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

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