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.

Soon.

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.

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