Friday, June 3, 2011

Weekend links

1--1937 in 2011?, Paul Krugman, New York Times

Excerpt: Gauti Eggertsson has a nice piece on the New York Fed blog about the great monetary/fiscal mistake of 1937, which sent the Great Depression into a second downward leg. As he notes, the underlying situation bore a significant resemblance to current events: unemployment still high (actually under 10 percent if measured by modern standards, so quite similar to now), but with rising prices thanks to commodity shocks.

Where I part with Gauti here is his assertion that modern economists won’t make the same mistake. The research staff at the NY Fed won’t; but the ECB very probably will, and the Board of Governors is under a lot of political pressure to raise rates.

We’ve learned a lot less these past 74 years than you might have imagined — or rather, we learned some stuff, but have spent the last few decades unlearning it.

2--Stocks Fall on Economic Growth Concern, Bloomberg

Excerpt: Global stocks fell for a second day amid concern the economic recovery is faltering, with the Standard & Poor’s 500 Index adding to losses from its worst drop since August. Treasuries slid as 10-year yields below 3 percent damped demand and commodities retreated.

The MSCI All-Country World Index lost 1 percent at 11:46 a.m. in New York. The Standard & Poor’s 500 Index slipped 0.5 percent after yesterday’s 2.3 percent tumble. Ten-year Treasury yields gained three basis points to 2.98 percent after sliding below 3 percent yesterday for the first time this year. The Dollar Index lost 0.1 percent, paring earlier declines, while the S&P GSCI Index of commodities decreased 0.6 percent.

The S&P 500 remained at a six-week low as retailers fell after reporting disappointing sales and economists cut forecasts for U.S. payroll gains in May, adding to evidence the global economy is slowing amid Europe’s debt crisis and the aftermath of Japan’s worst earthquake. European shares and Greek bonds slumped after Moody’s Investors Service downgraded the country’s debt and said Greece has a 50 percent chance of default.

“The market is vulnerable,” said Alan Gayle, senior investment strategist at RidgeWorth Capital Management in Richmond, Virginia, which oversees $48 billion. “The latest data suggests that the recovery is losing momentum. With all the uncertainties, the bears seem to have the upper hand right now.”

3--Japan Politics Enters ‘Real Chaos’ With Kan Pledge to Quit, Bloomberg

Excerpt: Naoto Kan’s pledge to step down as prime minister set off a contest to select Japan’s next leader, adding to the risk of delays in reconstruction and revenue bills needed to restore growth and assuage credit concerns.

Kan yesterday survived a no-confidence vote in parliament after appeasing Democratic Party of Japan rebels with an offer to resign once the nation’s worst postwar crisis is contained. DPJ lawmakers then divided over what that timeframe may be, with Kan’s predecessor saying it could be by month-end and the prime minister suggesting it might not be until early next year.

“This is a new stage of real chaos in Japanese politics, and I don’t see any scenario where things will suddenly get better,” said Koichi Nakano, a political science professor at Sophia University in Tokyo. “Japan is paying a very high price for the instability at the top.”

4--Quick International Finance Note #1, Economist's View

Tim Duy: Quick International Finance Note #1, by Tim Duy: Brad DeLong directs us to Ryan Avent, whose conclusion I agree with:

If Congress called into question the safety of the one safe asset for which markets have an almost unlimited appetite, all hell would break loose....

DeLong summarized this issue nicely last October in a takedown of John Cochrane:

When Cochrane writes….does he genuinely not understand that China's investment in the United States does not reflect a belief on the part of China's savers that the U.S. offers high rates of return? Does he genuinely not understand that this is a government-run foreign-exchange intervention program--the largest one in history?... that an economics professor is pretending that China's dollar asset-purchase policy is "a tragic investment decision, not a currency-manipulation effort" makes me want to hide my head in shame.

China did not deliberately “invest” in the US. That “investment” is a byproduct of an economic development strategy. They are investing in themselves, with the expected returns outweighing the expected losses to be suffered on the byproduct of their strategy, a portfolio of US assets. And when they rattle the saber of that portfolio, note any action on their part would make them the victim of self-inflicted wounds. That portfolio is like a noose around the necks of both nations.

5--Quick International Finance Note #2, Economist's View

Tim Duy once again:

Quick International Finance Note #2, by Tim Duy: For those that missed them, Paul Krugman and Felix Salmon have good pieces on the slow motion disaster that is the Eurozone. Krugman concludes with:

If you ask me, the water level has now dropped so far that the fuel rods are exposed. We really are in meltdown territory.

Salmon concludes with:

…it’s easy to see how Europe’s politicians and central bankers are doing everything they can to kick the can down the road and put off the moment that they have to make a big decision. But the longer they wait, of course, the more momentous and more difficult any such decision is going to be. Just how much risk are Europe’s central banks going to take on, before they draw the line and say no mas?

Reminds me of something Michael Pettis said back in November:

This has been said before, but in a way this crisis is the European equivalence of the American Civil War. Once the dust finally settles Europe will either be a unified country with fiscal sovereignty firmly established in Berlin or Brussels, or it will be fragmented with little chance of reunion.

6--CBO: Fannie, Freddie Guarantees to Cost Government $42 Billion, Wall Street Journal

Excerpt: Mortgage guarantees made by Fannie Mae and Freddie Mac in the coming decade are expected to cost the government another $42 billion, the Congressional Budget Office said Thursday.

The mortgage giants were seized by regulators and placed into a federal conservatorship in September 2008 as housing prices tumbled nationwide and foreclosures climbed.

Through the end of March, the government provided about $154 billion in capital to Fannie and Freddie, while the two government-sponsored enterprises paid out more than $24 billion in dividends to the government — resulting in a net cost of about $130 billion so far, according to Deborah Lucas, CBO’s assistant director for financial analysis. Ms. Lucas’ comments came in remarks prepared for a House Budget Committee hearing.

“CBO expects additional net cash payments from the government over the next several years,” she said.

If the two continue to do business on current trends, the CBO “estimates that the new guarantees the [enterprises] will make over the 2012-2021 period will cost the government $42 billion,” Ms. Lucas said. The agency bases its subsidy estimate on the capital and guarantees Fannie Mae and Freddie Mac provide to the mortgage market at prices below what private financial institutions offer.

Fannie and Freddie still account for the bulk of the mortgage market; in 2010, they financed 63% of new mortgages originated.

U.S. House lawmakers last month unveiled seven bills to speed up the eventual closure of Fannie and Freddie, part of a Republican push to dramatically reduce the U.S. government’s role in the mortgage market.

Republicans, especially in the House, want to unwind the government’s longstanding backing of the $10.5 trillion U.S. mortgage market, arguing that the high levels of support that have traditionally been part of American housing policy pose too much of a risk for future bailouts.

Fannie and Freddie purchase home loans from originators and package those loans into mortgage-backed securities. The securities are then held as investments, or sold to investors along with a guarantee against losses from defaults on the underlying mortgages

7--Virtual Casino: Robert Wilmers vs Jamie Dimon, The Big Picture

Excerpt: I’ve been meaning to discuss this Joe Nocera piece, The Good Banker, which is my favorite thing he’s done since moving to the OpEd pages.

“In the run-up to the financial crisis, the giant national banks — which he viewed as a distinct species from the typical American bank — had done things that deserved condemnation. And, he added, “They are still doing things that I don’t think are very good.”Such as? “It has become a virtual casino,” he replied. “To me, banks exist for people to keep their liquid income, and also to finance trade and commerce.” Yet the six largest holding companies, which made a combined $75 billion last year, had $56 billion in trading revenues. “If you assume, as I do, that trading revenues go straight to the bottom line, that means that trading, not lending, is how they make most of their money,” he said.

This was a problem for several reasons. First, it meant that banks were taking excessive risks that were never really envisioned when the government began insuring deposits — and became, in effect, the backstop for the banking industry. Second, bank C.E.O.’s were being compensated in no small part on their trading profits — which gave them every incentive to keep taking those excessive risks. Indeed, in 2007, the chief executives of the Too Big to Fail Banks made, on average, $26 million, according to Wilmers — more than double the compensation of the top nonbank Fortune 500 executives. (Wilmers made around $2 million last year.)

Finally — and this is what particularly galled him — trading derivatives and other securities really had nothing to do with the underlying purpose of banking. He told me that he thought the Glass-Steagall Act — the Depression-era law that separated commercial and investment banks — should never have been abolished and that derivatives need to be brought under government control. “It doesn’t need to be studied for two years,” he said. “I would put derivative trading in a subsidiary and tax it at a higher rate. If they fail, they fail.”

8--The QE3 conundrum, Pragmatic Capitalism

Excerpt: (Must See chart) Real GDP peaked as soon as QE2 began. Now, this shouldn’t be shocking to anyone who has been reading pragcap over the duration of this program. From its onset I said QE2 would do nothing for the real economy. In fact, operationally, it could do nothing. But its impacts actually appear to have been damaging to bottom line growth. How so? QE2 helped contribute to a massive surge in speculation in commodity prices.

You see, QE2 didn’t monetize anything. It didn’t cause the money supply to explode. It didn’t really do anything except cause a great deal of confusion and generate an enormous amount of speculation in financial markets that now appears to be contributing to turmoil and strife around the globe. Operationally, it is no different than what the Fed does at the short end when they implement monetary policy. The important distinction, however, is that this policy was implemented incorrectly. Instead of targeting price they targeted size. And the results in the bond market speak for themselves. Rates have meandered up and down and up and down without a care in the world for the Fed’s $600B purchase program. In other words, the program had no impact on rates.

Aside from targeting rates, the program was intended to generate a portfolio rebalancing effect. I won’t repeat the comments I’ve made in the past or those of Richard Koo, but the portfolio rebalancing effect is essentially a form of putting the cart before the horse. Creating nominal wealth without an accompanying real effect that results in real economic growth is very misguided and the worst form of ponzi finance.

Where we saw a real impact was in commodity prices, general price speculation and the financing pyramid.

9--How to Get Washington’s Attention, Robert Reich's blog

Excerpt: Finally, it seems, the economic burdens of America’s vast middle class may be catching up with the Street. The Dow lost 2.22 percent today; the Standard & Poor’s 500-stock index was down 2.28 percent. Both marked their worst declines since August 11, 2010. The Nasdaq composite index fell 2.33 percent.

We’re coming full circle: The stock market is dropping because corporate earnings are slowing. Corporate earnings are slowing because consumers are pulling back. Consumers are pulling back because they don’t have enough jobs or adequate wages.

The immediate cause of the sell-off was an announcement by ADP Employer Services, a payroll processing firm that estimates employment, that private employers added only 38,000 jobs in May. The economy needs 125,000 new jobs a month just to tread water, given that at least 125,000 people join the potential labor force every month. Simply put, if new hires are in the range of five digits, American consumers will not have enough purchasing power to buy what the private sector can produce.

The leaders of the Street and big business may now have to wake up to a reality they’ve tried to avoid — that the central economic problem of our time isn’t the long-term budget deficit but the immediate deficit in aggregate demand.

They may not yet see the necessity of a renewed social contract linking pay to per capita productivity, but they will understand something must be done to fuel jobs and wages.

Never underestimate the power of Wall Street and big business to set the terms of the economic debate in our nation’s capital. After all, Wall Street and big business pay the tab of politicians on both sides of the aisle. Even if the middle class can’t get the attention our representatives in Washington, those who fund their campaigns can.

10-- (From the archive): FHA-Backed Loans: The New Subprime, Businessweek

Excerpt: The same people whose reckless practices triggered the global financial crisis are onto a similar scheme that could cost taxpayers tons more

As if they haven't done enough damage. Thousands of subprime mortgage lenders and brokers—many of them the very sorts of firms that helped create the current financial crisis—are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means.

You read that correctly. Some of the same people who propelled us toward the housing market calamity are now seeking to profit by exploiting billions in federally insured mortgages. Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning economy.

For generations, these loans, backed by the Federal Housing Administration, have offered working-class families a legitimate means to purchase their own homes. But now there's a severe danger that aggressive lenders and brokers schooled in the rash ways of the subprime industry will overwhelm the FHA with loans for people unlikely to make their payments. Exacerbating matters, FHA officials seem oblivious to what's happening—or incapable of stopping it. They're giving mortgage firms licenses to dole out 100%-insured loans despite lender records blotted by state sanctions, bankruptcy filings, civil lawsuits, and even criminal convictions.
More Bad Debt

As a result, the nation could soon suffer a fresh wave of defaults and foreclosures, with Washington obliged to respond with yet another gargantuan bailout. Inside Mortgage Finance, a research and newsletter firm in Bethesda, Md., estimates that over the next five years fresh loans backed by the FHA that go sour will cost taxpayers $100 billion or more. That's on top of the $700 billion financial-system rescue Congress has already approved. Gary E. Lacefield, a former federal mortgage investigator who now runs Risk Mitigation Group, a consultancy in Arlington, Tex., predicts: "Within the next 12 to 18 months, there is going to be FHA-insurance Armageddon....

Congress and the Bush Administration are strongly encouraging lenders to apply for FHA approval and tap into the government's loan-guarantee reservoir. In September, the agency guaranteed 140,000 new loans, up from 60,000 in January. In October, as Congress and the White House scrambled to respond to the spreading financial disaster, the FHA began to extend $300 billion in additional loan guarantees under the banner of a new program called HOPE for Homeowners. The limit on the amount buyers may borrow will rise in January to $625,000 from $362,790 in 2007....

In April 2007, Goldman Sachs (GS) purchased a controlling stake in Senderra Funding, a former subprime lender in Fort Mill, S.C. Goldman, which has received $10 billion in direct federal rescue money, converted Senderra into an FHA lender and refinance organization. The strategy appears likely to produce hefty margins. In September, Goldman paid 63¢ on the dollar in a $760 million deal with Equity One (EQY), a unit of Banco Popular (BPOP), for a batch of subprime mortgage and auto loans. Through Senderra, Goldman plans to refinance at least some of the mortgages into FHA-backed loans. Because of the government guarantee, it can then sell those loans to other financial firms for as much as 90¢ on the dollar, according to people familiar with the mortgage market. That's a profit margin of more than 40%....

Defaults and Denials

Of the 158 units in Palmetto Towers, 66 are in foreclosure, records show. An additional 33 are unsold. Great Country has originated 1,855 FHA mortgages since November 2006; 923 of those were in default proceedings as of Oct. 31. The firm's 50% default rate is the highest in the entire FHA program.

11--Ally Bank, Formally Known as GMAC, to Pay Fannie Mae $462 Million Over Bad Mortgages, BoA Sued by Allstate, The economic Populist

Excerpt: GMAC, who changed their name to Ally Financial, is paying Fannie Mae $462 million to dump off their bad mortgages.

Ally Financial Inc, the lender formerly known as GMAC, on Monday said it agreed to pay $462 million to Fannie Mae (FNMA.OB) to avoid having to repurchase poorly underwritten mortgages sold to the housing finance giant.

Ally, which is majority-owned by U.S. taxpayers, said the agreement releases its Residential Capital LLC mortgage unit from any liability related to bad underwriting on $292 billion worth of loans sold to Fannie Mae, itself about 80 percent owned by the government.

Residential Capital owns GMAC Mortgage and Ditech Funding.

Ally, which is expected to go public next year, announced a smaller settlement with Freddie Mac (FMCC.OB) in March. Resolving questions about its potential liability could help Ally attract investors.

The lender, which is 56 percent owned by the U.S. government, said the agreements reduce the risk in its mortgage operations going forward.

Nice huh? Fannie Mae absorbs $292 billion worth of bad loans for less than half a billion dollars? According to the Wall Street Journal, Fannie Mae and Freddie Mac were demanding banks pay back bad mortgage loans when banks violated their mortgage purchase agreements.

Fannie and Freddie collected more than $9 billion from banks during the first three quarters of the year. At the end of September, another $13 billion in requests hadn’t been paid, including more than $4 billion that have been outstanding for more than four months.

So now we have a payoff to Fannie & Freddie, much less than the actual bad loans with a release from liability? Are Fannie and Freddie yet another garbage dump for Wall Street?

12--Fannie Mae & Freddie Mac Buy Back Bad Mortgages, Economic Populist

Excerpt: Fannie Mae and Freddie Mac have announced they will buy back mortgages which are delinquent:

The two companies are repurchasing mortgage loans for which borrowers have missed at least four months of payments. At the end of last year, Fannie had about $127 billion of such loans, while Freddie Mac had about $70 billion.

Now they are doing this supposedly because it's cheaper. They guarantee the underlying securities and have to pay interest on those MBS (bonds) and it's turning out to be cheaper to just buy the bad loans back.

Yet, Bloomberg reports:

Investors would lose about $12.5 billion in forgone interest.

Bond holders pay more than the face value due to expected interest payments.

It seems some accounting rules changed at the end of the year, otherwise they would have needed more capital.

Accounting-rule changes are forcing all mortgages in Fannie Mae and Freddie Mac securities onto their balance sheets and limiting the financial impact of actual repurchases to the companies.

But.....Fannie and Freddie got an unlimited bail out at the end of the year.

Note that the actual homeowners, don't get a break at all, it's all about underlying securities, investments and toxic waste...and I guess once again...making sure no one takes too bad of a haircut, except for the homeowners of course.

13--GSEs: $1 Trillion Dumping Ground for Bad Bank Loans, The Big Picture

Excerpt: Post-receivership, the GSEs have become a government sanctioned back door bailout of regular banks. Any mortgage that cannot be refi’d or modified ends up on their books. This includes mortgages on the verge of default and foreclosure.

How much is the worst case scenario for the ongoing bailout of the banking sector, plus Fannie’s and Freddie’s own screw ups?

If everything goes precisely wrong, taxpayers are potentially on the hook for another $1 trillion bailout:

The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

Fannie and Freddie, now 80 percent owned by U.S. taxpayers, already have drawn $145 billion from an unlimited line of government credit granted to ensure that home buyers can get loans while the private housing-finance industry is moribund. That surpasses the amount spent on rescues of American International Group Inc., General Motors Co. or Citigroup Inc., which have begun repaying their debts.

Its not a coincidence that many of these banks are finding the capital to pay back their bailout loans. The Obama administration is continuing one of the more horrific policies of the Bush administration: Using the GSEs as a back door bailout for the rest of the banking sector: These banks are selling their garbage to the GSEs — and according to some anecdotal evidence, are getting pretty close to full boat (100 cents on the dollar) for these bad loans.

Hence, Fannie and Freddie have become a dumping ground for all manner of bad bank loans.

The GSEs have had their own problems over the years — accounting fraud, recklessly chasing market share, lowering loan quality, etc. — but they have now become are now the last stop for every crappy mortgage ever written:

Fannie and Freddie may suffer additional losses as a result of the Treasury’s effort to prevent foreclosures. Under the program, banks with mortgages owned or guaranteed by the companies must rewrite loan terms to make them easier for borrowers to pay.

The Treasury program is budgeted to cost Fannie and Freddie $20 billion. The companies have already modified about 600,000 delinquent loans and refinanced almost 300,000 more, in some cases for an amount greater than the houses are worth.

The government is using Fannie and Freddie “for a public- policy purpose that may well increase the ultimate cost of the taxpayer rescue,” said Petrou of Federal Financial Analytics. “Treasury is rolling the dice.”

A recent Federal Reserve report pegged the total exposure of Fannie and Freddie at 53% percent of the nation’s $10.7 trillion in residential mortgages. That’s about $5.5 trillion dollars.

How do we get to trillion in losses?

About $1.98 trillion of the loans were made in states with the nation’s highest foreclosure rates — California, Florida, Nevada and Arizona — and $1.13 trillion were issued in 2006 and 2007, when real estate values peaked. Mortgages on which borrowers owe more than 90 percent of a property’s value total $402 billion.

That trillion dollar number has a number of challenging assumptions in it. It assumes a large downleg in housing prices, a continuing foreclosure surge, and ongoing unemployment.

My estimates are for about half of that — between $450-500 billion dollars. But with just the right — or wrong — economic policies, bailouts and bad decisions, I wouldn’t rule out a trillion dollar loss. And if we keep allowing banks to dump all of their bad loans onto the GSE’s books, I would raise my odds of a trillion dollars in losses from 25% to 100%.

14--ADP says job adds punk, The Big Picture

Excerpt: According to ADP, the pace of private sector hiring was anemic, totaling only 38k, well below expectations of 175k and down from 177k in April. The large drag was in the goods producing sector which shed 10k jobs led by manufacturing, the area around the world that has seen clear softening. There is no question though that the Japanese earthquake likely is a main catalyst for the slowdown but there is certainly a concerted effort in Asia to moderate growth and certain areas of Europe have their own issues. All of the job losses in the goods producing category were in large companies as small and medium sized businesses added jobs. Even taking out mfr’g, the service sector only added 48k jobs, down from a gain of 141k in April and 165k in Mar as large companies had no net job gains. Friday’s Payroll figure is expected to rise 180k with a private sector gain of 209k and its highly likely that economists reduce those estimates after today’s ADP report. Bottom line, I mentioned Japan as a catalyst for the weakness but there is clearly something else going on to account for the softness now in a variety of economic data points.

15--Housing blues, Streetlight blog

Excerpt: It's worth remembering that the bear market in houses probably still has a few years left to go. The real estate market is notoriously cyclical, and those cycles typically seem to be around 14 to 18 years long from peak to peak in the US. During the last bear market in residential real estate during the 1990s, it took about 8 or 9 years for prices to bottom out, as illustrated by this chart: (see chart)

So based on historical experience, it will probably be another 3 to 5 years before house prices begin to pick up in a meaningful way in the US. But if we could get stronger economic growth and reductions in unemployment in the US, that would surely help to prevent further price declines in real estate. And that in turn would help to wind down the vicious cycle of underwater mortgages, foreclosures, and continued declines in house prices. It's yet another reason that the focus of policy-makers should be on jobs, jobs, jobs.

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