Friday, October 14, 2011

Weekend links

1--Bankers’ Salaries vs. Everyone Else’s, New York Times

Excerpt: It shows that the average salary in the industry in 2010 was $361,330 — five and a half times the average salary in the rest of the private sector in the city ($66,120). By contrast, 30 years ago such salaries were only twice as high as in the rest of the private sector.
Last year helped contribute to the widening of that gap, too.
That’s not to say that bankers have job security.

The overall financial services sector was disproportionately hit by the financial crisis. The sector employs just 12 percent of the city’s work force, but accounted for one out of every three jobs lost in the recession. Some (not all) of those jobs were regained, but the comptroller’s office says the industry “is likely to experience significant job losses over the course of the next year.”

2--Congress Ends 5-Year Standoff on Trade Deals in Rare Accord, New York Times

Excerpt: Congress passed three long-awaited free trade agreements on Wednesday, ending a political standoff that has stretched across two presidencies. The move offered a rare moment of bipartisan accord at a time when Republicans and Democrats are bitterly divided over the role that government ought to play in reviving the sputtering economy.

The approval of the deals with South Korea, Colombia and Panama is a victory for President Obama and proponents of the view that foreign trade can drive America’s economic growth in the face of rising protectionist sentiment in both political parties. They are the first trade agreements to pass Congress since Democrats broke a decade of Republican control in 2007.

All three agreements cleared both chambers with overwhelming Republican support just one day after Senate Republicans prevented action on Mr. Obama’s jobs bill.

The passage of the trade deals is important primarily as a political achievement, and for its foreign policy value in solidifying relationships with strategic allies. The economic benefits are projected to be small. A federal agency estimated in 2007 that the impact on employment would be “negligible” and that the deals would increase gross domestic product by about $14.4 billion, or roughly 0.1 percent....

Economists generally predict that free trade agreements, which eliminate tariffs and other policies aimed at protecting domestic manufacturers, benefit all participating nations by creating a larger common market, increasing sales and reducing prices. But such deals also create clear losers, as workers lose well-paid jobs to foreign competition.

3--Weekly Initial Unemployment Claims at 404,000, Calculated Risk

The DOL reports:

In the week ending October 8, the advance figure for seasonally adjusted initial claims was 404,000, a decrease of 1,000 from the previous week's revised figure of 405,000 [revised up from 401,000]. The 4-week moving average was 408,000, a decrease of 7,000 from the previous week's revised average of 415,000.

4-- Three-Month Dollar Libor Climbs for 25th Day; TED Spread Widens, Bloomberg

Excerpt: The rate at which London-based banks say they can borrow for three months in dollars rose for the 25th straight day, reaching the highest level since August 2010.

The London interbank offered rate, or Libor, for dollar loans climbed to 0.403 percent from 0.401 percent yesterday, data from the British Bankers’ Association showed. That’s the highest since Aug. 9, 2010.

Credit Agricole SA submitted the highest rate today among the contributing panel of 19 lenders, at 0.4625 percent. HSBC Holdings Plc posted the lowest, at 0.2750 percent.

The dollar Libor-OIS spread, a gauge of banks’ reluctance to lend, was little changed at 31.8 basis points at 12:06 p.m. London time. The TED spread, or the difference between what lenders and the U.S. government pay to borrow for three months, widened to 39.29 basis points from 38.56 basis points yesterday. It reached 39.75 basis points on Oct. 11, the highest level since June 28, 2010.

5--What smaller government looks like in the US, Streetlight blog

Excerpt: Last week's employment report in the US contained a familiar story: the private sector continues to add jobs, albeit at a modest pace, while government layoffs continue to undo a portion of those job gains. In the absence of the current mania to reduce the size of government, the US labor market would have gained closer to 2 million jobs instead of the roughly 1.5 million actually created over the past year.

But it's informative to take a look at exactly which sort of government jobs are being cut. The following table tells the story. (See chart)
Over the past two years, government employment in the US at all levels (federal, state, and local) has fallen by a bit over half a million. Total federal employment has remained roughly constant (increased defense department jobs have made up for job losses elsewhere in the federal government), and employment by state governments has fallen by a bit. But local government employment has seen by far the largest change over the past two years, with local governments alone accounting for about 90% of all government job losses in the US. And of that, the majority of job losses are education jobs.

The US (along with many countries around the world right now) is currently going through a deeply unfortunate and harmful bout of fiscal contraction, right when it should be doing exactly the opposite. And by acheiving that fiscal contraction primarily by laying off teachers, it appears to have decided to do so on the backs of its schoolchildren.

6--Market Slumps After European Banks Admit They Can't/Won't Raise Capital; Will Proceed With Asset Liquidations Instead, zero hedge

Excerpt: From the Financial Times: Banks and their advisers said their scope to raise fresh capital from investors was all but non-existent. “I don’t think anyone has access to the markets now,” said one senior European investment banker. Investors are loath to commit to fresh equity injections, in the knowledge that the new money would simply be soaked up by sovereign debt writedowns, bankers said.

But by shrinking assets – the denominator of capital ratios – many banks believe they can reach the targets without resorting to government recapitalisation. In recent weeks, both BNP and SocGen have signalled plans to offload a combined €150bn of risk-weighted assets. Further businesses could now be sold. Italy’s Unicredit and Germany’s Commerzbank were likely to find themselves under most pressure to deleverage and divest assets, bankers said.

7--China: Continued Boom or Bursting Bubble, Credit Writedowns

Excerpt: While China was growing their economy by a phenomenal 2,800%, the US GDP grew from $2.3 trillion to $15 trillion – a mere 650% increase, of which 420% was due to inflation. There is no question that China’s progress has been remarkable. The question is whether that growth is sustainable and built upon a solid foundation.

In a February 2010 Casey Report article titled Is China’s Recovery a Fraud?, my thesis was the $2.1 trillion stimulus package rolled out by Chinese authorities after the 2008/2009 financial crash was leading to enormous malinvestment.

The officially announced stimulus package in November 2008 totaled $586 billion and was to be invested in key areas such as housing, rural infrastructure, transportation, health and education, environment, industry, disaster rebuilding, income building, tax cuts, and finance. In reality, the central government pumped an additional $1.5 trillion into the economy in an effort to maintain social stability through the subsidization of its industrial base. Chinese banks funneled cheap loans to state-owned enterprises in order to manufacture artificial profit margins to keep Chinese goods competitive and employment maximized. In the short term, the stimulus produced the desired effect.

Specifically, the Shanghai Index – which had topped out at 5,913 in October of 2007 and had fallen to a low of 1,678 by November 2008 – responded to the stimulus by rebounding to 3,300 in January 2010, as the chart below shows.

As with all monetary and fiscal stimuli, however, the initial high is always followed by a hangover. Today the Shanghai Index stands at 2,350, down 29% from when I penned my article. China is also experiencing accelerating inflation, a real estate bubble of epic proportions, a looming banking crisis due to the billions in bad loans made by Chinese banks as commanded by the Chinese government, and growing social unrest due to rising food and energy prices.

the trend is not improving: The latest data show year-over-year inflation surging by 6.4% in June and food prices skyrocketing by 14%. With annual disposable income of less than $2,500 in urban areas and just $600 in rural areas, food and energy account for a huge percentage of the average Chinese person’s daily living expenses. The Chinese authorities are terrified by the revolutions sweeping across the Middle East and are desperate to put out the inflationary fires.

To contain stubbornly high inflation, the Chinese central bank has raised the benchmark interest rate three times this year, including the latest rate hike of 25 basis points announced on July 6. In an attempt to rein in excess lending, it has also hiked the reserve requirement ratio six times, ordering banks to keep a record high of 21.5% of their deposits in reserve.
Even with inflation surging, the Manufacturing Output Index fell to 47.2 in July – the lowest in 28 months, and indicating contraction. China’s automobile industry, which overtook the US in 2010 with sales of 18 million autos, has experienced a dramatic slowdown, with growth of only 3% through June versus 32% growth last year. For all of 2011, the China Association of Automobile Manufacturers expects sales to decline versus 2010.

Real Estate Out of Reach

In response to the 2008 worldwide financial collapse, Chinese authorities unleashed $2.1 trillion of stimulus, or almost 33% of GDP. This compares to the US stimulus of $800 billion, or 5.5% of GDP, spent on worthless Keynesian pork. Unlike the US, where no jobs were created, China’s command-and-control structure funneled the stimulus into building cities, malls, roads, office buildings, and residential units. Millions of Chinese were employed in creating properties for which there was no demand. Moody’s approximates that China’s banks have funded at least RMB 8.5 trillion (US$1.3 trillion) of the RMB 10.7 trillion of outstanding local government debt, which was a significant portion of the 2008 national stimulus package. When the central authorities tell the banks to lend, the banks ask, “How much?” The result has been soaring real estate inflation and malinvestment.

The average size of a “cheap” apartment in second-tier Chinese cities is 60 square meters (650 sq ft) and fetches an average price of $1,230 per square meter, or $73,800. Mid-tier apartments in Shanghai or Beijing sell for $3,500 per square meter, or $210,000 for an average size apartment. “When prices are over 20 times more than annual household income, it’s not affordable,” says Andy Xie, an independent economist in Shanghai. Millions of working Chinese have been priced out of ever owning property and blame the corrupt local government cronies and connected speculators. Anger is simmering among the masses.

Moody’s cautioned that the non-performing loans on the balance sheets of Chinese banks could rise to between 8% and 12%, versus the 1% proclaimed by Chinese officials. China’s regulators have belatedly applied the brakes, but it is too late. The house of cards looks susceptible to just the slightest of breezes.

Fraser Howie, managing director at CLSA in Singapore, captured the essence of the coming collapse in his recent assessment:

If you are going to address the misallocation of capital in the banking system and credit system, that’s going to have huge knock-on effects on the profitability and viability of the banks. And if there were a major banking crisis, you would start to see money trying to get out of China.

What would the government do to maintain stability? You could have a whole host of problems. It’s almost far too complicated to contemplate.
There is one sure thing regarding bubbles: They always pop. It’s in their nature.

8--Will US consumer debt reduction kill the recovery, McKinsey Global Institute

9--Will internal devaluation work?, Credit Writedowns

Excerpt: Rob encouraged me to re-read Chapter 19 of Keynes’ General Theory, saying

“We know these deflationist arguments inside out. We know why lowering wages is unlikely to introduce a self-stabilizing return to a full employment growth path.”

I skimmed through Chapter 19 on “Changes in Money-Wages” as Rob suggested. Here’s the quote that bears remembering:

“the volume of employment is uniquely correlated with the volume of effective demand measured in wage-units, and that the effective demand, being the sum of the expected consumption and the expected investment cannot change, if the propensity to consume, the schedule of marginal efficiency of capital and the rate of interest are all unchanged. If, without any change in these factors, the entrepreneurs were to increase employment as a whole, their proceeds will necessarily fall short of their supply-price.”

Yes, that is where I was going with my thoughts yesterday on manufacturing inflation in a wage deflationary environment. I said that “until incomes rise enough to support the debt (numerator) or you get enough credit writedowns so that incomes support the debt (denominator), it’s not going to work.” What I meant was that we have household sector balance sheet problems. Unless you fix the debt/income number instead of the debt/GDP number, the balance sheet problem remains. Eroding the real burden of debt is dependent not on raising nominal GDP, but on raising nominal income to keep pace with consumer price inflation. A lot of economists are talking about ‘market-clearing’ wage prices, that is lowering incomes, to reduce unemployment. That will make the debt problem larger and leads to a debt deflationary outcome.

Bottom line: you won’t cut your way to prosperity. While you need to see a lot more credit writedowns to get through this crisis, the best one can hope for from the deflationary path is a reduction in debt from these defaults and writedowns with debt deflation attenuated by automatic stabilizers. This outlook is especially true when you see a collective debt reduction across a wide swathe of countries in both public and private sectors as we saw in the 1930s and as we are seeing again today.

10--Are household balance sheets as healthy as 2006?, Pragmatic Capitalism

Excerpt: “We have a major capital problem at the U.S. banking level. What Ben Bernanke and Hank Paulson are essentially proposing is an asset swap. The Fed will take on the toxic assets of the banks and they will receive reserves in exchange. This is important because it will alleviate the strains in the credit markets. That’s a good first step, however, it is not a solution to the problem at the household level and THAT is where the real economic weakness is. By introducing this asset swap idea Ben Bernanke is simply altering bank balance sheets. He is not fixing the economy.

So, the government has a partially correct solution. Not the BEST solution, but it gets to the core of the credit issues. They will essentially trade the bad paper for good paper and it will alleviate many of the pressures on the banks. As I have written here many times the banks are the lifeblood of the system. I like to think of the banks as the oil in the engine. If you run out oil the system begins to break down and eventually the engine stops running. You can’t have a healthy functioning economy if the banks aren’t lending. Unfortunately, because this won’t fix any problems at the household level it won’t induce any borrowing. So, it’s a clever way to resolve the banking crisis, however, it doesn’t fix the root of the problem which is at the household level. “

I am fairly certain that I am one of the few people who was saying this at a time when almost everyone in the world was saying that our primary problem was the banking crisis that could be resolved with monetary policy of some form (lower rates, more QE, GDP targeting, etc). What they failed to understand was that the real crisis was brewing at the household level and while monetary policy could alleviate the balance sheet problems, it would not fix it because it did not specifically target consumer balance sheets in a way that would serve to right the sinking ship in a timely manner.

So, the question that the quasi monetarists need to answer is not whether monetary policy has been debunked by the balance sheet recession theory, but how much monetary policy can actually help to generate a fix to the real cause of this crisis – the debt-laden U.S. consumer? And perhaps more importantly, they need to consider whether monetary policy is merely a supplemental policy in aiding the U.S. consumer or whether there are more effective approaches?

11--Europe eyes bigger Greek losses for banks, Reuters

Excerpt: Euro zone countries will ask banks to accept losses of up to 50 percent on their holdings of Greek debt, officials said on Wednesday, as part of a grand plan to avert a disorderly default and stem a crisis that threatens the world economy.

Ahead of a make-or-break summit of European leaders on October 23 at which a comprehensive new Franco-German crisis plan is expected to be discussed, four euro zone officials told Reuters that a "haircut" of between 30 and 50 percent for Greece's private creditors was under consideration.

That is far more than the 21 percent loss they had asked banks, pension funds and other financial institutions to accept in July as part of a second rescue package for Athens. Since then, the Greek economy has sunk deeper into recession, fanning fears of an outright default and forcing euro zone leaders to consider more radical action to stem their crisis.

To restore confidence in the banking system, they are also working on plans to shore up the balance sheets of banks through recapitalizations.

12--Special report: China's debt pileup raises risk of hard landing, Reuters

Excerpt: When China announced a nearly $600 billion package to ward off the 2008 global financial crisis, city planners across the country happily embarked on a frenzy of infrastructure projects, some of them of arguable need....

Local governments had amassed 10.7 trillion yuan in debt at the end of 2010. The government expects 2.5 to 3 trillion yuan of that will turn sour, while Standard and Chartered reckons as much as 8 to 9 trillion yuan will not be repaid -- or about $1.2 trillion to $1.4 trillion.

In other words, the potential debt defaults could be even larger than the $700 billion U.S. bail-out programme during the 2008 crisis.

Reuters reported in mid-year the government was working on a relief plan for local governments, including allowing them to tap the municipal bond market for the first time as an alternative to bank loans, which are becoming harder to get.

The risks of default are rising. Nearly 85 percent of the local government finance vehicle loans in northeast Liaoning province, for instance, missed debt service payments in 2010, an audit report posted on the Liaoning Daily website said....

SHADOW BANKING

Local officials need to keep their economies humming because they largely earn their Communist Party stripes with projects that boost employment and growth. With the loan spigots being turned off to rein in bubbly property prices, they face the prospect of housing projects grinding to a halt.
Enter the "shadow bankers". These are the underground lenders and trust companies who extend credit to people and companies that may not qualify for loans otherwise. They then slice and dice those loans into investment packages, akin to what American banks did with sub-prime mortgages for much of the past decade.

Credit Suisse last week described the burgeoning growth of informal lending as a "time bomb" that posed a bigger risk to the Chinese economy than even the local government debt pileup.

Credit Suisse estimated the size of China's informal lending at up to 4 trillion yuan, equivalent to around 8 percent of above-board bank lending. Interest rates on these loans runs as high as 70 percent and they are expanding at an annual rate of about 50 percent.

The shadow bankers have lent 208 billion yuan to real estate developers so far this year, nearly as much as formal bank lending of 211 billion yuan. The risks, analysts say, is that even healthy developers become vulnerable to a liquidity crisis, given the short tenor and high rates of these loans.
Formal banks have transferred some risky loans off their balance sheets to the shadow banking industry. As a result, Fitch Ratings has warned, lending has not slowed down as much as official data suggests -- and as Beijing would like.

Official banks have also been restructuring and reclassifying loans to dress up their books, analysts said. For example, they now get to classify local government borrowings as corporate loans, which allows them to set aside less in provisions and thus add to their quarterly earnings.

According to Chinese media reports, banks plan to reclassify 2.8 trillion yuan worth of loans.

"Banks have to admit to some NPLs (non-performing loans), but they don't want to admit it because regulators are allowing them to restructure these loans," said Victor Shih, a professor at Northwestern University in Chicago who has written a book on China's financial system

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