Wednesday, January 18, 2012

Today's links

Today's quote: "The economic doctrine of normal profits, vaguely apprehended by everyone, is a necessary condition for the justification of capitalism. The business man is tolerable so long as his gains can be said to bear some relation to what, roughly and in some sense, his activities have contributed to society.”--John Maynard Keynes

1--Disapproval of Congress hits new high: poll, Reuters

Excerpt: A record 84 percent of Americans say they disapprove of the way the Congress is doing its job compared with just 13 percent who approve of how things are going, according to a Washington Post/ABC News public opinion poll published on Monday.

The disapproval rating for Congress inched up two percentage points since October and reflects a year of lows for Congress that ended in a battle over a temporary extension of the payroll tax cuts for 160 million Americans.

Democrats and Republicans fought all last year over the best way to control the country's debt and annual budget deficit, as the two parties tried to position themselves for the 2012 elections.

A vitriolic debate leading up to an agreement last summer to allow President Barack Obama to raise the debt ceiling fueled public disgust with Congress and prompted Standard & Poor's credit rating agency to strip the United States of its stellar AAA rating.

The 84 percent disapproval rate is the highest for Congress in nearly 40 years of polling. The previous high was last October, when 82 percent of poll respondents said they disapproved of the way lawmakers on Capitol Hill were doing their jobs.

2--Why ECB's Tricks Won't Solve the Crisis, Der Speigel

Excerpt: Ever since the European Central Bank began flooding the markets with cheap money, European banks have rediscovered their taste for sovereign bonds. But the crisis is far from over, as Standard and Poor's recent raft of downgrades showed. Some bankers are saying it's just a matter of time before yields on peripheral bonds shoot up again...

Ever since the European Central Bank began flooding the markets with cheap money, European banks have rediscovered their taste for sovereign bonds. But the crisis is far from over, as Standard and Poor's recent raft of downgrades showed. Some bankers are saying it's just a matter of time before yields on peripheral bonds shoot up again. By SPIEGEL Staff

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During his first press conference of the year, European Central Bank (ECB) President Mario Draghi had been talking about the precarious state of the euro zone for almost half an hour when someone in the audience asked about Peer Steinbrück.

The former German finance minister had more or less said that the ECB was the EU's only functioning institution and that it had to get more involved in managing the ongoing crisis. With a forgiving smile, Draghi closed his long response by saying that "obviously we are always very pleased when people say that the ECB is the only institution that works."

Although it hasn't even been three months since Draghi stepped down as the Bank of Italy's governor to take over the reins of the ECB, he exudes the confidence of someone who has everything under control -- and not only in relation to the ECB, where he has reshuffled responsibilities on its governing council, but also in terms of the euro crisis.

In fact, the situation on the financial markets has noticeably relaxed. In sovereign bond auctions last Thursday and Friday, Italy and Spain had no problem raising fresh money for themselves -- and at tolerable yields too. On Thursday, while discussing the ECB's recent decision to make unlimited liquidity available to euro-zone banks, Draghi confidently stated that "the more time that passes … the more we see signs that it has been an effective policy measure."

A Wave of the Wand

Back in December, the yields on the bonds of crisis-ridden euro-zone countries had risen once again, and there were rumors that investors would boycott them in upcoming auctions. Indeed, it only looked like a matter of time before the ECB would be forced to bring out its so-called "big bazooka" and buy practically unlimited amounts of the unpopular bonds. However, at around the turn of the year, it looked like all these problems had been solved by the wave of some magic wand.

German Finance Minister Wolfgang Schäuble, a member of Chancellor Angela Merkel's center-right Christian Democratic Union (CDU), reacted to this positive development with cautious relief. He told colleagues at the Finance Ministry that the ECB's stabilization efforts appeared to be showing initial signs of success. But, he added, it was still too early to make any definite judgments.

As it turns out, Schäuble was right to be cautious. Reality already caught up with the euro's would-be saviors on Friday, when the ratings agency Standard & Poor's simultaneously downgraded the credit ratings of nine euro-zone countries. While France and Austria lost their coveted AAA ratings, countries like Italy, Spain and Portugal fell two notches in the ratings. That same day, private investors announced they had broken off talks with Greek government officials over a so-called haircut on Greek debt.

Artificial Demand

Indeed, the problems are too far-reaching to be solved with a single measure from the bank's bag of tricks. But for all intents and purposes, the ECB's new strategy is just that -- a trick. By flooding the banks with cheap money, it is artificially generating demand for sovereign bonds. In doing so, it can also cut back on its own bond purchases, which have also been highly controversial within the bank itself.

For the banks, it's a fantastic deal. They can borrow money from the ECB for three years at the prime interest rate, which currently stands at 1 percent. If they used that money, say, to buy Italian bonds last Friday, they would get the much higher interest rate of 4.83 percent. Then they could turn around and deposit these bonds at the ECB as security, and borrow even more money at 1 percent.

This new ECB strategy would appear to benefit all the major players: the banks, the cash-strapped countries and the ECB itself. But it has also triggered worries that Draghi has merely created a kind of financial perpetual-motion machine. In any case, the strategy does nothing to alter the fact that the institution ultimately bearing the risks is still the ECB -- and, with it, the taxpayers.

Since Draghi announced the new program on Dec. 8, 523 banks have taken advantage of the bargain offer to borrow almost €500 billion ($632 billion). However, instead of passing that money on in loans to companies so as to spur the economy, they have redeposited the money with the ECB. Deposits at the ECB -- which are regarded as a barometer of the banks' risk aversion during the crisis -- piled up higher and higher every night.

Then, last week, some of the banks dauntlessly used some of their liquidity to purchase Italian and Spanish bonds at the auctions. Overnight deposits at the ECB dropped by almost €15 billion....

Athens is pressuring private-sector creditors to agree to relinquish an even higher proportion of their claims, and the banks are calling for public-sector creditors, such as the ECB, to join in by writing off parts of their own claims. Meanwhile, hedge funds have been sabotaging every deal. With each passing day, there is a growing danger that there will either be no agreement, or that a deal is reached that isn't backed by a sufficient number of creditors.

In light of all this troubling news, Eugen Keller, a financial market expert with the Frankfurt-based private bank Metzler, predicts that demand for the sovereign bonds of southern euro-zone members will once again fall dramatically. "It's merely a matter of time," he says, "until we're back where we left off last year."

3--Wary banks boost ECB deposits; reserve change due, Reuters

Excerpt: Commercial banks parked almost half a trillion euros at the European Central Bank, the highest on record, as the mix of debt crisis worries and a recent giant injection of ECB cash left banks awash with money but too scared to lend it.

Overnight deposits at the ECB have regularly hit new records in recent weeks after the central bank's first ever offering of three-year loans pumped 490 billion euros ($620 billion) into the banking system.

ECB data on Monday showed overnight deposits reached a new high of 493 billion euros, up from the 490 billion they had risen to on Friday.

The total could climb further still. The end of the ECB's monthly reserves cycle - the point when banks have fulfilled their ECB targets and have few options to juggle their funding - is on Tuesday.

Changes to the ECB's reserves rules, which kick in on Wednesday and will mean banks have to keep less of a cash buffer at the ECB, are raising questions about future deposit levels.

4--Half Of Citi Pretax Income Over Past Two Years Comes From Loan Loss Reserve Releases, zero hedge

Excerpt: Wonder why nobody trusts bank numbers, and why US financial institutions trade at some fraction of book value? The chart below should explain a big part of it. As can be quite vividly seen, of the $28 billion in pre-tax net income from continuing operations "generated" over the past two years, exactly half, or $14 billion, has been due from a simply accounting trick, namely the release of loan loss reserves, which have been positive for 8 quarters in a row, and which in the just completed quarter amounted to more than the actual pretax number, confirming EPS would have been negative absent accounting trickery

5--$10 TRILLION Liquidity Injection Coming? Credit Suisse Hunkers Down Ahead Of The European Endgame, zero hedge

Excerpt: after reading the report by Credit Suisse's William Porter, we no longer assign a trivial probability to some ridiculous amount hitting the headlines early in the morning on February 29. Why? Because from this moment on, the market will no longer be preoccupied with a €1 trillion LTRO number as the potential headline, one which in itself would be sufficient to send the Euro tumbling, the USD surging, and provoking an immediate in kind response from the Fed. Instead, the new 'possible' number is just a "little" higher, which intuitively would make sense. After all both S&P and now Fitch expect Greece to default on March 20 (just to have the event somewhat "priced in"). Which means that in an attempt to front-run the unprecedented liquidity scramble that will certainly result as nobody has any idea what would happen should Greece default in an orderly fashion, let alone disorderly, the only buffer is having cash. Lots of it. A shock and awe liquidity firewall that will leave everyone stunned. How much. According to Credit Suisse the new LTRO number could be up to a gargantuan, and unprecedented, €10 TRILLION! (much more worth reading)

6--Is Europe About to Unravel?, Fed Watch, economist's view

Excerpt: Even the illusion of political unity in Europe appears to be dissolving before our eyes. This, of course, should come as no surprise to anyone watching the European crisis unfold. The key problem always was the internal imbalances, a problem for which European policymakers have never offered a credible solution. They simply don't have such a solution in the context of a system of fixed exchange rates. I believe that currency devaluation is the only option that will change relative competitiveness in any reasonable timeframe and restore internal balance. But that option is unavailable for Euro members.

Lacking currency devaluation as a tool to resolve imbalances, European policymakers turned to fiscal austerity. That plan has failed, pushing nation after nation into ever deepening recession. With Greece going on its fifth year of recession, I imagine by now that Portugal, Spain, and even Italy now see the writing on the wall for themselves. Sadly, however, the alternative is exiting the Euro, which almost certainly means financial chaos for the Continent as a whole.

The Eurozone is like a roach motel. You can get in, but you can't get out.

Still, peripheral nations can only accept so much pain before the costs of being in the Euro outweigh the costs of leaving. And Italy is now sending Berlin a clear warning that such an endgame is approaching. Via the Financial Times:

Italy’s prime minister has pleaded for Germany and other creditor countries to do more to help lower his country’s borrowing costs, warning there would be a “powerful backlash” among voters in the eurozone’s struggling periphery if they did not...

..Rome would push the German government to realise it was in “its own enlightened self-interest” to lend more of its fiscal weight to lowering borrowing costs of Italy and other highly indebted governments. The single currency had brought “huge benefits …and maybe [to] Germany even more than others,” he said....

Bottom Line: In Europe, the unstoppable force of austerity is colliding with the immovable object that is reality. Expect fireworks.

7--Feldstein: How to Create a Depression, Project Syndicate via economist's view

Excerpt: Martin Feldstein has a warning about European plans for further austerity:

European political leaders may be about to agree to a fiscal plan which, if implemented, could push Europe into a major depression. ...

The European Union’s summit in Brussels ... agreed to cap annual “structural” budget deficits at 0.5% of GDP, with penalties imposed on countries whose total fiscal deficits exceeded 3% of GDP – a limit that would include both structural and cyclical deficits, thus effectively limiting cyclical deficits to 3% of GDP. ...

The most frightening recent development is a formal complaint by the European Central Bank that the proposed rules are not tough enough. Jorg Asmussen, a key member of the ECB’s executive board, wrote to the negotiators that countries should be allowed to exceed the 0.5%-of-GDP limit for deficits only in times of “natural catastrophes and serious emergency situations” outside the control of governments.

If this language were adopted, it would eliminate automatic cyclical fiscal adjustments, which could easily lead to a downward spiral of demand and a serious depression.

8-- Europe’s The Road to Nowhere, naked capitalism

Excerpt: Nicolas Sarkozy was unusually direct: “each state can turn to its banks, which will have liquidity at their disposal.” He pointed out that earning 6% on Italian bonds that could then be financed at 1% from central banks was a “no brainer”. At the same, ECB President Mario Draghi is urging banks to reduce holdings of government securities and to use the funding provided to meet debt maturities.

Sarko-nomics perpetuates the circular flow of funds with governments supporting banks that are in turn supposed to bail out the government. It does not address the unsustainable high cost of funds for countries like Italy. If its cost of debt stays around current market rates, then Italy’s interest costs will rise by about Euro 30 billion over the next two years, from 4.2% of GDP currently to 5.1% next year and 5.6% in 2013.

In many countries, Sarko-nomics will be supplemented by “financial oppression” as government increasing coerce their citizens and institutions to purchase sovereign bonds. Regulatory changes will require a proportion of individual retirement savings to be invested in government securities. Banks and financial institutions will be required to hold increased amounts of government bonds to meet liquidity and other requirements. There may be restrictions on foreign investments and capital transfers out of the country.

Financial oppression will complement traditional public finance strategies such as direct reduction in government spending, indirect reductions in the form of changing eligibility such as delaying retirement age, and higher taxes, including re-introduction of wealth and property taxes as well as estate or gift duties.

Debt reduction through restructuring remains off the agenda. The adverse market reaction to the announcement of the 50% Greek writedown forced the EU to assure investors that it was a one-off and did not constitute a precedent. Despite this, investors remain sceptical, limiting purchases of European sovereign debt.

Weaker Euro-Zone countries may meet their debt requirements through these measures but it will merely prolong the adjustment period. It will also increase the size of the problem, locking Europe into a period of low growth and increasing debt levels...

In the weaker countries, austerity means high unemployment, reductions in social services, higher taxes and reduced living standards. Social benefits increasingly below subsistence are widening income inequality and creating a “new poor”. Protest movements are gaining ground, with growing social unrest....

In the short term, Europe needs to restructure the debt of number of countries, recapitalise its banks and re-finance maturing debt at acceptable financing costs. In the long term, it needs to bring public finances and debt under control. It also needs to work out a way to improve growth, probably by restructuring the Euro to increase the competitiveness of weaker nations other than through internal deflation.

9--Recovery at risk as Americans raid savings, Reuters

Excerpt: More than four years after the United States fell into recession, many Americans have resorted to raiding their savings to get them through the stop-start economic recovery.

In an ominous sign for America's economic growth prospects, workers are paring back contributions to college funds and growing numbers are borrowing from their retirement accounts.

Some policymakers worry that a recent spike in credit card usage could mean that people, many of whom are struggling on incomes that have lagged inflation, are taking out new debt just to meet the costs of day-to-day living.

American households "have been spending recently in a way that did not seem in line with income growth. So somehow they've been doing that through perhaps additional credit card usage," Chicago Federal Reserve President Charles Evans said on Friday.

"If they saw future income and employment increasing strongly then that would be reasonable. But I don't see that. So I've been puzzled by this," he said.

After a few years of relative frugality, the amount of money that Americans are saving has fallen back to its lowest level since December 2007 when the recession began. The personal saving rate dipped in November to 3.5 percent, down from 5.1 percent a year earlier, according to the U.S. Commerce Department....


Loans taken from retirement savings accounts jumped 20 percent last year across all demographics, according to a survey to be published in March. Among lower earners they leapt by as much as 60 percent, said Aon Hewitt's Hess. The vast majority of borrowers, she said, need the money for essential expenses like bills, car repairs and college tuition.

The non-profit Employee Benefit Research Institute's (EBRI) annual retirement confidence survey hit a new low in 2011 with 27 percent of workers saying they're "not at all confident" they'll have enough for a comfortable retirement. Almost 15 percent expect to work until at least the age of 70, up from 11 percent in 2006....

I question whether this consumer spending momentum will be sustained without a pickup in income growth."...

"Americans are still coming to terms with fact they're not going to earn as much income as they once thought and they are not going to have as much wealth," said Vitner at Wells Fargo. "They are now trying to work out how they are going to have to adjust their lifestyle to fit that."

10--Richard Koo---Euroanalysis, zero hedge

Excerpt: ...The EBA’s demand that banks raise core capital ratios to 9% by June 2012 in the midst of a systemic crisis seems spectacularly ill-advised. I think it a miracle if Europe does not experience a full-blown credit contraction.

EU’s response has aggravated crisis

This 9% rule effectively prescribes the size of European banks’ balance sheets. This means banks will not be able to increase lending no matter how much liquidity the ECB supplies, effectively rendering any monetary accommodation by the ECB powerless to stimulate the economy.

The EBA’s 9% rule may help in preventing the next crisis, but it will do nothing to resolve the current one—in fact, it will make it much worse....

...In Europe, however, I find few people—including the authorities—understand what a balance sheet recession is. The vast majority are unaware that such a thing even exists, and to some extent that is why the crisis continues to worsen. Since the ongoing balance sheet recession and sovereign downgrades are a first for eurozone investors, their confusion, like that of their predecessors in Japan, is understandable....

eurozone also has a unique problem that does not affect Japan, the US, or the UK: no matter how much the Spanish or Irish private sector saves, those funds end up being invested in German government bonds, which are dominated in the same currency. I have previously argued that something must be done to address this capital flight problem that is unique to the eurozone.

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