Monday, October 31, 2011

Today's links

1--Another reason the Fed might buy MBS, FT Alphaville

Excerpt: In his speech two weeks ago, Bernanke explained the evolving intellectual framework of central banking after the crisis, and specifically explained the increasing importance of monitoring financial stability along with its traditional responsibility for monetary policy. The details remain to be worked out, obviously, but buying MBS would seem a way to address both goals.

And speaking of those European banks….

Separately, anecdotes of European banks deleveraging dollar-denominated assets – such as mortgage securities – have proliferated. Should this trend continue, it would be most convenient to have the Federal Reserve positioned as a ready buyer of MBS, as well as Treasuries.

Convenient indeed, and too much of a coincidence not to at least mention. Just something to keep in mind next week…

2--Furious Greeks lampoon German 'overlords' as Nazis with picture of Merkel dressed as an SS guard, Daily Mail

Excerpt: Street poster depicts German Chancellor wearing a swastika armband bearing the EU stars logo on the outside...

Greeks angry at the fate of the euro are comparing the German government with the Nazis who occupied the country in the Second World War.

Newspaper cartoons have presented modern-day German officials dressed in Nazi uniform, and a street poster depicts Chancellor Angela Merkel dressed as an officer in Hitler’s regime accompanied with the words: ‘Public nuisance.’

She wears a swastika armband bearing the EU stars logo on the outside...

Opposition parties blasted the landmark agreement, with conservatives warning it condemned the country to ‘nine more years of collapse and poverty’.

But it is the fury of ordinary Greeks which is raising eyebrows.

Greek government officials who agreed to the belt-tightening moves have been portrayed in cartoons giving the Nazi ‘Sieg Heil’ salute.

And German visitors flocking to ancient tourist sites are being met with a hostile welcome from some Greeks.

3--Why No Action on Jobs?, Jared Bernstein, On The Economy

Excerpt: Why, you may be wondering, do politicians refuse to take the necessary fiscal steps to dislodge the unemployment rate from its elevated perch of 9.1%? Why, to the contrary, do they seem if anything intent on austerity measure that will push it in the wrong direction?

I can think of three reasons:

1) They want the President to fail;

2) They don’t believe fiscal measures will work;

3) They irrationally fear a higher budget deficit, even temporarily.

Re 1, what can anyone say? If you’re will to throw the economy under the bus to gain political advantage, you, not the millions hurt by your actions, should be the one who loses their job.

Re 2, I’ve got more sympathy for you. Folks have a hard time accepting counterfactuals—the idea that things would have been worse absent the Recovery Act. But the evidence is at this point pretty plain to see: here, where the economy improved while the Recovery Act was in place and stumbled as fiscal stimulus come off too soon, in the UK, where austerity is clearly stifling growth, and in southern Europe as well.

Re 3, it can’t be emphasized enough that temporary spending measures, even large one, are not what drive the long-term debt problem. Note how the Recovery Act—all $800 billion of it—adds nothing to the growth of the debt/GDP ratio starting around now. The culprit there would be the Bush tax cuts—it’s the permanent spending, not the temporary stuff that whacks you here.

I’m all for laying the groundwork to get on a sustainable budget path once the private sector is back in the business of creating jobs for people here in America. For now, the question regarding budget deficits should be: are they large enough to help pick up the slack until that moment arrives? (chart shows effects of Bush tax cuts)

4--Draghi to slip Trojan-style into ECB hot seat, Reuters

Excerpt: It bears a certain similarity to the Trojan horse story.

While the ECB’s staff are off enjoying a public holiday on Tuesday –which by the way no one else in Frankfurt will get– Mario Draghi will slip unnoticed into the bank and make himself comfortable in the president’s chair recently vacated by Jean-Claude Trichet.

While the covert changeover could never have been planned, it may end up being like Trichet was never there. The baguettes and coq au vin in the canteen may mysteriously turn into pizza and spaghetti in time for lunch on Wednesday when everyone else is back in the office, and that might be that.

Draghi has been careful to stay out of Trichet’s way in the final weeks of the Frenchman’s leadership. While new ECB board members usually turn up a few weeks early to get their feet under the table, there has been no sign of Mario on Kaiserstrasse yet. And ECB insiders say are no clearer now how life will be under the Italian than they were months ago when he was given the job.

The objective, to avoid any confusion about who is in charge at the central bank at such an important phase of the crisis, is probably a sensible one. But you can’t help thinking that behind Trichet’s back, everybody must have been checking with Draghi before committing the ECB to anything that might not have been to his taste.

5--Brussels Decisions 'Will Exacerbate the Crisis', Der Speigel

Excerpt: The euro-zone, it would seem, has managed to convince investors that it might be on the path to solving the common currency area's debt problems after all. In addition to the Greek debt haircut, the 17 euro-zone members also agreed on a requirement that European banks increase their core capital ratios to 9 percent, a move that will, it is hoped, help buffer them against the hefty write downs of Greek debt that some will have to swallow.

In addition, the EFSF is to be boosted, transforming the fund with a current lending capacity of €440 billion into one with firepower worth €1 trillion. At that size, it is hoped, investors will no longer be overly concerned about investing in euro-zone sovereign bonds, particularly those from larger area economies like Italy and Spain.

Still, despite the apparent investor euphoria over the deal, there are, for the moment, precious few details about how exactly the new EFSF fund will work. There are two competing models -- one involving an insurance scheme guaranteeing a portion of investments in euro-zone sovereign bonds against loss and another envisioning the creation of an investment fund to attract money from outside the euro zone. But euro-zone leaders won't be making a final decision until November.

'Several Additional Steps'

"The complete lack of details out of the European summit doesn't give investors a great sense of comfort," Fredrik Nerbrand, global head of asset allocation for HSBC, told Reuters....

The left-leaning daily Die Tageszeitung writes:

"Above all, €1 trillion simply won't cut it, because not even €2 trillion would be enough. The crisis now has a life of its own and has eaten its way into the heart of the euro zone. A real inability of Europe's debt-laden countries to pay back the money they owe would mean mass panic among financial investors. Meanwhile, Italy and even France are seen as potential candidates for insolvency, which is absurd. The countries possess two of the world's strongest economies."

"The euro crisis will only be over when the euro has become a normal currency like the yen, the dollar or the pound. This includes a European Central Bank able to buy up government bonds, much like the Bank of England routinely does."

"Such a solution remains distant, however. Chancellor Merkel continues to rely on state-level solutions like the so-called 'debt brake.' Each country is to tighten its purse strings in order to calm the financial markets. No one even talks about the alternative: that rich people could pay more taxes. The prescribed cuts will deepen the recession, which in turn produces deficits and sends investors into a whole new cycle of panic. The decisions from Brussels weren't harmless -- they will exacerbate the crisis rather than solve it."...

Would the markets still be reacting with such euphoria if the technical details of the 'voluntary' debt haircut were understood? How much in risk premiums will investors demand for government bonds that are only partially guaranteed by the EFSF? And then there is still Greece, this country without a business model, which is expected to reduce its debts down to 120 percent of its gross domestic product by 2020. It remains questionable as to whether this still enormous mountain of debt will be more manageable for the country (or more acceptable for the capital markets). But without stronger growth -- probably also fueled by EU aid -- this goal remains fiction."...

"Berlin is especially proud of the fact that the European Central Bank (ECB) is to be left out of the rescue of the highly indebted nations. This promise will be difficult to keep, at least in the short-term. As long as the EFSF is not yet fully functioning with sufficient 'firepower' at its command, the ECB will still have to jump in as the 'lender of the last resort.' Designated ECB President Mario Draghi knows that, and therefore deliberately left the door open to further buying up of government bonds."

6--German Constitutional Court Halts Special Euro Panel, Der Speigel

Excerpt: Germany's highest court has issued a temporary injunction banning the work of a new panel convened by the country's parliament to quickly green-light decisions on disbursement of taxpayer funds through the euro bailout program. The decision could lead to further delays in German decision-making in efforts to rescue the beleaguered common currency.

Germany's Federal Constitutional Court on Friday expressed doubts about the legality of a new panel of lawmakers set up by the German parliament to reach quick decisions on the release of funds from the euro bailout mechanism, the European Financial Stability Facility (EFSF). The court issued a temporary injunction banning the nine-person committee in the Bundestag from taking any decisions on the EFSF's deployment of German taxpayer money.

The special committee was recently created in order to be able to provide a quick green light for EFSF aid in especially urgent situations in which it wouldn't be feasible to put the issue up for a vote before the full parliament. The decision from the court, located in Karlsruhe, could also slow down Bundestag approval of the further application of German credit guarantees within the scope of the euro backstop fund....

'The Bundestag Cannot Be Replaced'

But the SPD members are contesting the law. "The Bundestag cannot be replaced by a nine-member committee on such important issues," Schulz told SPIEGEL ONLINE. Schulz argues that, at a minimum, the Bundestag's budget committee should be included in all decisions.

7--Euro Bailout Failure, 5 Ducats

Excerpt: Have so many ever been so enthusiastic over a plan to beg, borrow, and steal $1.5 trillion?

•Beg - Weaker European banks will have to raise over $100 billion in capital.

•Borrow - Eurozone will borrow $1.4 trillion to bailout future sovereign and bank defaults.

•Steal - Private investors lose 50% of their Greek bonds' face value (ok, "steal" is a bit strong).

Begging, borrowing, and stealing doesn't usually instill confidence. And it shouldn't. Piece by piece, here's why...

Greek bond 50% haircut:

1.Greek bonds held by the ECB and IMF don't get a haircut, so the Greek gov't didn't get half of all of their debt cut - only part of it. They still owe much more than 50%.

2.Greece's economy is still shrinking and it still runs a trade deficit, so they will continue to run a gov't budget deficit. They are going to default again.

3.The bank trade group agreed to the 50% cut as voluntary so that it wouldn't trigger a CDS default, but their decision doesn't bind the actual bond investors, and some probably won't volunteer.

4.The best reason to volunteer now is so that you haven't shot your wad early, before Greece defaults again, when you might get a bigger payout.

5.Nobody knows what the interest rate and term of the restructured bonds will be. Assume it will be very low and very long, so that the present value of the bonds will be much less than 50%. Looking for volunteers? (in truth there isn't that much Greek CDS out there).

Banks Raise Capital:

1.The rule was created so that it scarcely touches German and French banks, funny how that works since they negotiated the deal.

2.Italian banks have to raise a lot of capital, but do private investors want to put money in banks in a stagnant economy, with a government that probably can't bail them out?

3.The goal is to hit a target capital as a percentage of assets. Instead of raising capital, they could sell assets - particularly the good ones that will sell for a high price, which leaves them with the crummy assets and makes the bank weaker in the long run.

4.A scarcity of bank capital will cause banks to lend less and lend more conservatively, which will contrain economic growth and ultimately make it harder for banks and governments to pay back their debt.

5.If banks sell many of their assets, and lend less, then that will generally lower the price of European assets and further undermine bank solvency.

6.If the value of sovereign bonds is used to determine bank capital adequacy, why would a bank now buy Italian and Spanish bonds that have a greater risk of falling in value? Sovereign bonds are now risky to banks even if they don't default.

Borrow €1.0 trillion ($1.4 trillion):

1.€1 trillion equals 45% of China's foreign reserves, but China's reserves aren't in Euro cash, but mostly in US Treasury and Agency debt. And although these are very liquid assets, you can't sell $1.4 trillion of anything without driving down your price a lot (unless the Fed wants to buy it).

2.No nation will guarantee the €1 trillion debt, Germany explicitly will not.

3.Germany demanded that the ECB would not guarantee the debt either.

4.The Euro Emergency Stability Fund will take the first loss before any of the €1.0 in debt defaults, but the EFSF is backed by credit risks such as Italy and Spain, who are more likely to default than lend in an emergency.

5.Borrowing €1.0 trillion from China will increase demand for the Euro, causing it to rally and make the Eurozone trade deficit worse.

6.If the money is lent from within the Eurozone, then you are removing money that would otherwise be lent to someone else, which may constrain economic growth.

7.If the €1.0 debt is perceived as safer than some individual Eurozone members, then individual Eurozone members may not be able to sell their own bonds to refinance their debt - which means that they would be forced to tap the leveraged emergency fund.

8--European Bank Debt-Guarantee Proposals May Struggle to Thaw Funding Market, Bloomberg

Excerpt: European banks, which need to refinance more than $1 trillion of debt next year, may struggle to fund themselves until policy makers follow through on a pledge to guarantee their bond sales.

European Union leaders promised this week to “urgently” look at ways to guarantee bank debt in a bid to thaw funding markets frozen by the sovereign debt crisis. Lenders have found it hard to sell bonds for the past two years and have increasingly turned to the European Central Bank for unlimited short-term emergency financing.

“The biggest problem at the moment is that banks haven’t been able to fund themselves,” said David Moss, who helps manage about 8.5 billion euros ($12 billion) at F&C Asset Management Plc in London. “If banks can’t fund themselves, they’ll struggle to exist.”

ECB Funding

The extra yield investors demand to hold banks’ senior bonds instead of benchmark government debt soared to a record 360 basis points on Oct. 4, according to Barclays Capital’s Euro Aggregate Banking Senior Index. The spread has since narrowed to 315 basis points, still almost double its average of 178 basis points for the past four years.

Banks that have been unable to tap the bond markets are likely to become more reliant on the ECB for funding. When the Frankfurt-based central bank revived a tool last used at the end of 2009 to ease money-market tensions on Oct. 26, 181 banks borrowed a total of 56.9 billion euros for 12 months. The identities of the borrowers weren’t disclosed.

European governments including France, Spain, the U.K. and Germany guaranteed some bonds issued by their banks to reassure investors after the collapse of Lehman Brothers Holdings Inc. in September 2008. In May 2010, the EU ended the program when it said banks that relied on the pledges would face a review of their long-term viability.

U.S. Program

In the U.S., the Temporary Liquidity Guarantee Program allowed banks to issue bonds with backing from the FDIC for as long as three years. Borrowers paid a fee of 0.5 percent to guarantee debt due in six months or less, 0.75 percent for debt going out one year, or 1 percent for longer-dated maturities, according to terms on the agency’s website. More than 85 percent of U.S. banks participated in the program, including JPMorgan Chase & Co.

About 66 banks had issued $231 billion of FDIC-guaranteed debt as of Aug. 31, according to the FDIC. Sheila Bair, the agency’s former chairman, told Congress in November 2008 that in the month following introduction of the program, “we have seen bank funding rates moderate significantly.”

For the European guarantee to work, it would need to be provided by a pan-European body such as the European Investment Bank, said Philippe Bodereau, head of credit research at Pacific Investment Management Co.

9--Greece at its limit, The Street light Blog

Excerpt: (written before Thursday's agreement) The Greek parliament just passed the previously agreed-to package of tax increases and spending cuts. But I am willing to bet that it is the very last round of austerity measures that Greece will be able to enact. Here are excerpts from Gavin Hewitt's gripping column from yesterday:

Athens erupts over austerity cuts

Athens was expecting violence. The expectation of it hung in the air. It is all people have spoken of in recent days. Even tourist hotels some distance from the parliament were boarding up. As a 48-hour general strike took hold shopkeepers were hammering in place steel shutters. The fear that emerged in hushed conversations was that there could be serious casualties. Such is the rage, the frustration that has built over months.

...I joined some students heading for the parliament. They are outraged that schools have a shortage of books. One young man said to me that he was not prepared to see decades of social progress sacrificed to satisfy the European Union and the IMF. Some waved banners with Che Guevara's picture. Then the column stopped, and from the left marched builders, arms linked, carrying poles with red flags on top. They walked with purpose. They have seen the construction industry collapse.

Then metal workers and teachers. It seemed at times as if the whole city was on the move. ...Marches and skirmishes soon became running battles across the capital But the numbers kept coming; great rivers of protesters.

...And with the marchers came young men and women in black hoods and masks. They began tearing at a wire fence that the police had slung across the road at the side of the parliament.

When eventually the police lost patience and fired the first tear gas grenade, the sound echoed across Syntagma Square and the crowd cheered.

There is a sense here that this is the key battle if spending cuts and wage increases are to be defeated.

Then skirmishes became running battles. Some of the anarchists had petrol bombs that snaked through the air falling around the riot police. They replied with volleys of tear gas and stun grenades.

...Europe's leaders had insisted that in exchange for bailing Greece out, it had to slash its deficit. The Greek foreign minister told me on Tuesday that no European country had ever tried such cuts in such a short space of time.

But seeing the vast numbers on the street, the government ministries occupied, the violence, it has to be asked whether Greece can impose these new austerity measures.

And if it can't, will the EU and IMF go ahead with the next tranche of bailout money. The so-called troika (the EU, IMF, the ECB) is delivering its report this week. Without the next 8bn euros ($11bn; £7bn) Greece will be unable to pay its bills within weeks.

But the mood has hardened here. There is less fear of default.

The finance minister said on Wednesday that "what the country is going through is really tragic".

Greece will continue to miss the deficit targets set by the troika. The ECB can continue to demand that Greece raise taxes and cut spending by even more, but further austerity-punishment will not help. At some point very soon Germany is going to have to make a simple decision: does it, for its own self-interest, come up with the money needed to fix this crisis, irrespective of what's happening in Greece; or does it say no, and elevate the crisis by an order of magnitude. I wish I had confidence in the answer.

10--The Mysterious Drop in the Saving Rate, CEPR

Excerpt: The NYT told readers that the saving rate has fallen sharply in recent months, registering just 3.6 percent in September, down from rates of more than 5.0 percent earlier in the year. (In the pre-bubble era, the saving rate averaged more than 8.0 percent.)

The main reason for this decline was likely erratic income data. There are often erratic movements in these numbers that cannot be explained by actual developments in the economy. In the four months from January to May, a period in which the GDP data show the economy was barely growing, wage earnings reportedly increased at a 3.9 percent annual rate. By contrast, in the four months from May to September the data show that wage earnings rose at just a 0.4 percent annual rate even though the economy grew at a 2.5 percent rate in the third quarter.

This sort of sharp slowdown in wage earnings is not plausible in an economy where growth was actually accelerating. It is more likely that wages were understated in September and indeed the whole third quarter, which means that income growth would be stronger and that the savings rate would be higher.

It is also worth noting that some of the story here reflects the timing of car purchases. Car sales were depressed in the second quarter because os shortages related to the earthquake/tsunami in Japan. The third quarter sales were strong as manufacturers had big sales incentives to make up for lost ground.

11--Income Excluding Government Transfers Drops Again, WSJ

Excerpt: The economy’s third-quarter growth spurt has many economists saying the U.S. dodged the recession bullet. Not so fast, says at least one dissenter.

Yes, consumers and businesses are spending more, Thursday’s report on gross domestic product showed. But look deeper, especially at Friday’s data on household income, and the picture is more troubling, and indeed could point to a looming recession, says economist David Rosenberg of Gluskin Sheff & Associates Inc.

Even though consumer spending makes up most economic activity, Mr. Rosenberg argues the focus should be on income rather than spending in determining the health of the economy. And in that regard, the data don’t look good.

The main category to consider is “real personal earnings less government transfers,” Mr. Rosenberg says. Essentially, that’s income minus Social Security, Medicare, unemployment insurance and other government aid. What’s left is the bulk of consumer income Americans are actually earning.

The “real personal earnings less government transfers” category is among the host of indicators the National Bureau of Economic Research tracks in determining business cycles.

Friday’s Commerce Department report shows that personal income indicator has declined for three consecutive months — at a 2% annual rate. In the past, such steep drops in that category have been followed, three-quarters of the time, by a recession, according to Mr. Rosenberg’s research.

So while consumers boosted spending in the third quarter, they pulled it off by dipping into their savings and spending government dollars, not by earning more money at work. Mr. Rosenberg says stagnant wages, plunging consumer confidence, and low expectations for wage growth are a recipe for a dramatic drop in consumer spending in coming months.

“Absent the decline in the savings rate, consumer spending in real terms would have actually contracted over the past three months,” Mr. Rosenberg says. That won’t hold for long, he says. “Unless income picks up, I would expect spending to contract over the next several months,” Mr. Rosenberg says

12--The Spending-Income Shortfall, WSJ

Excerpt: A boost in consumer spending is largely what fueled the 2.5% growth in GDP in the third quarter. But the spending boost wasn’t accompanied by a similar increase in income, according to new data Friday by the Commerce Department. In September, for example, disposable personal income — the money left over after taxes and other payments to the government — edged up just 0.2% from a year earlier, when adjusted for inflation. Meanwhile, inflation-adjusted consumer spending jumped by 2.2% from September 2010. The report suggests that Americans are dipping into savings, rather than relying on higher wages, in order to boost spending, a trend that economists say is not sustainable in the long term. (See chart)

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