Thursday, January 12, 2012

Today's links

1--EURO GOVT-Italian, Spanish CDS fall, Bund futures rally, Reuters

Excerpt: The cost of insuring against Spanish and Italian debt defaults fell on Wednesday with benchmark 10-year government bond yields also lower as sentiment towards the periphery improved.

Five-year Italian credit default swaps were 20 basis points lower at 497 bps, according to monitor Markit, with the Spanish equivalent 23 bps lower at 400 bps.

The better tone was partially attributed to comments from an official at Fitch Ratings on Tuesday saying that the agency did not expect to cut France's triple-A credit rating this year as well as domestic buying of Spanish paper ahead of a debt sale on Thursday.

Spanish 10-year yields were 20 bps lower at 5.32 percent, while Italian 10-year yields were attempting to break below 7.0 percent.

2--Euro, global stocks fall on call for ECB debt action, Reuters

Excerpt: The euro and global stocks fell on Wednesday after ratings agency Fitch called on the European Central Bank to do more to solve the currency bloc's debt crisis, unnerving investors ahead of auctions for Spanish and Italian bonds later in the week.

U.S. stock index futures also turned lower, pointing to a weaker start on Wall Street, hurt by computer giant Microsoft's (MSFT.O) warning that sales of personal computers will probably be lower than analysts expect in the fourth quarter.

The euro hit session lows of $1.2695 after Fitch said the ECB needed to ramp up its buying of troubled euro zone debt to support Italy and prevent a "cataclysmic" collapse of the euro.

"Can the euro be saved without more active engagement from the ECB? Quite frankly we think no," David Riley, the head of sovereign ratings for Fitch, said at an investor roadshow in Frankfurt....

Italian 10-year bond yields rose back above 7.0 percent and Spanish yields rose about 10 basis points to 5.34 percent as investors sought higher returns to hold the debt...

GREEK DEAL EYED

Concerns were also growing over Greece where negotiations with private sector bondholders over a debt restructuring plan are coming to a head.

Hedge funds are taking on the International Monetary Fund over its plan to slash Greece's towering debt burden as time runs out to seal a deal to secure further funds from its euro zone partners.

3--Banks in Europe Resist Draghi Bid to Avert Credit Crunch by Hoarding Cash, Bloomberg

Excerpt: Banks are hoarding the European Central Bank’s record 489 billion-euro ($625 billion) injection into the banking system, thwarting attempts by policy makers to avert a credit crunch in the region.

Almost all of the money loaned to 523 euro-area lenders last month wound up back on deposit at the Frankfurt-based central bank instead of pouring into the financial system, according to estimates by Barclays Capital based on ECB data. Banks will use most of the money from the three-year loans to meet their refinancing needs for this year and next, analysts at Morgan Stanley and Royal Bank of Scotland Group Plc estimate.

“It’s illusory to think that the measure will translate into credit generation,” Philippe Waechter, chief economist at Natixis Asset Management in Paris, said in an interview. “It will assuage some of the anxiety banks have regarding their liquidity needs. But they’ve engaged into a massive overhaul of their strategy and shrinkage of their balance sheets, which is, coupled with the deteriorating economy, not compatible with increasing credit.”

Governments are urging European banks to keep lending to companies and individuals while requiring them to raise an additional 114.7 billion euros of core capital by June to weather a deepening sovereign-debt crisis. Instead of raising equity, most lenders across Europe have vowed to meet capital rules by trimming at least 950 billion euros from their balance sheets over the next two years, either by selling assets or not renewing credit lines, according to data compiled by Bloomberg....

“The ECB loans will largely be used to pre-fund 2012 and some of 2013’s bank refinancing needs, but it will not stimulate lending,” Van Steenis said. They will “just stop it falling off precipitously.”

Euro-area banks have more than 600 billion euros of debt maturing this year, the Bank of England said in its financial stability report last month. The first ECB loan offering should help cover about two-thirds of that amount, Goldman Sachs Group Inc. analysts say. Morgan Stanley’s Van Steenis estimates banks may reduce assets by as much as 2.5 trillion euros in two years, a process known as deleveraging.

The volume of loans to households and companies in the 17- nation euro area shrank in November for the second consecutive month, the ECB said on Dec. 29. Loans were still up 1.7 percent over the year-earlier period, slowing from a 2.7 percent increase in the 12 months through October....

The ECB loans are a kick-the-can measure that doesn’t fix the banks’ structural problems,” Gallo said. “Deleveraging needs to happen.”

4--Bernanke Doubles Down on Fed Mortgage Bet, Bloomberg

Excerpt: (NB) ...Bernanke’s Fed study said “more might be done,” including eliminating entirely the reduced fees for risky loans, “more comprehensively” cutting lenders’ put-back risks; and further streamlining refinancing for other Fannie Mae and Freddie Mac borrowers. The U.S. also should consider having Fannie Mae and Freddie Mac refinance loans not already backed by the government, which would add credit risk for the companies, according to the report....

Ben S. Bernanke is signaling his willingness to double down on a three-year bet that’s failed to revive housing, showing the extent of the Federal Reserve chairman’s effort to wrest a recovery from the deepest recession.

Since the Fed started buying $1.25 trillion of mortgage bonds in January 2009, the value of U.S. housing has fallen 4.1 percent, and is down 32 percent from its 2006 peak, according to an S&P/Case-Shiller index. The central bank is poised to buy about $200 billion this year, or more than 20 percent of new loans, as it reinvests debt that’s being paid off. Some Fed officials have said they may support additional purchases that Barclays Capital estimates could total as much as $750 billion.

Even as Bernanke and fellow U.S. central bankers consider expanding their efforts, they are acknowledging their inability to turn around the housing market without help from the rest of the government. Bernanke underscored the importance of residential real estate, which represents 15 percent of the economy, in a study he sent to Congress last week that said ending the slump is necessary for a broader recovery....

While the Fed has helped push mortgage rates to record lows of less than 4 percent, home-loan borrowing in 2012 is forecast to decline to the least in 15 years. Americans who might refinance and buy properties are getting shut out by stricter lending standards or avoiding transactions as values tumble amid mounting foreclosures, according to the Fed study.

Eventual Losses

Bernanke’s report urged Congress and President Barack Obama’s administration to consider steps with short-term costs for taxpayers, such as widening the role of Fannie Mae (FNMA) and Freddie Mac (FRE), the government-supported mortgage guarantors...

The Fed has taken unprecedented steps to lower borrowing costs as it held short-term interest rates near zero since 2008. It acquired $1.25 trillion of government-backed mortgage securities and $172 billion of federal agency bonds from December 2008 through March 2010, as part of a process known as quantitative easing, or QE. It embarked on a second stage involving $600 billion of Treasuries through last June.

QE3 Likelihood

In October, it began recycling proceeds from the mortgage and agency debt into home-loan securities, buying $80.2 billion through Jan. 4. Reinvestment will probably total about $200 billion this year, according to Barclays, JPMorgan Chase & Co. and Credit Suisse Group AG.

Dudley’s comments and the Fed study signal a greater likelihood of QE3, according to Ajay Rajadhyaksha, a Barclays analyst in New York, who has estimated it could involve $500 billion to $750 billion of mortgage-bond purchases over a year.

“The investment community is almost regarding quantitative easing as a free good and if it’s a free good, why not just do QE10,000,” said Sanders, a former head of mortgage-bond research at Deutsche Bank AG. “If rates start going up, somebody’s going to have to pay the tab, and you know who that is: John Q. Public.”....

Property Slump

Monetary policy hasn’t been enough to prevent house prices from continuing their more than five-year long slide, with Pacific Investment Management Co.’s Scott Simon, the bond manager’s mortgage head, forecasting further declines of 6 percent to 8 percent.

An S&P/Case-Shiller index of property values in 20 cities dropped 3.4 percent in the year through October. Existing home sales remain 18 percent below their 10-year average and Dudley estimated properties seized by lenders may rise to 1.8 million this year, and the same number next year, from about 1.1 million last year and 600,000 in 2010....

The Mortgage Bankers Association, based in Washington, estimates that home-loan originations declined last year to an 11-year low of $1.3 trillion and will fall to $968 billion this year, the least since 1997....

Only about 85 percent of lenders are offering loans eligible for guarantees by Fannie Mae and Freddie Mac, which were seized by the government in 2008, to borrowers with 680 credit scores and 10 percent down payments, according to LoanSifter Inc. data cited by the study. Fewer than 50 percent are making loans in the companies’ lowest credit tier, the Fed’s Duke said last week.

Although Fannie Mae and Freddie Mac’s ability “to put back loans to lenders helps protect the taxpayers from losses, an open question is whether the costs of the associated contraction in credit availability outweigh the benefits” of lower losses, she said.

Borrowers Locked Out

Most troubling is that creditworthy borrowers are being locked out for minor blemishes or documentation challenges as lenders look to protect themselves, said Willie Newman, head of residential mortgage originations at Cole Taylor Bank in Chicago.

“There are people where everything about them looks good except this one little thing,” he said. “But you do precisely what they tell you to do, you don’t deviate, because the price of getting it wrong is too large.”...

The central bank is funding its portfolio mainly with cash borrowed from banks at 0.25 percent, a financing cost that will rise when it raises its benchmark for short-term rates. The central bank may lose money on the investments if it sells the securities after increases in long-term rates, or pays more on its borrowings than the yields on its holdings. The central bank would take those steps to stem inflation...

The projected average lives of Fannie Mae-guaranteed securities with 3.5 percent coupons, which accounted for the largest portion of the Fed’s purchases last week, would extend from 5.2 years to 10.8 years if rates rose 3 percentage points, according to data compiled by Bloomberg. That means the central bank could be stuck with them for longer and their value would drop more with further increases in interest rates.

‘No Confusion’

“Rates go up, and you’re going to see a pretty significant level of extension in terms of the duration and meaningful book losses residing on the Fed’s balance sheet,” said Jason Callan, head of structured products at Columbia Management Investment Advisers LLC, a Minneapolis-based firm overseeing $170 billion in fixed-income. “That’s kind of the name of the game in mortgages.”

A report by the New York Fed in March discussed how the central bank’s net income can remain “sizable” even if it sells some bonds at losses, while Sack said in July that the central bank’s bond portfolio will earn about $500 billion from 2009 to 2018.

“There should be no confusion, no mistake, that we’ve put duration risk onto the Fed’s balance sheet,” Sack said in 2010. “These decisions are being made to produce economic outcomes” rather than “to produce a certain return on the portfolio.”

5--Why the Fed Needs to Talk More About Housing, IRA

Excerpt: The sad fact is that neither the Fed nor the WSJ understand that without movement on housing, there will be neither any meaningful inflation or job growth in the US for years. The real estate sector is a millstone around the neck of the US economy with a decided deflationary bias. Without a restructuring of BAC, Ally and some of the other TBTF banks, there will be no sustained credit or job growth in the US and thus no movement in government revenues. After five years of zero rates, all that the Fed has to show for its trouble is a banking industry where the top four institutions representing 70% of total assets remains crippled.

If you think of the US financial sector as three legs of a stool, the markets for government debt and mortgage debt are constrained. In many respects, the US corporate debt sector is the only functioning capital market in the US and the world. We cannot achieve economic recovery in the US or globally without repairing the markets for mortgage and government finance. The housing sector is half of all bank balance sheets and two-thirds of total US bank exposure.

Not only should the Fed be talking about the housing sector but it should do so more often. We note in this regard that the creditors of Ally Financial have begun to organize in preparation for the restructuring we predicted last week. The bottom line message from Fed Chairman Bernanke and other Fed members to Congress and the White House should be this: there will be no economic recovery until we deal with the housing sector. Refinancing for performing borrowers and restructuring for troubled loans is the route to salvation. But once the housing market boil is lanced, then the real fun starts in addressing the parlous US fiscal situation.

6--Chart of the Day: Greek workers work 48% more hours than Germans, credit writedowns

Excerpt: The conventional narrative about the European debt crisis largely accepts the contention that the periphery of Europe have different work habits and these account to a large extent the economic and financial problems. Yet often time the discussion takes on such ethnocentric dimensions that sometimes it is difficult to see what is real...see chart...This chart: to the right illustrates what many will find to be counter-intuitive. The most recent data from the OECD covers 2008 and shows that in that year, Greek workers on average worked 48% more than their industrious German neighbors.

7--Europe’s Vicious Spirals, Barry Eichengreen, Project Syndicate

Excerpt: The euro crisis shows no signs of letting up. While 2011 was supposed to be the year when European leaders finally got a grip on events, the eurozone’s problems went from bad to worse. What had been a Greek crisis became a southern European crisis and then a pan-European crisis. Indeed, by the end of the year, banks and governments had begun making contingency plans for the collapse of the monetary union.

None of this was inevitable. Rather, it reflected European leaders’ failure to stop a pair of vicious spirals.

The first spiral ran from public debt to the banks and back to public debt. Doubts about whether governments would be able to service their debts caused borrowing costs to soar and bond prices to plummet. But, critically, these debt crises undermined confidence in Europe’s banks, which held many of the bonds in question. Unable to borrow, the banks became unable to lend. As economies then weakened, the prospects for fiscal consolidation grew dimmer. Bond prices then fell further, damaging European banks even more.

The European Central Bank has now halted this vicious spiral by providing the banks with guaranteed liquidity for three years against a wide range of collateral. Reassured that they will have access to funding, the banks again have the confidence to lend.

Cynical observers suggest that the ECB’s real agenda is to encourage the banks to buy the crisis countries’ bonds. But that would only further weaken the banks’ credit portfolios at a time when European regulators are desperate to strengthen them. The ECB’s decision to provide the banks with unlimited liquidity does not solve governments’ debt problems, nor is that its intent. But it at least prevents the debt problem from creating banking problems, which, in turn, worsen the debt problem without end....

Hence the continuing need for demand-side measures, which puts the ball back in the ECB’s court.

Cutting interest rates will not be enough. Pushing up asset prices and pushing down the euro’s exchange rate will require the ECB to buy bonds on the secondary market – not the crisis countries’ bonds per se, but those of all eurozone members. In other words, it will require quantitative easing.

Nothing is guaranteed. But Europe can still escape its vicious spirals if everyone does their part.

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