Tuesday, November 8, 2011

Today's links

1--Insight: Euro has new politburo but no solution yet, Reuters

Excerpt: The French are convinced that Merkel understands the ECB will have to be more centrally involved in fighting bond market contagion, but she cannot get it through her divided coalition for now. They see the ECB as the main center of resistance.

After hearing a chorus of Obama, Cameron and the leaders of India, Canada and Australia at the G20, Merkel acknowledged that the rest of the world found it hard to understand that the ECB was not allowed to play the role of lender of last resort.

But the crisis may have to get still worse before the Germans and the ECB relent, if they ever do.

2--For Markets in Europe, the Focus of Fear Moves to Italy, NY Times

Excerpt: Even as Greece reached an agreement on Sunday to form a coalition government meant to avert the collapse of the latest bailout plan for the euro zone, investors are still demanding greater certainty on how Europe would pay for a rescue package aimed at stopping the Greek financial contagion from spreading to Italy or Spain.

“This is a bit of a sideshow,” Mark D. Luschini, chief strategist at Janney Montgomery Scott, said of the shifting political leadership in Greece. “Markets will react favorably to this, but they won’t rally hard on the news. Italy is the bigger issue.”

In the United States, credit markets tightened earlier this year during a political stand-off over the debt ceiling and the ratings downgrade of the country’s long-term debt by Standard & Poor’s, but conditions have eased since then....

The yield on 10-year Italian notes has surpassed that on Spanish debt, reaching 6.35 percent on Friday after leaders at a meeting of the Group of 20 nations failed to come up with details on how to stop the European crisis from spreading. The rising yield is troubling because once the interest rates on the debt of the bailed out countries Greece and Portugal surpassed 7 percent they shot up far higher, requiring those countries to turn to outside sources of financing. Rates on their debt remain in double digits.

At the end of last month, Italy issued 3 billion euros worth of bonds at an interest rate of more than 6 percent, about 1.5 percentage points higher than it had had to pay as recently as the summer. The extra bond yields are adding as much as 3 billion euros (about $4.1 billion ) annually in additional interest payments, estimates Tobias Blattner, a former economist at the European Central Bank who is an economist at Daiwa Securities in London.

Analysts are concerned that if interest rates on Italian debt keep rising, the country may no longer be able to afford to borrow on the open markets and instead would have to turn to official lenders like the European Union or the International Monetary Fund.

3--Euro Finance Chiefs Focus on ‘Bazooka’ Fund, Bloomberg

Excerpt: European finance chiefs return to Brussels today on a mission to convince global leaders that they can shield countries such as Italy and Spain from the spreading debt crisis by bulking out their bailout fund.
As political turmoil envelops governments in Athens and Rome, finance ministers from the 17-member euro area will work on the details of plans to increase the muscle of the European Financial Stability Facility. Leveraging the fund would aim to ramp up spending capacity to 1 trillion euros ($1.4 trillion).

European leaders’ failure to resolve the two-year-old debt crisis threatens to drag down the global economy and trigger another financial downturn. World leaders at a Group of 20 meeting last week demanded euro governments do more to staunch the turmoil -- including fleshing out how an expanded EFSF would work -- before they commit fresh cash to the region.

“The leveraged EFSF may still turn into a bazooka, but so far it looks more like a water pistol,” Joachim Fels, Morgan Stanley’s chief global economist in London, wrote in a note to clients yesterday. While ministers may furnish some detail on how the fund operates, “don’t hold your breath,” he wrote.,,,,

Although EU officials have said an agreement on EFSF leveraging won’t be finalized today, finance ministers will discuss technical details on how to partly insure bond sales and set up a special investment vehicle to draw outside money. European leaders outlined plans at an Oct. 26-27 summit.

4--Interest Rates on Italian Bonds Pushed to New Levels, NY Times

Excerpt: Is the endgame near for Italy?

Interest rates on Italian bonds rose to euro-era records on Monday, close to the level that have forced Greece, Ireland and Portugal to seek financial rescues.

Most economists do not expect Italy to plead for a bailout yet. Instead, they say they think the higher rates will force the European Central Bank or other European neighbors to intervene more forcefully with measures to push down rates.

The yields on Italy’s 10-year bonds, a measure of investor anxiety about lending money to the country, rose to 6.63 percent at one point during trading on Monday. Five-year yields were even higher, at 6.65 percent, up half a percentage point on the day. The two-year yield also rose, to 5.9 percent.

Economists and investors say the dynamic is worrying. They fear the higher rates may incite bond clearing houses — the middlemen between buyers and sellers of the bonds — to demand higher collateral payments from traders of Italian debt. That, in turn, could lead to a further damaging spike in interest rates. Higher rates also threaten to sap Italy’s long-term ability to support its debt load, nearly 120 percent of its annual economic output at the end of last year, which is among the highest for countries that use the euro currency.

“This is feeding on itself,” said Eric Green, an economist at TD Securities. “It continues to put pressure on Italy.”

Bond rates are being driven by investors’ doubts that Prime Minister Silvio Berlusconi of Italy can push through sweeping changes to improve economic growth, including making pensions less generous and selling off some of the country’s assets. The measures are widely considered necessary to tackle Italy’s heavy debt load and revive its stagnating economy.

5--From Nick Timiraos at the WSJ: Nevada Foreclosure Filings Dry Up After ‘Robo-Signing’ Law, Calculated Risk

Excerpt: Foreclosure filings in Nevada plunged in October during the first month of a new state law stiffening foreclosure-processing requirements.
...

Nevada’s state Assembly passed a measure that took effect on Oct. 1 ... the Nevada law makes it a felony—and threatens to hold individuals criminally liable—for making false representations concerning real estate title. Individuals are also subject to civil penalties of $5,000 for each violation.
...
The Nevada law makes an important technical change to those rules by forbidding trustees from handling foreclosures if the trustee is a subsidiary of foreclosing bank.

BofA uses ReconTrust, a wholly owned subsidiary, to handle foreclosures. With this new law, BofA will have to use another trustee.

6--Italy: 10 Year bond yields continue to increase, Calculated Risk

Excerpt: In October 2010, the Irish 10 year yield moved above 6.6%, and by the end of November the yield hit 9% and Ireland asked for help.
Now the Italian 10 year yield is at 6.65% and there is a sense of deja vu.
From the NY Times: Italy Bonds Push Higher

Interest rates on Italian bonds rose to new euro-era records on Monday, close to the level that earlier forced Greece, Ireland and Portugal to seek financial rescues.

And from the WSJ: Reasons to Be Fearful as Italian Yields Spike
Greek, Irish, and Portuguese 10-year bond yields spent an average of 43 trading days above 5.50% before they climbed above 6.00%, notes Gary Jenkins, head of fixed income at Evolution Securities.

The move to 6.50% took 24 days, while the move to 7.00% was even quicker, taking just 15 days, he said. An Italian treasury bill sale on Thursday will be a good test.

Italy's deficit to GDP is only around 4% - that is much lower than the other countries in trouble. But Italy already has a high debt to GDP ratio (around 118%), and slow (or no) growth ... not a good combination.

7--US State Balances Of Payments, Paul Krugman, NY Times

Excerpt: A number of readers have asked why the United States doesn’t have internal problems with balance of payments imbalances comparable to those afflicting the euro zone.

I’ll try to put together a more thorough analysis in a few days. But there was actually a lot of discussion about these issues two decades ago, when Europeans were launching their big drive for monetary union and skeptical Anglo-Saxons were saying hey, are you sure about this?

At the time, there were two big stories; now we have to add a third.

First, we have huge interregional labor mobility. (Blanchard and Katz (pdf) is the classic reference). This helps in the boom as well as the slump: when there’s an inrush of money into a state, that draws in workers, but does not do too much to drive up wages relative to the rest of the country. That way, when the music stops, costs aren’t as much out of line as they are in, say, Spain right now.

Second, fiscal integration: booming states pay a lot in taxes, slumping states get a lot of automatic transfers.

Finally, what we’ve learned now is that an integrated banking system and common deposit insurance / FannieFreddie and all that mean that the vicious circle running through sovereign debt and banks is a lot less severe.

What all this comes down to, of course, is that a common currency has a much better chance of working if you actually have a nation.

8--Who Rules the Global Economy?, Nancy Folbre, NY Times via Economist's View

Excerpt: ...Three Swiss experts on complex network analysis have recently examined the architecture of international ownership, analyzing a large database of transnational corporations. They concluded that a large portion of control resides with a relatively small core of financial institutions, with about 147 tightly knit companies controlling about 40 percent of the total wealth in the network. ... An article in the British magazine New Scientist describes the research as evidence of a global financial oligarchy. ...

A recent article in the socialist journal Monthly Review, by John Bellamy Foster, Robert W. McChesney and R. Jamil Janna, criticizes both mainstream and left-wing economists for their lack of attention to monopoly power.
Focusing on the United States, they note that the percentage of manufacturing industries in which the largest four companies account for at least 50 percent of shipping value has increased to almost 40 percent, up from about 25 percent in 1987.

Even more striking is the increase in retail consolidation, largely reflecting a “Wal-Mart effect.” In 1992, the top four companies accounted for about 47 percent of all general merchandise sales. By 2007, their share had reached 73.2 percent.

Banking, however, takes the cake. Citing my fellow Economix blogger Simon Johnson, the Monthly Review article notes that in 1995, the six largest bank-holding companies (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley) had assets equal to 17 percent of gross domestic product in the United States. By the third quarter of 2010, this had risen to 64 percent. ...

Public concerns about economic concentration are stoked by hard times. Congress authorized a full-scale investigation of the topic back in days of the Great Depression. Seems like the time has come for a fully international update.

9--Revolving credit outstanding falls to lowest since ’04, The Big Picture

Excerpt: Revolving consumer credit (mostly credit card debt) outstanding fell a slight $600mm in Sept from Aug but to the lowest level since Aug 2004 at $789.6b. Nonrevolving credit outstanding (mostly auto and student loans) rose by $8b. While nonrevolving debt outstanding has picked up coincident with the improvement in auto sales and persistent rise in student loan debt, through a combination of reduced credit lines, more use of debit cards and debt paydown, the amount of credit card debt taken on continues to decline. As a % of nominal GDP, revolving consumer credit outstanding is currently 5.2%, down from the peak of revolving debt in ’08 at 6.8%. At 5.2%, it’s the lowest since Q3 1995 but still remains above the level of 4.0% in 1990 and 2.9% in 1985.

10--Sizing the mortgage default mess, FT Alphaville

Excerpt: New York Times’ Joe Nocera has spoken to FT Alphaville favourite Laurie Goodman of Amherst Securities Group and is now convinced of the need for principal reductions to clean-up the US mortgage mess. More…
The New York Times’ Joe Nocera has spoken to FT Alphaville favourite Laurie Goodman of Amherst Securities Group and is now convinced of the need for principal reductions to clean-up the US mortgage mess.

Nocera’s column on Monday contains some startling statistics from Goodman:
Her [Goodman's] truth begins with a shocking calculation: of the 55 million mortgages in America, more than 10 million are reasonably likely to default. That is a staggering number — and it is, in large part, because so many homes are worth so much less than the mortgage the homeowners are holding. That is, they’re underwater.

Her second calculation is that the supply of housing is going to drastically outstrip demand for the foreseeable future; she estimates that the glut of unneeded homes could get as high as 6.2 million over the next six years. The primary reason for this, she says, is that household formation has been very low in recent years, presumably because of the grim economy. (Young adults are living with their parents instead of moving into their own homes, etc.) What’s more, nearly 20 percent of current homeowners no longer qualify for a mortgage, as lending standards have tightened.

Nocera argues that we’re close to a “housing death spiral”: house prices fall –> more borrowers become underwater –> more defaults and foreclosures –> house prices fall further.

This leads Nocera, like Goodman, to advocate for principal reduction. Harp II, with its lack of ambition, may help a little but interest rate modification doesn’t solve the fundamental problem — underwater homeowners, says Nocera.

For more on this line of reasoning and the data behind it (“more than 10 million are reasonably likely to default”), check out Goodman’s September testimony to the House Subcommittee on Housing, Transportation and Community Development, which Nocera embeds in his column. It’s an excellent analytical short summary of the US housing market and comes highly recommended.

Goodman starts from the basis that of the 80m homes in the US, 55m have mortgages. She thus divides the mortgage market as follows:

– 4.5m non-performing loans
– 3.9m re-performing loans (RPLs, i.e. those were previously 60+ days delinquent but are now being paid)
– 2.6m always performing loans with LTVs greater than 120 per cent
– 5.4m always performing loans with LTVs between 100 and 120 per cent
– 38.6m always performing loans with LTVs less than 100 per cent

Goodman then estimates likely default rates for each of these categories. Her methodology is exhaustively detailed in the appendix.

Her inclusion of RPLs is especially important — too often our focus is just on NPLs, such as those on second mortgages. But, in essence, Goodman argues that most RPLs are NPLs, they just don’t know it yet. In the appendix she notes that “over the past 3 months, 47.2 per cent of the re-performers (on an annualized basis) have again transitioned to delinquent status” and 44.6 per cent of RPLs are either delinquent or in default after two years.

Tallying all this up provides this useful table and the headline stats Nocera refers to in his column (click to expand):chart

Our results indicate if no changes in policy are made, 10.4 million additional borrowers are likely to default under our base “reasonable” case, and 8.3 million borrowers will default under our lower bound numbers. Since there are 55 million homes carrying mortgages, 10.4 million borrowers roughly equates to 1 borrower out of every 5. This includes 4.1 million of the 4.5 million borrowers who are already non-performing; the remainder of defaults will come from borrowers current on their loans, but who are likely to eventually default. Many in this group (2.5 million) represent re-performing loans that history suggests are very prone to another default.

Goodman says she has made conservative assumptions. Let’s, for example, look at what she assumes for NPLs and RPLs, which together comprise two-thirds of future defaults, according to Goodman. Current experience would suggest default rates of over 99 per cent and 94.7 per cent on NPLs and RPLs, respectively. However, Goodman’s “reasonable estimate” is 90 per cent for NPLs and 65 per cent for RPLs. The RPL estimate could be contested but it’s definitely not outside the bounds of possibility. The more serious problem with the assumptions is, as Goodman implies, the time scale — she assumes an “arbitrary” six year window but given the current pace of events it could easily have take even longer to get through the inventories of delinquent and defaulted homes.

What to do, then, with those 10m underwater borrowers?

On the supply side, there’s principal reduction, which in spite of the moral hazard risk, might just be the least worst idea around right now.
But we need a demand side solution as well, says Goodman. Thus, she proposes regulatory changes to encourage more large scale private sector home purchases, which can then be rented out. She makes a strong case but we’re not sufficiently smart sighted to understand the full ramifications.
Other than to note it echoes Morgan Stanley’s call that “The beginning of the rentership society is upon us,” as the FT reports in an analysis piece on the state of the US housing market.

The end of the home ownership dream, redux.

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