Tuesday, March 1, 2011

Today's links

1--Madoff comes clean: Government a Ponzi scheme, Wall Street Journal

Excerpt: Wall Street swindler Bernard Madoff said in a magazine interview published Sunday that new regulatory reform enacted after the recent national financial crisis is laughable and that the federal government is a Ponzi scheme.

"The whole new regulatory reform is a joke," Madoff said during a telephone interview with New York magazine in which he discussed his disdain for the financial industry and for its regulators.

The interview was published on the magazine's website Sunday night.

Madoff did an earlier New York Times interview in which he accused banks and hedge funds of being "complicit" in his Ponzi scheme to fleece people out of billions of dollars. He said they failed to scrutinize the discrepancies between his regulatory filings and other information.

He said in the New York magazine interview the Securities and Exchange Commission "looks terrible in this thing," and he said the "whole government is a Ponzi scheme."

2--How to end housing mess, Robert Kuttner, Boston.com

Excerpt: IN MOST US cities, housing prices are falling again. They were down in 18 out of 20 metropolitan areas in December, according to the Case-Shiller index released Tuesday. The Boston metro area did “better’’ than most — down only 0.8 percent over the previous year.

That’s bad news for the economic recovery, the financial system, and the American middle class. There are solutions that could restore a normal housing market — but political gridlock and the influence of the financial industry is keeping them off Congress’s agenda.

Today, about one home in three carries a mortgage worth more than the underlying property, and some 7 million homeowners are at risk of foreclosure. The banking system is reeling under the weight of non-performing loans and depressed mortgage-backed securities....

All of this adds up to a horrible downward spiral. But it’s not as if we are without solutions. For starters, we could use a true refinancing program that reduces principal and interest owed, so that homeowners who took out mortgages in good faith could afford to keep their homes.

The banks would take a financial hit, but they will take one anyway. It’s better to get it over with, and stabilize housing prices.

Adam Levitin of the Georgetown Law School has proposed to amend the bankruptcy code to allow a distressed homeowner to go before a judge and have the mortgage reduced to current value of the house. Howell Jackson of Harvard Law School wants government to use its power of eminent domain to turn securitized loans back into whole mortgages. The reduced market value of the security would translate into a subsidy for the new mortgage.

Either approach would enable millions of distressed homeowners to keep their homes, and thus arrest the decline in real estate values.....

3--Fed Runs Scared With Boost to Bank Dividends, Bloomberg

Excerpt: Like homeowners who took a mortgage with little down payments, when banks are highly leveraged, their equity can be easily wiped out by small declines in asset values. If 95 percent of a bank’s assets are funded with debt, even a 3 percent decline in the asset value raises concerns about solvency and can lead to disruption, the need to “deleverage” by liquidating inefficiently, and possible contagion through the interconnected system. As we have seen, this can have severe consequences for the economy.

While equity is used extensively to fund productive business, bankers hate to use it. With more equity, banks have to “own” not only the upside but also more of the downside of the risks they take. They have to provide a cushion at their own expense to reduce the risk of default, rather than rely on insurers and eventually taxpayers to protect them and their creditors if things don’t work out...

Capital is simply equity, the value of shareholders’ ownership claims in banks; and it represents a way for banks to fund their investments without undertaking debt commitments that they might not be able to meet and which add to systemic risk. Bankers are fiercely resisting the suggestion that they use more equity and less debt in funding, even though this would reduce their dangerous degree of leverage...

Fixation with return on equity also contributes to bankers’ love of leverage because higher leverage mechanically increases ROE, whether or not true value is generated. This is because higher leverage increases the risk of equity, and thus its required return. Focus on ROE is also a reason bankers find hybrid securities, such as debt that converts to equity under some conditions, more attractive than equity....

...the structure of current capital requirements distorts banks’ decisions. The structure, which is focused on the ratio of equity to so-called risk- weighted assets, might induce banks to choose investments in securities over lending, because securities with high credit ratings require less capital and thus allow more debt funding.

These failures of the system of risk weights, however, have nothing to do with the overall level of capital. Allowing banks to pay dividends and maintain high leverage isn’t the solution to this problem. Instead, better ways to monitor the true leverage and risk of financial institutions should be found....The proposed solutions that regulators in the U.S. are focused on, such as resolution mechanisms, bail-ins, contingent capital and living wills, are based on false hopes. They can’t be relied on to prevent a crisis. Increasing equity funding is simpler and better than these pie-in-the-sky ideas.

4--Dollar's Haven Allure Slips on the Oil Patch, Kelly Evans, Wall Street Journal

Excerpt: The dollar is looking more like a frayed hammock than a safety net....The greenback typically appreciates when global markets are in "risk-off" mode. During the financial crisis, it surged roughly 24% against a basket of major currencies. It jumped about 10% during last spring's "flash crash" and European sovereign-debt crisis.

But the latest bout of market angst, spurred by revolutions and unrest in the Middle East and North Africa, hasn't prompted a similar rally. In fact, the opposite has occurred.

That illustrates a key difference between this wave of risk aversion and previous ones: It's driven not by a financial crisis, but by a spike in oil prices. And in coming days and weeks, any continued upward march by black gold will likely put further pressure on the dollar.

The main reason is that oil is the Achilles' heel of the U.S. economy. America's energy intensity has declined in recent years, but still is higher than that of Europe or Japan, according to the World Bank. Montreal-based broker Brockhouse Cooper reckons a spike in oil prices to $130 a barrel would lower U.S. industrial-production growth from roughly 5% annually to about 4%. It would cost consumers upwards of $100 billion this year, wiping out much of the boost from the payroll-tax cut, according to Capital Economics.

Such concerns have reduced already low odds the Federal Reserve will raise interest rates this year. Yet the opposite is true of the European Central Bank, Nomura Securities currency strategist Jens Nordvig points out. The ECB targets headline inflation. In contrast, the Fed focuses on core inflation, which excludes volatile food and energy costs.

5-- The Budget Fight Continues, New York Times via Economist's View

Excerpt: In defense of their bill to slash federal spending by $61 billion over the next seven months, House Republicans claim they are trying to make the economy grow and create jobs. In truth, such deep and sudden cuts could derail the recovery, without ever addressing the real sources of budget deficits — mainly explosive health care costs and incessant high-end tax cuts.

The question is whether the Obama administration and the Senate can prevail against the false rhetoric. ...

In a recent report, economists at Goldman Sachs estimated that the House cuts would reduce economic growth by 1.5 percentage points to 2 percentage points in the second and third quarters of 2011. That would devastate employment. ... [Update: see here for corrections to these numbers.]

The cuts also would be off point. All of them come from discretionary spending, a sliver of the budget... Over the past decade, Pentagon spending has accounted for almost all of the increase in discretionary outlays... Aside from defense, there is not a lot to cut prudently.

Which leads to the strongest argument of all against the House Republican bill — most of the cuts would be counterproductive. Annual spending on education through high school is cut by 12 percent... (since the cuts would be squeezed into the rest of the current budget year, they are even deeper on an annualized basis).

Those cuts include reductions to Head Start that would remove 218,000 children from the program and cuts to elementary education that would hit 2,400 schools and nearly one million students. Pell Grants for college would also be cut by nearly $6 billion. Transportation investments would be cut by 9 percent, or $8.1 billion... Americorps and other community-service programs would be eliminated, although their benefit to society surely exceeds their $1.2 billion cost. Since national service programs are matched by $800 million from foundations and other sources, that would be lost, too. ... Financial regulators would endure deep cuts that would cripple their ability to carry out the Dodd-Frank financial reform law. That’s asking for another financial crisis.

6--The Debate That’s Muting the Fed’s Response, by Christina Romer, New York Times

Excerpt: the main division is between the empiricists who say “inflation is unlikely at 9 percent unemployment” and the theorists who say “inflation could bite us at any moment.” ... Although the Survey of Professional Forecasters ... shows virtually no change in long-run inflation expectations since the start of the program, the theorists hold fast to their concerns.

As a confirmed empiricist, I am frustrated that the two sides have been able to agree only on painfully small additional aid for a very troubled economy. For a sense of how much more useful monetary policy could be, one can look to the Great Depression.

By 1933, short-term interest rates were near zero — just as they are today. As I described in a 1992 academic article, Franklin D. Roosevelt took the United States off the gold standard in April 1933, and rapid devaluation led to huge gold inflows and a large increase in the money supply. ... Expectations of deflation, which had been enormous, abated quickly. As a result, with nominal rates at zero, real interest rates ... plummeted. The first types of demand to recover were ones that were sensitive to interest rates. ...

The Fed could engage in much more aggressive quantitative easing, both in size and in scope, to further lower long-term interest rates and value of the dollar. It could more effectively convey to markets its intentions for the funds rate, which would also lower long-term rates. And it could set a price-level target, which, unlike an inflation target, calls for Fed policy to take past years’ price changes into account. That would lead the Fed to counteract some of the extremely low inflation during the recession with a more expansionary policy and lower real rates for a while.

All of these alternatives would be helpful and would retain the Fed’s credibility as a defender of price stability. And any would be better than doing too little just because some Fed policy makers believe in an unproven, theoretical view of how inflation works.

7--QE3? Tim Duy, Fed Watch via Economists' View

Excerpt: we are experiencing a significant commodity price shock this quarter. While certainly a drag on growth, is it yet sufficient to derail the recovery? The White House thinks no:

Earlier in the day, Austan Goolsbee, chairman of the White House Council of Economic Advisers, said that the U.S. economy can withstand oil price increases so far.

“Anything like we have seen so far neither we nor the private sector has forecast that would derail our recovery,” Goolsbee said yesterday at a breakfast with reporters organized by the Christian Science Monitor.

I would tend to agree – if commodity price inflation slows sharply at this point. But the surge of recent weeks has already exceeded my expectations, and memories of 2007 and 2008 still linger fresh in my mind. The economy can’t withstand another quick run to $140 a barrel, and I suddenly feel that we are at a tipping point to brings such a run into view.

Bottom Line: The recent surge in oil has been a blow to my rising optimism. With this surge coming on the heels of accelerating US activity, monetary policymakers will offer some concern over the inflationary impact. Recent history, however, suggests the opposite - that unless the tide of rising commodity prices is soon arrested, Fed officials will find themselves faced with the prospect of yet another round of quantitative easing.

8--That Iraq Feeling, Paul Krugman, New York Times

Excerpt: I don’t watch cable news, or actually any kind of TV news. But I gather that there’s a virtual blackout on the huge demonstrations in Wisconsin, except on Fox, which portrays them as thuggish and violent.

What that makes me think of is January-February 2003, when anyone watching cable news would have believed that only a few kooks were opposed to the imminent invasion of Iraq. It was quite spooky, realizing that hundreds of thousands of people could march through New York, and by tacit agreement be ignored by news networks whose headquarters were just a few blocks away.

And it’s even more spooky to see it happening all over again.

9--Personal Income and Outlays Report for January, Calculated Risk

Excerpt: The BEA released the Personal Income and Outlays report for January:

Personal income increased $133.2 billion, or 1.0 percent ... Personal consumption expenditures (PCE) increased $23.7 billion, or 0.2 percent.
Real PCE -- PCE adjusted to remove price changes -- decreased 0.1 percent in January, in contrast to an increase of 0.3 percent in December.

Real PCE declined in January after increasing sharply in Q4....Also personal income less transfer payments increased again in January. This increased to $9,427 billion (SAAR, 2005 dollars) from $9,325 billion in December....

When the recession began, I expected the saving rate to rise to 8% or more. With a rising saving rate, consumption growth would be below income growth. But that 8% rate was just a guess. It is possible the saving rate has peaked, or it might rise a little further, but either way most of the adjustment has already happened...

Overall this is a decent report. Even with the decline in real PCE, the 1.0% increase in income, the increase in the saving rate - and sharp increase in personal income less transfer payments - all were good news.

10---Housing update, Housingwire

Excerpt: Despite an increase in existing home sales, analysts at FNC, said home prices continued to decline in December because so many of those sales were foreclosures.

"Driven in part by rising sales of distressed properties and higher foreclosure-sales discounts, home prices declined for the seventh straight month in December and suffered their largest one-month drop during the year," according to FNC.

Of the 30 major metro areas tracked by FNC, 23 had price declines in December by an average of 2.2%.

FNC's dim view of house prices is not theirs alone. CoreLogic (CLGX: 18.37 +0.33%) Chief Economist Mark Fleming expects home prices to decline between 5% and 10% through 2011. Fleming added that stabilization should occur by the end of the year, but the damage has been extensive and the road to recovery will be a long one.

"The flooding may have finally stopped," Fleming said. "But the living room is half underwater."

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