Friday, October 28, 2011

Weekend links

1--To forgive is divine, Credit Writedowns

Excerpt: This is to say we do not think the European agreement ends the debt crisis and there will be the need for an other emergency summit in the not-to-distant future. Exaggerated growth forecasts and inflated privatization revenue projections will require additional adjustments going forward. The agreements in principle still needs the details to be worked out, but the broad outline is less than the shock and awe that would rebuild the lost credibility. At least twice earlier this year, European officials said they would present a comprehensive solution and finally put some closure on the debt crisis. At least twice this year they have failed and we are not confident that the third time is a charm.

The 50% haircut to private sector Greek bond holders is unlikely to be the last. Even by their own admission, the Greece's debt to GDP will be 120% in 2020. That is twice the Stability and Growth pact cap of 60%. That is simply not a sustainable solution.

Ironically the ECB purchases of Greek bonds and its refusal to accept a haircut means that the private sector has to take a bigger haircut to reduce Greece's overall debt burden. The market does not know how much Greek bonds the ECB owns. The guesstimate 70-75 bln euros. That is roughly 20% of Greece debt that will not be lowered. It is as if the Federal Reserve carried it Maiden Lane assets at face value not market value.

2--Another Bear Market Trap, Credit Writedowns

Excerpt: The EU itself in its release calls the plan a "broad agreement" to increase bank reserves. We would emphasize the word "broad." Banks would be recapitalized subject to the approval of a number of policies still to be determined. It intends to broaden the rescue fund to a trillion Euros, ask Greek bondholders to take a haircut of at least 50% and force the banks to recapitalize by June 30th. How all of this is going to happen remains unclear. And the haircuts apply only to Greek debt. The hope is that the markets would gain enough confidence to ring-fence Spain and Italy from following in Greece's footsteps. The markets have bought the story so far, but how long that feeling lasts is highly uncertain, particularly in view of the violent nature of recent trading.

As for the U.S. economy, although we've seen a small recent bump following the summer debt-ceiling circus, the economy remains in the doldrums. Consumer confidence remains near all-time lows as a result of the weak labor market. Consumer spending has improved somewhat lately, but only because households lowered their savings rates. Personal income is still scraping along the bottom. Core capital goods expenditures were up, but surveys indicate the business investment may slow in coming months. Confidence in the small business sector is still at historical lows. Recent unwanted inventory accumulation may also point to a coming slowdown in production. Housing is scraping along the bottom and may drop even more as the foreclosure backlog comes on to the market.

The economic sectors that have shown some recent improvement are generally coincident or lagging indicators while leading indicators appear to be showing some weakness. The ECRI Weekly Leading Indicator is at levels indicating a recession ahead. This indicator has a good record of predicting past recessions and has never forecast one that didn't occur. If this prediction is accurate, we will be going into a recession in such a fragile economic environment that we would expect any recession to be severe. Some of the statistics are; 9.1% unemployment, 22% of homeowners underwater, about 5 million homes in inventory or shadow inventory, home prices continuing to decline, and debt (all sectors) at historically high levels.

3--The Creeping Eurozone Credit Crunch, Credit Writedowns

Excerpt: Here’s a very informative chart via Morgan Stanley showing the deterioration in the Eurozone’s key credit indicators. Banks will no doubt sell assets, at least in part, as a way to meet their required capital targets. (See charts)

4--Foreigners Sell Second Largest Amount Of US Bonds Ever In Past Week, Record $93 Billion In US Paper Sold In Past 2 Months, zero hedge

Excerpt: According to today's update in the H.4.1, the total amount of securities held in the custodial account for foreign official and international accounts just plunged by $20 billion, of which $19 billion was attributable solely to Treasurys: the second largest weekly dumb ever. And since this total number includes both Treasurys, which are used for political purposes, as well as Agency securities, which don't really serve much in terms of a diplomatic statement but are great at shoring up liquidity, one can assume that the relentless selling in all types of US paper has had one purpose only: to generate capital. As the third chart shows, that amount is substantial: in the last 8 weeks foreigners have sold a unprecedented $93 billion across the custodial account bringing it to $3.392 trillion, the lowest since March 2011! So the next time someone asks where European banks are finding emergency liquidity now that commercial paper, money market and Libor Markets are all dead, you will have the answer.

5--China on ‘Bigger, Faster Treadmill’: Chanos, Bloomberg

Excerpt: China is on “a bigger and faster treadmill” than ever as a slowdown in the property market has already started, said Jim Chanos, president and founder of $6 billion hedge fund Kynikos Associates Ltd.

“The Chinese are beginning to realize that property prices can go down as well as up and this is going to be a very, very troubling development for the Chinese property market,” said Chanos in an interview from Singapore with Susan Li on Bloomberg Television today.

China’s home prices gained in fewer than half of the 70 cities monitored by the government in September for a second month as sales eased after government curbs this year to keep housing affordable and prevent an asset bubble. ...

Real estate transactions in September, October, in the tier-one, two and three cities the firm tracks are down 40 percent to 60 percent year on year, said Chanos, who had predicted the market may crash as early as 2010.

“The property slowdown or worse has started,” he said. “The question is how is it resolved.”

6--The Euro Area Precedent for Policy Failure, The Wilder View

Excerpt: Last weekend, a leaked Troika report (Troika = ECB + EC + IMF) revealed that European policy makers now comprehend that the Greek policy prescription is not working (bold by yours truly):

The growth and fiscal policy adjustments assumed under the program individually have precedent in other countries’ experience, but experience to date under the program suggests that Greece will not be able to set a new precedent by realizing at the same time and from very weak initial conditions a large internal devaluation, fiscal adjustment, and privatization program.

Rob Parenteau and Marshall Auerback sum up the implications of this point (1 A.):

On the first page of the document is not only a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece, but there is also a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.

I agree with Rob and Marshall – the grand plan does not work. Greece will (of course) not be able to set a new precedent of public sector and private sector deleveraging amid weakening external demand and a fixed exchange rate. However, I’d like to focus here on the ‘precedent in other countries’ experience’. What precedent?...

Finally, I leave you with a potent illustration of what not to do when it comes to fiscal austerity: Portugal vs. France.

(chart) Portugal was doing all right – better than France, even – until they ran into 2010 financial stability problems that forced the government to start ‘cutting’. Portugal started to contract in Q4 2010, applied for funding in April 2011, and contracted thereafter. Economic Intelligence Unit sees Portugal contracting throughout 2012 (no link). The Euro area prescription for austerity is tantamount to economic collapse amid a fixed exchange rate and meager global growth prospects.

The EA policy plan for fiscal austerity is setting a precedent, all right, a precedent for policy failure.

7--Could be worse, Econbrowser

Excerpt: The Bureau of Economic Analysis reported today that U.S. real GDP grew at an annual rate of 2.5% during the third quarter of 2011. That's below the average postwar growth rate of 3.2% and well below the 4.3% growth for an average expansion quarter. Even so, it's better than any of the previous 3 quarters, and better than many analysts had been expecting when the quarter began in July....

The growth in 2011:Q3 GDP was led by solid consumer spending and encouraging strength in business purchases of equipment and software, with the latter contributing 1.2 percentage points to the 2.5% total all by itself. An investment- and net export-led recovery would be the ideal scenario, if it can continue. Inventory cutbacks subtracted 1.1%, which means that real final sales registered an encouraging 3.6% annual growth rate and suggests that fourth-quarter GDP growth could be better than the third. Housing remains stuck in its own depression, but since there's no quarter-to-quarter change, it's making no contribution, positive or negative, to the observed GDP growth rates. And no, the chart below has not mistakenly omitted the government sector's contribution to third-quarter growth-- the slight increase in federal defense spending was exactly offset by cuts in other categories of federal, state, and local spending, for a net contribution from this sector of exactly zero. (charts)

8--What are those Italian bonds telling us?, Pragmatic Capitalism

Excerpt: Equity markets are rightfully celebrating the fact that, in the near-term, a full blown banking crisis with private sector contagion has been avoided. But we shouldn’t get too far ahead of ourselves here. An interesting development in response to this Euro package is the Italian bond market. The bond vigilantes are shrugging their shoulders at this. As you can see in the chart below, yields on the 10 year Italian bond initially fell, but have since recovered all of their lost ground since the announcement last night. What’s going on here? Why are the equity markets responding so favorably while the bond market barely budges? I think the message from the Italian bond market is quite clear – this is not a real solution to the Euro crisis. Equity markets are more hyperbolic and looking at the near-term. One is saying, “the coast is clear for now” while the other market is saying “there is much work to be done here”.

Bond vigilantes in Greece have already learned the lesson from this crisis. The ECB’s current strategy cannot stop yields from surging in the case of worsening budgets. If the ECB wants to control the yields on these periphery debts they need to set the rate and be a willing buyer in any size at that rate. This would be a step towards fiscal union and unfortunately, the Germans won’t have that. They’d rather backstop their banks, impose austerity and hope that this crisis resolves itself. Wishful thinking if you ask me and the Italian bond vigilantes seem to agree.

The Italians have made bold targets for the coming months. It’s eerily reminiscent of the targets the Greeks have been setting for years now. Can they grow their economy during a balance sheet recession while the government sector contracts? The math says no and talk is cheap. The Greek experiment confirms this. Italian bond markets are shrugging their shoulders at this plan. While it may be a step in the right direction, it is by no means a real fix. The question now is how long before the bond vigilantes get impatient and force the EMU leaders into truly bold action?

9--Student Loans, Social Security and Debts You Carry for Life, Rortybomb

Excerpt: According to the Project on Student Debt, the average debt load for graduating seniors in 1996, when this law was passed, was $12,750. Now it is over $23,200. Also note that, post-1991 and upheld by the Supreme Court in 2005 as it regards Social Security payments, student loan collection has no statute of limitations. This is one of the very few kinds of debts without such limitations. As this site puts it, ”Creditors and debt collectors have a limited time window in which to sue debtors for nonpayment of credit card bills… In most states, the statute of limitations period on debts is between three and 10 years.” But in this case, the Department of Education notes, ”[b]y virtue of section 484A(a) of the Higher Education Act, statute of limitations of no kind now limits Department’s or the guaranty agency’s ability to file suit, enforce judgments, initiate offsets, or other actions, to collect a defaulted student loan.”

It is impossible to discharge bad debts in this system under our normal mechanism for handling bad debts — bankruptcy. When delinquencies happen — say when you graduate into a recession that elites refuse to fix — you get thrown into the fee-churning world of private debt collection. This world was memorably described by law professor Ronald Mann as a “sweat box” of fees and other ways of increasing the total debt owed. With fees churning, there’s no date after which creditors can no longer go after your student loan payment, and they can even go after the baseline measure society has created to prevent poverty in old age.

Now with all this in mind, let’s quickly examine the New York Fed’s recent release of its Quarterly Report on Consumer Credit, specifically this delinquency data: (Chart)

Student loan delinquencies look to be slowly increasing over time, while credit cards and mortgages go up and down. On the flip side of this dynamic is the amount of loans being “charged off” by private institutions. These are loans that will never be fully replayed, and a cost-benefit analysis tells the lender that it is no longer worth trying to collect the full amount. These are tough estimates to get, but Karen Dynan of the Brookings Institute has one estimate in her “Household Deleveraging and the Economic Recovery”:

As credit card and housing debt become unbearable, there’s a point at which they get written down. That point is too high, but because of various laws regarding debt collection that shift the strategy and potential end results between the actors, there’s a logic to it. As far as I can tell, there’s simply no equivalent chart, or even logic, for student loans. Because of legal choices we’ve made in how to set up this relationship, it stays forever, is virtually impossible to discharge under hardship, churns fees when it goes bad, and creditors can get to anything, including Social Security, to get it repaid. Meanwhile, we have a Great Depression-like event that is throwing college graduates into a labor market that is far too weak.

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