Tuesday, August 23, 2011

Today's links

1--Why is Bank of America’s Stock Cratering Yet Again? It’s the Extend and Pretend Endgame
Naked Capitalism

Excerpt: We are now seeing the downside to extend and pretend. Years of regulatory forbearance mean that investors know the marks on the balance sheet of a beast like Bank of America (and frankly all the other big banks) have a ton of air in them. And now that the economy is looking seriously wobbly and the odds of son of Credit Anstalt are well above zero, it means big banks are at real risk of getting seriously whacked in a major stress event. Worse, with Dodd Frank (supposedly) barring bailouts and Tea Partiers on an anti-bank, anti-Fed, anti-spending warpath, it might not be so easy for the authorities to rescue a big bank if a run started (not that I’m advocating a rescue, mind you, I’m looking at this from the vantage of a bank shareholder).

Steve Waldman set forth the basic issue in a very important post last year:

Bank capital cannot be measured. Think about that until you really get it. “Large complex financial institutions” report leverage ratios and “tier one” capital and all kinds of aromatic stuff. But those numbers are meaningless. For any large complex financial institution levered at the House-proposed limit of 15×, a reasonable confidence interval surrounding its estimate of bank capital would be greater than 100% of the reported value. In English, we cannot distinguish “well capitalized” from insolvent banks, even in good times, and regardless of their formal statements.

Now normally, investors accept the unknowability of bank equity because they have some faith in the system. Does anyone have any confidence in the system now? Financial regulators have shown themselves to be incompetent and/or badly captured by banks. Earth to base: letting off bank management easy is bad for investors in the long run. Being an investor in an overly risky bank looks swell until it suddenly isn’t.

2--Housing’s Drag on Economy May Worsen, Bloomberg

Excerpt: Sanjay Jain called his real estate broker four days ago to cancel a deal to buy a three-bedroom home in Folsom, California, unnerved by another plunge in the most volatile equities market on record.

“Seeing what’s happening on the stock market made me think that it’s not a good time to be buying a home,” Jain said. “I’m going to wait and see.”

As the U.S. economy shows signs of sputtering, instability on Wall Street is sapping the confidence of would-be property buyers, said Karl Case, co-founder of the S&P/Case-Shiller home- price index. That means housing, which aided every recovery except one before the most recent recession, may deepen its five-year drag on growth.

“There’s a dramatic effect on an economy when a major sector is flat out,” said Case, professor emeritus of economics at Wellesley College in Massachusetts. “If housing takes another leg down, it’s an accelerator. It’s going to make a recession happen faster and deeper.”

Home sales in July fell to the lowest point this year, the National Association of Realtors said in a report last week. Applications for mortgages to buy homes dropped to a 13-month low in the week ended Aug. 12, even as borrowing costs tumbled, according to the Mortgage Bankers Association. The Bloomberg Consumer Comfort Index sank to the lowest since the recession......

As of May, home prices were 7.3 percent below the start of the recovery, according to the Federal Housing Finance Administration.

The share of mortgages with late payments in the second quarter rose to 8.44 percent from 8.32 percent the previous three months, the Mortgage Bankers Association reported today.

3--The United States of Unemployment, David Wessel, WSJ

Excerpt: There are 13.9 million unemployed people in the U.S. – and that just counts those looking for work. That works out to 9.1% of the labor force, the widely publicized unemployed rate.

But here are a few more ways to look at it.

There are more unemployed people in the U.S. than there are people in the state of Illinois, the fifth largest state.

In fact there, there are more unemployed people in the U.S. than there are people in 46 of the 50 states, all but Florida, New York, Texas and California.

There are more unemployed than the combined populations of Wyoming, Vermont, North Dakota, Alaska, South Dakota, Delaware, Montana, Rhode Island, Hawaii, Maine, New Hampshire, Idaho and the District of Columbia.

If they were a country, the 13.9 million unemployed Americans would be the 68th largest country in the world, bigger than the population of Greece or Portugal (each of which has 10.8 million people) and more than twice the population of Norway (4.7 million.)

4--European bank stocks hurt by borrowing crunch, Yahoo Finance

Excerpt: European bank stocks battered as fears mount about their exposure to region's debt crisis...

Some European banks with heavy exposure to the debts of Greece and other weak countries are relying on loans from the European Central Bank because other private banks are reluctant to do business with them. The ECB said one bank, which it didn't identify, had paid above-market rates to borrow $500 million a day for seven days.

No bank had requested such a loan for nearly six months. Analysts said fears about one bank's troubles are enough to spark concerns about the entire industry.

"These are worrying signs," said Neil MacKinnon, an economist at VTB Capital in London. "You could think of it as a mini-Lehman moment: There is the risk that a major eurozone bank might be a casualty."

In 2008, the investment bank Lehman Brothers collapsed, causing the global credit markets to freeze up. Banks refused to lend to each other because they feared more failures and greater losses. Companies and consumers couldn't get loans....

Poor economic news in the U.S. helped fuel the flight from bank shares in Europe and on Wall Street. Shares of big U.S. banks plunged faster than the broader market indexes. Bank of America Corp. and Citigroup Inc. closed more than 6 percent lower. Morgan Stanley and Wells Fargo slid more than 4.5 percent. The Dow Jones industrial average closed 4.3 percent lower.

"People are putting the pieces together," said Will Hedden, a sales trader with IG Index.

Banks have also been under pressure because German Chancellor Angela Merkel and French President Nicolas Sarkozy said earlier this week that their countries were developing a plan to tax financial transactions. That would cut into banks' profits, analysts said.

5--UBS' George Magnus On Marxist Existential Crises And The "Convulsions Of A Political Economy", zero hedge

Excerpt: ....First, to lighten the household debt load, we have to think about debt restructuring, possibly even debt forgiveness in certain circumstances, so that eligible mortgage holders receive relief in respect of current debt obligations, for example, in exchange for future home price appreciation gains accruing to lenders. To lighten the sovereign debt load, lower interest rates and longer debt maturities, as recently proposed for Greece, will almost certainly become the norm as afflicted debtor countries reach the limits of forced austerity.

Second, to sustain aggregate demand, governments must seek to promote employment in the short-term, as well as through education and supply side reforms in the longer-term. Cutting income taxes and VAT, for example, might have short-term political advantages but they won’t necessarily get people to spend more. Better to cut employer payroll taxes, or offer companies tax holidays contingent on employment criteria. Better still for the government to embrace some national investment or national infrastructure strategy. It could even capitalise a bank to make investment loans to small and medium-sized companies, which are the real employment-creating part of the company sector.

Third, to build defences against falling into a debt trap, we should use monetary policy in a more radical way than even asset purchases. In other words, while fiscal and debt management policies operate over time on the numerator of the debt ratio, monetary policy should work to bolster the denominator, that is, GDP, income, cash-flow and so on. Most of you will have to hold on now, because this would involve a significant change in monetary policy, in which, for a while at least, central banks would actively target higher inflation, suspending their commitments to 2% inflation or whatever, and to interest rate targeting.

6--Michael Pettis: Long-Term Outlook for China, Europe, and the World; 12 Global Predictions, MIsh's Global Economic Trend Analysis

Excerpt: Pettis Writes: The US downgrade set off a storm of market volatility, along with bizarre concern in the US about whether or not China will stop buying US debt and the economic consequence if it does, and equally bizarre bluster within China about their refraining from buying more debt until the US reforms the economy and brings down debt levels.

What both sides seem to have in common is an almost breathtaking ignorance of the global balance of payment mechanisms. China cannot stop buying US debt until it engineers a major adjustment within its economy, which it is reluctant to do. Until it does, any move by the US to cut down its borrowing and spending will trigger a drop in global demand which will cause either US unemployment to rise, if the US ignores trade issues, or will cause Chinese unemployment to rise, if the US moves to counteract Chinese currency intervention.

The Big Picture

Rather than try to wade through all the news this month, much of which doesn’t seem to have much informational content, I thought I would duck out altogether and instead make a list of things I expect will happen over the next several years. We are so caught up in noise and market volatility – as the market swings first in one direction and then, as regulators react, in the other direction – that it is easy to lose sight of the bigger picture.

My basic sense is that we are at the end of one of the six or so major globalization cycles that have occurred in the past two centuries. If I am right, this means that there still is a pretty significant set of major adjustments globally that have to take place before we will have reversed the most important of the many global debt and payments imbalances that have been created during the last two decades. These will be driven overall by a contraction in global liquidity, a sharply rising risk premium, substantial deleveraging, and a sharp contraction in international trade and capital imbalances.

7--European Banks Must Pay Up to Borrow $100 Billion Amid Crisis: Euro Credit, Bloomberg

Excerpt: European banks with more than $100 billion of cash to raise by year-end will have to pay up because investors perceive them as the worst credits they’ve ever been.

The cost of insuring the senior and junior bonds of 25 banks and insurers doubled since April to records, according to the Markit iTraxx Financial indexes of credit-default swaps. The Euribor-OIS spread, a gauge of banks’ reluctance to lend to each other, reached the widest since April 2009 this month, while the cost for European banks to fund in dollars was near a 2 1/2-year high.

“This return of generalized banking risk marks a new phase in the unfolding European drama,” said Lisa Hintz, an analyst in New York at Capital Markets Research Group, a unit of ratings firm Moody’s Investors Service. “Investors have heightened concerns about sovereign and financial institution risk.”

Morgan Stanley’s estimate of the 80 billion euros ($116 billion) banks need until year-end doesn’t include the extra capital that regulators have ordered many to raise to protect against a re-run of the 2007 global financial meltdown. With the bond market shut to all but the strongest banks, weaker lenders, particularly those from the euro region’s so-called peripheral nations, are relying on the European Central Bank for its unlimited six-month loans.

Hoarding Cash

Even when banks receive the ECB’s money, many are hoarding it rather than lending it on. French, German and Austrian lenders -- those from countries considered safer credits than the likes of Greece, Italy and Spain -- are the lenders depositing the most funds back with central banks, according to CreditSights Inc.

“The banks seem to prefer to deposit cash with the ECB rather than lend it out to others that need it,” said John Raymond, an analyst at the financial-research firm in London. “In itself, that’s a sign of stress in the interbank market” and means companies must also pay more to borrow, he said.

8--Bob Janjuah: "It's Only Just Begun", zero hedge

Excerpt: We are in a balance sheet recession which will take at least 2 to 3 more years to clean up. The cost of capital will keep rising. The outcome is weak trend growth – I feel 1% pa on a 2 to 3 year basis in the balance sheet impaired West is the central case. Soft patches will be the norm. Cushions against economic shocks will be thin/non-existent. Aggregate real Earnings and Incomes will stagnate/fall. Defaults (amongst weak balance sheet corporates, consumers, AND sovereigns) will rise and P/Es will fall. In this world, and using the S&P 500 purely as a risk proxy, I see ‘fair value’ for the S&P down in the 800/900 area. I think we will see these levels trade in the next 12/15 months. And we may even „undershoot? to levels last seen at the lows of Q1 09. For this year I still expect – as I have said all year – that between now and end 2011 the S&P will trade, as a low print, in the low-1000s.

3. In my view the market remains too optimistic and full of hope. In particular the sell-side remains too hopeful on trend growth. (I think Q2 11 US GDP will be revised down heavily, and H2 11 and 2012 expectations are, I think, way too high.) Further, the sell-side remains way too addicted to policy and policy makers. Over the next year I feel that all the things we have talked about all year – weak trend growth in the West, growth risks in EM as the focus remains on combating inflation and excessive credit creation, euro zone restructuring, and fast diminishing policy maker credibility, policy ineffectiveness and policy options - will get priced into markets and asset prices. These last few weeks and months are the beginning of this process.

As I write all eyes - for now - seem to be focussed on Bernanke and Jackson Hole. Why? I don’t know. After all, QE2 was – in the eyes of, many - a dramatic failure. Bernanke will likely disappoint the more bullish expectations with his Jackson Hole speech, but as I have said all year QE3 is coming in late 2011/early 2012, once S&P trades at 1000 and once the unemployment rate hits 10%.

9--Euro banks CDS spreads: Worse than 2008, Pragmatic Capitalism

Excerpt: What’s frightening about the developments in Europe in recent weeks is that the CDS market is once again sending the same signals. Someone is going to get left holding the grenade again. And this time, the market is actually telling us that it’s even worse than it was in 2008. The only difference is that the problems appear to be across the pond.

The following chart from Danske Bank shows the 5 year CDS rates for 6 of the largest banks in Europe – SocGen, Unicredit, Barclays, Credit Agricole, Banco Santander and BNP. If this market is giving us a cue its message is more than clear – someone’s paying an awful lot to avoid the inevitable explosion and they’re even more eager to avoid this explosion than they were in 2008. Is the market underestimating the risk of further credit contagion? That would appear to be the message from the CDS market.

10--Merkel: We won't be bullied by the market, Pragmatic Capitalism

Excerpt: Angela Merkel is sending a pretty clear message this weekend – EMU leaders will not be bullied into action just because the markets are throwing a fit about the speed of their actions. Bloomberg provides some highlights of her recent comments:

“At this time — we’re in a dramatic crisis — euro bonds are precisely the wrong answer,”

“They lead us into a debt union, not a stability union. Each country has to take its own steps to reduce its debt.”

“Politicians can’t and won’t simply run after the markets,”

“The markets want to force us to do certain things. That we won’t do. Politicians have to make sure that we’re unassailable, that we can make policy for the people.”

These are pretty staggering comments. If you’re a market speculator you can basically read her comments as such:

“We are in no rush whatsoever to solve the crisis in Europe. We will not be swayed by market crashes or panics.”

In other words, they are 100% behind the curve. The markets are sending them a very clear message. There is a very serious risk of a banking crisis in Europe. And it all stems from the fact that the Euro is inherently flawed. As Merkel and her friends fail to provide markets with a solution, they will continue to push the envelope. Let’s see who blinks first. Rich politicians have a tendency to pay attention when their personal wealth starts sinking into a blackhole that they could have closed...

11--The Destructive Power of the Financial Markets, Der Spiegel

Excerpt: Speculators are betting against the euro, banks are taking incalculable risks and the markets are in turmoil. Three years after the Lehman Brothers bankruptcy, the financial industry has become a threat to the global economy again. Governments missed the chance to regulate the industry, and another crash is just a matter of time.

Stock markets are currently in turmoil. Even the most experienced equity traders cannot remember a time when prices fluctuated as widely from day to day -- and often even within a single day -- as they have in recent weeks. The German stock index, the DAX, fell by 5.8 percent last Thursday and lost another 2.2 percent the next day.

There is no calm in sight for the global economy. Sharp declines on the stock market and crises have become an everyday reality. This raises the question of why the financial markets are so erratic. They have developed into a permanent threat to the global economy. But what can be done to avert this risk?

It cannot be a coincidence that the number and scope of disruptions have increased with the expansion of the financial industry. The Asian financial crisis in the 1990s was followed by the bursting of the Internet bubble at the turn of the millennium. When Lehman Brothers went bankrupt in 2008, the financial world suddenly found itself on the brink of collapse. Now that the euro is at risk, and millions of people are afraid of their currency collapsing. A number of countries, including the United States, are groaning under debt burdens that run into the trillions....

Naturally the financial industry -- all those who trade in securities, currencies, money and the products derived from them, known as derivatives -- is not responsible for all the crises in the global economy. Politicians also share some of the blame, for having accumulated too much debt and given the banks too much leeway. But without the destructive power of the banks, hedge funds and other investment companies, the world would not be where it is today -- at the edge of an abyss....

Once upon a time, the sole purpose of banks was to supply the economy with money. They were service providers, sources of energy for the economy, so to speak, but nothing more. But now the financial industry has largely disconnected itself from the manufacturing economy, transforming its role from subservient to dominant in the process....

the law was intended to completely prohibit banks from engaging in proprietary trading, with which they speculate in the foreign currency, stock and commodities markets. But the legislation contains so many exceptions that business will continue to flourish, in some cases by simply outsourcing trading activities.

The United States also wants to force hedge funds to disclose more information about their business. But even though the law doesn't go into effect until next March, speculator Soros is already demonstrating how it can be circumvented. After buying out the outside investors in his hedge fund, he now intends to conduct business in the future as a so-called family-owned company. Funds that manage the assets of a family are not subject to the new disclosure rules.

In Europe, the European Commission has developed a draft of new capital market rules, which includes 165 pages of guidelines and another 500 pages of regulations. Under the proposed rules, banks would be required to keep more capital resources in reserve to protect against risk, and they would only be allowed to borrow up to a certain ratio.

These proposals make sense, but the financial industry is already two steps ahead. It has created a world in which the usual rules for exchanges and banks do not apply: the realm of the "shadow banks."

For bankers, this is by no means a world of illegal or semi-legal institutions, despite what the term implies. Hedge funds and private equity firms are known as shadow banks. In the United States, shadow banks have already incurred debts of more than $16 trillion, as compared with $13 trillion among commercial banks.....

the monster cannot be tamed with half-hearted reforms, which is why people who have been involved in the financial world for decades assume that it will strike again soon.





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