Tuesday, June 14, 2011

Today's links

1---Larry Summers: How to avoid stumbling into our own lost decade, Financial Times via Economist's View

Excerpt: Even with the 2008-2009 policy effort that successfully prevented financial collapse, the US is now half way to a lost economic decade. ...

That the problem in a period of high unemployment, as now, is a lack of business demand for employees not any lack of desire to work is all but self-evident... When demand is constraining an economy, there is little to be gained from increasing potential supply. ...

What, then, is to be done? This is no time for ... traditional political agendas. ... The fiscal debate must accept that the greatest threat to our creditworthiness is a sustained period of slow growth. Discussions about medium-term austerity need to be coupled with a focus on near-term growth. ... Substantial withdrawal of fiscal stimulus at the end of 2011 would be premature. Stimulus should be continued and indeed expanded by providing the payroll tax cut to employers as well as employees. ...

At the same time we should recognize that it is a false economy to defer infrastructure maintenance and replacement, and take advantage of a moment when 10 year interest rates are below 3 per cent and construction unemployment approaches 20 per cent to expand infrastructure investment.

It is far too soon for financial policy to shift towards preventing ... possible inflation, and away from assuring adequate demand. ... Policy in other dimensions should be informed by the shortage of demand... The Obama administration is doing important work in promoting export growth by modernizing export controls, promoting US products abroad, and reaching and enforcing trade agreements. Much more could be done...

We averted Depression in 2008/2009 by acting decisively. Now we can avert a lost decade by recognizing economic reality.

2--Flawed Titan of the Fed, Newsweek

Excerpt: In the fall of 2008, with the global economy in shambles and panic spreading throughout the financial system, a seemingly humbled Alan Greenspan—the former chairman of the U.S. Federal Reserve—appeared before Congress and admitted the unimaginable: there was a “flaw” in his world view that had prevented him from foreseeing the worst credit crisis in American history.

And so begins The Flaw, David Sington’s new documentary about the origins of the financial crisis. The movie, which opened in London last week, makes a compelling argument that the nature of American capitalism has changed in recent decades, giving rise to unstable levels of inequality and a mistaken belief in the self-correcting power of free markets. The Flaw focuses largely on the housing market and offers a far less blistering critique of Wall Street than Inside Job¸ Charles Ferguson’s 2010 Oscar-winning documentary. Yet in both films, Greenspan, who spoke with NEWSWEEK at his office in Washington, D.C., is cast in a similar role—as someone who personifies much of what went wrong with the economy.

Since the housing bubble burst, and Wall Street teetered on the brink of collapse, Greenspan—once widely hailed as the oracle of the American economy—has seen his standing plummet. Most recently, Paul Krugman, the Nobel Prize–winning economist and columnist for The New York Times, wrote that Greenspan is continuing “to cement his reputation as the worst ex–Fed chairman in history”—a searing statement even for someone on the left.

3--The Collateral Crunch, FT Alphaville

Excerpt: (wonkish) It gets less attention than its credit-denominated relative, but the 2008 financial crisis actually sprung from a massive ‘collateral crunch’ within the shadow banking system...

Now we have that emphasis on the safest of collateral assets — government bonds, and especially US Treasuries. Some $4,000bn of these are currently used in the repo market, according to JPMorgan. Presumably, what you wouldn’t want is any further reduction in the amount of decent, liquid collateral available to a still nervous-financial system.

On that note — here’s a nice tidbit from Monday’s Financial Times:

Some of Wall Street’s biggest banks are preparing to cut their use of US Treasuries in August as a precaution against any turbulence that could follow if warring Republicans and Democrats fail to increase soon the US debt ceiling, a senior bank chief said.

One strategy, which bank executives only agreed to discuss without attribution due to the political sensitivities related to discussing Treasury debt, is to have more cash on hand to put up as collateral against derivatives and other transactions, decreasing the financial system’s reliance on Treasuries.

Combine a shift away from US Treasuries with everything else that’s currently happening in the collateral sphere. The Federal Reserve Bank of Chicago has a nifty new software programme to help banks estimate the amount of assets that may be needed once stuff like central counterparty clearing comes into effect. There’s been a worldwide shift towards collateralised lending just when upcoming Basel III rules for banks are busy redefining what can count as liquid or safe assets. And much more.

Now go back to that UST point, specifically.

JP Morgan managing director Matthew Zames warned back in April that:

A Treasury default could severely disrupt the $4 trillion Treasury financing market, which could sharply raise borrowing rates for some market participants and possibly lead to another acute deleveraging event. Because Treasuries have historically been viewed as the world’s safest asset, they are the most widely-used collateral in the world and underpin large parts of the financing markets. A default could trigger a wave of margin calls and a widening of haircuts on collateral, which in turn could lead to leveraging and a sharp drop in lending.


4--The long trek back to sustainable debt levels, Pragmatic Capitalism

Excerpt: The private sector debt problem is no secret although the mainstream media is still blinded by the supposed public sector debt problem. Of course, there is no public sector debt problem in the USA so it’s not surprising that the economy remains in a funk while policymakers fail to focus their efforts on the right problems....

Earlier this year, I provided an analysis showing how and when the balance sheet recession might end. I said:

“At the current trajectory it’s not unreasonable to assume that the balance sheet recession will last well into 2012 and potentially longer. While a 1:1 ratio is “sustainable” by my estimates, it would be comforting to see levels closer to the historical levels in the 80% range. If that is the case we could see the impact of the balance sheet recession persist far longer than anyone believes. The obvious upside risk is a dramatic improvement in the labor market. On the other hand, our government is now explicitly encouraging fiscal imprudence in an attempt to “keep asset prices higher than they otherwise would be”. This sort of policy has the very real potential to increase instability and turnrecovery into bubble. Other exogenous risks (Europe, China, housing prices, etc) also pose substantial risks to the downside. For now, I think it’s safe to assume that the recovery will remain fairly fragile well into 2012, but given the size of the deficit and potential for labor market improvement we could see continued economic strength.”...

This still very much applies today. I don’t necessarily think we have to get back to the 1990 debt levels as the WSJ piece implies, but we must see incomes come back in-line with total debt levels in order to allow for proper servicing of these debts. The Fed is convinced they can fix this issue via their wealth effect, however, as I’ve repeatedly noted, this economy requires real wealth expansion and not just nominal wealth increases based on speculation. Unfortunately, there are no quick fixes here. And as the WSJ notes, there’s really only one thing that can heal the balance sheet recession – time. In the meantime, we should remain cognizant of our issues and ensure that we don’t repeat the mistakes of Japan and Europe.

5--The Swamp of Washington and the Morass of the Economy, Robert Reich's blog

Excerpt: The recovery is stalling across the nation yet in the Washington swamp it’s business as usual.

Americans are scared, with reason. We’re in a vicious cycle in which lower wages and net job losses and high debt are causing consumers to cut their spending — which is causing businesses to cut back on hiring and reduce pay. There’s no way out of this morass without bold leadership from Washington to rekindle consumer demand.

If the Democrats remain silent, the vacuum will be filled by the Republican snake oil of federal spending cuts and cut taxes on big corporations and the wealthy. Democrats — starting with the President — must have the courage and conviction to tell the nation the recovery is stalling, and what must be done.

6--Contractionary Mania, The Streetlight blog


Excerpt: The current bizaare mania for contractionary policies during a time of low inflation and economic weakness is not confined to the US, or to fiscal policy:

ECB signals eurozone interest rates are set to rise

The European Central Bank (ECB) has signalled that it will raise interest rates next month, from 1.25%.

Earlier on Thursday, the ECB kept rates unchanged for the second month in a row, after increasing them in April for the first time in almost two years. The central bank wants to raise rates again in July to curb inflation in some of the eurozone's 17 member states.

However, one really has to squint to see any signs of an inflation problem in Europe. Commodity prices around the world (particularly oil and some raw agricultural products) experienced a bump in prices between the fall of 2010 and spring of 2011. But that is really the only source of inflation the Euro area has experienced recently, as the ECB itself admits, writing in their most recent Monthly Bulletin (pdf):

The increase in inflation rates during the first four months of 2011 largely reflects higher commodity prices.

Excluding energy and raw food prices, the core rate of inflation remains in the neighborhood of 1.5% over the past 12 month, well below the Euro-zone's average inflation rate over the past decade. The following chart shows core inflation separately in Germany and in the rest of the core Euro-zone over the past decade.

Yet despite its acknowledgement that the recent rise in inflation is almost completely due to transitory factors (which began to reverse themselves in May), and without providing any reasoning for this statement, the ECB continued its discussion of inflation in the latest Monthly Bulletin by adding:

Looking ahead, inflation rates are likely to stay clearly above 2% over the coming months. It's hard to see how this will happen, when core inflation is well under 2%

7--Maiden Lane crowding the mortgage bond market, Housingwire

Excerpt: The Federal Reserve's ongoing initiative to sell private-label residential mortgage-backed securities acquired from American International Group (AIG: 28.8262 -0.46%) in the wake of the financial crisis continues to pressure bond prices, upsetting traders.

The assets, which are part of the Fed's Maiden Lane II portfolio, are being sold through investment manager, BlackRock Solutions, a unit of BlackRock Inc. (BLK: 188.34 +1.36%). Last week, reports indicated that the Federal Reserve Bank of New York had sold $1.9 billion of MBS from Maiden Lane. Initially, $3.8 billion was up for bid.

A Monday report from Interactive Data concluded that Maiden Lane II listings represented 40% of all bid activity for nonagency adjustable-rate CMOs and subprime RMBS in May. With Maiden Lane activity putting additional pricing pressures on the broader structured products market, analysts with Interactive Data found May activity is "reinforcing the possibility that the Maiden Lane II lists are making a negative impact on market pricing."

"In the face of this supply, execution levels for adjustable-rate bonds appeared to weaken as the month progressed," analysts said. "Prices were generally weaker by approximately one-half point across various categories of adjustable-rate products, based on Interactive Data’s observations of bids, offers and actual trades."

8--Monday Morning Cup of Coffee, Housingwire

Excerpt: Some of the largest U.S. banks are preparing to lower their use of U.S. Treasurys in August, according to an article by the Financial Times.

The publication cited a senior bank chief who said banks are lowering Treasurys use as a precaution to economic turbulence should the government fail to increase the national debt ceiling.

Republicans and Democrats are in debate about the current U.S. debt ceiling, set at $14.29 trillion. The deadline to agree on a new limit is Aug. 2, and if the government cannot reach an agreement some experts say it will be financially catastrophic.

The FT report did not name specific banks that will be cutting their Treasurys, but the article did mention a strategic alternative — to have more cash on hand to put up as collateral against derivatives and other transactions, the bank source said.

9--Obama Meets With Immelt Business Panel, Bloomberg

Excerpt:President Barack Obama meets today with almost two dozen current and former company leaders including General Electric Co. (GE) Chief Executive Officer Jeffrey Immelt to try and convince the business community as well as voters that the slowing economy doesn’t undercut his policies.

It isn’t an easy sell. Obama is stopping in two states that are critical to his re-election, North Carolina and Florida, where unemployment rates top the national average of 9.1 percent. With the White House and Congress mired in negotiations to cut government spending and raise the $14.3 trillion federal debt ceiling, Obama has few fiscal options to give the economy a jolt.

“The administration has put themselves in a box,” said Gus Faucher, director of macroeconomics at Moody’s Analytics in West Chester, Pennsylvania. “The most important thing for deficit reduction is to get the economy growing again.” ...

Transition Period

“We want to be for any policies that are going to help incentivize and stand up the private sector to drive the recovery,” Austan Goolsbee, chairman of the White House Council of Economic Advisers, said in an interview on Bloomberg Television’s “Political Capital With Al Hunt.”

Immelt said in an op-ed article in today’s Wall Street Journal that the panel is recommending five “fast-action” steps to create more than one million jobs in five specific areas.

They include training workers through partnerships with community colleges, cutting red tape to speed creation of construction jobs, boosting travel and tourism by making easing the visa process for visitors, offering more help to small business owners seeking funding from the Small Business Administration and concentrating on jobless construction workers by putting them to work on energy efficient projects....

Since World War II, no U.S. president has won re-election with a jobless rate above 6 percent with the exception of Ronald Reagan, who faced 7.2 percent unemployment on Election Day in 1984.

The meeting with the jobs council is one of the ways Obama can help restore confidence so U.S. companies take their $2.6 trillion in capital “off the sidelines,” said Senator Mark Warner, a Virginia Democrat.

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