Wednesday, September 21, 2011

Today's links

1--Europe Banks Have $410 Billion Credit Risk: IMF, Bloomberg

Excerpt: The European debt crisis has generated as much as 300 billion euros ($410 billion) in credit risk for European banks, the International Monetary Fund said, calling for capital injections to reassure investors and support lending.

Political squabbling in Europe over ways to fight contagion and delays in implementing agreed measures are raising concerns about the risk of defaults by governments, the IMF said. Banks in turn face “funding challenges” because of investor concern about their potential losses from government bonds they hold, with some relying heavily on the European Central Bank for liquidity, it said.

“A number of banks must raise capital to help ensure the confidence of their creditors and depositors,” the IMF wrote in its Global Financial Stability Report released today. “Without additional capital buffers, problems in accessing funding are likely to create deleveraging pressures at banks, which will force them to cut credit to the real economy.”

The Washington-based IMF yesterday cut its global growth forecast and predicted “severe’ repercussions if policy makers fail to stem the debt turmoil that’s threatening to engulf Italy and Spain. Bank recapitalization, through public injections if necessary, should come in addition to “credible” strategies by governments to reduce their public debt, the IMF said today.

2--MBA: Mortgage Purchase Application Index declines, Record Low Mortgage Rates, Calculated Risk

Excerpt: The MBA reports: Mortgage Applications Increase in Latest MBA Weekly Survey

The Refinance Index increased 2.2 percent from the previous week. The seasonally adjusted Purchase Index decreased 4.7 percent from one week earlier.
...
The average contract interest rate for 30-year fixed-rate mortgages with conforming loan balances ($417,500 or less) remained unchanged at 4.29 percent, with points increasing to 0.41 from 0.38 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans.

The average contract interest rate for 30-year fixed-rate mortgages with jumbo loan balances (> $417,500) decreased to 4.55 percent from 4.57 percent, with points increasing to 0.46 from 0.42 (including the origination fee) for 80 percent loan-to-value (LTV) ratio loans.

Note: Existing home sales will probably increase to around 4.92 million SAAR in August (Lawler's estimate) - above the consensus forecast of 4.75 million SAAR - but this index suggests another decline in September and October.

3--McConnell, Boehner, Kyl, and Cantor's Letter to the Fed, Economist's View

Excerpt: This letter from Senators McConnell, Boehner, Kyl, and Cantor crosses a line that shouldn't be crossed:

Dear Chairman Bernanke,

It is our understanding that the Board Members of the Federal Reserve will meet later this week to consider additional monetary stimulus proposals. We write to express our reservations about any such measures.

Respectfully, we submit that the board should resist further extraordinary intervention in the U.S. economy, particularly without a clear articulation of the goals of such a policy, direction for success, ample data proving a case for economic action and quantifiable benefits to the American people.

It is not clear that the recent round of quantitative easing undertaken by the Federal Reserve has facilitated economic growth or reduced the unemployment rate. ...

We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy. ...
Sincerely,

Sen. Mitch McConnell, Rep. John Boehner, Sen. Jon Kyl, Rep. Eric Cantor

4--The Consequences of Angela Merkel, Robert Skidelsky, Project Syndicate

Excerpt: So far, three countries – Greece, Ireland, and Portugal – have availed themselves of this facility. In mid-July 2011, Greece’s sovereign debt stood at €350 billion (160% of GDP). The Greek government currently must pay 25% for its ten-year bonds, which are trading at a 50% discount in the secondary market.

In other words, investors are expecting to receive only about half of what they are owed. The hope is that the reduction in borrowing costs on new loans, plus the austerity programs promised by governments, will enable bond prices to recover to par without the need for the creditor banks to take a hit.

This is pie in the sky. Unless a large part of its debt is forgiven, Greece will not regain creditworthiness. (Indeed, by most accounts, it is about to default.) And the same is true, albeit to a lesser degree, for other heavily indebted sovereigns.

Any credible bailout plan must require creditor banks to accept that they will lose at least half of their money. In the United States’ successful Brady Bond plan in 1989, the debtors – Mexico, Argentina, and Brazil – agreed to pay what they could. The banks that had loaned them the money replaced the old debt with new bonds at par value, which averaged 50% of the old bonds, and the US government provided some sweeteners.

It was write-offs and devaluations, not austerity programs, that allowed bond prices to recover. In the Greek case, creditors have yet to accept the need for write-offs, and European governments have provided them with no incentives to do so.

Germany’s opposition to debt forgiveness is thus bad economics, bad politics (except at home), and bad history. The Germans should remember the reparations fiasco of the 1920’s. In the Treaty of Versailles, the victorious Allies insisted that Germany should pay for “the cost of the war.” They added up the figures, and in 1921 they presented the bill: Germany “owed” the victors £6.6 billion (85% of its GDP), payable in 30 annual installments. This amounted to transferring annually 8-10% of Germany’s national income, or 65-76% of its exports....

The point to which Keynes kept returning was that the attempt to extract debt payments over many years would have disastrous social consequences. “The policy of reducing Germany to servitude for a generation, of degrading the lives of millions of human beings, and of depriving a whole nation of happiness should be abhorrent and detestable,” he wrote, “even if it does not sow the decay of the whole civilized life of Europe.”

History never repeats itself exactly, but there are lessons to be learned from that episode. Germans today would say that, unlike reparations, the Greek and Mediterranean debts were voluntarily incurred, not coerced. This raises the question of justice, but not the economic consequences of insisting on payment. Moreover, there is a fallacy of composition: if there are too many debt collectors, they will impoverish the very people on whom their own prosperity depends.

In the 1920’s, Germany ended up having to pay only a small fraction of its reparation bill, but the long time it took to get to that point prevented the full recovery of Europe, made Germany itself the most conspicuous victim of the Great Depression, and bred widespread resentment, with dire political consequences. German Chancellor Angela Merkel would do well to ponder that history.

5--Spooked into austerity, we dig our own economic grave, Jayati Ghosh, Triple Crisis

Excerpt: The stupidity of the current macroeconomic stance in the UK is surprising in itself; but when combined with similar voices in Europe and the US, it is downright astonishing. Three years after the collapse of Lehman Brothers, the global economy is not going through a recovery from financial crisis, but simply entering act two after a brief intermission. On current form this play is a farce that will end in tragedy.

Policy discussion on both sides of the Atlantic is dominated by extreme fiscal hawks, who wrongly see public spending as the problem rather than at least part of the solution. The emphasis on fiscal rectitude is accompanied by the inability to rein in finance. All this condemns economies to financial instability, depressed and even contracting GDP and worsening conditions for ordinary citizens.

Consider: the UK government’s focus is still on cutting the budget deficit, though the economy is not just tottering but into the downswing already. The Vickers report on controlling the financial sector is well-intentioned but so modest as to tend to irrelevance. It misses essential points about the financial system, and the lengthy grace period it awards to banks (more than seven years before they have to ringfence their operations) risks being completely overtaken by the likely future volatility in banking.

Part of the problem is that the bulk of the mainstream economics profession has forgotten basic Keynesian macroeconomics, and so is unable to offer even the most obvious advice. But the other aspect of the problem is deeper, reflecting the class configurations that create and intensify the mess. The choice between increasingly futile and counterproductive monetary easing and dithering about policies oriented to more austerity to satisfy bond markets is ultimately a political one, reflecting the continued power of finance.

There are some voices of sanity. The 2011 UNCTAD trade and development report makes the point that fiscal tightening, especially in the advanced economies, is likely to be self-defeating. It will reduce GDP growth and revenues – not just bad news for a sustained recovery but counterproductive for fiscal consolidation.

What is happening in Greece confirms this analysis. After aggressive cutbacks in public spending forced by the EU-IMF bailout, the economy shrank at an annual rate of 7.3% in the second quarter of 2011. This far exceeds the most pessimistic projections of the IMF or the EU. Since tax revenues can hardly improve now, even with the most sweeping attempts at better collection, fiscal balances will improve only with further public spending cuts. Even so, public-debt-to-GDP ratios will deteriorate.

The point is that fiscal space is not a static variable. Expansionary policies increase demand and revenues and therefore generate more tax revenues. It makes much more sense to grow out of debt than to plunge into a downward spiral worsened by public austerity...

So there must be restructuring of the financial system: giant institutions must be downsized; the activities of commercial and investment banking should be clearly separated; and the aim should be more diverse financial systems, with a bigger role for public and co-operative institutions. Commodity markets, which have been subject to wild price swings related to speculative and herd behaviour, need to be made more transparent, with more controls on financial activity and direct intervention when required to curb price bubbles and prevent sharp declines.

6--Munchau: 'we are moving closer towards an involuntary break-up', Credit Writedowns

Excerpt: In an FT article with the pro-European title of “Eurobonds and fiscal union are the only way out”, Munchau writes about a Greek default:

In Berlin, there is now a consensus among senior policymakers that Greece is very likely to default inside the eurozone, but not right away. By the time it happens, the European financial stability facility will be empowered to protect European banks directly. Those who advocate this approach clearly hope that the improved institutional set-up will be sufficient to deal with contagion.

Munchau also writes about Italian solvency:

The EFSF and its successor, the European Stability Mechanism, have been set up to handle small countries. They are not big enough to handle large countries. Besides, Italy does not have a short-term funding gap, but a long-term solvency problem. With debt of 120 per cent of gross domestic product, a potential real economic growth rate of around 1 per cent, and a long-term interest rate of 5-6 per cent, Italy’s debt sustainability is in doubt. A monetary union, which solves crises through a combination of default and backstops for the financial sector, would hardly solve Italy’s problem.

Yes, the European Sovereign Debt Crisis is a solvency crisis. My version of what Munchau writes is this:

Is it debatable whether Italy is solvent longer-term? Sure. That’s why Italy is under attack. But the right way to deal with this is to stop the panic and address the issues that could lead to longer-term insolvency. Remember, Italy has a primary surplus. It is high debt and interest costs plus slow growth which are Italy’s problems....

Finally, there’s the money quote. Munchau writes about the dissolution of the euro zone:

The ruling of the German constitutional court has raised legislative hurdles, while political hostility is rising. We are moving away from what I consider the only effective solution to the crisis. This means, by extension, that we are moving closer towards an involuntary break-up.

My version of why a breakup of the euro zone is likely:

This ruling by the German Constitutional Court does allow the EFSF to operate as planned. Most commentators have focused on this. However, the language of the decision means there can be no eurobonds and no “supra-national” fiscal agent because these are in violation of the German constitution....

In my view, eurobonds and a “supra-national” fiscal agent are almost the only mechanisms which make the euro zone viable. Therefore, with these options now excluded, the euro zone is almost doomed to failure. The euro zone double dip is almost here and I think that spells bailout fatigue, austerity fatigue, default, and political unrest which will break the euro zone apart.

7--Lloyd’s of London Pulls Deposits From European Banks as Confidence Withers, Bloomberg

Excerpt: Lloyd’s of London, concerned European governments may be unable to support lenders in a worsening debt crisis, has pulled deposits in some peripheral economies as the European Central Bank provided dollars to one euro-area institution.

“There are a lot of banks who, because of the uncertainty around Europe, the market has stopped using to place deposits with,” Luke Savage, finance director of the world’s oldest insurance market, said today in a phone interview. “If you’re worried the government itself might be at risk, then you’re certainly worried the banks could be taken down with them.”

European banks and their regulators are trying to reassure investors and customers that lenders have enough capital to withstand a default by Greece and slowing economic growth caused by governments’ austerity measures. Siemens AG (SIE), European’s biggest engineering company, withdrew short-term deposits from Societe Generale SA, France’s second-largest bank, in July, a person with knowledge of the matter said yesterday.

Lloyd’s, which holds about a third of its 2.5 billion pounds ($3.9 billion) of central assets in cash, has stopped depositing money with some banks in Europe’s peripheral economies, Savage said, declining to name the countries or institutions....

The premium European banks pay to borrow in dollars through the swaps market is close to the highest level in almost three years.

8--Austerity USA, Paul Krugman, New York Times

Excerpt: Goldman Sachs (no link) has a nice chart showing just how much fiscal policy has been a drag on the economy since the second half of last year, and also shows that the Obama jobs plan, even if enacted in full, would only be enough to put it in neutral(see chart)

9--Doom!, The New Republic

Excerpt: TODAY’S RECESSION does not merely resemble the Great Depression; it is, to a real extent, a recurrence of it. It has the same unique causes and the same initial trajectory. Both downturns were triggered by a financial crisis coming on top of, and then deepening, a slowdown in industrial production and employment that had begun earlier and that was caused in part by rapid technological innovation. The 1920s saw the spread of electrification in industry; the 1990s saw the triumph of computerization in manufacturing and services. The recessions in 1926 and 2001 were both followed by “jobless recoveries.”

In each case, the financial crisis generated an overhang of consumer and business debt that—along with growing unemployment and underemployment, and the failure of real wages to rise—reduced effective demand to the point where the economy, without extensive government intervention, spun into a downward spiral of joblessness. The accumulation of debt also undermined the use of monetary policy to revive the economy. Even zero-percent interest rates could not induce private investment....

when firms continued to cut back, unemployment continued to rise, and tax revenues dropped—creating a budget deficit—Hoover and the Republicans turned to cutting government spending and raising taxes on the assumption that a government, like a business, should not respond to hard times by going further into debt. In a news conference in December 1930, Hoover declared, “Prosperity cannot be restored by raids upon the Public Treasury.” In fiscal year 1933 (which began in June 1932), federal spending actually decreased. By March 1933, when Franklin Roosevelt took office, the unemployment rate had climbed to 24.9 percent from 3.2 percent in 1929....

In all these cases, the lesson was clear: Cutting spending and raising taxes to balance the budget had made things much worse. And, as these governments discovered, there was a political price to be paid. In the United States, Franklin Roosevelt and the Democrats turned out Hoover and his party by a landslide. The Republicans would not win the presidency again for 20 years and would remain the de facto minority party for almost 50 years. In the October 1931 elections in Britain, the Labour Party suffered its worst defeat. MacDonald would be expelled from the party, and Labour would not regain power until 1945. In Germany, Adolf Hitler’s National Socialist Party would best the other parties in the 1932 elections. And, in January 1933, Hitler would become chancellor....

In Great Britain, the dour Brown, who was inept as a politician, was replaced in May 2010 by Tory David Cameron. A modest recovery had begun under Brown, but Cameron, concerned about a rising deficit, slashed spending and raised taxes. Cameron’s five-year plan calls for the elimination of 300,000 public-sector jobs. As a result, growth has slowed to a crawl in Britain. The economy increased .2 percent in the second quarter. And unemployment, which fell in 2010, has begun to rise.

On the continent, the leaders of more prosperous nations have responded to growing unemployment, lagging growth, and the threat of insolvency on the periphery by calling for austerity. Dutch Prime Minister Mark Rutte has proposed appointing a Eurozone commissioner who could expel countries (like Greece) that don’t adhere to strict budget rules. Sarkozy and Merkel have proposed that all the Euro countries pass legislation requiring balanced budgets and balked at creating “Eurobonds” that would give struggling countries access to lower-interest loans. “Austerity is the only cure for the Eurozone,” Merkel’s finance minister, Wolfgang Schäuble, declared in The Financial Times....

TO EXTRICATE THEMSELVES from this mess, the United States and other leading nations are going to have take the same kind of steps that the West took after World War II—steps that led to 25 years of prosperity. After World War II, governments came to play a much greater role in national economies, particularly in the United States. In 1929, U.S. federal spending accounted for 3.68 percent of GDP. During World War II, it rose to 43.6 percent; by the mid-’50s, it had leveled off between 17 and 23 percent. This spending helped complement private investment and sustain consumer demand.

In the future, the United States will once again have to raise rather than lower the level of federal spending as a percentage of GDP. Republicans want to cap spending at 19 percent of GDP, but, in the wake of the recession, it may have to hover between 25 and 30 percent or perhaps climb even higher. That’s because of an aging population that will need public services, the growing importance of publicly funded science and technology, the need to transform the nation’s energy and transportation networks, and the impact on employment of the trend toward automation in manufacturing and services. Even if the U.S. economy grows at a healthy pace, the private sector may not provide enough jobs.

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