Tuesday, August 16, 2011

Today's links

1--Fed: Consumer and Mortgage Lending Remains Weak, The Daily Capitalist

Excerpt: The monthly Fed survey of bankers and lending says that in July lending conditions remained largely unchanged–that is, relatively tight:

While banks have been easing up since the financial crisis, lending standards remain tighter than they were before the recession. For most loan categories, the survey found large numbers of banks reporting that their current level of lending standards remained tighter than the middle of their historical range since 2005.

The most improvement came in lending to commercial and industrial customers as many businesses rebound from years of extreme caution. Large and middle-market companies saw standards ease the most as their demand picked up and banks competed aggressively for their business. Some banks also eased terms for small-business customers, though demand from those customers remained weak.

Lending to consumers remained relatively downbeat. Despite improvement in demand for credit-card and auto loans, the Fed said, “the pickup in demand was not widespread.” Banks also see little improvement ahead for the housing sector. Three-fourths said they expect originations of residential real estate loans to remain weak through 2011, pointing to “unfavorable or uncertain forecasts for the broad economy and for house prices,” the survey found.

2--Roubini: Is Capitalism Doomed?,Project Syndicate via Economist's View

Excerpt: Nouriel Roubini says that if things don't change, capitalism is in trouble:

...Karl Marx, it seems, was partly right in arguing that globalization, financial intermediation run amok, and redistribution of income and wealth from labor to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). ...

Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China – and soon enough in other advanced economies and emerging markets – are all driven by the same issues and tensions: growing inequality, poverty, unemployment, and hopelessness. Even the world’s middle classes are feeling the squeeze of falling incomes and opportunities.

To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.

The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts. ...

The alternative is – like in the 1930s - unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.

3--Global slowdown underway - it's more than the Japanese supply chain disruptions, News n Economics

Excerpt: The global economic rebound is slowing markedly. With a tightening bias in emerging markets and a US recovery that continues to disappoint, external demand for any country that 'needs it' - those countries mired in fiscal austerity without monetary autonomy, i.e. euro area countries - is decelerating precipitously.

Exhibit 1: import demand for manufactured goods from 22.5% of the world (see chart at the end of this post) is slowing quickly, even contracting....

Global growth is slowing - according to import demand of manufactured goods by the US and China, it's slowing rather quickly. Where will this be felt? In Europe, of course. Germany derives near 50% of GDP from export demand, and imports roughly 45% of its goods and services from within the euro area (data here). The PIIGS countries - Portugal, Ireland, Italy, Greece, and Spain - necessitate strong external demand from the core countries (Germany and France) and from outside the euro area in order to successfully deleverage amid sharp fiscal retrenchment. Unless the German consumer really starts spending, the global industrial sector is unlikely to drive demand sufficiently enough in Europe.

4--Who said it?, The big Picture

Excerpt: Christina Romer, August 2011

“The basic idea that if you increase government spending or you cut people’s taxes that stimulates the economy and lowers the unemployment rate, is a very widely accepted idea. It’s in every economics textbook, that’s what we teach our undergraduates, and I certainly try to teach them the truth. It is a very known and accepted idea and fact and the empirical evidence is definitely there, and people just want to say the sky is green.”

Paul Krugman, July 2, 2009

“Once again a Democratic president has pushed through job-creation policies that will mitigate the slump but aren’t aggressive enough to produce a full recovery. Once again much of the stimulus at the federal level is being undone by budget retrenchment at the state and local level.”

Alan Greenspan, October 2008

“And what I’m saying to you is, yes, I found a flaw. I don’t know how significant or permanent it is, but I’ve been very distressed by that fact. [A] flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak. That is — precisely. No, that’s precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.”"

Ben Bernanke, March 28, 2007

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

Tim Geithner, May 15, 2007

“Financial innovation has improved the capacity to measure and manage risk. Risk is spread more broadly across countries and institutions.”

5--How to Resolve the Euro Crisis, George Soros, Project Syndicate

Excerpt: A European banking agency would break up the incestuous relationship between banks and regulators that was at the root of the excesses that fueled the current crisis. And it would interfere much less with national sovereignty than would the subordination of fiscal policies to an EU or eurozone-wide authority.

Second, Europe needs eurobonds. The introduction of the euro was supposed to reinforce convergence; in fact, it created divergences, with widely different levels of indebtedness and competitiveness separating the member countries. If heavily indebted countries have to pay heavy risk premiums, their debt becomes unsustainable. And that is now happening.

The solution is obvious: deficit countries must be allowed to refinance the bulk of their debt on the same terms as surplus countries. This is best accomplished by authorizing the issuance of eurobonds, which would be jointly guaranteed by all of the member countries.

While the principle is clear, the details will require a lot of work. Which supranational agency will be in charge of issuing eurobonds? What rules will it follow in authorizing issuance? How will it enforce the rules?

6--Aftershock to Economy Has a Precedent That Holds lessons, New York Times

Excerpt: Are we at similar risk today? David Bianco, chief investment strategist for Merrill Lynch Bank of America, told me this week that “the market is collapsing faster than any fundamentals would warrant.” The possibility that the United States faces a recession as bad as 1937’s seems far-fetched. Nonetheless, Mr. Bianco notes that the market is now pricing in an 80 percent chance of recession, one likely to be more severe than in 1991. (He said Merrill Lynch places the odds at 35 percent.) He noted that there had been only three instances when such a steep market decline was not followed by recession: 1966, 1987 (after the October stock market crash) and 1998 (after the implosion of Long Term Capital Management.) “Confidence is shaken and rapidly falling,” he said, a problem worsened by falling stock prices ...

By 1937 an economic recovery seemed to be in full swing, giving policy makers every reason to believe the economy was strong enough to withdraw government stimulus. Growth from 1933 to 1936 averaged a booming 9 percent a year (rivaling modern-day China’s), albeit from a very low base. The federal debt had swelled to 40 percent of gross domestic product in 1936 (from 16 percent in 1929.). Faced with strident calls from both Republicans and members of his own party to balance the federal budget, President Franklin D. Roosevelt and Congress raised income taxes, levied a Social Security tax (which preceded by several years any payments of benefits) and slashed federal spending in an effort to balance the federal budget. Income-tax revenue grew by 66 percent between 1936 and 1937 and the marginal tax rate on incomes over $4,000 nearly doubled, to 11.6 percent from an average marginal rate of 6.4 percent. (The marginal tax rate on the rich — those making over $1 million — went to 75 percent, from 59 percent.)

The Federal Reserve did its part to throw the economy back into recession by tightening credit. Wholesale prices were rising in 1936, setting off inflation fears. There was concern that the Fed’s accommodative monetary policies of the 1920s had led to asset speculation that precipitated the 1929 crash and ensuing Depression. The Fed responded by increasing banks’ reserve requirements in several stages, leading to a drop in the money supply....

The possible causes of the ensuing stock market plunge and steep contraction in the economy provide fodder for just about everyone in the current political debate. Republicans can point to the Roosevelt tax increases. Democrats have the spending reductions, which coincides with Mr. McElvaine’s view. “It appears clear to me that the cause was policies put into effect in 1936-37, mainly cutting spending when F.D.R. believed his re-election was secured,” he said.

The Nobel-prize winning economist Milton Friedman blamed the Fed and the contraction in the money supply in his epic “Monetary History of the U.S.” And the stock market itself may have been a culprit, falling so steeply that it wiped out the wealth effect of rising prices, undermined confidence and brought back painful memories of the crash. But taken together, they suggest that policy makers moved too quickly to withdraw government support for the economy....

But monetary policy can only do so much, especially if fiscal policy is moving in the opposite direction.

Christina Romer, a professor at the University of California, Berkeley, who has written extensively about the Great Depression, declared two years ago while chairman of President Obama’s Council of Economic Advisors: “The urge to declare victory and get back to normal after an economic crisis is strong. That urge needs to be resisted.”

Yet both political parties have strapped themselves to the mast of deficit reduction, one through spending cuts, the other tax increases. ...

The good news about the 1937-38 recession, severe though it was, is that it lasted just a year, from May 1937 to June 1938 by most calculations. The precipitous 1937 stock market decline and surging unemployment jolted Washington into action. The Fed reversed its higher bank reserves policy and cut the discount rate to 1 percent. In April, President Roosevelt announced a $2 billion “spend-lend” program and embraced deficit spending. But the tax increases remained in effect. Economic growth resumed in June 1938 and was stronger than it had been in the 1933-37 period. Stocks surged....

7--It’s the Aggregate Demand, Stupid!, Economix, New York Times

Excerpt: Aggregate demand simply means spending — spending by households, businesses and governments for consumption goods and services or investments in structures, machinery and equipment. At the moment, businesses don’t need to invest because their biggest problem is a lack of consumer demand, as a July 21 study by the Federal Reserve Bank of New York documented.

The federal government could increase aggregate spending by directly employing workers or undertaking public works projects. But there is no possibility of that given the political gridlock in Congress and President’s Obama’s desire to appear moderate and fiscally responsible going into next year’s election....

That really leaves just consumers as a potential avenue for increasing spending. But that will be difficult as long as unemployment remains high, thus reducing aggregate income, and households are still saving heavily to rebuild wealth, which was decimated by the collapse in housing prices. Saving is, in a sense, negative spending....

Home prices roughly doubled between 2000 and 2006, according to the Case-Shiller index, and many homeowners talked themselves into believing they would continue rising indefinitely. Thus they increased their spending and reduced their saving based not only on actual price increases, but also on expectations of future increases.

8--Bank of America Death Watch: Unloading “Non-Core” Assets Aggressively, Naked Capitalism

Excerpt: Bank of America’s actions continue to betray its words. CEO Brian Moynihan bravely maintained in an investor conference call last week that the beleaguered bank would be around for the next 230 years and did not need more new capital. He nixed selling equity at its current price levels, because it would be highly dilutive.

Yet we and others have raised the issue that the bank is in a corner in dealing with its not so hot balance sheet. Not only are equity sales an alternative the bank desperately wants to avoid, but the other route back to health, earning its way out, looks constrained. Bank expert Chris Whalen forecasts reduced profits for major banks. And the industry seems to see that coming too. A Financial Times story yesterday reported that top global banks were making serious headcount cuts based on their expectation of earnings pressure.

So what’s a struggling bank to do? If you are in a leaky boat, you throw anything disposable overboard and bail like crazy. But BofA is in the weird position of having potential a long term solvency problem without immediate liquidity pressures. So while selling dispensable operations is a good strategy right now, it needs to sell ones where it can show a profit over book vale or otherwise have a favorable impact on its capital levels.

And the Charlotte seems a wee bit eager to dispose of assets....Bank of America could limp along for years in a less than healthy state; it could take a long time to see how these mortgage lawsuits play out. Recent setbacks suggest that the hope of settling them on the cheap is waning fast. But bank confidence is a fragile thing. If the bank’s stock price continues to languish and CDS spreads remain elevated, it may simply take the wrong turn of events, say the expected Eurocrisis, which will lead to heightened concern about counterparty exposures, and some new bad BofA revelation, to trigger an unwind. I’d rather not be proven right on this one, but the risk is all too real.

A prescient 2007 Congressional Budget Office study explained how this would affect spending and growth in the economy. It said that if people were expecting a 10 percent rise in home prices and instead they fell 10 percent, the impact on spending would be equivalent to a 20 percent fall in prices. The budget office estimated that this might reduce growth of gross domestic product by 2.2 percent per year. Since actual home prices have fallen by about a third, this suggests that G.D.P. may be $500 billion less this year than it would be if home prices had simply remained flat since 2006.

One way that the rise and fall of spending can be visualized is by looking at the velocity of money. This is the speed at which money turns over in the economy. When velocity rises, more G.D.P. is produced per dollar of the money supply. When velocity falls, the economic impact is exactly the same as if the money supply shrank by the same percentage.

The chart below comes from the Federal Reserve Bank of St. Louis and shows velocity as the ratio of the money supply (M2) to nominal G.D.P. It rose from 1.85 in 2003 to 1.96 in 2006. It has since fallen to a current level of 1.66. Thus one can say that each $1 increase in the money supply produced almost $2 of G.D.P. in 2006 and only $1.66 today.....

The right policy can be debated, but the important thing is for policy makers to stop obsessing about debt and focus instead on raising aggregate demand. As Bill Gross of the investment firm Pimco put it recently: “While our debt crisis is real and promises to grow to Frankenstein proportions in future years, debt is not the disease — it is a symptom. Lack of aggregate demand or, to put it simply, insufficient consumption and investment is the disease.”

9--China Slowing ‘Significantly’: Conference Board, Bloomberg

Excerpt: China will achieve a “soft landing” even as growth moderates after the government tightened monetary policy, the Conference Board said as its main indicator for the economy rose.

The New York-based researcher’s leading economic index for China increased 1 percent in June, it said in a release today. The index climbed 0.6 percent in May and 0.3 percent in April.

The gain may ease concern that Europe’s debt crisis and a weakening U.S. recovery will weigh on growth in the world’s second-largest economy. China’s benchmark stock index has retreated 14 percent from its April high as the government stepped up efforts to cool the fastest inflation in three years.

“The economy is significantly moderating right now and also over the next couple of months,” Bart van Ark, the organization’s chief economist, told Bloomberg Television from New York today. “We still expect it to be pretty much a soft landing.”

10--Has the Credit Contraction Finally Begun?, Naked Capitalism

Excerpt: (From the archive July 11, 2007) As MarketWatch noted:
Standard & Poor’s just drove a huge harpoon into the heart of the mortgage credit bubble, and it’s going to take a long time to clean up the mess once the beast finally dies.
S&P, one of the three main credit-rating agencies that served as enablers of the subprime-mortgage boom, announced Tuesday that it would lower its ratings on 612 bonds, a small portion of the mortgage-backed securities it had given its seal of approval to.

But the bigger news is that S&P isn’t going along with the charade anymore. S&P said it would change its methodology for rating hundreds of billions of dollars in residential-mortgage-backed securities. And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans.

A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.

S&P’s announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust.

“We do not foresee the poor performance abating,” S&P said.

Prices will fall, and foreclosures will rise. More mortgage fraud will be uncovered as the tide goes out.
And hedge funds will have to find another way to beat the market — if they survive this blow, that is.

Now that may sound terribly melodramatic, but consider this tidbit from (of all places) the UK’s Telegraph:

When creditors led by Merrill Lynch forced a fire-sale of assets, they inadvertently revealed that up to $2 trillion of debt linked to the crumbling US sub-prime and “Alt A” property market was falsely priced on books.
Even A-rated securities fetched just 85pc of face value. B-grades fell off a cliff. The banks halted the sale before “price discovery” set off a wider chain-reaction.

“It was a cover-up,” says Charles Dumas, global strategist at Lombard Street Research. He believes the banks alone have $750bn in exposure. They may have to call in loans.

The reason I take this seriously is that I heard rumors after the Feb 27 global selloff, in which subprime related paper took a bit hit, that if the downtrend had continued much longer, the margin calls to hedge funds would have forced a larger wave of selling that would likely have damaged dealers.

The rest of the Telegraph piece is sobering reading:
Not even the Bank for International Settlements (BIS) has a handle on the “opaque” instruments taking over world finance.
“Who now holds these risks, and can they manage them adequately? The honest answer is that we do not know,” it said.

Markets have been wobbly since the surge in yields on 10-year US Treasuries, the world’s benchmark price of money. Yields have jumped 55 basis points since early May on inflation scares, the steepest rise since 1994. It infects everything; hence that ugly “double top” on Wall Street and Morgan Stanley’s “triple sell signal” on equities.

Wobbles are turning to fear. Just $3bn of the $20bn junk bonds planned for issue last week were actually sold. Lenders are refusing “covenant-lite” deals for leveraged buy-outs, especially those with “toggles” that allow debtors to pay bills with fresh bonds. Carlyle, Arcelor, MISC, and US Food Services are all shelving plans to raise money. This is how a credit crunch starts.

“This is the big one: all investment portfolios will be shredded to ribbons,” said Albert Edwards, from Dresdner Kleinwort.

The BIS had warned days earlier that markets were febrile: “more risk-taking, more leverage, more funding, higher prices, more collateral, and in turn, more risk-taking. The danger with such endogenous market processes is that they can, indeed must, eventually go into reverse if the fundamentals have been over-priced. Such cycles have been seen many times in the past,” it said.

The last few months look like the final blow-off peak of an enormous credit balloon. Global M&A deals reached $2,278bn in the first half, up 50pc on a year. Corporate debt jumped $1,450bn, up 32pc. Private equity buy-outs reached $568.7bn, up 23pc. Collateralised debt obligations (CDOs) rose $251bn in the first quarter, double last year’s record rate.

Leveraged deals are running at 5.4 debt/cash flow ratio, an all-time high. As the BIS warns, this debt will prove a killer when the cycle turns. “The strategy depends on the availability of cheap funding,” it said.

Why has such excess happened? Because global liquidity flooded the bond markets in 2005, 2006, and early 2007, compressing yields to wafer-thin levels. It created an irresistible incentive to use debt.

What is the source of this liquidity? Take your pick. Goldman Sachs says oil exporters armed with $1,250bn in annual revenues have been the silent force, sinking wealth into bonds; China is recycling $1.3 trillion of reserves into global credit, a by-product of its policy to cap the yuan; Japan’s near-zero rates have spawned a “carry trade”, injecting $500bn of Japanese money into Anglo-Saxon bonds, and such; the Swiss franc carry trade has juiced Europe, financing property booms in the ex-Communist bloc. And, all the while, cheap Asian manufactures have doused inflation, masking the monetary bubble.

The deeper reason is the ultra-loose policy of the world’s central banks over a decade. They “fixed” the price of money too low in the 1990s, prevented a liquidation purge to clear the dotcom excesses, then kept rates too low again from 2003 to 2006. Belated tightening has yet to catch up.

Don’t blame capitalism. This is a 100pc-proof government-created monster. Bureaucrats (yes, Alan Greenspan) have distorted market signals, leading to the warped behaviour we see all around us.

As the BIS notes tartly in its warning on the nexus of excess, this blunder has official fingerprints all over it. “Behind each set of concerns lurks the common factor of highly accommodating financial conditions” it said.

Rebuking the Fed, it said Japan and Europe have turned sceptical of the orthodoxy that central banks can safely let asset booms run wild, merely stepping in afterwards to “clean-up”.

The strategy leads to serial bubbles, creates an addiction to easy money, and transfers wealth from savers to debtors, “sowing the seeds for more serious problems further ahead”.

If you think we are too clever now to let a full-blown slump occur, read the BIS report.

“Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and south-east Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a ‘new era’ had arrived,” it said.

The subtext is that you bake slumps into the pie when you let credit booms run wild. You can put off the day of reckoning, as the Fed did in 2003, but not forever, and not without other costs.

So the oldest and most venerable global watchdog is worried enough to evoke the dangers of depression. It will not happen. Fed chief Ben Bernanke made his name studying depressions. He will slash rates to zero if necessary, and then – in his own words – drop cash from helicopters. But his solution is somebody else’s dollar crisis.

On it goes. Perhaps governments should simply stop trying to rig the price of money in the first place.

11--The Sucking Sound of Liquidity Draining From the Eurobank Market, Naked Capitlaism

Excerpt: A very good overview at the end of last week by the International Financing Review highlighted one clear danger sign: many mid tier banks in Europe are unable to get funding in interbank markets and are increasingly dependent on the ECB. The whole piece is very much worth reading. Key extracts:

Bankers who once ran the now-defunct repo facilities for medium-sized European banks say the credit lines were withdrawn after risk managers became concerned about their own exposure to the unfolding sovereign debt crisis, leaving some clients now solely reliant on central banks for cash….

The closure of traditional credit lines is a clear sign that concern about European sovereign debt has infected the region’s banks. Many in the region are big holders of the debt of their respective governments. According to the EBA stress tests published in July, the 90 banks it surveyed held a total of €326bn in Italian government debt, €287bn of Spanish public debt, and €215bn of French debt.

“Everyone has been cutting their exposure,” said the head of another European investment bank. “It started with Greece, then Spain and now Italy. People don’t want to do business with these banks. Many of them have good underlying businesses, but they are stuffed.”…

For many, the European Central Bank is now the last remaining source of liquidity. Under its open market operations – brought in during the depths of the crisis to pump liquidity into the region’s banks – its member central banks provide unlimited repo financing against certain eligible assets.

Demand for that money has been picking up of late, as banks feel the squeeze of dry private credit lines. Earlier this week, the Italian central bank said lenders asked for €80.5bn of liquidity during July, almost double what it had provided only a month earlier, in a sign of banks’ deteriorating finances.

Total use of the ECB’s main refinancing and long-term refinancing facilities – both part of the open market operations – are now close to €500bn, up from about €400bn in the spring.

FT Alphaville also took up the theme of Eurobank financing stress, citing Morgan Stanley analyst Huw van Steenis, who points out that the 5 year CDS of Eurobanks are trading wider than they did in 2008 and provided this cheery chart:...

And the journalist from (Graham) Greeneland, John Dizard, also points that the system is close to going into a critical state:

Not that there’s a European banking crisis just yet. We can see how close we are coming, though. As US money market funds cut back on their European exposures, even the best European banks have to fill the gap by borrowing euros short term from the ECB, and swapping those into dollars. Last week the cost of that process for large banks reached between 80 and 85 basis points. Measuring that against the 100 basis point penalty rate for the Federal Reserve dollar swap facility with the ECB, the system was about 15 or 20 one hundredths of 1 per cent away from a crisis.

Dizard also points out that the Eurozone isn’t prepared to enter into broad scale bank recapitalization programs; they’ll have to take place on a country by country basis. Yet he argues that the concerns are still overdone, for the Fed would ride to the rescue with swap facilities in a crisis, so US money market funds can keep their funding of Eurobanks (via repos) in place.

Yet it does not appear that money market funds are all that sanguine. They’ve been pulling back from European banks for a while; the dry up of funding to medium-sized banks described in the IFR article is in part due to their newfound caution. And one can’t forget how public hostility can impede action. The reason the authorities didn’t bail out Lehman was that it was politically unacceptable to do so. And I’m not saying a rescue was the right answer, but relying solely on a private sector solution and not considering a resolution or a good bank/bad bank structure was remarkably short-sighted. Here again, a failure to appreciate the downside may again lead to sluggish responses and tactical rigidity that could prove deadly in a crunch.

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