Thursday, November 17, 2011

Today's links

1--Asian Stocks Fall After Fitch Says Europe Crisis Threatens U.S. Banks, Bloomberg

Asian stocks fell for a third day, with the regional benchmark heading for the lowest close in four weeks, after Fitch Ratings said a worsening European debt crisis poses a “serious risk” to U.S. banks, stoking concern about the global financial system...

“This is a bad case for Europe and growth forecasters who were optimistic are definitely cutting back,” said Matt Riordan, who helps manage close to $6.4 billion in Sydney at Paradice Investment Management Pty. “We are going into quite a difficult point where some sort of a new strategy might be required.”

2--David McWilliams on Irish (and Italian) euro exit, credit writedowns

Excerpt: Consider what the two-speed Europe might look like.

The first thing we know is that the peripheral countries can’t keep up with Germany. Take Ireland as an example. When we had the Punt linked to the Deutsche Mark we devalued six times in thirteen years just to try to keep up competitively with the Germans. Conversely, when we joined the Euro and could not devalue, we lost 30% competitiveness against Germany. It could not be clearer.

For the other peripheral countries the situation is worse.

So we all need a change in the value of the currencies we trade in to make our companies more competitive and thus, more likely to export. In tandem, we need to make imports more expensive so we don’t buy too many of them. The weaker exchange rate achieves this. Devaluations work. And to any one who doubts this, just point to the lasting competitive gains garnered by Finland and Sweden after their 1992 devaluations.

Without currency change, we can’t keep up with the Germans and this makes the EU’s promise of economic convergence hard to achieve without huge borrowing. Up till now, we borrowed to achieve a lifestyle and a level of economic activity. Now none of us can pay this money back.

So we need debt forgiveness or some debt deal. Accompanying the new euro would be mass debt write downs because if you reduce the value of the currency that the people get paid in but you don’t commensurately reduce the value of their outstanding debts, the people will simply not be able to pay and the country will default after the devaluation. This would not be clever. Everything must be done together.

So let’s think about the new euro. The new soft euro would trade at 70% of the old one (my figure plucked out of the air). This would mean that relative to Germans, our standard of living would be cut by one third overnight. We would achieve in one night what the present policy seeks to do in five years.

We would be extremely attractive place to investment in because our labour would be much cheaper. But don’t forget that this reduces our income by the same amount.

All our debts would be reduced by 30% because they would be in a new currency. Obviously, the banks that lent in hard euros and would now get paid in soft euros would carry a huge exchange rate loss. This would need to be dealt with. Possibly, the banks in each country could issue bonds backed by the EU and redeemable for new euros at the ECB. These bonds could be considered capital so that the banks didn’t go bust.

What about the savers who lost out on their stock of old euro saving which would be devalued by 30% when converted into the new euro? They could be given new inflation-linked euro bonds issued by the State and redeemable from the ECB but not straight away. There would be an incentive to keep them in the banks as savings. This is normal because if you think about it, most people don’t touch their savings. The State would have to make sure that the new bonds were credible enough so that people wouldn’t want to cash them straight away.

There is no easy way out of this mess. There is no way we can wave a magic wand and promise that no one will be affected, but it is clear that the euro is on its way out and will at best, mutate into something else.

The two-speed euro idea, at least prevents the chaos of a messy implosion and the rushed reintroduction of many currencies. It achieves the competitive devaluation, which for us with the majority of our trade and investment coming from and going to, America and Britain, it would give us a shot in the arm. The debt forgiveness element would also give the heavily indebted commuter generation – the Pope’s Children – a break.

There is never a best way to do things in a crisis, simply a least bad way. Maybe this is it.

3--Jumbo Prime Loans, Eisen Tower

Excerpt: Jumbo prime loans are those made to borrowers with good credit histories, but which are too big to be sold to the GSEs, which have a limit of $417,000 (in some areas, $729,750). In many ways, these loans have the same problems as option ARMs, the only difference being no negative amortization.

Averaging $750,000, jumbo loans are most common in areas with high home prices like California and Florida—in other words, the areas where the bubble inflated the most and that are now suffering the greatest collapse. Also, some lenders were making jumbo loans to borrowers with FICO scores as low as 620 and calling them prime, but such loans are most certainly not prime.

There are approximately $1.0 trillion to $1.5 trillion of prime jumbo mortgages currently outstanding...

Jumbo prime are high-leverage programs that allowed borrowers to buy much more home than they should have. Because jumbo prime borrowers had better credit overall, banks were very easy on the qualifying. For example, with full documentation, a 620 credit score [borrower] could get an 80% $750,000 first mortgage that allowed a 15% second [lien] on top of that for a 95% loan....


A 5/1 interest-only [loan] at 5% . . . means that a $520,000 loan carried a payment of only $2,166 per month. Add in $650 per month for taxes and insurance, and the total is roughly $2,825.

With a 15% second [lien] of $97,500 at prime [interest rate] carrying payments of $325 per month and reasonable "other debt" at the time of $400 per month, the total payment out the door would be $3,541 approximately.

This means a household income of $7,082 per month could buy a $650,000 home with 5% down. This is not out of the realm of hourly workers or moderate-income single-worker families.

Now the same home is worth $450,000, the borrowers added debt after the loan was funded and all of their after-tax income is going out to [service the] debt each month. They can' t save a penny and are going broke just to live in this underwater house.

They can rent the same house for $2,500 per month. The best decision is to walk.

Nowadays, the same income buys a $275,000-$300,000 mortgage with 10% down. This shows why housing prices keep falling...

All over the nation, especially in California, there are millions of high- value homes in which the homeowners are trapped, unable to sell due to lack of equity or refinance due to the lack of financing. I have been watching mid-to-upper-end properties in California teetering on the verge of a major fall for a year now—they have held better than the lower end, but in 2008 everything changed, as subprime loan defaults waned and higher grade defaults (Alt-A, option ARM and jumbo prime) attached to higher home values look the lead. Now the lion 's share of defaults is everything but subprime.

The higher grade default wave intensified mid-2008 and now those houses have been foreclosed upon and are coming to market fast, in large quantities. Bottom line: the mid-to-upper-end housing collapse—which has largely been avoided to date, mostly due to better borrowers coupled with higher-leverage and longer-teaser-term loan programs—is upon us.

With all of these foreclosures coming to market and very little financing available to purchase all of the high-end homes available, the supply factor is going to bring down values rapidly—and this does not even count Ma and Pa Homeowner who want to sell. Based upon what I see so far in 2009 prior to the spring and summer selling season, my best forecast is that homes with present values over $750,000 will lose at least 30% in 2009 and those currently worth over $1.5 million will likely decline even more.

4--Citi Chief Economist Willem Buiter: A Spanish Or Italian Default Could Happen In A Few Short Days, zero hedge

Excerpt: Buiter on Europe's crisis:

"Time is running out fast. I think we have maybe a few months -- it could be weeks, it could be days -- before there is a material risk of a fundamentally unnecessary default by a country like Spain or Italy which would be a financial catastrophe dragging the European banking system and North America with it. So they have to act now."

"The only two guns in town, one is only theoretical, and that is increasing the size of the EFSF to 3 trillion. It should happen but it can't for political reasons. The other one, the only remaining share is the ECB. They may have to hold their noses while they do it, and if they don't do it, it's the end of the euro zone."

On why the ECB hasn't acted yet:

"Because after the error of the Bundesbank, they consider central banks purchasing sovereign debt outright to be like swearing in church. It's just not done. This has been in fact to a certain extent embedded in the treaty which forbids the ECB from lending directly to governments or buying stuff in the primary market. But there is no restriction at all on them buying any amount of sovereign debt at any time in the secondary market, so they can do it."

5--U.S. Banks Face Contagion Risk From European Debt: Fitch, Bloomberg

Excerpt: U.S. banks face a “serious risk” that their creditworthiness will deteriorate if Europe’s debt crisis deepens and spreads beyond the five most-troubled nations, Fitch Ratings said.

“Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen,” the New York-based rating company said yesterday in a statement. Even as U.S. banks have “manageable” exposure to stressed European markets, “further contagion poses a serious risk,” Fitch said, without explaining what it meant by contagion.

The “exposures” of U.S. lenders to major European banks and the stressed nations of Greece, Ireland, Italy, Portugal and Spain, known as the GIIPS, are smaller than those to some of the continent’s larger countries, Fitch said.

6--Prepare for the Italian bank runs, Pragmatic Capitalism

Excerpt: In the case of most countries that are starting to suffer from deposit outflow, the banks have to increasingly rely on higher interest rates to lure depositors. Is this starting to happen in Italy? The answer is yes, particularly in the case of corporate accounts. The spread on new deposits against German rates is now around 150bps for corporates and 100bps for households. Although not as aggressive as Greece, where spreads on corporate accounts are now around 250bps or Portugal where it exceeds 300bps, Italy is offering higher inducements vs (say) Spain.

 One of the key leading indicators of a bank run is the bank’s increasing reliance on ECB’s refinancing facilities. Over the past three-to-four months, we have seen increasing reliance by Italian banks on eurosystem refinancing. Whereas in 2008 and 2009, Italian banks were average users of ECB facilities, accounting for only 3-4% of the total vs Italy’s share of 13.7% of the eurozone’s banking assets. However, since July, the share of ECB’s refinancing attributable to Italian banks rose to a historically high level of 18.8% (end-October). For example, in August, Italy got €85bn from the ECB, a further €105bn in September, and €111bn in Oct 2011. Although as a percentage of total assets, countries such as Greece and Ireland are far more reliant, Italy’s share is going up rapidly.

….markets remain frozen

Banking refinancing markets remain largely closed. Whether one looks at OIS spreads (90bps on the euro), ECB deposits or CDS spreads between the eurozone’s senior and subordinated debt (235bps) remain at extremely elevated levels, indicating extreme reluctance of banks to lend to each other for longer than overnight or preference for depositing funds with the ECB rather than lending.”

7--Analysis - Four weeks countdown to rescue euro zone, Reuters

Excerpt: Europe's leaders have less than a month to strike another grand bargain to rescue the euro zone from a worsening sovereign debt crisis. Contagion in financial markets may have to get still worse to concentrate their minds.

In that short time scale, German Chancellor Angela Merkel must unite her coalition behind potentially unpopular decisions and French President Nicolas Sarkozy must act to defend his country's shaky AAA credit rating.

The new leaders of Italy and Greece must start enacting far-reaching austerity plans and economic reforms despite feuding politicians and social protests. A new Spanish government to be elected on Sunday must convince investors it will take bold action to restore competitiveness and clean up a housing bust.

And the European Central Bank may have to conclude that the biggest threat to stability in the euro zone lies in recession, a credit crunch and the risk of deflation rather than inflation.

8--Things That Make You Go Hmmm…, The Big Picture

Excerpt: What do the “Big Fitz,” the largest ship ever to sail the Great Lakes, and the Eurozone have in common? Hint: the former sank without a trace. Or, as Grant Williams so eloquently puts it, in his Things That Make You Go Hmmm… for Nov. 13 (this week’s Outside the Box), “One can’t help but think … that this week may well have brought us to the wall at the end of the road down which Europe has been kicking the can for quite some time now.”

Grant inspects the SS Europe from bow to stern and concludes: “The smoke has pretty much cleared now and those in charge of the SS Europe are left with a stark choice – print money or allow the break-up of the Eurozone and the end of the common currency known as the Euro. At this point it really IS that simple.”

So come on along as Grant takes us on an eye-opening and at times jaw-dropping ride – there are some real insights here. From his perch in Singapore he sees the same problems I do, just from the other side of the globe. And that perspective is worth your time.

9--The Great Debate» See all analysis and opinion“Act and learn” versus “debate and wait”, Reuters

Excerpt: Signs of disappointing policy outcomes are, unfortunately, all around us. Over the last two years, American policymakers have failed miserably to lower persistently high unemployment despite a series of stimulus measures, fiscal and monetary, conventional and unconventional. In Europe, the debt crisis has spread despite numerous summits, declarations, policy actions and political changes.
In both cases, policymakers identified and sometimes mis-identified the problems and took highly publicized steps to solve them. Considerable financial resources and political capital were deployed. The credibility of policymakers (and policymaking itself) was placed on the line. Yet to no avail. The identified problems not only persisted, they deepened.

When one compares policymaking episodes around the world – successful and less so – it seems clear that there is more at play than the content of policies. The mindset of policymakers and the process of policymaking seem to also have a lot to do with the disappointing outcomes. Indeed, one often hears policymakers point to political dysfunctionality as being the major hindrance to good outcomes....

Any five year destination plan includes a detailed restoration of growth and job creation coupled with the rebalancing of the economy and with an expansion of the tradable sector, employment and competitiveness. There are skills, educational and infrastructure deficits to be overcome, and regulatory impediments to remove (including tax policy that adversely affects growth and the productive deployment of the two key underutilized resources). Government’s role is to close the gaps and deficits. The optimal mix of reforms and policies that will work is not necessarily known in advance. Instead its about starting a process and learning from it — and, in the process, avoiding and mistrusting simple formulas and claims of a policy “killer app.”

In Europe, the process should start (rather than end) with a very explicit determination of what the Eurozone should look like in 3-5 years. Does it involve a fiscal union among the seventeen existing members, supported by much deeper political integration and much greater delegation of national sovereignty to the regional level? Or does it involve a smaller, less imperfect union of countries with similar initial conditions? Once this is decided, it will be much easier to move aggressively on the other parts of the required solution.

Whether it is Europe or the US, the welfare of citizens – indeed, the well-being of the global economy – requires much better pragmatic and adaptive policymaking. The more this is delayed, the greater the social damage is associated with subdued economic growth, persistently high unemployment, recurrent financial crises, and growing income and wealth inequalities. A fundamental review and reform of “how” policymaking takes place can go a long way in improving outcomes.

10--Financial Alchemy Foils Capital Rules as Banks Redefine Risk, Bloomberg

Excerpt: Banks in Europe are undercutting regulators' demands that they boost capital by declaring assets they hold less risky today than they were yesterday.

Banco Santander SA, Spain's largest lender, and Banco Bilbao Vizcaya Argentaria SA, the second-biggest, say they can go halfway to adding 13.6 billion euros ($18.8 billion) of capital by changing how they calculate risk-weightings, the probability of default lenders assign to loans, mortgages and derivatives. The practice, known as “risk-weighted asset optimization,” allows banks to boost capital ratios without cutting lending, selling assets or tapping shareholders.

Regulators in Europe, seeking to stem the region's sovereign-debt crisis, ordered banks last month to increase core capital to 9 percent of risk-weighted assets by the end of June. Lenders, facing a 106 billion-euro shortfall, are reluctant to plug the gap by cutting dividends or bonuses and are struggling to sell assets or raise cash in rights offerings. Politicians are trying to stop banks from the alternative, cutting back lending, because it could trigger a recession.

By allowing sophisticated banks to do their own modeling, we are allowing the poacher to participate in being the game- keeper,” said Adrian Blundell-Wignall, deputy director of the Organization for Economic Cooperation and Development's financial and enterprise affairs division in Paris. “That risks making core capital ratios useless.”

11--FHA: Loan Backer's Cash Runs Low, WSJ

Exxcerpt: The Federal Housing Administration's cash reserves have fallen so low that there is a "close to 50%" chance the agency could run out of money and require a taxpayer bailout in the next year, according to the annual independent audit of the FHA's finances.

The audit, to be released Tuesday by the FHA, estimated that the value of the agency's reserves stood at $2.6 billion as of Sept. 30, down 45% from an already low $4.7 billion last year. The drop reflects the impact of rising home-loan defaults amid falling home prices, which together generate greater losses on the sale ...

12--Invisible to tourists: Italy's growing poor,

Excerpt: They line up at soup kitchens by the thousands. Individual debt is rising, savings are eroding and many young people have simply given up, staying home without studying or even looking for a job.

They are Italy's invisible poor, unseen by tourists, ignored by the country's fat-cat politicians and living in a reality that's a far cry from former Premier Silvio Berlusconi's description of an affluent country where "the restaurants are full."

Or in the words of Francesa Zuccari, who runs a soup kitchen in Rome: "There is another city out there where people can't get to the end of the month."

This is the Italy facing Mario Monti, the economics professor tapped to form an interim technocratic government after Berlusconi was forced to resign last weekend. International markets and the European Community decided the 75-year-old media mogul lacked the political clout to enact needed reforms to head off a debt crisis and get the economy moving.

On Tuesday, Monti won support from Italy's two largest parties, but the question remains whether politicians will back his expected painful reform measures at the risk of social peace.

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