Wednesday, September 7, 2011

Today's links

1--Europeans Talk of Sharp Change in Fiscal Affairs, New York Times

Excerpt: As leaders in Europe try to contain a deepening financial crisis, they are also increasingly talking about making fundamental changes to the way their 17-nation economic union works....The idea is to create a central financial authority — with powers in areas like taxation, bond issuance and budget approval — that could eventually turn the euro zone into something resembling a United States of Europe....

“If they had the equivalent of the U.S. Treasury, then this treasury could have formulated proposals with the collective objective in mind, rather than 17 national objectives competing with each other,” said Garry J. Schinasi, a former official with the International Monetary Fund who now privately advises European central banks and governments. “Instead, they fumbled around and took two baby steps forward and three backward.”

The idea of a European Treasury that would enforce fiscal discipline on wayward countries, while also having the power to spread European Union wealth from healthier countries to ones struggling to pay their debts, is fiercely unpopular among voters in many countries. Those in prosperous nations like Germany do not want to see their taxes used to bail out countries that borrowed their way into trouble. And those in weaker nations are reluctant to allow outsiders to dictate how their governments spend their money and tax their citizens.

Europe’s currency union has its roots in the agreement signed in 1992 known as the Maastricht Treaty, which set in motion the rules for creating the euro and for joining the euro zone. A later agreement established the European Central Bank, which manages interest rates much like the United States Federal Reserve.

2--In Euro Zone, Banking Fear Feeds on Itself, New York Times

Excerpt: As Europe struggles to contain its government debt crisis, the greatest fear is that one of the Continent’s major banks may fail, setting off a financial panic like the one sparked by Lehman’s bankruptcy in September 2008.

European policy makers, determined to avoid such a catastrophe, are prepared to use hundreds of billions of euros of bailout money to prevent any major bank from failing.

But questions continue to mount about the ability of Europe’s banks to ride out the crisis, as some are having a harder time securing loans needed for daily operations....

“This crisis has the potential to be a lot worse than Lehman Brothers,” said George Soros, the hedge fund investor, citing the lack of an authoritative pan-European body to handle a banking crisis of this severity. “That is why the problem is so serious. You need a crisis to create the political will for Europe to create such an authority, but there is still no understanding as to what the authority will do.”

The growing nervousness was reflected in financial markets Tuesday, with stocks in the United States and Europe falling 1 percent and European bank stocks falling 5 percent or more after steep drops in recent weeks.

European bank shares are now at their lowest point since March 2009, when the global banking system was still shaky following Lehman’s collapse.

3--Roubini: Slowdown Brings Forward New Financial Crisis, Bloomberg

Excerpt: Nouriel Roubini, co-founder and chairman of Roubini Global Economics LLC, said the current slowdown in the world economy has brought forward the timing of a new financial crisis.

“I thought a few months ago that the perfect storm would be 2013,” Roubini said in an interview in London today. “But now, the economic weakness in the U.S., euro zone and the U.K. is front loaded. So we’re going to double dip earlier. The climax of it could be 2013, or it could be already earlier. It depends on what policy tools are available.”...

“You need to restore economic growth, not five years from now, you need to restore it today,” Roubini said. “In the short term, we need to do massive stimulus, otherwise there’s going to be another Great Depression. Things are getting worse and the big difference between now and a few years ago is that this time around we’re running out of policy bullets.”

4--Bailout Rebellion In Germany, Zero Hedge

Excerpt: We're on the way to a worldwide financial dictatorship governed by bankers," said Peter Gauweiler, German Bundestags Representative (CSU), in an interview published Monday in the Welt Online. "We don't support Greece," he said. "We support 25 or 30 worldwide investment banks and their insane activities."

Successful lawyer, he fought back in the German Supreme Court, claiming that the money-printing and bailout operations by the European Central Bank (ECB), and Germany's role in them, violate the constitution. The court's decision is expected on Wednesday. The foundation of the euro was the Stability Pact, he said—a contract that now has been broken. And he wonders if "the euro can still function as a value-retaining currency."

This, just as Wolfgang Schäuble, Finance Minister, has been dealt a defeat of sorts by his own governing coalition during the trial vote for the expansion of the current European Financial Stability Facility (EFSF) whose purpose it is to bail out an ever lager circle of debt-sinner countries. 25 members of his coalition voted against it or abstained. The actual vote is scheduled for September 29.

And the numbers are ugly. 89% of the population oppose the expansion of the EFSF and doubt that ever larger amounts will solve the debt crisis, according to a recent poll. 80% demand that parliament must agree each time before Germany can take on additional burdens and risks. And 85% demand that financial institutions, rather than taxpayer, take the first losses when a country defaults. What galls them is that they have to shoulder these risks and burdens so that debt-sinner countries can borrow even more at lower interest rates.

5--Martin Wolf: Please, Please, Please, Please Listen to the Bond Market, Grasping Reality with both hands

Excerpt: Martin Wolf: We must listen to what bond markets are telling us: What is to be done? To find an answer, listen to the markets. They are saying: borrow and spend, please. Yet those who profess faith in the magic of the markets are most determined to ignore the cry. The fiscal skies are falling, they insist.

HSBC forecasts that the economies of high-income countries will now grow by 1.3 per cent this year and 1.6 per cent in 2012. Bond markets are at least as pessimistic: US 10-year Treasuries yielded 1.98 per cent on Monday, their lowest for 60 years; German Bunds yielded 1.85 per cent; even the UK could borrow at 2.5 per cent. These yields are falling fast towards Japanese levels. Incredibly yields on index-linked bonds were close to zero in the US, 0.12 per cent in Germany and 0.27 per cent in the UK.

Are the markets mad? Yes, insist the wise folk: the biggest risk is not slump, as markets fear, but default. Yet if markets get the prices of such governments’ bonds so wrong, why should one ever take them seriously? The massive fiscal deficits of today, particularly in countries where huge financial crises occurred, are not the result of deliberate Keynesian stimulus: even in the US, the ill-targeted and inadequate stimulus amounted to less than 6 per cent of gross domestic product or, at most, a fifth of the actual deficits over three years. The latter were largely the result of the crisis: governments let fiscal deficits rise, as the private sector savagely retrenched.

To have prevented this would have caused a catastrophe. As Richard Koo of Nomura Research has argued, fiscal deficits help the private sector deleverage. That is precisely what is happening in the US and UK (see chart at bottom). In the US, the household sector moved into financial surplus after house prices started to fall, while the business sector moved into surplus in the crisis. Foreigners are persistent suppliers of capital. This has left the government as borrower of last resort. The UK picture is not so different, except that the business sector has been in persistent surplus.

So long as the private and foreign sectors run huge surpluses (despite the ultra-low interest rates), some governments must find it easy to borrow. The only question is: which governments? Investors seem to choose one safe haven per currency area: the US federal government in the dollar area; the UK government in the sterling area; and the German government in the eurozone. Meanwhile, among the currency areas, adjustment occurs far more via the exchange rates than through interest rates on safe-haven debts.

The larger the surpluses of the private sectors (and so the bigger the offsetting fiscal deficits), the faster the former can pay down their debts. Fiscal deficits are helpful, therefore, in a balance-sheet contraction, not because they return the economy swiftly to health, but because they promote the painfully slow healing.

One objection – laid out by Harvard’s Kenneth Rogoff in the Financial Times in August – is that people will fear higher future taxes and save still more. I am unpersuaded: household savings have fallen in Japan. But there is a good answer: use cheap funds to raise future wealth and so improve the fiscal position in the long run. It is inconceivable that creditworthy governments would be unable to earn a return well above their negligible costs of borrowing, by investing in physical and human assets, on their own or together with the private sector….

Another noteworthy objection – grounded in the seminal work of Prof Rogoff and Carmen Reinhart of the Peterson Institute for International Economics in Washington – is that growth slows sharply once public debt exceeds 90 per cent of GDP. Yet this is a statistical relationship, not an iron law. In 1815, UK public debt was 260 per cent of GDP. What followed? The industrial revolution.
What matters is how borrowing is used…. Contrary to conventional wisdom, fiscal policy is not exhausted. This is what Christine Lagarde, new managing director of the International Monetary Fund, argued at the Jackson Hole monetary conference last month. The need is to combine borrowing of cheap funds now with credible curbs on spending in the longer term. The need is no less for surplus countries with the ability to expand demand to do so. It is becoming ever clearer that the developed world is making Japan’s mistake of premature retrenchment during a balance-sheet depression, but on a more dangerous – far more global – scale. Conventional wisdom is that fiscal retrenchment will lead to resurgent investment and growth. An alternative wisdom is that suffering is good. The former is foolish. The latter is immoral.

Reconsidering fiscal policy is not all that is needed. Monetary policy still has an important role. So, too, do supply-side reforms, particularly changes in taxation that promote investment. So, not least, does global rebalancing. Yet now, in a world of excess saving, the last thing we need is for creditworthy governments to slash their borrowings. Markets are loudly saying exactly this.

So listen.

6--NBER Research Summary: The Role of Household Leverage, Economist's view

Excerpt: This NBER Research Summary by Atif Mian and Amir Sufi echoes many of the arguments I've been making about balance sheet recessions. In addition, the authors argue that the trouble in mortgage markets can be traced to a "securitization-driven shift in the supply of mortgage credit," and that "the expansion in mortgage credit was more likely to be a driver of house price growth than a response to it." They also show that "non-GSE securitization primarily targeted zip codes that had a large share of subprime borrowers. In these zip codes, mortgage denial rates dropped dramatically and debt-to-income ratios skyrocketed":

Finance and Macroeconomics: The Role of Household Leverage, by Atif R. Mian and Amir Sufi, NBER Reporter 2011 Number 3, Research Summary: The increase in household leverage prior to the most recent recession was stunning by any historical comparison. From 2001 to 2007, household debt doubled, from $7 trillion to $14 trillion. The household debt-to-income ratio increased by more during these six years than it had in the prior 45 years. In fact, the household debt-to-income ratio in 2007 was higher than at any point since 1929. Our research agenda explores the causes and consequences of this tremendous rise in household debt. Why did U.S. households borrow so much and in such a short span of time? What factors triggered the slowdown and collapse of the real economy? Did household leverage amplify macroeconomic shocks and make a quick recovery less likely? How do politics constrain policy responses to an economic crisis?

While the focus of our research is on the recent U.S. economic downturn, we believe the implications of our work are wider. For example, both the Great Depression and Japan's Great Recession were preceded by sharp increases in leverage.1 We believe that understanding the impact of household debt on the economy is crucial to developing a better understanding of the linkages between finance and macroeconomics. ...[continue reading]...


Excerpt: To inquire and to learn is the function of the mind. By learning I do not mean the mere cultivation of memory or the accumulation of knowledge, but the capacity to think clearly and sanely without illusion, to start from facts and not from beliefs and ideals. There is no learning if thought originates from conclusions. Merely to acquire information or knowledge is not to learn. Learning implies the love of understanding and the love of doing a thing for itself. Learning is possible only when there is no coercion of any kind. And coercion takes many forms, does it not? There is coercion through influence, through attachment or threat, through persuasive encouragement or subtle forms of reward.

Most people think that learning is encouraged through comparison, whereas the contrary is the fact. Comparison brings about frustration and merely encourages envy, which is called competition. Like other forms of persuasion, comparison prevents learning and breeds fear. Ambition also breeds fear. Ambition, whether personal or identified with the collective, is always antisocial. So-called noble ambition in relationship is fundamentally destructive.

It is necessary to encourage the development of a good mind—a mind which is capable of dealing with the many issues of life as a whole, and which does not try to escape from them and so become self-contradictory, frustrated, bitter or cynical. And it is essential for the mind to be aware of its own conditioning, its own motives and pursuits.

Since the development of a good mind is one of our chief concerns, how one teaches becomes very important. There must be a cultivation of the totality of the mind, and not merely the giving of information. In the process of imparting knowledge, the educator has to invite discussion and encourage the students to inquire and to think independently.Authority, as ‘the one who knows’, has no place in learning. The educator and the student are both learning through their special relationship with each other; but this does not mean that the educator disregards the orderliness of thought. Orderliness of thought is not brought about by discipline in the form of assertive statements of knowledge; but it comes into being naturally when the educator understands that in cultivating intelligence there must be a sense of freedom. This does not mean freedom to do whatever one likes, or to think in the spirit of mere contradiction. It is the freedom in which the student is being helped to be aware of his own urges and motives, which are revealed to him through his daily thought and action.A disciplined mind is never a free mind; nor can a mind that has suppressed desire ever be free. It is only through understanding the whole process of desire that the mind can be free. Discipline always limits the mind to a movement within the framework of a particular system of thought or belief, does it not? And such a mind is never free to be intelligent. Discipline brings about submission to authority. It gives the capacity to function within the pattern of a society which demands functional ability, but it does not awaken the intelligence which has its own capacity. The mind that has cultivated nothing but capacity through memory is like the modern electronic computer which, though it functions with astonishing ability and accuracy, is still only a machine. Authority can persuade the mind to think in a particular direction. But being guided to think along certain lines, or in terms of a foregone conclusion, is not to think at all; it is merely to function like a human machine, which breeds thoughtless discontent, bringing with it frustration and other miseries.

We are concerned with the total development of each human being, helping him to realize his own highest and fullest capacity—not some fictitious capacity which the educator has in view as a concept or an ideal. Any spirit of comparison prevents this full flowering of the individual, whether he is to be a scientist or a gardener. The fullest capacity of the gardener is the same as the fullest capacity of the scientist when there is no comparison; but when comparison comes in, then there is the disparagement and the envious reactions which create conflict between man and man. Like sorrow, love is not comparative; it cannot be compared with the greater or the lesser. Sorrow is sorrow, as love is love, whether it be in the rich or in the poor.

8--Bond market signals that Europe is broken, Pragmatic Capitalism

Excerpt:...Moody’s highlighted the surging Euribor-OIS which is eerily reminiscent of 2008:

“European bank lending is showing stresses not seen since the ending of the recent recession, which casts a pall over global demand for high-risk assets. Excess interbank lending costs, as measured by the Euribor-OIS spread, are up sharply.The Euribor-OIS differential now stands at 61 bp, compared to this year’s low of only 8 bp. The current level is near its widest level since May 2009. European Central Bank purchases of sovereign debt and special bank lending facilities have formed a dam that is preventing a broad market collapse. US high yield credit spreads have closely mirrored fluctuations in European bank funding markets over the past few years (Figure 1). Now at 729 bp, the average spread on US high yield bonds is near its highest level since October 2009. The Euribor-OIS spread is only marginally below its Q4 2007 average of 67 bp that reflected the clamping up of credit markets. This signal of disappearing liquidity fed into the recession and the steady rise in defaults. More confidence in a lasting solution for the eurozone crisis will be needed to alleviate banking sector pressures, and to bring the US high yield spread back toward its historical average of 517 bp.”...

“The importance of bank bond spreads to the functioning of capital markets cannot be understated. Stubbornly wide bank bond spreads question the adequacy of financial liquidity for all borrowers in the event of an adverse macro shock. An elevated level of uncertainty surrounding access to financial capital implies that both businesses and consumers will be more “risk averse” than otherwise. An atypically acute aversion to risk will curb capital spending, hiring activity, and purchases of big ticket items, especially housing. Put simply, the attainment of a respectable economic recovery seems all but impossible as long as the credit spreads of high-grade financial company bonds remain extraordinarily wide. Getting both real economies and financial markets back to normal requires a renewed narrowing by high-grade financial company spreads from their now below-investment-grade widths.”

9--Europe's banks wag the dog, Reuters

Excerpt: With European banks facing mounting funding problems, it is time once again for the tail to try to wag the dog.

Democracy or not, procedure or not, principles or not, a funding crisis could soon put euro zone policy makers in a position where they either take radical steps to resolve their debt crisis, or face having their decisions made for them by events which would overwhelm their banking systems.

That, at least, is the impression given by recent comments from leading bankers. I’d love to tell you they are bluffing, but I am not so sure.
First, chief executive of state-owned ABN Amro Group, Gerrit Zalm, a former Dutch finance minister, warned on Sunday both that funding markets were becoming difficult and of the catastrophic consequences of a break up of the euro zone.

“We will have a recession which makes the 1930s look like nothing,” he told Dutch television. “The whole of Europe will crumble.”

The connection between bank funding and euro zone breakup risks is clear. Many euro zone banks are not solvent if true market prices on their holdings of euro zone government debts are taken into account, and investors will only fund banks to the extent that they believe that those debts will never be marked to market, as they would be immediately for banks if their countries spun out of the euro.

“It’s stating the obvious that many European banks would not survive having to revalue sovereign debt held on the banking book at market levels,” Deutsche Bank Chief Executive Josef Ackermann said at a meeting of banking executives....
“The situation for banks is more dramatic than it was in 2008,” said Ulrich Schroeder, head of German government-backed KFW, speaking at the same conference.

“In 2008, governments were still able to support their banks. Now this is simply no longer possible.”

The distinction here is between individual states supporting their banks, which for Italy or Greece would clearly not be possible in a euro exit, and of the euro zone as a whole supporting its members and thereby, hopefully, avoiding the whole nasty issue of bank capital.

Really though, this analysis only gets half of the story right. While it is true that many banks would be vaporized by a euro breakup, it is not therefore true that if you deal with the sovereign debt problem you needn’t bother with bank capital levels. The key is to do both at the same time, rather than pretending that doing one will mean you don’t need to do the other.

European banks need more capital not simply because they happen to be holding a lot of dubious paper issued by euro zone countries. They need more capital because they have been operating at levels where they cannot absorb even moderate losses and survive without implied and real government aid.

Even worse, euro zone banks, and those in the U.S. for that matter, continue to pretend that profits gained by government license have been created by existing employees and executives in a competitive market. Much of that money flying out the door as compensation should be retained to build up capital, thereby reducing dependence on the public purse. Euro zone reform, banking recapitalization and further regulation should come as a package.

We should be afraid that the euro zone will break up – that is both increasingly possible and would be a disaster. But we should not conflate keeping the euro zone intact with maintaining an unfair and debilitating status quo in its banking system.

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