasing $600 billion of Treasuries in a second round of quantitative easing is helping European borrowers hurt by the sovereign debt crisis at home. As a result of the extra dollars created, cross-currency basis swaps show that it’s cheaper for European banks to sell bonds in dollars and swap the proceeds back to euros than it was at the same time last year.

“There’s no doubt QE2 provided a great boost to the U.S. capital markets,” said David Marks, the London-based chairman of debt capital markets for financial institutions at JPMorgan Chase & Co., last year’s biggest underwriter of corporate bonds. “European banks are beneficiaries of that as much as any other participant.” ...

“Those European banks that can issue in U.S. dollars are definitely relying more on dollar funding than before,” said Alberto Gallo, a credit strategist at Goldman Sachs Group Inc. in New York.

For the biggest European issuers, Fed policy is easing the way for bond sales. The money set aside for buying Treasuries through June is in addition to the $1.7 trillion of government and mortgage debt that the U.S. central bank bought in the first round of QE from December 2008 to March 2010.
The extra cash these purchases freed up has helped drive investors’ appetite for riskier assets, reducing the extra yield they need to own U.S. investment-grade bank debt instead of government securities to the lowest since May

7-- Twelve of the 13 largest U.S. financial institutions "were at risk of failure" at the depth of the 2008 financial crisis, Wall Street Journal

Excerpt: Twelve of the 13 largest U.S. financial institutions "were at risk of failure" at the depth of the 2008 financial crisis, while at least 50 hedge funds tried to capitalize on it, according to a report released Thursday by a U.S. panel investigating how the financial system unraveled.

The report quantifies a huge run on the bank at Morgan Stanley, describes the alleged trading practices of a secretive hedge fund and tallies the number of such funds betting against U.S. homeowners.

The 545-page document paints a picture of a financial system let loose by lax regulation and careening out of control. Regulators now are hammering out a financial-regulatory overhaul, though some analysts say not enough has been done since to prevent a recurrence....

The report described a shadow banking system that helped trigger a more than tenfold surge in financial-sector debt, to $36 trillion in 2007 from $3 trillion in 1978.

Then it crumbled, Federal Reserve Chairman Ben Bernanke told the commission in a November 2009 interview.

"As a scholar of the Great Depression, I honestly believe that September and October of 2008 was the worst financial crisis in global history, including the Great Depression," Mr. Bernanke said, according to the commission's report.

The report also provided clarity about the number of hedge funds gambling homeowners couldn't pay their mortgages.

In an interview with the commission, former Deutsche Bank AG trader Greg Lippmann—who played a key role in facilitating short bets—told the commission that in 2006 and 2007 he handled trades for at least 50 hedge funds and "maybe as many as 100" betting that mortgage-backed securities would fall.

An FCIC survey of some hedge funds found they had a total of $45 billion of short bets, which easily outweighed roughly $25 billion of bullish positions they had on mortgages.

The panel also scrutinized the conflicts of interest—involving Wall Street banks, hedge funds and investors—created by the pools of mortgage debt known as collateralized debt obligations.

The crisis panel cited a $1.5 billion CDO called "Norma," underwritten by Merrill Lynch & Co. in 2007. The assets backing the CDOs were to be selected and overseen by a third-party "collateral" manager called NIR Capital Management.

As Norma's value crumbled, some investors and others complained that Magnetar Capital—a hedge fund that had placed bearish and bullish bets on the Norma CDO—played an active role in helping to select Norma's assets.

This would potentially have created a conflict because Magnetar, a Merrill client, would have had an incentive to select poor-performing assets and benefit from short bets it made against the CDO.

The crisis panel said Magnetar had "executed approximately $600 million in trades for Norma" and that Merrill failed to disclose that Magnetar "was selecting collateral when it also had a short position that would benefit from losses."....

Of the 13 most important U.S. financial institutions, "12 were at risk of failure within a period of a week or two," the report quoted Mr. Bernanke as saying.

8-- Treasury Yields are Blinking Red, zero hedge

Excerpt: Treasury yields are "blinking red", but the Fed keeps acting like nothing's wrong. What's the deal?

Let's explain: Fed chairman Ben Bernanke's bond purchasing program (QE2) has sent the yield on the 30-year Treasury skyrocketing. At the same time, the the 2-year Treasury is stuck at a lowly 0.61. That means, the "yield curve" between the two bonds has grown steeper, which normally happens at the beginning of a recovery because investors are moving out of "risk free" bonds to riskier assets like stocks. Typically, the yield on the long-term bond will start to go down on its own because investors expect the Fed to raise short-term rates to curb potential inflation. But that's not happening this time. Why? And why should we care?

The reason we should care is because the yield curve is signaling one of two things; inflation or default. What it is not signaling is a robust recovery....

Here's how the Wall Street Journal's Kelly Evans summed it up:

"...the limits of monetary policy are becoming clearer. History suggests any further easing probably would do too much for the stock market and asset prices, and too little for jobs.

The only real fix is to lower the cost of U.S. workers relative to foreign rivals and machines, or else raise their bang for the buck. The latter, while clearly preferable, requires education and training that won't turn things around overnight." ("The Fed's Magic Show Appears to Be Over", Wall Street Journal)

9--Banks still holding 70% of REO from market, Housingwire via

Excerpt: RealtyTrac Senior Vice President Rick Sharga said major banks currently hold roughly 1 million REO, or homes repossessed through foreclosure, but only 30% have actually made it onto the market...

According to its year-end report, foreclosure filings reached a new high in 2010 and should climb even higher this year, possibly surpassing 4 million filings. And that's not counting the more than 5 million delinquent loans that have yet to enter the initial stages of the foreclosure process, Sharga said.

"I think you're looking at a 2011 that will be worse than 2010, then some stabilization through 2012.

The major kink in the housing market's recovery, and for the macro economy overall, is the work left to be done on homes currently in the foreclosure process, those about to enter it and the amount of repossessed homes the banks must shed. Striking a proper balance on how to mange this shadow inventory of foreclosures is vital for the banks to show a healthy balance sheet while not dumping too many distressed properties onto the market, further dragging down home prices and values.

A recent study from Morgan Stanley (MS: 29.40 0.00%) showed the shadow inventory, those properties facing imminent default, evolving from mostly subprime and Alt-A loans to containing more prime loans as elevated unemployment levels have pushed more homeowners behind on their mortgage. Analysts said that some 8 million repossessions would need to be liquidated over the next five years before the market stabilizes.

Adding to the problem are recent issues the banks are having processing the paperwork. In October, the banks had to hold up foreclosures to refile affidavits signed improperly in many states, pushing more than 250,000 foreclosure cases into 2011. Reports recently showed that the problem may have spread to the notices of default as well.

As RealtyTrac employees have found, notices of default "dropped off a cliff" late last year and are still off in January, Sharga said.

And in the 23 states where lenders must foreclose on a homeowner through the court system, backlogs of cases have formed month-long delays. Sharga said a court clerk in Florida, one of the states with the longest traffic jams, told him between 500,000 and 600,000 cases are yet to be heard.

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