Thursday, July 21, 2011

Today's links

1--Is Weak Aggregate Demand Really the Main Problem?, David Beckworth, Macro and other Market Musings

Excerpt: Or is it the regime uncertainty that many observers attribute to the Obama administration? The answer from several recent surveys say it is weak aggregate demand. First, a Wall Street Journal survey shows most economists see the lackluster recovery as a the result of weak aggregate demand rather than uncertainty over government policy:

The main reason U.S. companies are reluctant to step up hiring is scant demand, rather than uncertainty over government policies, according to a majority of economists in a new Wall Street Journal survey...In the survey, conducted July 8-13 and released Monday, 53 economists—not all of whom answer every question—were asked the main reason employers aren't hiring more readily. Of the 51 who responded to the question, 31 cited lack of demand (65%) and 14 (27%) cited uncertainty about government policy. The others said hiring overseas was more appealing.

This conclusion is supported by the findings in the most recent NFIB's survey of small businesses. This survey has consistently shown, and shows for June, that the number one problem facing small business is not regulation or taxes--though they do matter according to the survey--but weak sales.

2--Dodd-Frank Under Fire a Year Later, New York Times

Excerpt: Two dozen bills in Congress seek to dismantle parts of the Dodd-Frank Act, which President Obama signed a year ago Thursday. Business groups have argued that too many new regulations could snuff out the start of an economic recovery.

President Obama says he believes the battle is far from over.

“The financial crisis and the recession were not the result of normal economic cycles or just a run of bad luck,” the president said Monday as he nominated a new director for the Consumer Financial Protection Bureau, a centerpiece of the Dodd-Frank Act. “There were abuses and there was a lack of smart regulations. So we’re not just going to shrug our shoulders and hope it doesn’t happen again.”

Uncertainty has long been the watchword for opponents of Dodd-Frank. When Mr. Obama signed the act last year, the United States Chamber of Commerce said it was “a broad, sweeping bill” that “epitomizes a law with unintended consequences that creates more uncertainty for American businesses.”...

The Council of Institutional Investors, a lobbying group that represents pension and employee benefit funds, endowments and foundations, said Monday that the Dodd-Frank Act was “a clear win for investors.”

“Excessive risk by Wall Street fueled the market meltdown that wiped out millions of U.S. jobs and billions in retirement savings,” Ann Yerger, the council’s executive director, said in a statement. “The Dodd-Frank Act, if implemented as intended, will be a critical bulwark against such massive abuse of investors.”...

Several crucial financial issues remain to be resolved, including what is known as the Volcker Rule, a ban on banks trading for their own accounts. Rules governing the trading and processing of derivatives, the complex financial instruments that contributed to the difficulties of several banking and insurance companies, have yet to be completed.

3--Debt Compromise Pressure Intensifies in U.S., Bloomberg

Excerpt: A bipartisan Senate proposal for a $3.7 trillion debt-cutting plan praised by President Barack Obama faces resistance from House Republicans, as lawmakers intensify efforts for a compromise on government spending less than two weeks before a threatened default.

Obama said he will renew talks at the White House this week with congressional leaders as the Democratic-led Senate and Republican House pursue divergent paths toward ending the stalemate over lifting the nation’s $14.3 trillion debt limit.

“The problem we have now is we’re in the 11th hour and we don’t have a lot more time left,” Obama said yesterday, referring to an Aug. 2 deadline officials have set for raising the debt cap. The president, in remarks at the White House, said he will urge congressional leaders “to start talking turkey” and get “down to the hard business of crafting a plan that can move this forward.”

House Republicans last night passed their debt-reduction plan 234-190 -- legislation that stands little chance of passing the Senate and that Obama has said he would veto if it did. The measure would cut and cap government spending and allow the debt ceiling to be raised by $2.4 trillion only if Congress approves a balanced budget amendment to the Constitution.

4---Securitization and overleverage, Grasping reality with both hands

Excerpt: Mike Konczal:

Rortybomb: [T]he GSEs had political pressures to purchase private-label mortgages in 2007 as the credit market was freezing up, in a desperate attempt to unlock it.... This argument, and the graph above, is developed in Roosevelt Institute senior fellows Rob Johnson and Tom Ferguson’s Too Big to Bail: The ‘Paulson Put,’ Presidential Politics, and the Global Financial Meltdown Part II. One could easily assume that they were buying the worst loans here, aggregating losses on the GSEs. I’d love to see much more investigations into this... (chart-

5--Gold's run is just about over, Marketwatch

Excerpt: Bullion’s extraordinary run is fast running out of steam. Don’t be surprised if gold pulls back in coming sessions.

At a minimum, such a pullback would be a health-restoring event for the bull. However, such a pullback could also be the start of something more serious. We’ll know soon after it begins.

For now, though, the important thing for short-term traders to know is that excitement has grown markedly over the last couple of sessions, and now stands at close to the fever pitch that prevailed in late April. Soon after that previous crescendo of bullish enthusiasm, of course, gold encountered a stunning air pocket and fell more than $100 per ounce.

Consider the average recommended gold market exposure among a subset of short-term gold timers tracked by the Hulbert Financial Digest (as measured by the Hulbert Gold Newsletter Sentiment Index, or HGNSI). This average currently stands at 67%, which is within shouting distance of the 73.7% level the HGNSI rose to in late April, which was a several-year high.

The wall of worry that the gold market has been climbing in recent weeks is close to disintegrating, in other words.

6--Sign of Housing Bottom? Deja Vu All Over Again, Wall Street Journal

Excerpt: We’ve been here before. Home builders report a spike in activity and hopes build that housing is in recovery.

The latest signs of improvement came from a 14.6% jump in June housing starts, a 2.5% gain in building permits and a 2-point rise in the July housing market index.

At best, the latest numbers on housing starts suggest housing is bottoming out–finally. At worst, the June increase in starts is a rebound from harsh weather in the spring.

Residential construction has been the number one drag on gross domestic product, having subtracted from growth in almost every quarter since 2006. The continued drag over the past two years is in stark contrast with past recoveries, when housing was a leader to growth.

What could the June starts jump signal?...

The overriding obstacle is demand that is too weak when compared with the overhang of almost-new homes built during the boom and now sitting on the market even after multiple price cuts.

Whether housing has actually turned the corner will depend on an influx of home buyers who have the money and confidence to complete the purchase. As with so many other facets of the outlook, job growth must pick up to change househunters into contract-signers.

7--There is a Boom Out There Somewhere, Modeled Behavior

Excerpt: all the stats are beginning to align. In a way this is like 2005 all over again. In late 2004 there were a number of people from the outside who started to grumble about the unsustainability of housing prices. There also were those who told stories about how this time was different.

And, let me be honest. Many of those stories were compelling. I continued maintained that the price bubble would eventually pop but I count that as more an act of luck than insight. I don’t want to relitigate that battle but I will say the soft landing people did not have a ridiculous case.

Now the same thing is happening in housing supply. There were those of us last year looking around and saying – this is just not sustainable. Yet, people told stories about vacancy rates and getting the rot out that were compelling. Lots of people said we are not going to see booming construction for a long time and seemed to feel the fundamentals backed that up.

Yet, over the beginning of 2011 lots of data series have started to turn in the same direction. We are seeing growing consensus that this is simply not sustainable and something is going to have to give.

Moreover, just like a price bubble, this housing shortage is a growing phenomenon. The longer it goes unaddressed the bigger the correct will be. And, quite frankly there is no reason to think actual housing supply will begin to tick up in the next 12 months. The lead time on home building is just too long.

So we are probably looking at 2 years minimum before we get a significant reduction in pressure. All the while shadow households are still forming. Couples are still getting married or waiting to get married. Babies are still being born, etc.

When housing corrects, I have to guess that it will correct hard.

8--Financial Crisis: Final Essay Exam, Barry Ritholtz, The Big Picture

Excerpt: 1. Following the dotcom implosion and 2000 market crash, the Federal Reserve lower rates to then unprecedented levels to 2% for 3 years, including 1% for a year. Discuss the impact this has on various asset classes, including Real Estate, Fixed Income, Oil and Gold. What difference might a more traditional interest rate regime have made for these assets?

Bonus Question: Imagine you were FOMC Chair. Where would you have set rates in the 1990s? After the 2000 crash? Today?

2. Prior to the late 1990s, the rating agencies (NRSROs) — Moody’s Investors Service, Standard & Poor’s, and Fitch Ratings — business models was funded by bond investors buying their research. This changed to a securities syndicating underwriter funded model. How did this business model change impact the performance of ratings agencies?

Bonus question: Does the financial world still require NRSROs? What potential alternatives might replace these entities in evaluating complex financial products.

3. The Commodity Futures Modernization Act of 2000 was an unusual piece of deregulatory legislation, creating a new world of uniquely self-regulated financial instruments. What was the impact of this on risk management, leverage, and mortgage underwriting?

Bonus: What did the lack of reserve requirements for derivative mean for firms such as AIG, Bear Stearns and Lehman Brothers specifically?

4. More than 50% of subprime loans were made by nonbank mortgage underwriters not subject to comprehensive federal supervision; another 30% were made by banks or thrifts also not subject to routine supervision or examinations. What did this do to the supply/demand curve in the housing and mortgage markets?

Bonus: What is the role of changing credit standards in prior bubbles and financial crises?

5. In 2004, the SEC issued the Bear Stearns exemption: They changed the Net Capitalization rule from 12 to 1 leverage to essentially unlimited for Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers and Bear Stearns. None of these companies exist today in the same structure as prior to the rule change. Discuss.

Bonus: Changing broad legislation for only 5 companies is unusual. What does this say about regulatory capture, democracy and the impact of lobbying on American society?

6A. Mortgage underwriting standards changed rapidly in the 2000s. Many lenders stopped verifying income, payment history, credit scores.

6B. The loans themselves changed: Loan to value (LTV) went from 80% (20% down payment) to 100% (No Money Down) to even 120% (Piggyback mortgages).

6C. “Innovative” new mortgage products were developed and marketed in the 2000s: 2/28 ARMs, I/O s, Neg Ams

Discuss the correlation this had on a) home prices; b) new inventory build; and c) foreclosures.

7. Banks developed automated underwriting (AU) systems that emphasized speed rather than accuracy in order to process the greatest number of mortgage apps as quickly as possible. What was the impact of this on Housing prices, defaults and foreclosures?

Bonus: Real estate agents and mortgage brokers were known to repeatedly use the same corrupt appraisers to facilitate loans approval. Did this correlate with AU? Discuss how.

8. Collateralized debt obligation (CDO/CMOs) managers who created trillions of dollars in mortgage backed securities and the institutional investors (pensions, insurance firms, banks, etc.) who purchased these appear to have failed to engage in effective due diligence prior to the purchases of these products. Reconcile this in terms of the Efficient Market Hypothesis

Bonus: What does this mean for self regulation of the financial industry?

9. The Depression era Glass Steagall legislation was repealed in 1998. What impact did this have on the size of banking institutions? What did this do to the competitive landscape of financial services industry? Did this impact bank risk taking? Discuss.

10. Numerous states had anti-predatory lending laws which were in 2005 “Fedrally Pre-empted” by order of John Dugan, head of the Office of the Comptroller of the Currency (OCC). What impact did this have on states with anti-predatory lending laws default and foreclosure levels, pre and post pre-emption?

11. In 2006, more than 84% of subprime mortgages were issued by private lending institutions not covered by government regulations (McClatchy). Discuss what this means in terms of profit motive, government policy, and the GSEs

9--Phone hacking crisis shows News Corp is no ordinary news company, The Guardian

Excerpt: Rupert Murdoch's news organisations are not in the news business. What they crave is influence...

"This is not just about one individual but about the culture of an organization." Carl Bernstein agrees. He wrote this in Newsweek a few days ago:

As anyone in the business will tell you, the standards and culture of a journalistic institution are set from the top down, by its owner, publisher, and top editors. Reporters and editors do not routinely break the law, bribe policemen, wiretap, and generally conduct themselves like thugs unless it is a matter of recognized and understood policy.

Private detectives and phone hackers do not become the primary sources of a newspaper's information without the tacit knowledge and approval of the people at the top, all the more so in the case of newspapers owned by Rupert Murdoch, according to those who know him best.

Bernstein tells us that one of his sources is a former executive at News Corp, who says: "Murdoch invented and established this culture in the newsroom, where you do whatever it takes to get the story, take no prisoners, destroy the competition, and the end will justify the means."...

Here's my little theory: News Corp is not a news company at all, but a global media empire that employs its newspapers – and in the US, Fox News – as a lobbying arm. The logic of holding these "press" properties is to wield influence on behalf of the rest of the (much bigger and more profitable) media business and also to satisfy Murdoch's own power urges....

What makes them different is not that they have a more conservative take on the world – that's the fiction in which opponents and supporters join – but rather: news is not their first business. Wielding influence is.

Scaring politicians into going along with News Corp's plans. Building up an atmosphere of fear and paranoia, which then admits Rupert into the back door of 10 Downing Street.

10--The Battle of the Bonds, Robert Skidelsky, Project Syndicate

Excerpt: .... in the twentieth century, with greater security of conditions and continuous economic growth, it became normal for individuals, companies, and governments to borrow in anticipation of earnings – to spend money they did not have, but that they expected to have.

With fear of bank runs and defaults receding, banks’ reserve ratios became ever smaller, thus increasing their lending facilities. On this bedrock rose an imposing edifice of bond markets and banks that drove down the cost of finance, and thus sped up the rate of economic growth.

It was this system of financial intermediation whose near-collapse in 2008 seemed for many to justify the ancient warnings of the perils of indebtedness. In their exhaustive historical review of financial crises, Carmen Reinhart and Kenneth Rogoff write: “Again and again, countries, banks, individuals, and firms take on excessive debt in good times without enough awareness of the risks that will follow when the inevitable recession hits.”...

The last legal restrictions on taking interest on money were lifted only in the nineteenth century, when they succumbed to the economic argument that lending money was a service, for which the lender was entitled to charge whatever the market would bear. But the theory of usury survived in the view that it was morally wrong to extract some additional amount that was made feasible by the borrower’s weak bargaining position or extreme need.

These two moral attitudes confront each other today in the battle of the bonds. The demand for debt repayment confronts the philosophy of debt forgiveness. In the lender’s view, the 17% interest rate that Greece’s government now has to pay for its 10-year bonds accurately reflects the lender’s risk in buying Greek government debt. It is the price of past profligacy. But in the borrower’s view it is usurious – taking advantage of the borrower’s desperation.

The sensible middle position would surely be an agreed write-off of a portion of the outstanding Greek debt, combined with a five-year moratorium on interest payments on the remainder. This would immediately relieve pressure on Greece’s budget and give its government the time and incentive to put the country’s economy in order.

In the long run, however, we will have to answer the broader question that the eurozone’s various debt crises have raised: Is the social value of making finance cheap worth the days of reckoning for stricken debtors?

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