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."

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