Friday, September 30, 2011

Weekend links

1--Randy Wray: Euro Toast, Anyone? The Meltdown Picks Up Speed, Naked Capitalism

Excerpt: While the story of fiscal excess is a stretch even in the case of the Greeks, it certainly cannot apply to Ireland and Iceland—or even to Spain. In the former cases, these nations adopted the neoliberal attitude toward banks that was pushed by policymakers in Europe and America, with disastrous results. The banks blew up in a speculative fever and then expected their governments to absorb all the losses. Further, as Ambrose Evans-Pritchard argues, even Greece’s total outstanding debt (private plus sovereign) is not high: 250% of GDP (versus nearly 500% in the US); Spain’s government debt ratio is just 65% of GDP. And while it is true that Italy’s government debt ratio is high, its household debt ratio is very low by global standards.

But it is not at all clear that the nuclear option—dissolution–will be avoided. Even Very Serious People are providing analyses of a Euroland divorce—with resolution ranging from a complete break-up to a split between a Teutonic Union embracing fiscal rectitude with an overvalued currency and a Latin Union with a greatly devalued currency.

A recent report from Credit Suisse dares to ask “What if?” there is a disorderly break-up of the EMU, with the narrowly defined PIGS (Portugal, Ireland, Greece and Spain) abandoning the euro and each adopting its own currency. The report paints a bleak picture because the currencies on the periphery would depreciate, raising the cost of servicing euro debt and leading to a snowball of sovereign defaults across highly indebted euro nations.

The report assumes Italy does not default—if it did, losses on sovereign debt would be very much higher. With the assumption that Italy remains on the euro and manages to avoid default, total losses to the core European banks would be 300 billion euros and 630 billion euros for the periphery nations’ banks (excluding Italy), while the ECB’s losses would be 150 billion. (Note that gets very close to the rumored bailout costs of 1.75 trillion euros—without including any knock-on costs.)

2--Bank Funding, Not Capital, Must Be Priority, Wall Street Journal

Excerpt: European bank funding markets are in the deep freeze, with no public senior euro issuance since early July. That is becoming a major problem: Three-quarters of financing for Europe's economy comes from banks, according to the European Central Bank. Restoring access to long-term funding must be a priority for Europe's policymakers.

Bank bond issuance has collapsed as the sovereign crisis has deepened. Euro senior-unsecured bank bonds yield 3.5 percentage points more than safe-haven government debt, according to Barclays Capital, more than the 3.2 point peak after Lehman Brothers' collapse. Fear of sovereign defaults risks a vicious circle where banks unable to borrow then cut back on lending. That crimps growth prospects and increases the risk of sovereign solvency problems.

The International Monetary Fund estimates that spillover costs from the turmoil in government bond markets could amount to EUR300 billion and calls have mounted for banks to raise fresh capital. But this alone is unlikely to reduce funding costs and boost issuance: If the fear is one of widespread sovereign defaults, including heavyweights such as Spain or Italy, it is difficult to imagine enough capital could be raised to withstand the subsequent havoc.

Rather, efforts must be made to deal with the root of the problem: sovereign solvency. Euro-zone governments heightened the fear of default when they sanctioned a Greek haircut. Now they must prove that no other euro-zone state will default. But this will take time. Structural reforms will take years to feed through to stronger growth, and debt burdens may only start to fall in 2013.

In the meantime, policymakers need to ease the funding pressure on banks. The ECB has already reactivated a six-month lending facility and could offer longer-term finance. Guarantees could also be useful in kickstarting long-term issuance, although they could no longer simply come from individual governments; a euro-zone guarantee would be needed. And the ECB could restart its purchases of covered bonds, although it is unlikely to be as successful as 2009, when issuance surged even before it spent a single euro.

The longer the euro area dithers, the worse the downturn is likely to be.

3--Bernanke: Unemployment Poses ‘National Crisis’, Bloomberg

Excerpt: Federal Reserve Chairman Ben S. Bernanke said the U.S. is facing a crisis with a jobless rate at or above 9 percent since April 2009, and that fiscal discipline would help spur the economic recovery.

“This unemployment situation we have, the jobs situation, is really a national crisis,” Bernanke said in response to questions after a speech yesterday in Cleveland. “We’ve had close to 10 percent unemployment now for a number of years and, of the people who are unemployed, about 45 percent have been unemployed for six months or more. This is unheard of.”

The chairman is contending with the most opposition on the Federal Open Market Committee in almost 19 years, with three policy makers opposing the central bank’s decision last week to push down longer-term interest rates. Fed regional bank presidents Thomas Hoenig of Kansas City and Richard Fisher of Dallas spoke out against the plan this week, while Eric Rosengren of Boston backed it and Dennis Lockhart of Atlanta said the move will probably have a “modest” effect....

“Monetary policy is not a panacea,” Bernanke said. “There are certainly some areas where other policy makers could contribute,” and “strong housing policies to help the housing markets recover would certainly be useful.” ...

The U.S. should learn from the success of many emerging market economies and support strong economic growth through “disciplined fiscal policies,” Bernanke said in his speech yesterday. He didn’t address the outlook for the U.S. economy or monetary policy in his remarks on “Lessons from Emerging Market Economies on the Sources of Sustained Growth.”...

“This is unheard of,” he said in a question-and-answer session after a speech in Cleveland. “This has never happened in the post-war period in the United States. They are losing the skills they had, they are losing their connections, their attachment to the labor force.” He added: “The unemployment situation we have, the job situation, is really a national crisis.”

Bernanke said the government needs to provide support to help the long-term unemployed retrain for jobs and find work. And he suggested that Congress should take more responsibility.

4--Bundestag Approves, Agenda Shifts, Credit Writedowns

Excerpt: ...The dollar largely reversed most of its overnight gains witnessed late in the North American session and into Asia in anticipation of EFSF ratification vote by Germany, which was passed by 438 votes....

...many observers expect the EFSF to increase its firepower by allowing it to use bonds purchased with initial funds as collateral to borrow more from the private sector and buy yet more bonds. But this is not a panacea either given that the use of leverage is not risk free and most likely would drive up the EFSF’s financing costs. In turn higher funding rates would imply higher borrowing costs for indebted governments than if the EFSF’s guarantees were increased outright, which of course may limits the facilities effectiveness. Looking ahead, we see three factors that are likely to limit any EUR/USD bounce over the coming weeks, which include: the potential for more accommodative policy from the ECB, uncertainty over the EFSF and political discord over the Greek 2.0 bailout package, given there is talk that as many as 7 countries want a large haircuts and more private sector participation. Elsewhere, in the US we have initial jobless claims (which continue to show a gradual improvement in the employment picture, at odds with most other employment figures) and we are also expected to see Q2 GDP revised higher.

5--Buiter: Euro area recession likely to begin in Q4, FT.Alphaville

Excerpt: Citigroup’s chief economist goes on a 2012 forecast-cutting binge in his latest note (bolding ours in all cases):
Over the last three months, we have cut our global growth forecasts for the current and following year by 0.65% (from 3.4% to 3.0% for this year, More…

In this note he rehashes some of his earlier points but emphasises the deep uncertainty about the contagion threat to Spain and Italy and, especially, the accelerated timeline on which Europe now finds itself:
The most likely date for [Greek] restructuring is after the ratification of the EFSF enlargement is complete, which probably will be in late October or early November. At that stage, the existing official facilities could handle the direct implications of an orderly deep sovereign debt restructuring of Greece, Ireland and Portugal, a recapitalisation of the banks of these three countries, and of the banks in the core EA exposed to the outer periphery.

We expect Ireland and Portugal to follow Greece into sovereign debt restructuring soon afterwards, mainly because of ‘political contagion’. A Greek default would further raise the market assessment of the likelihood of default by these sovereigns, and undermine the political commitment to austerity in Ireland and Portugal. If Greece gets a deal that offers debt relief and further funding in return for efforts of questionable determination to tighten their belts, then Irish and Portuguese voters and politicians are likely to demand the same lenient treatment, especially given that they have so far stuck to the conditions of their programmes.
Early restructuring is likely to be far more disruptive to economies and financial markets, and we expect the Euro Area to fall into a fresh recession in coming quarters.

Nevertheless, there is a huge range of uncertainty, and it is unclear how much contagion will spread to other Euro Area countries, notably Italy and Spain. This is likely to depend on a range of factors. In particular, we assume that (1) Greece will not leave EMU, and nor will any other country; (2) there will be a large backstop facility, via the EFSF and/or ECB, for Euro Area countries other than Greece, Ireland and Portugal, notably Italy and Spain; (3) there will be more widespread recapitalization of European banks.

We’ve reached a stage where none of these can be taken for granted, obviously — and in the meantime Buiter adds that even with an leveraged EFSF, the creditor countries of the EU and the ECB are likely to request additional austerity measures in exchange for their support.


Even with a leveraged EFSF, additional fiscal tightening and tighter financial conditions are likely to be sizeable drags for Euro Area growth. Taking this into account, we revise down our Euro Area 2012 GDP growth forecast from +0.6% to -0.2%, now expecting a mild recession to start in 4Q 2011.

6--A free lunch for America, Bradford Delong, Project Syndicate

Excerpt: The US government can currently borrow for 30 years at a real (inflation-adjusted) interest rate of 1% per year. Suppose that the US government were to borrow an extra $500 billion over the next two years and spend it on infrastructure – even unproductively, on projects for which the social rate of return is a measly 25% per year. Suppose that – as seems to be the case – the simple Keynesian government-expenditure multiplier on this spending is only two.

In that case, the $500 billion of extra federal infrastructure spending over the next two years would produce $1 trillion of extra output of goods and services, generate approximately seven million person-years of extra employment, and push down the unemployment rate by two percentage points in each of those years. And, with tighter labor-force attachment on the part of those who have jobs, the unemployment rate thereafter would likely be about 0.1 percentage points lower in the indefinite future.

The impressive gains don’t stop there. Better infrastructure would mean an extra $20 billion a year of income and social welfare. A lower unemployment rate into the future would mean another $20 billion a year in higher production. And half of the extra $1 trillion of goods and services would show up as consumption goods and services for American households.

In sum, on the benefits side of the equation: more jobs now, $500 billion of additional consumption of goods and services over the next two years, and then a $40 billion a year flow of higher incomes and production each year thereafter. So, what are the likely costs of an extra $500 billion in infrastructure spending over the next two years?...

In other words, taxpayers win, because the benefits from the healthier economy would more than compensate for the costs of servicing the higher national debt, enabling the government to provide more services without raising tax rates. Households win, too, because they get to buy more and nicer things with their incomes. Companies win, because goods and workers get to use the improved infrastructure. The unemployed win, because some of them get jobs. And even bond investors win, because they get their money back, with the interest for which they contracted.

7--The Road from Depression, George Soros, Project Syndicate

Excerpt: Financial markets are driving the world towards another Great Depression with incalculable political consequences. The authorities, particularly in Europe, have lost control of the situation. They need to regain control, and they need to do so now.

Three bold steps are needed. First, the governments of the eurozone must agree in principle on a new treaty creating a common treasury for the eurozone. In the meantime, the major banks must be put under the direction of the European Central Bank in exchange for a temporary guarantee and permanent recapitalization. Third, the ECB would enable countries such as Italy and Spain temporarily to refinance their debt at a very low cost.

These steps would calm the markets and give Europe time to develop a growth strategy without which the debt problem cannot be solved. Indeed, the importance of developing a growth strategy cannot be overstated, because the debt burden – the ratio of debt to annual GDP – rises and falls in part as a function of the rate of economic growth.

Since a eurozone treaty establishing a common treasury will take a long time to conclude, in the interim the member states must appeal to the financial authority that already exists, the ECB, to fill the vacuum. In its current form, the embryo of a common treasury – the European Financial Stabilization Facility – is only a source of funds; how they are spent is left to the member states. Enabling the EFSF to cooperate with the ECB will require a newly created intergovernmental agency, which will have to be authorized by Germany’s Bundestag and perhaps by other eurozone members’ parliaments as well.

The immediate task is to erect the necessary safeguards against contagion from a possible Greek default. Two vulnerable groups – the banks and the government bonds of countries like Italy and Spain – need to be protected.

To accomplish these related tasks, the EFSF would be used primarily to guarantee and recapitalize the banks. Systemically important banks would have to agree with the EFSF to abide by the ECB’s instructions as long as the guarantees are in force.

8--The Moral Question, Robert Reich, via Economist's View

Excerpt: We dodged another shut-down bullet, but only until November 18. That’s when the next temporary bill to keep the government going runs out. House Republicans want more budget cuts as their price for another stopgap spending bill.

Among other items, Republicans are demanding major cuts in a nutrition program for low-income women and children. The appropriation bill the House passed June 16 would deny benefits to more than 700,000 eligible low-income women and young children next year.

What kind of country are we living in? ... We’re in the worst economy since the Great Depression – with lower-income families and kids are bearing the worst of it – and what are Republicans doing? Cutting programs Americans desperately need to get through it.

Medicaid is also under assault. Congressional Republicans want to reduce the federal contribution to Medicaid by $771 billion over next decade and shift more costs to states and low-income Americans.

It gets worse. Most federal programs to help children and lower-income families are in the so-called “non-defense discretionary” category of the federal budget. The congressional super-committee charged with coming up with $1.5 trillion of cuts ... will almost certainly take a big whack at this category because it’s the easiest to cut. Unlike entitlements, these programs depend on yearly appropriations. ...

It gets even worse. Drastic cuts are already underway at the state and local levels. ... So far this year, 23 states have reduced education spending. ... Local family services are being cut or terminated. Tens of thousands of social workers have been laid off. Cities and counties are reducing or eliminating their contributions to Head Start...

All this would be bad enough if the economy were functioning normally. For these cuts to happen now is morally indefensible.

Yet Republicans won’t consider increasing taxes on the rich to pay for what’s needed – even though the wealthiest members of our society are richer than ever, taking home a bigger slice of total income and wealth than in seventy-five years, and paying the lowest tax rates in three decades. ...

When Republicans recently charged the President with promoting “class warfare,” he answered it was “just math.” But it’s more than math. It’s a matter of morality. Republicans have posed the deepest moral question of any society: whether we’re all in it together. Their answer is we’re not.
President Obama should proclaim, loudly and clearly, we are.

9--Plosser: Recent Stimulus Will Hurt the Fed's Credibility, Economist's View

Excerpt: Federal Reserve Bank of Philadelphia President Charles Plosser voted against Operation Twist -- the recent attempt for the Fed to help the economy -- because:

“The actions taken in August and September tend to undermine the Fed’s credibility by giving the impression that we think such policies can have a major impact on the speed of the recovery. It is my assessment that they will not,” ... “We should not take certain actions simply because we can.”
“If we act as if the Fed has the ability to solve all our economic problems, the credibility of the institution is undermined,” Plosser said. “The loss of that credibility and confidence could be costly to the economy because it will make it much harder for the Fed to implement effective monetary policy in the future,” he said....

But from Plosser's point of view, the Fed can't do much at all at this point, and the fear of inflation down the road trumps concerns about unemployment now. Plus, the Fed can't do anything about unemployment anyway:

“I am skeptical that this will do much to spur businesses to hire or consumers to spend, given the ongoing structural adjustments occurring in the economy and the uncertainties posed by the fiscal challenges both here and abroad,” Plosser said. Meanwhile, “we should be cautious and vigilant that our previous accommodative policies do not translate into a steady rise in inflation over the medium term even while the unemployment rate remains elevated.”

10--Richard Koo (video) explains Balance Sheet Recession-- from the archives

11--This ‘Competitiveness’ Thing Is a Scam, Rebecca Wilder, Economonitor

Excerpt: The World Economic Forum measures competitiveness as a composite of various factors that describe institutions, infrastructure, macroeconomic environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation....

In 2011-2012, Germany ranks #6 out of 142 countries, where 95.8% of the 142 countries are less competitive than Germany. Also ranked below Germany is every euro area economy except Finland. So when a German finance minister says that he wants economies to increase competitiveness, he’s effectively saying that he wants economies to be more German. From the bottom up, countries should reform their education, financial markets, business sophistication, innovation, etc., all the while emulating those institutions in Germany.

Better put: being asked to increase competitiveness is really a scam to get these economies to become more ‘German’. If I were Italy or Spain or even Ireland (who by the way is very open but less ‘competitive’ according to this measure), I’d have a problem with that.

12--It’s 1987 Without Bubble in Japan as Job Losses Spur Hollowing-Out Concern, Bloomberg

Excerpt: Japan’s labor force shrank last month to its smallest size since October 1987, when the nation’s stock-market benchmark was 185 percent higher and land prices were 85 percent greater than today.

Employers cut payrolls by 160,000 and a further 200,000 workers retired or abandoned efforts to find a job, leaving the seasonally adjusted number of employed at 59.4 million, the statistics bureau said today in Tokyo. Separate figures showed industrial production rose 0.8 percent from the previous month, less than all but three of 28 forecasts in a Bloomberg survey.

The data deepen concern that Japan’s recovery from the March earthquake will be stunted by manufacturers shifting operations abroad because of gains in the yen, a deterioration in consumer confidence and prospects for higher taxes at home. The challenges add to the burden of an economy already beset by a shrinking and aging population.

“We’ve seen an acceleration in the hollowing out of industry this year with the yen’s surge and the earthquake,” said Hiroshi Miyazaki, chief economist at Shinkin Asset Management Co. in Tokyo. “The government doesn’t have a sense of crisis about the yen and emerging economies are luring Japanese companies away.”

13--The No-Evictions Sheriff, YES Magazine

Excerpt: Cheri Honkala promises to be a sheriff who will stand up for families, not banks.

There’s a new sheriff in town—or there could be soon. Cheri Honkala, a single mom, sometimes homeless, who launched one of the country’s biggest multi-racial movements led by the poor and homeless, is running for sheriff of Philadelphia.

Her platform? No evictions. No throwing people out on the street because of a financial crisis that they didn’t create. Her slogan: “Keeping families in their homes and protecting the 'hood.”...

Cheri Honkala: For 25 years I’ve been trying to change things in the halls of Congress—trying to find a politician with a backbone to say that we have to have a moratorium on foreclosures. The banks are continuing to do whatever they want with the bailout money; they’re not modifying loans or finding ways to help people stay in their houses.

As Sheriff, I will use what's known as "selective enforcement"—I will refuse to rip down families’ doors and refuse to have my deputies throw them out. Instead, the Sheriff’s office will work with families that are in trouble: help them access resources; help them figure out how they can pay their mortgages.

Thursday, September 29, 2011

Today's links

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1--Debt Levels Alone Don’t Tell the Whole Story, New York Times

Excerpt: AS the world’s central bankers and finance ministers gather in Washington this weekend for the annual meetings of the International Monetary Fund and World Bank, government debt is at the top of the agenda. Some governments can no longer borrow money and others can do so only at relatively high interest rates. Reducing budget deficits has become a prime goal for nearly all countries...

In 2007, before the credit crisis hit, an analysis of government debt would have shown that Ireland was by far the most fiscally conservative of the countries. Its net government debt — a figure that deducts government financial assets like gold and foreign exchange reserves from the money owed by the government — stood at just 11 percent of G.D.P.

By contrast, Germany appeared to be in the middle of the pack and Italy was among the most indebted of the group.

Yet Ireland was slated to become one of the first casualties of the credit crisis, and is now among the most heavily indebted. Germany is doing just fine. Italian debt has risen only slowly. The I.M.F. forecasts that Ireland’s debt-to-G.D.P. ratio will be greater than that of Italy by 2013.
It turned out that what mattered most in Ireland was private sector debt. As the charts show, debts of households and nonfinancial corporations then amounted to 241 percent of G.D.P., the highest of any country in the group.

“In Ireland, as in Spain, the government paid down debt while private sector grew,” said Rebecca Wilder, an economist and money manager whose blog at the Roubini Global Economics Web site highlighted the figures this week. She was referring to trends in the early 2000s, before the crisis hit....

The differences highlight the fact that debt numbers alone tell little. For a country, the ability of the economy to generate growth and profit, and thus tax revenue, is more important. For the private sector, it matters greatly what the debt was used to finance. If it created valuable assets that will bring in future income, it may be good. Even if the borrowed money went to support consumption, it may still be fine if the borrowers have ample income to repay the debt.

That is one reason many euro zone countries are struggling even with harsh programs to slash government spending. With unemployment high and growth low — or nonexistent — it is not easy to find the money to reduce debts. And debt-to-G.D.P. ratios will rise when economies shrink, even if the government is not borrowing more money.

2--Europe: Why the One-Size-Fits-All Solution Won’t Work, Rebecca Wilder, Economonitor

Excerpt: Update: the government net-debt data is from the IMF World Economic Outlook, April 2011. I’ve eyeballed the levels and circled the areas that could be considered ‘high leverage’ (generally 90% or above, except for the Spanish household sector which I circled at 84.9% due to its stark contrast with the core countries).

The thing to notice here is, that broadly speaking the 2010 leverage build was not in the government sector (fiscal consolidation) but generally in the private sector. Ireland is in a real quandary – what was previously leverage heavily weighted in the private-sector is now passing through to the public sector via meager growth and harsh fiscal reform (see Edward Hugh’s post on the latest in Ireland).

(see chart)
The only way for some of these countries to drive down fiscal deficits amid such high private-sector leverage (presumably increased desire to save) is to run massive current account surpluses. Just look at Rob Parenteau’s 3 Sector Financial Balances Map. With the US growing at stall-speed and China still in tightening mode, there’s not much hope for the OSFA approach in Europe.

The policy directive needs to change.

3- Split opens over Greek bail-out terms, The Financial Times via Mish's Global Economic Trend Analysis

Excerpt: A split has opened in the eurozone over the terms of Greece's second €109bn bail-out with as many as seven of the bloc's 17 members arguing for private creditors to swallow a bigger writedown on their Greek bond holdings, according to senior European officials.

The divisions have emerged amid mounting concerns that Athens' funding needs are much bigger than estimated just two months ago. They threaten to unpick a painfully negotiated deal reached with private sector bond holders in July.

While hardliners in Germany and the Netherlands are leading the calls for more losses to be imposed on the private sector, France and the European Central Bank are fiercely resisting any such move. They fear re-opening the bond deal could spark renewed selling of shares in European banks, which have significant holdings of Greek and other peripheral eurozone debt.

Senior European said there was significant division over the move to re-open the bondholders' deal, which could trigger a bigger and earlier restructuring of Greek debt. Even within Germany, officials are split over whether to press for a bigger "haircut" for private sector creditors.

Under the terms of the July bail-out, bondholders agreed to trade about €135bn in bonds that come due through 2020 for new, European Union-backed bonds that would not be repaid for decades. This deal implied a haircut of 21 per cent for bondholders, but many German officials say they were forced to agree a deal that was too beneficial for the banks.

4--Europe's Banks Face New Funding Squeeze, Wall Street Journal
Excerpt: An extraordinary dry spell in the market for long-term European bank funding is amplifying pressure on policy makers to devise a solution to the Continent's banking crisis.

For the past three months, European banks have been largely unable to sell debt at affordable prices to investors, who are wary of the banks' vulnerability to risky euro-zone government bonds and other loans.

At $34 billion, the amount of senior unsecured debt issued by the Continent's financial institutions this quarter is on track to be the smallest of any quarter in more than a decade, according to data provider Dealogic. Most of those were bite-size deals of less than $500 million apiece. Traditionally, issuing such debt has been among the most popular ways for banks to finance themselves over the long term.

Now market observers are worried that the funding freeze is going to continue and perhaps worsen heading into 2012, with potentially serious repercussions for the banking industry.

Most banks say they have raised enough money to get through the final three months of the year, and they have access to safety valves like central-bank liquidity to ensure they can meet their day-to-day funding needs.

Yet analysts estimate that the banks face a mountain of debt, totaling nearly €800 billion ($1.08 trillion), that comes due in 2012. Much of that will need to be replaced with new debt. If banks can't raise this, they might have to shrink their balance sheets by selling assets or curbing lending.

5--Are the banks creating a permanent depression?, Naked Capitalism

Michael Hudson---That’s the outcome of their business plan, which is to take the entire economic surplus in the form of debt service. Banks want to create as much debt as they can. Debt is their “product.” The economy is merely “collateral damage” to a financial dynamic that is impersonal, not deliberate.

Every economy for hundreds of years has seen debts grow more rapidly than can be paid. At a point there’s a crash, which normally wipes out debts. It also wipes out savings on the other side of the balance sheet, of course. But this time the government has tried to keep the debt overhead on the books – and to tax the population to give banks enough to make sure that the rich don’t lose money. Only industry and labor will lose.

The effect will be to de-industrialize the economy even more, because markets shrink without consumer spending. Companies won’t invest, stores will close, “for rent” signs will go up, tax payments to the cities will fall, and municipal employees will be laid off while social services are cut back. The economy will shrink and life will get harder.

Why aren’t economists talking more about this obvious phenomenon of debt deflation? It is the distinguishing phenomenon of our time. But opinion-makers are insisting that the solution is simply to give more money to the banks. Not many people are asking why this isn’t working. And when they do ask, they don’t get much media coverage.

6--Causes of the Eurozone Crisis (Part 2): Policy Implications, The Streetlight Blog

Excerpt: In the previous post I sketched out the origins of the eurozone crisis, and argued that powerful systemic forces, not irresponsible behavior, pushed the periphery countries toward crisis – and may well have done so no matter what the peripheral eurozone countries had done. The common currency encouraged (in fact, was designed to encourage) large-scale capital flows from the eurozone (EZ) core to periphery. We know from experience that such “capital flow bonanzas” are susceptible to sudden changes in investor sentiment, and very often come to a sudden stop. The sudden stop in this case happened in 2009 (exploring the specific reasons for that stop is interesting, but will have to wait for another day), made it difficult for the periphery countries to roll over their debt, and thus caused a crisis.

But note that other aspects of the common currency meant that the odds were stacked even more heavily against the peripheral EZ countries. Euro-adoption not only set the stage for the crisis by encouraging a capital flow bonanza to the EZ periphery; it also made it impossible for the periphery countries to deal with the sudden stop to those capital flows if and when it came. In his excellent recent paper (pdf), Paul De Grauwe has pointed out that the adoption of the euro by Europe’s periphery effectively caused them to be “downgraded to the status of emerging countries”, in the sense that they could no longer issue sovereign debt in their own currency. This made those countries peculiarly vulnerable to changes in investor sentiment. As Paul Krugman recently put it, thanks to the common currency, the periphery countries lacked the tools to manage their balance of payments....

Austerity is not helpful.

Severe fiscal austerity by the periphery EZ countries has been the condition attached to assistance from the core EZ. But that austerity requirement brings with it several problems.

First, it is largely counterproductive with respect to reducing annual deficits; a simple textbook example illustrates how fiscal contraction during a recession will typically fail to meet deficit reduction goals, because the austerity itself makes the recession worse. That’s exactly why Greece keeps missing its deficit reduction goals: not because they aren’t trying hard enough, but because it’s inherently unrealistic and unreasonable to try to balance a budget through austerity during a recession.

Second, austerity is completely counterproductive with respect to reducing debt burdens. As the economy shrinks thanks to austerity, the debt burden skyrockets relative to the country's income. Just look at the debt, GDP, and debt-to-GDP ratios for Greece to see how that works. It's no wonder that it has recently become crystal clear that Greece will never have enough income to repay this level of debt....

But finally, and most importantly in the context of this analysis, austerity shifts most of the burden of dealing with the crisis onto the EZ periphery countries. And that means that citizens of the core EZ countries like Germany, France, and Benelux are essentially getting a free ride...
But there is a fundamental asymmetry that goes along with international capital flows: the country on the receiving end risks a serious financial crisis when that flow stops, while the country that is the source of the capital bears no similar risk. In other words, the periphery of the EZ bore the bulk of the systemic risks inherent to the common currency area, while the benefits were shared by both the core and the periphery. In a sense, the periphery countries “took one for the team” when they allowed themselves to be placed at risk for the greater good of the entire eurozone....

And let’s not kid ourselves about something: policy-makers in Europe know exactly how the crisis can be solved. It’s not a mystery that if the core EZ countries contribute sufficient funds to finance Greece’s debts for the foreseeable future, accept a substantial write-down on the amount owed by Greece, and provide funds to recapitalize banks in Greece and elsewhere in the EZ, then the crisis will be over. So the question is simply whether the core EZ countries are willing to pay that required price. If they are, then the EZ will remain intact. If not, it will not. The current debate going on among European policy-makers is simply the unpretty process of figuring out the answer to that question. (Brilliant, comprehensive analysis)

7--A European Plan Can Be Big Or Fast, But Not Both.., Wall Street Journal

Excerpt: In a note called “Still Too Early for a ‘Grand Plan,’” economists Jurgen Michels, Giada Giani, Willem Buiter and Ebrahim Rahbari write:
Although there are different possibilities to leverage up the EFSF capacity of €440bn based on the amended framework, we believe all options have their shortcomings and are unlikely to be implemented quickly. Even in the unlikely case of a smooth process, a leveraged EFSF, with a bond purchasing capacity of €2,000bn, would not be available before end October/early November.

Therefore it is likely that market participants will, once again, be disappointed by euro area policymakers. However, with multiple sovereign defaults looming, the pressure on policymakers to act decisively has increased substantially in recent weeks.

Here’s why they think it’s going to take a long time to get a plan off the ground:

For the leveraged EFSF to be a success in the near-term in our view, four conditions have to be met: i) it has to increase the available effective firepower without increasing the (maximum) amount of support provided by the EA member states, ii) it must avoid the need to reopen national (in particular parliamentary) approval processes, iii) it must not run foul of constraints set by the amended EFSF Treaty and the German Constitutional Court, and iv) it must be able to generate sufficient consensus at the level of decision makers in the European Council. Several proposals for how to leverage the EFSF exist, but none of the options currently discussed appears to satisfy all four constraints concurrently.

This suggests that for the time being the talks regarding the leveraging-up of the EFSF are at an early stage, and that it is very unlikely that there will be an agreement on a “grand plan” to deal with the sovereign debt crisis in the next week or two.

8--The Daily Show (archives) Diane Ravitch believes education reform should focus on getting children out of poverty, not finding the bad teachers. (Video)

9--Bernanke Lacks Tools to Prevent Double Dip, Stiglitz Says, Bloomberg

Excerpt: Monetary policy changes aren’t enough to save the U.S. from a “double dip” recession, as the Federal Reserve has only limited ability to boost the economy, Nobel-prize winning economist Joseph Stiglitz said.
“So just like QE1 didn’t work, QE2, QE2-and-a-half is not going to work,” Stiglitz said in an interview with Bloomberg HT television in Istanbul yesterday. “If we’re going to get out of the current mess it will take fiscal policy.”

Federal Reserve ChairmanBen Bernanke and his predecessor Alan Greenspan “obviously did a very bad job managing monetary policy in the run up to the crisis and letting the bubble grow, not putting in place adequate regulation,” Stiglitz said.

“Now the Fed is going to try and seem relevant so it will try to do something,” he said. “Monetary policy is much better at restraining the economy than pushing it when you’re in a severe downturn such as the current time.”

Fixing problems created by Fed chairmen is much more difficult than creating them, he said.

Stiglitz, who won the Nobel prize in 2001 and is now a professor at Columbia University, said there’s “a serious risk at least for a double-dip for the United States and Europe” and growth will “almost surely” be “too anemic” to create jobs.

“The jobs deficit is going to be growing and the sense of the American economy not working is going to be worse,” he said.

10--German Parliament Backs Euro Rescue Fund, Bloomberg

Excerpt: German lawmakers approved an expansion of the euro-area rescue fund’s firepower, freeing the way for European officials to focus on what next steps may be needed to stem the debt crisis.

The lower house of parliament passed the measure with 523 votes in favor and 85 against, granting the fund powers to buy bonds in secondary markets, enable bank recapitalizations and offer precautionary credit lines. It raises Germany’s guarantees to 211 billion euros ($287 billion) from 123 billion euros. The main opposition Social Democrats and Greens said before today’s session in Berlin that they’d vote with Chancellor Angela Merkel’s government, assuring passage.

The bill’s passage by Europe’s biggest economy allows euro- area officials to weigh further measures to bolster Greece and stem investor concern that helped end the biggest three-day rally in 16 months for European stocks. Options include seeking further writedowns on Greek sovereign bonds, adding yet more firepower to the rescue fund and a plan to protect banks.

Beefing up the fund bolsters defenses against the crisis, setting the stage for German policy makers to focus on Greece’s second bailout, said Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co. in London. That “may morph into a debate about an orderly Greek default later this year, with a haircut on Greek debt, an immediate recapitalization of Greek banks, European guarantees for restructured Greek debt and conditional fiscal support” for Greece, he said.

Wednesday, September 28, 2011

Today's links

"We believe it would not be an overstatement to consider disorderly Eurozone sovereign default as the chief risk to global recovery." UBS Europe economist

1--Home Prices Fell 4.1% in Year Ended July, Bloomberg

Excerpt: Home prices in the U.S. declined less than forecast in July from a year earlier, a sign bank delays in processing foreclosures may have temporarily slowed the slump in real-estate values.

The S&P/Case-Shiller index of property values in 20 cities fell 4.1 percent from July 2010, after a revised 4.4 percent drop in the 12 months to June, the group said today in New York. The median forecast of 28 economists surveyed by Bloomberg News projected a 4.4 percent decline.

Values were little changed in July from the prior month after adjusting for seasonal changes, the same as in June.

Investigations into bank foreclosure practices led to delays in processing that may have helped stabilize prices in recent months. Values may soon resume their slide as the holdups dissipate, putting more houses on to the market and pushing back any recovery in the industry that precipitated the last recession.

“The enormous supply overhang of existing homes, particularly factoring in all those in foreclosure or soon to be, promises to keep pressure on prices for some time,” Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York, said in a note to clients. “We look for further declines to be registered in the quarters ahead, although in all likelihood the rate of deterioration will be nowhere near as steep as that recorded earlier.”...

Home sales remain in the doldrums. Purchases of new houses fell in August to a six month low, figures from the Commerce Department showed yesterday. Purchases of previously owned homes rose to a five-month high, boosted by demand of low-priced, distressed houses, the National Association of Realtors said Sept. 21. Sales of existing properties have averaged a 4.97 million annual pace this year, compared with the 7.25 million peak reached in September 2005.

2--On Pace for Record Low New Home Sales in 2011, Calculated Risk

Excerpt: Alejandro Lazo at the LA Times wrote today: New home sales stuck at the bottom in August

"This year is shaping up to be the worst year on record for new home sales," [Patrick Newport, U.S. economist with IHS Global Insight] wrote in a note.

The Census Bureau started tracking New Home sales in 1963, and the record low was 412,000 in 1982 - until that record was broken in 2009 - and then again in 2010 - and it looks another new record in 2011.

Here is a table of the last ten years - remember that sales in 2009 and 2010 were boosted by the tax credit....(see chart)

3--Europe’s Banking Crisis Is No Longer a Liquidity Crisis, nor Is It a European Version of ‘Subprime’ – It’s a Sovereign Coordination Crisis, The Wilder View

Excerpt:..This is a crisis of fear of sovereign risk amid a breakdown of coordination – and with good reason.

My view is that it’s not about the banks, per se, it’s about the sovereigns that implicitly guarantee the banks. At this time, there’s no credible “lender of last resort”, like was the Treasury in the 2008 US banking crisis. There’s the ECB – but that’s not a long-term solution unless it’s done in concert with the governments.

According to the Global Financial Stability Report (GFSR Septmeber 2011, .pdf link here) sovereign risks to the banks are both explicit and implicit in nature:

(1) direct exposure to the sovereign via eroding market value of sovereign assets (we all know this data).

Just 12% of sovereign exposure is held on the trading book, the rest is available for sale (AFS), 49%, and held to maturity (HTM), 39% (see Box 1.3 of Chapter 1 in GFSR report). In the case of HTM, German banks, for example, that bought at par (€100) Greeek debt that is now worth €43 at market is being held on balance at €100. The crisis has spread to Italy and Spain, so the stock of assets that need to be written down is growing.
2) Interbank lending poses a risk (See chart to left, click to enlarge, and ECB for chart data ). In this manner, banks have indirect exposure to sovereign risk even if they have minimal explicit holdings. This is one reason that the average interbank rate (LIBOR) has been rising – banks don’t trust each other (see chart to left and click to enlarge).

(3) Margin calls rise as government bonds used as collateral see rating or potential rating downgrades. Likewise, banks face direct rating downgrade risk of the as asset quality erodes.

(4) Eroding implicit government guarantees on the liabilities side of bank balance sheets and ability to recapitalize writedowns on the asset side of bank balance sheets. This is big; and in my view, the driving force of bank risk at this time. As policy makers debate about what cannot be done, they’re missing a glowing opportunity to prevent a banking crisis (see Munchau’s article in the FT). Essentially, bond investors do not ‘believe’ that policy makers can individually address their own banks’ capital needs and imminent delevaraging (see my previous post on bank leverage) – a joint euro-wide effort is needed. Lack of credible coordination among the sovereigns has left banks wide open to speculative attack.

The pressure’s on. We’ll see if policy makers can understand what I see: this is not a liquidity crisis, this is a sovereign coordination crisis.

4--Misrepresenting the Recovery from the Great Depression, Uneasy Money

Excerpt: In today’s Wall Street Journal, Harold Cole and Lee Ohanian try to teach us some lessons from the Great Depression. According to Cole and Ohanian, those of us who believe that increasing aggregate demand had anything to do with recovery from the Great Depression are totally misguided.

[B]oosting aggregate demand did not end the Great Depression. After the initial stock-market crash of 1929 and subsequent economic plunge, recovery began in the summer of 1932, well before the New Deal. The Federal Reserve Board’s Index of Industrial Production rose nearly 50% between the Depression’s trough of July 1932 and June 1933. This was a period of significant deflation. Inflation began after June 1933, following the demise of the gold standard. Despite higher aggregate demand, industrial production was flat over the following year.

Though not wrong in every detail, the version of events offered by Cole and Ohanian is still a shocking distortion of what happened before FDR took office in March 1933. In particular, although Cole and Ohanian are correct that the trough of the Great Depression was reached in July 1932, when the Industrial Production Index stood at 3.67, rising to 4.15 in October, an increase of about 13%, they conveniently leave out the fact that there was a double dip; industrial production was flat in November and started falling in December, the Industrial Production Index dropping to 3.78 in March 1933, barely above its level the previous July. And their assertion that deflation continued during the recovery is even farther from the truth than their description of what happened to industrial production. When industrial production started to rise, the Producer Price Index (PPI) increased almost 1% three months in a row, July to September, the only monthly increases since July 1929. The PPI resumed its downward trend in October, falling about 9% from September 1932 t0 February 1933, at the same time that industrial production peaked and started falling again.

That is why most observers date the trough of the Great Depression in the US not in July 1932, but in March 1933 when FDR took office in the midst of a banking crisis that threatened to drive the US economy even deeper into deflation and depression than it had been in July 1932. So when Cole and Ohanian assert that recovery from the Great Depression started in July 1932, and go on to say that the recovery took place during a period of significant deflation, it is hard to avoid the conclusion that they are twisting the facts to suit their own ideological predilection.
The misrepresentation perpetrated by Cole and Ohanian only gets worse when they describe what happened during the period of true recovery, April through July 1933....

Another point overlooked by Cole and Ohanian, presumably because it doesn’t exactly fit the ideological message that they want to propagate, is that the timing of the recovery — immediately after the monetary stimulus resulting from suspension of the gold standard – shows that monetary policy can be effective with little or no fiscal stimulus. It is hard to see how any fiscal stimulus could have taken effect by April 1933 when the recovery had already begun. Moreover, Roosevelt campaigned as a fiscal conservative, so it would not be easy to argue that anticipated fiscal stimulus was being felt in advance of its actual implementation.
The real lesson the Great Depression is that monetary policy works — for good or ill.

5--Stimulus Tales, Paul Krugman, New York Times

Excerpt: Dean Baker is upset with David Brooks — not for the first time. Let me just put in a word here.

The story of Keynesian economists and the Obama stimulus, as anyone who’s been reading me knows, runs as follows: When information about the planned stimulus began emerging, those of us who took our macro seriously warned, often and strenuously, that it was far short of what was needed — that given what we already knew about the likely depth of the slump, the plan would fill only a fraction of the hole. Worse yet, I in particular argued, the plan would probably be seen as a failure, making another round impossible.

But never mind. What we keep hearing instead is a narrative that runs like this: “Keynesians said that the stimulus would solve the problems, then when it didn’t, instead of admitting they were wrong, they came back and said it wasn’t big enough. Heh heh heh.” That’s their story, and they’re sticking to it, never mind the facts.

And what the facts say is that Keynesian policy didn’t fail, because it wasn’t tried. The only real tests we’ve had of Keynesian economics were the prediction that large budget deficits in a depressed economy wouldn’t drive up interest rates, and the prediction that austerity in depressed economies would deepen their depression. How do you think that turned out?

6--Bring on the Euro TARP!, Pragmatic Capitalism

Excerpt: So it looks like we’re headed towards a Euro TARP. Rumors all day today make it sounds like they’re going to use something similar to the aggregator bank in the USA with a special purpose vehicle. What does it all mean? It means we’re essentially going to leverage up the current EFSF and broaden its influence. This will work in several ways. The two primary effects of this leveraged EFSF is the ability to provide increased funding for (austere) periphery budgets. In addition, it will likely offer some form of bank recapitalization by allowing banks to sell sovereign debt for SPV/EFSF debt (in essence, swapping toxic debt for AAA debt – sound familiar?). So, it’s a bank recapitalization plan AND an increase in the funding capacity of the EFSF. That’s actually a good start although it doesn’t ultimately close the loop on the crux of the problem.

This is really similar to the American bank bailout plan. It WILL solve the credit crisis. But it will not solve the underlying problem. In the USA, the underlying problem was a household debt crisis. We thought it was a banking crisis so we focused our efforts on the banks. We went on to fix the banks, but we never fixed the households. So, we still have a broken economy and a balance sheet recession. The issue in Europe is a bit more complex, but still very similar. Europe has an inherent imbalance due to a broken currency system. The lack of a balancing mechanism (fiscal transfer union or floating FX) results in the same sort of trade imbalances and sovereign debt crises that we used to see under the gold standard. This plan doesn’t appear to acknowledge this as the root cause of the problem. That’s highly disconcerting....

Will this sort of a plan work?

Well, it depends on who you ask. From the perspective of the core, it will work swimmingly. Their banks will get recapitalized and saved from the brink of disaster while they also impose austerity on the periphery....

So, it’s America 2.0. Fix the banks, give Main Street the middle finger and move along. Nothing to see here. The good news is that this plan might just buy them enough time to generate a sustainable fix. On October 17-18 the EU will discuss a potential move towards further fiscal union. This is ultimately the direction that Europe must head in if they are going to make the EMU work. If they can’t put together a sustainable fix then the current crisis will simply resurface at a later date as the inherent imbalances remain and continue to pressure these economies....

7--More on Obama's stimulus, Dean Baker, CEPR

Excerpt: ...Suppose Brooks ever took 10 minutes to read the Obama administration's projections for the stimulus. (It's on the web and can be downloaded for free, so a NYT columnist should have access to it.) The first item in the summary of Romer-Bernstein report would tell Brooks that:
"A package in the range that the President-Elect has discussed would create between 3-4 million jobs by the end of 2010."

Let look at that one again:

"A package in the range that the President-Elect has discussed would create between 3-4 million jobs by the end of 2010."

Okay, 3-4 million jobs from a "package in the range that the President-Elect has discussed."

How many jobs did the economy need? By April of 2009, when the first stimulus payments were going out the door, the economy had already lost more than 6.5 million jobs. If we add in normal job growth that we would have seen in a healthy economy, we were already down by more than 8.0 million jobs.

And the economy was still losing jobs at the rate of more than 400,000 jobs a month. By July, we down by almost 10 million jobs from what would have been expected if the economy had sustained a normal pace of job growth from the start of the recession. This is what Brooks would know if ever bothered to look at the numbers.

Now let's look at that quote one more time:

"A package in the range that the President-Elect has discussed would create between 3-4 million jobs by the end of 2010."

President Obama proposed a stimulus package of about $800 billion. He got a package of around $700 billion. (We have to pull out $80 billion for the Alternative Minimum Tax fix. No one, I mean no one, thinks that this fix, which is done every year, had anything to do with stimulus.)

Furthermore, the package was more heavily tilted toward tax cuts than the package that President Obama proposed. Tax cuts have less impact per dollar than spending. David Brooks could find this fact in the Romer-Bernstein paper as well. The appendix tells us that a tax cut equal to 1 percent of GDP will eventually increase GDP by 0.99 percent. By contrast, government spending equal to 1 percent of GDP will increase GDP by 1.57 percent of GDP.

If President Obama got a package that was smaller than what he requested and more tilted towards tax cuts than what he expected, then the impact on growth and jobs would be less than what he expected. He expected that the package he rquested would create 3-4 million jobs, the package he got would be expected to create something less than 3-4 million jobs. And, we know that the economy needed somewhere in the neighborhood of 10 million jobs.

So how is anything about stimulus disproved because a stimulus that could have been expected to create maybe 3 million jobs was not adequate in a downturn where we needed 10 million jobs? There are no tricks here, this is all arithmetic and it is all right there in black and white.

8--Premature euro rescue talk buoys markets, Reuters

Excerpt: Talk of beefing up the euro zone's bailout fund lifted stocks on Tuesday but complicated the debate in Germany where Angela Merkel is struggling to unite her coalition behind more modest steps to aid Europe's weak economies and banks.

European shares rose for a second day and safe-haven German bonds fell on reports that European policymakers were preparing decisive action to tackle the bloc's sovereign debt crisis by leveraging up the 440 billion euro rescue pot.

The cost of insuring Italian, Spanish and French debt against default also fell on hopes of a bold solution, which appear to have little grounding in immediate political reality.

German Finance Minister Wolfgang Schaeuble was forced to deny that any increase in the volume of the bailout fund is planned in a bid to calm irate lawmakers in the center-right coalition. Parliament holds a crucial vote on Thursday on July's EU agreement to extend the scope of the existing fund.

"We do not intend to increase it," Schaeuble told n-tv.

That did not directly address the question of whether the EFSF fund could be leveraged to raise more money to prevent contagion spreading from Greece to Italy and Spain, the euro zone's third and fourth economies.
Leverage would make it possible to borrow more for financial firefighting without increasing the EFSF's size, but critics say it would also raise German taxpayers' liability for any losses. Some lawmakers are concerned that EU officials are just waiting for them to approve what they were assured would be the final increase before pressing ahead with bigger bailout plans.

French Finance Minister Francois Baroin made clear there were tactical reasons to avoid discussing how to boost the fund's firepower before the German decision.

Asked at a dinner in Paris whether there was a need to boost the EFSF, he said: "It is out of the question to put forward, three days from the Bundestag (lower house) vote, the issue of whether we should increase the fund... Let's not open Pandora's box on something that is a red flag for Germany."...

The European Investment Bank, the 27-nation EU's soft-loan project finance arm, denied a U.S. television report that it might get involved in leveraged finance for euro zone bailouts, which diplomats said was legally impossible.

Credit ratings agency Standard & Poor's was quick to warn when talk of leveraging the EFSF became public last week that such a move could potentially trigger ratings downgrades for leading euro zone countries Germany and France....

"Nobody wants to talk about this before Thursday night," he said in a reference to the German parliament vote. "It cannot be discussed formally before the Bundestag (lower house) and maybe all other national parliaments have voted."

9--German turmoil over EU bail-outs as top judge calls for referendum, Telegraph

Excerpt: Germany's top judge has issued a blunt warning that no further fiscal powers may be surrendered to Europe without a new constitution and a popular referendum, vastly complicating plans to boost the EU's rescue machinery to €2 trillion (£1.7 trillion).

Andreas Vosskuhle, head of the constitutional court, said politicians do not have the legal authority to sign away the birthright of the German people without their explicit consent.

"The sovereignty of the German state is inviolate and anchored in perpetuity by basic law. It may not be abandoned by the legislature (even with its powers to amend the constitution)," he said.

"There is little leeway left for giving up core powers to the EU. If one wants to go beyond this limit – which might be politically legitimate and desirable – then Germany must give itself a new constitution. A referendum would be necessary. This cannot be done without the people," he told newspaper Frankfurter Allgemeine.

The extraordinary interview comes just days before the Bundestag votes on a bill to revamp the EU's €440bn bail-out fund (EFSF), enabling it to purchase EMU bonds pre-emptively and recapitalise banks....

Prince Hermann Otto zu Solms-Hohensolms-Lich, the Bundestag's deputy president and finance chief for the Free Democrats (FDP) in the ruling coalition, expressed outrage over the secret plans.

"Unless the German finance minister can give an immediate assurance that there will be no leveraged formula, I will not vote for this law. We might as well dispense with months of negotiations if all this means is that the Bundestag will be circumvented and served cold left-overs," he said

Tuesday, September 27, 2011

Today's links

1--Geithner Plan for Europe is last chance to avoid global catastrophe, Telegraph

Excerpt: ...the G20, and the global authorities have one last chance to contain the EMU debt crisis with a nuclear solution or abdicate responsibility and watch as the world slides into depression, endangering the benign but fragile order that has taken shape over the last three decades.

The International Monetary Fund warned last week that emerging markets face the risk of "sharp reversals" or even a "sudden stop" if there is further spill-over from Europe. This comes at a time when Asia and parts of Latin America are already in the topping phase of a credit boom, one of epic proportions in China where loans have doubled to almost 200pc of GDP over the last five years

Commercial banks that cannot raise money from Mid-East wealth funds will be seized by the state, partly or fully, or be recapitalized by the EFSF. This should leave them strong enough to absorb a 50pc default imposed on Greece, and potential knock-on defaults in Portugal and Ireland.

Or at least, that is the idea. We will see how the Bundestag reacts this week. It has not even voted on the July deal to boost the powers of the EFSF, itself a furiously contested plan that may provoke a 30-strong rebellion within Chancellor Angela Merkel's own coalition. German lawmakers now learn that implicit liabilities may be five times as big.

"We should not think of leveraging a public pot of funds as a free lunch," said

2--German Central Bank Opposed to Merkel's Euro Course, Der Speigel

Excerpt: Even the expanded European Financial Stability Fund (EFSF), whose new powers are expected to be ready to use by the middle of next month -- assuming that all the euro-zone parliaments ratify the reforms by then -- won't change things much. In short, the amounts of money that would be needed to help Italy would simply be too big for it.

"If the EFSF purchased €50 billion worth of Italian sovereign bonds, it would exhaust a good deal of its free resources without achieving anything on the markets," say Michael Heise, chief economist at the German insurance giant Allianz. This has led many central bankers to fear that European leaders will soon put pressure on the ECB to take renewed action.

US Treasury Secretary Timothy Geithner has already done just that. At the recent summit in Poland with his European counterparts, Geithner called for a banking license to be issued to the newly expanded bailout fund. The suggestion was also discussed at the meeting of the International Monetary Fund (IMF) and the World Bank held last week in Washington. Even Finance Minister Schäuble said he would think about the idea.

If this model were actually implemented, the EFSF could purchase significantly larger amounts of state debt and deposit them at the ECB as collateral in return for fresh money with which it could, in turn, purchase additional sovereign bonds.

Nightmarish Idea

But what Geithner and the Obama administration view as a particularly elegant solution to the euro crisis is a nightmarish idea to stability champions like Weidmann. Last week, he warned the German parliament's budget committee that "state financing through monetary policy" would become a permanent fixture if the solution were adopted.

3--Plan B: Flood the markets, The Telegraph

Excerpt: The Europeans, insiders claimed, were beginning to coalesce around a nascent plan.

The idea had three key elements – a bank recapitalisation, a bigger eurozone bail-out fund, and a possible Greek default. The goal was to put a firebreak around the single currency periphery to prevent contagion spreading across Europe to the core of Spain and Italy in particular. “A political solution is not insurmountable,” one source said.

According to insiders, a resolution package would be announced in one go and, until then, the public line would remain consistent – that Greece would not default and that the European Financial Stability Facility (the eurozone’s Eu440bn bail-out fund), would not be augmented beyond the terms agreed on July 21.

But hints of the plan were being dropped publicly. The G20 communique stated: “We will ensure that banks are adequately capitalised and have sufficient access to funding to deal with current risks.”

“Current risks” indicated something far beyond the recent European stress tests that called for 16 banks to find a little extra capital. It suggested many tens of billions of euros would be needed, not the paltry Eu2.5bn identified.

4--Euro Zone Death Trip, Paul Krugman, NY Times via Economist's View

Excerpt: Europe’s situation is really, really scary: with countries that account for a third of the euro area’s economy now under speculative attack, the single currency’s very existence is being threatened — and a euro collapse could inflict vast damage on the world.

On the other side, European policy makers seem set to deliver more of the same. They’ll probably find a way to provide more credit to countries in trouble, which may or may not stave off imminent disaster. But they don’t seem at all ready to acknowledge a crucial fact — namely, that without more expansionary fiscal and monetary policies in Europe’s stronger economies, all of their rescue attempts will fail.

The story so far: The introduction of the euro in 1999 led to a vast boom in lending to Europe’s peripheral economies, because investors believed (wrongly) that the shared currency made Greek or Spanish debt just as safe as German debt. ... But when the lending boom abruptly ended, the result was both an economic and a fiscal crisis. ...

So now what? Europe’s answer has been to demand harsh fiscal austerity,... meanwhile providing stopgap financing until private-investor confidence returns. Can this strategy work?

Not for Greece... Probably not for Ireland and Portugal... But given a favorable external environment — specifically, a strong overall European economy with moderate inflation — Spain ... and ... Italy ... could possibly pull it off.

Unfortunately, European policy makers seem determined to deny those debtors the environment they need. ... And I see no sign at all that European policy elites are ready to rethink their hard-money-and-austerity dogma.

5--Commodities Drop as Silver Slumps on Europe, Bloomberg

Excerpt: Commodities fell to their lowest in almost 10 months and silver tumbled below $28 for the first time since February on speculation Europe’s debt crisis will worsen, curbing raw-material demand. Copper plunged below $7,000 a ton for the first time in more than a year.

The Standard & Poor’s GSCI Spot Index shed 1.1 percent to 592.5 by 9:28 a.m. in London after slumping as much as 2.6 percent to the lowest since Dec. 1. The gauge slumped 8.3 percent last week, the worst performance since May. Cash silver plunged as much as 16.3 percent to its lowest level since November. Copper slumped as much as 7.6 percent, a seventh day of declines and the worst losing streak since December 2008.

European policy makers are facing mounting pressure to step up efforts to prevent their sovereign-debt crisis from further roiling the world’s financial markets and economy. Pacific Investment Management Co., which runs the world’s biggest bond fund, is forecasting that advanced economies will stall over the next year as Europe slides into a recession

6--Industrial metals prices point to global contraction, Pramatic Capitalism

Excerpt: The latest slide by industrial commodity prices suggests that, unlike QE2, Operation Twist 2 will not swell

inflation expectations. QE2 probably encouraged an overbidding for commodities that a number of buyers

now regret. The latest plunge by base metals prices starkly shows the impossibility of sustaining rapid price

inflation without the full participation of the labor market. If sluggish wages and diminished access to credit prevent consumers from “affording” higher prices, inventories ultimately will outrun sales by enough to

prompt price discounting.”

We’re seeing an incredible confluence of events here as the Fed appears powerless, the economic slow-down continues and the global credit crisis persists. The disequilibrium that the Fed helped induce is now coming out of the industrial metals complex and as I’ve discussed in detail, we have to consider the very real possibility that this disequilibrium will exacerbate the economic slow-down. The precious metals decline might capture most of the headlines here, but keep an eye on the industrial metals. The action there is far more telling of global economic trends and just how bad this downturn is likely to get.

7--The Wages of Bad Macroeconomics, Paul Krugman, NY Times

Excerpt: What you missed if you believed that the bond vigilantes were coming any day now, that rates would soar as soon as Bernanke ended QE2, and all that: Betting on Bernanke Returns 28% for Treasuries.

Betting on Ben S. Bernanke has been the most profitable trade for government bond investors in 16 years, defying lawmakers in the U.S. and abroad who said the Federal Reserve chairman’s policies would lead to runaway inflation and the dollar’s debasement.

Treasuries due in 10 or more years have returned 28 percent in 2011, exceeding the 24.4 percent gain in all of 2008 during worst financial crisis since the Great Depression, according to Bank of America Merrill Lynch indexes. Not since 1995, when the securities soared 30.7 percent, have investors done so well owning longer-dated U.S. government debt.

Tell me why business people pay attention to the WSJ editorial page?

8--Euro zone damps talk of rapid debt crisis steps, Reuters

Excerpt: Euro zone officials played down reports on Monday of emerging plans to halve Greece's debts and recapitalize European banks to cope with the fallout, stressing that no such scheme is yet on the table.

Europe came under fierce pressure from the United States and other major economies at weekend talks in Washington to take swift, decisive action to stop the Greek debt crisis engulfing bigger euro zone states and derailing world economic recovery.

But officials said media reports that planning was already in place for a 50 percent writedown in Greek debt and a vast increase in the euro zone rescue fund, the EFSF, were highly premature.

"There is no change to the framework we are working on," said a euro zone official who is involved in decision-making on financial assistance to Greece, Ireland and Portugal.

"All this talk of a specific haircut for Greece or an enlargement of the EFSF, it is all just speculation. We are not working along those lines," said the official.

9--Report: Six Week deadline to Prepare New European Plan, Calculated Risk

Excerpt: From the Telegraph: Multi-trillion plan to save the eurozone being prepared

German and French authorities have begun work on a three-pronged strategy behind the scenes amid escalating fears that the eurozone’s sovereign debt crisis is spiralling out of control.

According to sources, progress has been made at the G20 meeting in Washington ... the world’s leading economies set themselves a six-week deadline to resolve the crisis – to unveil a solution by the G20 summit in Cannes on November 4.

First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. ... Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) ...

The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target.

The complex deal would see the EFSF provide a loss-bearing “equity” tranche of any bail-out fund and the ECB the rest in protected “debt”.


Monday, September 26, 2011

Today's links

PLEDGE DRIVE: If you can afford to support this website, please give what you can. Thanks, Mike

1--The longer we delay, the worse it will be for peripheral Europe, Credit Writedowns

Excerpt: Slow growth is embedding itself solidly into the US economy and the bond mayhem in Europe continues. The external environment for China is getting worse. This will almost certainly make China’s adjustment – when Beijing finally gets serious about it – all the more difficult. With still weak domestic consumption growth, and little chance of this changing any time soon, weaker foreign demand for Chinese exports will cause greater reliance than ever on investment growth to generate GDP growth.

Europe’s travails in particular can’t be good for exports. What’s worse, it’s now pretty much official that the euro will fail soon enough...

As I see it, we cannot continue with the existing currency arrangement. Countries like Spain (I am reverting to my habit of calling all the deficit countries “Spain” and all the surplus countries “Germany”) simply will not adjust quickly enough as long as they maintain the euro, and we are going to watch their economies contract and their debts grow until finally the electorate has had enough and forces a radical change in strategy.

Much if not most of peripheral Europe will then leave the euro and default, and Germany will have to eat the losses on its outstanding (and growing) loans. But why wait? The longer we put off the reckoning the worse it will be for peripheral Europe and the greater the losses that Germany will have to swallow. So shouldn’t Germany simply force Spain to leave the euro now?

2--Art Cashin: Eye of the storm, Wall Street Journal

Excerpt: The classic Thursday/Monday syndrome starts with the kind of action we saw yesterday. The markets open under pressure and selling accelerates in swelling volume. By early afternoon, there is a virtual stampede of selling. Then, later in the session, stocks stabilize a bit based on some reassurance…

The action on Friday (and Saturday in the case of 1929) is uneven, often ending choppily steady or somewhat weaker.

Then on Monday, the trapdoor opens with liquidation and margin calls bringing tsunamis of selling.

Is that what’s going to happen? Who knows? If it were that easy, kindergarten kids could do this. But chance favors the prepared mind. Old fogeys will guard against undue risk and exposure. Some may even get out a special shopping list…

Not infrequently, the Monday massacre spills over into Tuesday morning – a capitulation bottom in mid-morning resulting in a massive reversal to the upside.

Will this follow the pattern? It’s always a long shot, but we thought you should at least know the history of the pattern. Grace under pressure, Grasshopper. Grace under pressure.

3--Did EU just unleash the bazooka, Pragmatic Capitalism

Excerpt: “German and French authorities have begun work on a three-pronged strategy behind the scenes amid escalating fears that the eurozone’s sovereign debt crisis is spiralling out of control.

…First, Europe’s banks would have to be recapitalised with many tens of billions of euros to reassure markets that a Greek or Portuguese default would not precipitate a systemic financial crisis. The recapitalisation plan would go much further than the €2.5bn (£2.2bn) required by regulators following the European bank stress tests in July and crucially would include the under-pressure French lenders.

Officials are confident that some banks could raise the funds privately, but if they are unable they would either be recapitalised by the state or by the European Financial Stability Facility (EFSF) – the eurozone’s €440bn bail-out scheme.

The second leg of the plan is to bolster the EFSF. Economists have estimated it would need about Eu2 trillion of firepower to meet Italy and Spain’s financing needs in the event that the two countries were shut out of the markets. Officials are working on a way to leverage the EFSF through the European Central Bank to reach the target.

4--Credit Update: Emerging market contagion, Pragmatic Capitalism

Excerpt: China’s Squeeze on Property Market Nearing ‘Tipping Point’ – Bloomberg – 23rd of September:

“The squeeze on China’s property market may be reaching a “tipping point” that drives growth lower just when exports are under threat from a global slowdown and investor confidence is plunging, said Zhang Zhiwei, Hong Kong-based chief China economist at Nomura Holdings Inc.

Land transactions in 133 cities tracked by Soufun Holdings Ltd., the country’s biggest real-estate website, fell 14 percent by area in August from a month earlier. Prices of new homes declined in 16 of 70 cities last month compared with July, according to government data.”

Pop goes the real estate bubble in China, from the same article:

“Property construction is a mainstay of investment that last year drove more than a half of economic growth while land sales contributed 40 percent of revenues earned by local authorities that have amassed 10.7 trillion yuan ($1.67 trillion) of debt.

A funding squeeze on developers risks a “domino effect” as companies needing cash cut prices, forcing others to follow, Credit Suisse Group AG said yesterday.

“We’re reaching a tipping point where land sales are dropping much faster than before, developers are losing more access to bank financing, and housing prices are showing weakness,” Nomura’s Zhang said in an interview in Beijing yesterday.”

And Bloomberg to add:

“The price of land in Beijing slumped 76 percent in August from a month earlier, while in Guangzhou it plummeted 53 percent, according to Soufun. Land auction failures surged 242 percent in the first seven months of this year because of government curbs on the property market, the Beijing Times reported Aug. 3.”

A Chinese Subprime crisis in the making?

“Some developers have turned to trust firms for financing, usually in the form of loans that are repackaged into investment products and sold to retail investors. The debt is typically funded by banks or investors themselves, according to Samsung Securities Asia Ltd.”...

“The equity market finally realized what the credit market was” flashing” for a while… and reacted accordingly. But the race to catch back with the credit market has still a long way to go…and the path may not be a straight line. Bottom line, equities will go lower as the new “norm” of slow economy worldwide will be accepted…

Which means lower prices for commodities (goodbye Canadian dollar and Australian dollar carry trade), higher US dollar (a higher US dollar and slower growth will be the poison pill for the international US corporations)…”

No more safe havens, even in Switzerland, as the country now flirts with deflation, Japanese style...” ‘No more risk free assets’ may result in a big re-pricing of all asset classes.

When there is too much debt in a system and when everybody is reluctant to erase the debt, the only solution is to deflate the value of the debt and the capital in order to bring them in line with the value of the assets or collateral… The trend will be “to deflate”, because we are in “deflation” … even if nobody wants to hear it.”

5--The main problem with the eurozone is...?, Pragmatic Capitalism

Excerpt: The ESM, like the EFSF is fatally flawed as it doesn’t resolve the inherent flaw in the currency union. The ESM is a reactive fix to problems and not the proactive fix that the Euro needs. For instance, in the USA, the states are given an allotted disbursement from the Federal government each year. This helps fill any budget gaps that might be caused by a state’s funding deficiencies. And the USA does this every single year and even at times when Congress decides it to be appropriate.

It’s a proactive measure. A way of saying – “bring it on bond vigilantes because we are a union of 50 strong and if you try to bring one of us down we will unleash the wrath of the other 49 on you via fiscal disbursement!”. The vigilantes understand this message and they stay in their corners like good dogs should. Like it or not, Europe needs the same sort of mechanism. I am not sure how they’ll finally come up with it, but it’s the endgame here….

6--Romer: A Plan on Jobs Deserves a Hearing, Christina Romer, Commentary, NY Times via Economist's View

Excerpt: ... People are concerned about the deficit, and this concern is holding back the recovery. Fiscal austerity, not more stimulus, is the answer.

This argument makes me crazy. There’s simply no evidence that concern about the current deficit is a significant factor limiting consumer spending or business investment. And government borrowing rates are at record lows, suggesting that financial markets are not worried about the deficit, either.

Moreover, as I discussed in a previous column, the best evidence shows that fiscal austerity depresses growth and raises unemployment in the near term. That’s the experience of countries like Greece, Portugal and Britain... Cut the current deficit and you will raise unemployment, not lower it.

Like many other countries, the United States has two terrible problems: a devastating lack of jobs right now and an unsustainable budget deficit over the longer run. The right question is not whether we can reduce unemployment by lowering the deficit (we can’t), but whether we can make progress on both problems.

With 14 million Americans unemployed and no prospect of rapid recovery on the horizon, we really have no choice: we must take additional measures to create jobs. ... Just as important, policy makers should be discussing how to make meaningful progress on the long-run deficit at the same time. We need a credible plan that phases in aggressive deficit reduction as the economy recovers.

The president has started a discussion about job creation. His proposal deserves a full debate based on facts, evidence and careful analysis.

7--America and Europe: Saving the Rich and Losing the Economy, Paul Craig Roberts, Global Research

Excerpt: Economic policy in the United States and Europe has failed, and people are suffering.

Economic policy failed for three reasons: (1) policymakers focused on enabling offshoring corporations to move middle class jobs, and the consumer demand, tax base, GDP, and careers associated with the jobs, to foreign countries, such as China and India, where labor is inexpensive;

(2) policymakers permitted financial deregulation that unleashed fraud and debt leverage on a scale previously unimaginable; (3) policymakers responded to the resulting financial crisis by imposing austerity on the population and running the printing press in order to bail out banks and prevent any losses to the banks regardless of the cost to national economies and innocent parties.

Jobs offshoring was made possible because the collapse of the Soviet Union resulted in China and India opening their vast excess supplies of labor to Western exploitation. Pressed by Wall Street for higher profits, US corporations relocated their factories abroad. Foreign labor working with Western capital, technology, and business know-how is just as productive as US labor. However, the excess supplies of labor (and lower living standards) mean that Indian and Chinese labor can be hired for less than labor’s contribution to the value of output. The difference flows into profits, resulting in capital gains for shareholders and performance bonuses for executives.

As reported by Manufacturing and Technology News (September 20, 2011) the Quarterly Census of Employment and Wages reports that in the last 10 years, the US lost 54,621 factories, and manufacturing employment fell by 5 million employees. Over the decade, the number of larger factories (those employing 1,000 or more employees) declined by 40 percent. US factories employing 500-1,000 workers declined by 44 percent; those employing between 250-500 workers declined by 37 percent, and those employing between 100-250 workers shrunk by 30 percent.

8--Banks Splinter on Europe Debt Crisis, Bloomberg

Excerpt: Wall Street leaders, urging coordinated action from world governments to solve the European sovereign-debt crisis, struggled themselves during four days of meetings in Washington to agree on what’s needed to end it.

The chiefs of firms including JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK) and Societe Generale (GLE) SA met for three hours at the National Archives on Sept. 23. They differed on which government and private solutions may restore confidence in European debt and banks, and on some elements of regulation, said two participants who spoke on condition of anonymity because the meeting wasn’t public.

“It was a big group there, they’re going to differ about stuff; there’s a lot of tension in the air because of the world we live in,” Morgan Stanley (MS) Chief Executive Officer James Gorman, 53, said as he left the event, which coincided with weekend meetings of the International Monetary Fund and Institute of International Finance. “There’s no one solution. It’s going to be 25 different things.”

Bank-stock indexes in Europe and the U.S. have dropped more than 30 percent this year and borrowing costs for European lenders have climbed amid concern that Greece and other European countries may default. The level of disagreement between bankers and government officials who gathered for the annual IMF meeting was matched only by their shared sense that the stakes have rarely been higher....

Compares With 1930s

Yet in private discussions, bankers said the environment was exceptional. A senior European banker said he sees policy makers’ decisions as being as momentous as those in the 1930s. A senior U.S. bank executive said he’s more worried than he was at any point during the financial crisis of 2008 and 2009.

9--Maritime firms to struggle with credit squeeze, Reuters

Excerpt: With fears of a recession rising, the maritime industry will find it increasingly difficult to obtain financing for expansion over the next year, with the exception of the offshore-energy sector, industry experts said.

The economic gloom in Europe and the United States has amplified the pain for shipping companies, already struggling with rock-bottom freight rates and a glut of new vessels that were ordered when times were good.

The International Monetary Fund last week warned that the West could slip back into recession next year unless they quickly tackled economic problems that could infect the rest of the world.

"Given the underlying economics of oversupply and current day (freight) rates, the banks are far more cautious," said Gervais Green, head of Asia shipping with law firm Norton Rose.

Friday, September 23, 2011

Weekend links

1--US banks hit by Fed and funding fears, Financial Times

Excerpt:US bank stocks were pummelled on Thursday by a grim combination of European contagion fears and doubts over future profitability after the Federal Reserve’s “twist” of the yield curve and concern that some groups may fall to a loss in the third quarter.

Goldman Sachs will fall to the second loss in its history as a public company, Barclays Capital predicted; Morgan Stanley was plagued with rumours about exposure to ailing French banks; and Bank of America and Citigroup hit new 12-month lows....

“Options investors are now clamouring out for protection against an adverse event amid funding fears on both sides of the Atlantic,” said Andrew Wilkinson, chief economic strategist at Miller Tabak.

A hedge fund analyst said the banks looked “overdumped” but the market volatility was scaring off potential buyers of US bank stocks, while European banks could be hit further if their US liquidity providers felt stigmatised by lending to them.

2--European bank recap recap, FT Alphaville

Excerpt: We’ll resist any further “spillover” jokes as we pass along the main points from this earlier article by our colleagues in Europe, which for mysterious reasons appears to have prevented today’s selloff from being worse:

European officials look set to speed up plans to recapitalise the 16 banks that came close to failing last summer’s pan-EU stress tests as part of a co-ordinated effort to reassure the markets about the strength of the 27-nation bloc’s banking sector.

A senior French official said the 16 banks regarded to be close to the threshold would now have to seek new funds immediately. Although there has been widespread speculation that French banks are seeking more capital, none is on the list....

The article notes that if private sources of funds are unavailable, then some governments (reportedly including the French) favour allowing the EFSF to inject capital into the banks. Other governments are less keen on the idea and want the individual nations to invest themselves. So there’s some fractiousness over the issue — shocking.

Anyways, we’re not really sure how meaningful this is. The scale of the recapitalisation being described seems tiny in comparison to what the IMF wants (which the ECB and eurozone economies find excessive).

3--UPDATE 1-Overnight borrowing from ECB plunges, Reuters

Excerpt: Emergency borrowing from the European Central Bank plunged overnight, data showed on Thursday, after the central bank handed out funds in its weekly refinancing operation, easing fears that any particular bank was in trouble.

Commercial banks took 179 million euros ($245 mln) of overnight funds from the ECB, the lowest since Sept. 12 and following a three-day period when borrowing topped 1 billion euros.

Banks have to pay 2.25 percent for the money as opposed to 1.5 percent for regular ECB liquidity and 1.061 percent for overnight funds on the open market , so use of the facility is often seen as a sign of stress.
Traders said the spike and subsequent fall was likely due to one bank tapping the facility.

"You can assume it was one bank for 1 billion, but no one can prove it," said a euro zone money market trader.

4--Euribor-OIS Spread Measure Rises to Highest Since March 2009, Bloomberg

Excerpt: A measure of banks’ reluctance to lend to one another in Europe rose to the highest in 2 1/2 years after the Federal Reserve signalled “significant downside risks” to the U.S. economy.

The Euribor-OIS spread, the difference between the three- month euro interbank offered rate and overnight index swaps, climbed to 85 basis points as of 3:45 p.m. in London, the highest since March 2009, Bloomberg data show. The gauge was at 82.6 yesterday.

The Federal Open Market Committee gave its judgement on the economy as it announced measures aimed at preventing the U.S. from sliding into another recession. Standard & Poor’s cut ratings or lowered the outlooks on Italian banks including UniCredit SpA (UCG) yesterday after the government’s credit was downgraded for the first time in five years this week.

Europe’s “crisis remains at an elevated level, and the tone coming from the Fed heightens the macro risks which make resolution of debt dynamics very difficult,” Padhraic Garvey, head of developed debt-market strategy at ING Groep NV in Amsterdam, wrote in a note. “There is no sense that market sentiment has latched on to a more positive tack,” he wrote.
European banks have the highest dollar funding costs in almost three years, according to one indicator....

The three-month dollar London interbank offered rate, or Libor, rose for a 10th day, to 0.35806 percent from 0.35556 percent, according to the British Bankers’ Association. That’s the highest since Aug. 16, 2010.

TED Spread

The TED spread, the difference between what lenders and the U.S. government pay to borrow for three months, rose to 36 basis points, the highest since July 20, 2010, from 35 basis points.

The ECB said financial institutions increased overnight deposits. Banks parked 121.4 billion euros ($157 billion) with the Frankfurt-based lender yesterday, compared with 114.7 billion euros on Sept. 20 and 197.8 billion euros on Sept. 12, the ECB said.

5--Europe Officials Weigh Forming Crisis ‘Firewall’, Bloomberg

Excerpt: European officials said governments may leverage the region’s bailout program to erect a “firewall” around the sovereign debt crisis once a revamp of the fund is completed.

“To stabilize the euro zone, we need the right firewall to prevent contagion,” French Finance Minister Francois Baroin told reporters today in Washington before meeting his Group of 20 counterparts. The firewall is the European Financial Stability Facility, and “we can discuss how to give it the necessary strength, about using the power of leverage to give it systemic force,” he said.

European parliaments are now focused on approving a July plan to expand the remit of the 440-billion euro ($593 billion) EFSF to allow it to buy the debt of stressed euro-area governments, aid troubled banks and offer credit lines. Its current role is to sell bonds to fund rescue loans for cash- strapped governments....

‘Stronger Impact’

“It is very important that we look at the possibility of leveraging the EFSF resources and funding to have a stronger impact and make it more effective,” European Union Monetary Affairs Commissioner Olli Rehn said in Washington today. He said the enhanced facility will be “up and running” in the second half of October.

The use of leverage is similar to the Federal Reserve’s Term Asset-Backed-Securities Loan Facility, or TALF, set up in 2008 after the failure of Lehman Brothers Holdings Inc. Under that program, the New York Fed offered loans to firms that held eligible collateral. Under the terms of the program, if borrowers didn’t repay the loan, the Fed would sell the collateral to a special-purpose entity, and the Treasury Department would be first in line to absorb any resulting losses.

6--Bernanke chooses deflation, macrobusiness

Excerpt: So, down we go. The last impediment to lower … well … everything (except the $US) has been removed. There’s no QE3. Markets didn’t muck around. Everything risk and $US sensitive took an instant pounding and the $US jumped. The equity market got smashed into the close and is signaling more to come....

As I’ve argued before, at the zero bound, where the only price signal is the signal of policy-maker intentions to deflate or inflate the system, you can’t feed a market rich desserts with thick topping then offer them a dry donut and still expect the system to inflate. Only a bigger dessert with more topping will serve.

I see no reason why both stocks and commodities shouldn’t revert to the prices we saw pre-QE2, roughly 20%+ down for commodities and maybe 15% on the S&P. And that’s before we factor in any recession....
The deflation in commodity markets (especially oil) should also work to boost demand.

So, we now have a struggle set up between deflation in global market pricing and (assuming it works) inflation of lending targeted at demand. There’ll be some new equilibrium struck between these two.

In theory this looks OK, but the fly in the ointment for me is the $US. With Europe burning and the Fed being seen to be backing off debasement of its currency, the $US must rise. That will slowly choke off the US export recovery and, making matter worse, will exaggerate the downswings in equities and commodities.

The new equilibrium we are about to find is lower.

7--Soros: "We are in a double dip recession", Pragmatic Capitalism

Excerpt: (Video)In an interview with CNBC yesterday Soros made some blunt comments:

--The USA is already in a double dip recession.
--The USA needs more fiscal stimulus.
--Europe could experience TWO or THREE periphery defaults. They would most likely remain in the EMU and default would be controlled. Uncontrolled default could result in defection.
The Euro currency should remain fairly strong even in the case of defaults.
--The European leaders are way behind the curve here.
--A form of a central Treasury is required in Europe
--This is a “more dangerous” situation than Lehman Bros.
--The EMU will do what it takes to hold it all together.

8--The biggest bubble of all time, Pragmatic Capitalism

Excerpt: From 2004 to 2008 we experienced the biggest commodities bubble the world had ever seen. If you looked to the top 25 traded commodities, you found prices had doubled over the period....

what is more surprising is that over the past decade, the price rises you find for these 33 commodities are just about beyond the realm of possibility—2, 3, and 4 standard deviations away from trend. It is a boom without any precedent. Quite simply, nothing even close has ever happened before, in any market, including hi tech bubbles and real estate bubbles.

By now you’ve all read about black swans with fat tails—a reference to supposedly “unexpected” and highly improbable default rates on subprime mortgages and other toxic waste assets. (Way out the normal distribution’s “tail”.) As an insider quipped, you had once in 100,000 year events happening every day. But that is misleading. These were junk assets that from the get-go had nearly 100% probabilities of default—NINJA loans and so on. The models were flawed, indeed, fraudulent. That was all a scam. Those weren’t black swans with fat tails—they were Hindenburg blimps filled with explosive hydrogen just waiting for someone to light a cigarette....

remember, we are in the worst global slowdown since the 1930s. I will not go through all the data, but demand for most commodities is actually slumping. For many there is substantial excess supply. And China wants to slow. China is still largely a socialist society. China basically does what it wants to do. China will slow.

And yet the prices rise far beyond anything that has ever happened before. Beyond anything that can happen.

Why? Financialization. Just as homes became financialized (in many ways, including serving as the collateral for “ATM” cash-out home equity loans), commodities became thoroughly financialized. (So did healthcare and death, with peasant insurance and death settlements—topics for another day.)...

Now, to be sure, the whole thing is going to blow up, in what Frank Veneroso calls a commodities nuclear winter. As prices rise, consumption of the commodities falls (as we are already observing) both through substitution and through conservation. At the same time, additional supplies come on line. Real world suppliers feel the imperative to slash prices to have some actual real world sales. They cannot forever live in never-never land with rising prices and collapsing sales.

There are many shoes that will drop, bringing back the Global Financial Crisis with a vengeance. Commodities crash, default by a Euro periphery nation, failure of a Euro bank, or the closure of Bank of America or Citi. All of these are likely events, less than one standard deviation from the mean; probably all of them will happen within the next year.

No matter what the triggering event is, that commodities nuclear winter will happen.


9--Misunderstanding the effects of QE2 was a grave mistake, Pragmatic Capitalism

Excerpt: .... there is the potential for a very frightening market development in the coming years (work with me through this hypothetical). Let’s say the Bernanke Put continues to cause asset prices to deviate from their fundamentals – the economy continues to recover (marginally), but the Bernanke Put becomes so ingrained in market perception that the disequilibrium in markets expands. This results in an imbalance so severe that market bubbles appear (could already be occurring in the commodity space). What happens to the market if the disequilibrium Ben Bernanke causes results in some sort of serious market dislocation similar to 2000 or 2008? All it would take is a minor exogenous threat to cause a global panic. It could be surging oil, a slow-down in China, a repeat of the Euro scares….The result would not only be economic slow-down (into an already weak developed market), but potentially crashing asset prices as bubbles have a tendency to overshoot on the downside. But it’s not the recession that would scare the markets. It is the potential backlash against the Fed.

After three bubble implosions in less than 15 years (all somehow directly tied to Fed intervention), I think the public would call on Congress to revisit the Fed’s dual mandate, its impact on markets and whether their actions over the last 20 years have been appropriate. The rational response would be to reduce the Fed’s role in markets. From a societal perspective I think this is an enormous long-term positive. The sooner we get the Fed out of the market manipulation game the sooner this economy can stabilize, definancialize and get back to becoming the economic growth machine that it has been for so long. For the markets, however, this would be a traumatic event. Imagine 20 years of Greenspan/Bernanke Put being sucked out of the market…it might sound far fetched right now, but I have a feeling the Fed will be far less involved in markets at some point in my lifetime. It might be wishful thinking, but I am confident that America will wise up to the destruction this institution causes by constantly distorting our markets and economy.”

Now, I think it’s a bit hyperbolic to say that the markets have lost faith in the Fed entirely, but I think we’re certainly seeing the market lose some faith in the Fed’s omnipotence. 20 years of flawed monetary policy, mythical thinking about the workings of our monetary system and misguided market intervention bring us to this point. Unfortunately, misguided policy has now created such disequilibrium in the markets that the backlash has the very real potential to cause real economic declines.

So buckle up folks. We’re living in a golden age of economic transformation and theory. Unfortunately, that means we have to erase the decades of myth and fantasy perpetuated by the same neoclassical economists who got us into this mess in the first place (most of whom are still driving this bus). And that’s going to cause a great deal of policy error, misconception and uncertainty. Hopefully in the end we’ll come out of this a bit wiser. One can hope….

10--What Profit Hath A Man Of All His Labor?, Paul Krugman, New York Times

Excerpt: I’m in a weird mood as the markets tumble. It will pass, but right now I feel like the preacher in Ecclesiastes, wondering about the point of it all.

Here’s the point: back around 1998 I was among those who looked at the crisis in Asia and realized what it implied — namely, that the problems that caused the Great Depression had not been solved, and that it could happen again. The speculative attacks on smaller nations, the liquidity trap in Japan, were omens for all of us. In 1999 I wrote a book, The Return of Depression Economics, saying all that.

When the 2008 crisis struck, it was immediately clear that this was what we had been afraid of. And it was desperately important that policy makers realize that we were in a world where the usual rules no longer applied.
But they didn’t. The banks were rescued — but as soon as that happened, the moralizers and deficit worriers, the people who see hyperinflation lurking under every bed, took over. Warnings that we were repeating not just the mistakes of Japan but the mistakes of Hoover and Bruening were waved away as the squeaking of people of no consequence, never mind the fact that some of us had pretty fancy credentials.

And now we are exactly where I feared we’d be, repeating all the old mistakes and experiencing all the old consequences.

As I said, I’ll get over it. But grant me a moment to look on the past three years, and despair.

11--One Point Seven Seven, Paul Krugman, New York Times

Excerpt: That’s the current interest rate on 10-year US bonds.

Remember, back in 2009 there was a big debate between people like me, who said that we were in a liquidity trap and that interest rates would stay low as long as the economy was depressed, and people like the WSJ editorial page and Niall Ferguson, who said that government borrowing would bring on the bond vigilantes and send rates soaring.
How’s it going?

And just to be clear: this isn’t just about I-told-you-so. We’re talking about different models, different visions of how the economy works. Their vision led to calls for austerity now now now; mine said that the overwhelming danger was that we wouldn’t provide enough stimulus, and that we would pull back too soon. Sure enough, we didn’t and we did. And now catastrophe looms.

12--ECB Ready to Act Next Month If Outlook Worsens, Bloomberg

Excerpt: EFSF Firepower

That has fanned speculation Europe may eventually ratchet up the fund’s spending power, perhaps by using the bonds it sells as collateral to borrow more cash from the ECB. Another proposal is to mimic a U.S. program established following the 2008 collapse of Lehman Brothers Holdings Inc. by allowing the fund to offer the ECB credit protection for buying more sovereign bonds.

“It is very important that we look at the possibility of leveraging the EFSF resources and funding to have a stronger impact and make it more effective,” EU Monetary Affairs Commissioner Olli Rehn said in Washington yesterday. French Finance Minister Francois Baroin said separately that policy makers “need the right firewall to prevent contagion” and can discuss giving the fund “the necessary strength.”

Germany’s Weidmann has said he opposes turning the EFSF into a bank that can refinance itself at the ECB as it would amount to “monetizing state debt.” Coene also said he’s “not sure that will be a good idea.”

13--What Really Caused the Eurozone Crisis?, The Streetlight Blog

Excerpt: suppose that the adoption of the euro suddenly made it more attractive for investors in the rest of Europe to buy assets in the periphery. This could have caused a large, exuberant capital flow from Europe's core to periphery, much like NAFTA helped to spark a surge in capital flows from the US to Mexico in the early 1990s. In theory, that's a good thing, and should help the process of economic convergence. But we know that such "capital flow bonanzas" (so named by Reinhart and Reinhart) are notoriously susceptible to changes in investor attitudes, and can come to an abrupt halt. These sudden stops in capital flows, as they are referred to in the literature, typically trigger a financial crisis. (See this paper by Calvo, Izquierdo, and Mejia for much more about sudden stops.) As noted by Rudi Dornbusch in the context of the Mexico crisis of 1994, it's not speed that kills; it's the sudden stop.

Crucially, sudden stops may happen even when a country is following all the right macroeconomic policies. As a result, financial crisis may be largely outside the control of a country that's on the receiving end of a capital flow bonanza. Mexico in 1994 is a good example of that, I think. And it could be that some of the peripheral EZ countries also fit this characterization. If so, then it's not appropriate to lay the blame for the crisis entirely at the doorstep of the peripheral EZ's governments; while they may have done some things that contributed to the crisis, the odds were significantly stacked against them to begin with....

The factor that crisis countries have in common is that, without exception, they ran the largest current account deficits in the EZ during the period 2000-2007. The relationship between budget deficits and crisis is much weaker; some of the crisis countries had significant average surpluses during the years leading up to the crisis, while some of the EZ countries with large fiscal deficits did not experience crisis. This is one piece of evidence that a surge in capital flows, not budget deficits, may have been what laid the groundwork for the crisis....

It’s useful to reevaluate the macroeconomic history of peripheral Europe in light of this interpretation. Rather than large current account deficits being the result of fiscal mismanagement or excessive consumption, the current account deficits were the necessary and unavoidable counterpart to the surge in capital flows from the EZ core. Rather than above-average inflation rates and deteriorating competitiveness being signs of labor market inefficiencies or lax fiscal policies in the peripheral countries, appreciating real exchange rates were inevitable as the mechanism by which those current account deficits were effected.

The eurozone debt crisis is big enough that there's plenty of blame to go around, and some of it certainly should go to the crisis countries themselves. But it must also be recognized that as soon as those countries adopted the euro, powerful forces were set in motion that made a financial crisis likely, and very possibly unavoidable, no matter what the governments of the peripheral euro countries did. Irresponsible behavior by the periphery countries did not set the stage for the eurozone crisis; the common currency itself did.