Tuesday, January 24, 2012

Today's links

Today's quote: "By 2008 the United States had become the biggest international borrower in world history, with almost half of its 6.4 trillion dollar federal debt in foreign hands." Menzie Chinn, Econbrowser

1--IMF’s Lagarde Sounds Alarm Over Europe, WSJ

Excerpt: The International Monetary Fund is elevating its warnings about the risk of a global economic meltdown triggered by the euro-zone debt crisis. In a speech today in Berlin, IMF managing director Christine Lagarde says the world could see a repeat of the Great Depression if Europe doesn’t take stronger action.

Without proper measures, she says, “we could easily slide into a ’1930s moment.’ A moment where trust and cooperation break down and countries turn inward. A moment, ultimately, leading to a downward spiral that could engulf the entire world.”

Lagarde’s message includes appeals for more money from Europe (for its own bailout fund) and from the rest of the world (to boost the IMF’s war chest).

Her latest call to action comes as the IMF prepares to downgrade its economic outlook on Tuesday and presses European nations to put more money behind fighting the crisis. The IMF told its board members last week that the 17-nation euro zone needs to double the size of its existing firewall to at least €1 trillion to guard against spreading turmoil. Other nations, including the U.S., in recent months have offered a similar message about vastly expanding the size of the firewall.

Prior IMF calls for action have faced resistance from powerful corners of the world. And many of Lagarde’s latest recommendations include previously discussed ideas that have been met with opposition in those regions.

In her remarks to the German Council on Foreign Relations, Lagarde calls for three sets of actions by policymakers around the world:

1. The euro zone needs “stronger growth, larger firewalls, and deeper integration,” she says.

Stronger growth means keeping banks from tightening credit, avoiding across-the-board austerity throughout Europe and enacting overhauls to boost competitiveness in some countries, she says.

For the European firewall, she calls for folding the temporary €440 billion bailout find into the permanent €500 billion bailout fund and increasing the size of the permanent bailout fund. Lagarde also says action by the European Central Bank “to provide the necessary liquidity support to stabilize bank funding and sovereign debt markets would also be essential.”

For deeper integration, she says the continent needs more risk-sharing across borders in the banking system, through a euro-area facility to take direct stakes in banks, a unified bank supervisor, a single bank resolution authority and a single deposit insurance fund. For more integrated fiscal policy, she calls for financing options such as euro bonds. “Political agreement on a joint bond to underpin risk sharing would help convince markets of the future viability of European economic and monetary union,” she says.

2. Among other parts of the world, she calls on the debt-saddled large economies (U.S., Japan) to deal with their debt and growth problems. The U.S., for instance, must “relieve the burden of household debt” (through mortgage write-downs) and “deal decisively with the issue of public debt.” And she says countries with current account surpluses (such as China) must raise domestic demand to support global growth.

3. Lagarde is leading the charge to increase the IMF’s current lending capacity (total unused resources of almost $400 billion), even though the U.S. — the IMF’s largest shareholder — is not on board with the effort. She’s suggested since the fall that she wants more money, and last week the IMF put a number on it: $500 billion in additional resources. “The goal here is to supplement the resources Europe will be putting on the table, but also to meet the needs of ‘innocent bystanders’ infected by contagion, anywhere in the world,” she said.

2--$25B nationwide mortgage deal goes to states, AP

Excerpt: The nation's five largest mortgage lenders have agreed to overhaul their industry after deceptive foreclosure practices drove homeowners out of their homes, government officials said Monday.

A draft settlement between the banks and U.S. states has been sent to state officials for review.

Those who lost their homes to foreclosure are unlikely to get their homes back or benefit much financially from the settlement, which could be as high as $25 billion. About 750,000 Americans — about half of the households who might be eligible for assistance under the deal — will likely receive checks for about $1,800.

But the agreement could reshape long-standing mortgage lending guidelines and make it easier for those at risk of foreclosure to restructure their loans. And roughly 1 million homeowners could see the size of the mortgage reduced.

Five major banks — Bank of America, JPMorgan Chase, Wells Fargo, Citibank and Ally Financial — and U.S. state attorneys general could adopt the agreement within weeks, according to two officials briefed on the discussions. They spoke on condition of anonymity because they are not authorized to discuss the agreement publicly.

The settlement would be the biggest of a single industry since the 1998 multistate tobacco deal. And it would end a painful chapter that grew out of the 2008 financial crisis.

Nearly 8 million Americans have faced foreclosure since the housing bubble burst. In some cases, companies that process mortgages failed to verify the information on foreclosure documents. The worst practices, known collectively as "robo-signing," included employees signing documents they hadn't read or using fake signatures to sign off on foreclosures.

President Barack Obama is expected to tout the settlement in his State of the Union address Tuesday. His administration has put pressure on state officials to wrap up a deal more than a year in the making.

But some say the proposed deal doesn't go far enough. They have argued for a thorough investigation of potentially illegal foreclosure practices before a settlement is hammered out.

"Wall Street again is trying to pass the buck. Instead of criminal prosecutions, we're talking about something that's not more than a slap on the wrist," said Sen. Sherrod Brown (D-Ohio), who has been critical of the proposed settlement.

A signed deal is not expected this week, said Geoff Greenwood, a spokesman for Iowa Attorney General Tom Miller, who has led the 50-state negotiations.

The settlement would only apply to privately held mortgages issued between 2008 and 2011, not those held by government-controlled Fannie Mae or Freddie Mac. Fannie and Freddie own about half of all U.S. mortgages, roughly about 31 million U.S. home loans.

As part of the deal, about 1 million homeowners could also get the principal amount of their mortgages written down by an average of $20,000. One in four homeowners with a mortgage — or roughly 11 million people — owe more than their home is worth. These so-called "underwater" borrowers have little chance at refinancing.

Democratic attorneys general are meeting Monday in Chicago to discuss the deal with Housing and Urban Development Secretary Shaun Donovan. Republican attorneys general will be briefed about the deals via conference call later in the day.

Under the deal:

— $17 billion would go toward reducing the principal that struggling homeowners owe on their mortgages.

— $5 billion would be placed in a reserve account for various state and federal programs; a portion of that money would cover the $1,800 checks sent to those homeowners affected by the deceptive practices.

— About $3 billion would to help homeowners refinance at 5.25 percent.

In October 2010, major banks temporarily suspended foreclosures following revelations of widespread deceptive foreclosure practices by banks. Discussions then began over a national settlement.

Some states have disagreed over what terms to offer the banks. In September, California announced it would not agree to a settlement over foreclosure abuses that state and federal officials have been working on for more than a year.

New York, Delaware, Nevada and Massachusetts, which sued five major banks earlier in December over deceptive foreclosure practices, have also argued that banks should not be protected from future civil liability. The deal will not fully release banks from future criminal lawsuits by individual states.

And both sides have also fought over the amounts of money that should be placed in the reserve account for property owners who were improperly foreclosed upon. Many of the larger points of the deal, including a $25 billion cost for the banks, have long been worked out, officials say.

3--Death sanitised through credit, FT Alphaville

Excerpt: Also, as IFR’s Gareth Gore reported at the time, refinancing need had been widely trailed as bank’s main motive for taking funds before the first LTRO tender.

So, the charts help to explain a bit further what the ultimate point of the ECB’s three-year liquidity operations has been. It’s not been to spark a carry trade to ‘covertly’ stabilise or monetise sovereign debt. Of course, yields have collapsed at bond auctions throughout the eurozone periphery, between the first LTRO giving banks cash to park somewhere, and banks preparing assets to pledge at the second LTRO. It’s been easy to read this effect backwards as the ECB’s original motive. “Back-door QE”, it’s usually been called. Not so, we think.

In fact — charts like the first one above tend to show that the central bank’s mission was “only” to stop a heart attack of bank deleveraging in the eurozone. It “only” stemmed the flight from the last functioning sector of the interbank market – secured lending – and substituted itself as the broker of last resort. Admittedly, banks could still quite easily run out of collateral and thus fail in this environment (Dexia!). But for the rest it’s a huge move.

Why this effect if the LTRO is being overshadowed, relative to the current effects on sovereign borrowing, is a bit of a mystery to us. It’s enormous. The point is, though, that it’s more like the open market operations in response to the commercial paper crisis in late 2008 than anything like the Fed’s QE1.

4--Economists Talk Europe, Daily Beast

Excerpt: JOSEPH STIGLITZ I don’t doubt the commitment of Europe’s leaders to preserve the euro. But there is clearly a lack of understanding of what is required and/or a willingness to do what is required, either for ideological or political reasons. These leaders must know that austerity by itself will restore neither growth nor confidence. They must know that without growth, there will be no confidence, and the debt crisis will almost surely only mount, which is what has been happening. They must know that even if strong fiscal constraints might prevent the next crisis, they don’t solve the current one. And they must know that, as desirable as the structural reforms that are being discussed may be, they are supply-side measures when the problem in many of these countries is inadequate demand, and the time horizon required for their implementation is out of sync with the imperatives of the crisis. In short, the policy framework on which Europe is embarked—unless accompanied by additional measures that mitigate the risk of default and enhance growth—is more likely to fail than to succeed. Markets know this. The rating agencies know this. The question is, when will the political leaders recognize this and take the necessary actions?

GLENN HUBBARD When you have a currency union but you don’t have a fiscal union, you lose your flexibility. You’d better hope the shocks are identical and that all the countries behave, which didn’t happen. Another component: there’s an argument sometimes in Europe that some countries are virtuous and others are not. That’s not the whole story. Germany got a big benefit in competitiveness terms from the euro. Germany got an undervalued exchange rate, and Greece got an overvalued exchange rate. But this created account imbalances. A third component is banking and financial regulation. There were no capital requirements, so you have banks that were heavily invested in this debt, much of which has to be restructured.

5--Notes On Deleveraging, Paul Krugman, NY Times

Excerpt: The new McKinsey Global Institute report on debt and deleveraging has attracted a lot of attention, and rightly so. I have some quibbles with the way the data are presented, but they’re very useful data — and lead to some surprising conclusions

...if you take the financial-sector debt out of the total, MGI’s conclusion that the United States has experienced substantial deleveraging goes away: overall debt to GDP has been more or less flat since the end of 2008. But as I wrote yesterday, the shift of debt away from over-indebted households to a federal government that is not borrowing-constrained is a big plus; it’s setting the stage for recovery.

What about MGI’s claim that the United States is doing much better than Europe? It still holds up. I wish they had done eurozone-as-a-whole numbers; I’m not finding that at all easy to do myself. (Eurostat’s categories do not match US flow-of-funds data). But what I’ve been able to gather is that Europe has had a substantial rise in public debt, with little or no private-sector deleveraging. Here’s Spain: (chart)

So what you get is a seeming paradox: once you realize that private debt is as much or more of a problem than public debt, what you see is that Europe, where the key policymakers have preached the evils of debt and the need for austerity, is not making any progress in bringing debt problems under control — while we are. Of course, it’s not a paradox if you have been reading Richard Koo on balance sheet recessions, if you understood the importance of expansionary monetary policy, and if you had grasped the meaning of Sam and Janet.

Oh, and if we had done what the usual suspects on the right wanted — if we had slashed spending to ward off the invisible bond vigilantes, and had tightened money to ward off the phantom inflation menace — we’d be emulating Europe, and hence emulating Europe’s failure.

6--Americans more dissatisfied than ever, Gallup

Excerpt: PRINCETON, NJ -- As President Barack Obama prepares his annual address to Congress, Americans are broadly dissatisfied with the state of the nation in several specific issue areas, with satisfaction down sharply in some cases since January 2008. However, three issues -- the nation's economy, the size and power of the federal government, and the moral and ethical climate in the country -- fit both of these unwelcome criteria.

Americans' satisfaction with the state of the nation's economy has dropped by 23 percentage points since January 2008 to 13%, according to a Jan. 5-8 Gallup poll. These figures represent both the lowest rate of satisfaction and the biggest decline seen for any of 24 issues measured in the survey. Attitudes toward the moral and ethical climate and the size and power of the federal government are similar to each other. Slightly fewer than 3 in 10 Americans are satisfied with each, down from about 4 in 10 in 2008, the last presidential election year and the last time Gallup measured satisfaction on all 24 items.

7--Americans Are Deleveraging, But Not Because They Want To, zero hedge

Excerpt: ...two-thirds of the 4% ($584bn) in US household debt deleveraging is from defaults on home-loans (and other consumer debt)!

The United States: A light at the end of the tunnel

From 1990 to 2008, US private-sector debt rose from 148 percent of GDP to 234 percent (Exhibit 5). Household debt rose by more than half, peaking at 98 percent of GDP in 2008. Debt of nonfinancial corporations rose to 79 percent of GDP, while debt of financial institutions reached 57 percent of GDP.

Since the end of 2008, all categories of US private-sector debt have fallen as a percent of GDP. The reduction by financial institutions has been most striking. By mid-2011 the ratio of financial-sector debt relative to GDP had fallen below where it stood in 2000. In dollar terms, it declined from $8 trillion to $6.1 trillion. Nearly $1 trillion of this decline can be attributed to the collapse of Lehman Brothers, JP Morgan Chase’s purchase of Bear Stearns, and the Bank of America-Merrill Lynch merger. Since 2008, banks also have been funding themselves with more deposits and less debt.

Among US households, debt has fallen by 4 percent in absolute terms, or $584 billion. Some two-thirds of that reduction is from defaults on home loans and other consumer debt. An estimated $254 billion of troubled mortgages remain in the foreclosure pipeline, suggesting the potential for several more percentage points of household debt reduction as these loans are discharged. A majority of defaults reflect financial distress: overextended homeowners who lost jobs or faced medical emergencies and found that they could not afford to keep up with payments. Low-income households are affected most by defaults—in areas with high foreclosure rates, the average annual household income is around $35,000, compared with $55,000 in areas with low foreclosure rates.

Up to 35 percent of US mortgage defaults, it is estimated, are the result of strategic decisions by borrowers to walk away from homes that have negative equity, or those in which the mortgage exceeds the value of the property. This option is more available in the United States than in other countries, because in 11 of the 50 states—including hard-hit Arizona and California—mortgages are nonrecourse loans. This means that lenders cannot pursue other assets or income of borrowers who default. Even in recourse states, US banks historically have rarely pursued nonhousing assets of borrowers who default.

We estimate that US households could face roughly two more years of deleveraging....

A more conservative goal for US household deleveraging, then, might be to aim for a return to the ratio of debt relative to income of 2000, before the credit bubble. This would require a reduction of 22 percentage points from the ratio of mid-2011.

Another comparison is with Swedish households in the 1990s, which reduced household debt relative to income by 41 percentage points. By this measure, US households are a bit more than one-third of the way through deleveraging

8--Is Our Economy Healing?, Paul Krugman, NY Times

Excerpt: How goes the state of the union? Well, the state of the economy remains terrible. ... But there are reasons to think that we’re finally on the (slow) road to better times. And we wouldn’t be on that road if Mr. Obama had given in to Republican demands that he slash spending, or the Federal Reserve had given in to Republican demands that it tighten money.

Why am I letting a bit of optimism break through the clouds? Recent economic data have been a bit better... More important, there’s evidence that the two great problems at the root of our slump — the housing bust and excessive private debt — are finally easing. ...

There are, of course, still big risks — above all, the risk that trouble in Europe could derail our own incipient recovery. And thereby hangs a tale — a tale told by a recent report from the McKinsey Global Institute.

The report tracks progress on “deleveraging,” the process of bringing down excessive debt levels. It documents substantial progress in the United States, which it contrasts with failure to make progress in Europe. And while the report doesn’t say this explicitly, it’s pretty clear why Europe is doing worse than we are: it’s because European policy makers have been afraid of the wrong things.

In particular, the European Central Bank has been worrying about inflation ... rather than worrying about how to sustain economic recovery. And fiscal austerity ... has depressed the economy, making it impossible to achieve urgently needed reductions in private debt. The end result is that for all their moralizing about the evils of borrowing, the Europeans aren’t making any progress against excessive debt — whereas we are.

Back to the U.S. situation: my guarded optimism should not be taken as a statement that all is well. We have already suffered enormous, unnecessary damage because of an inadequate response to the slump. We have failed to provide significant mortgage relief, which could have moved us much more quickly to lower debt. And ... it will be years before we get to anything resembling full employment.

But things could have been worse; they would have been worse if we had followed the policies demanded by Mr. Obama’s opponents. For as I said at the beginning, Republicans have been demanding that the Fed stop trying to bring down interest rates and that federal spending be slashed immediately — which amounts to demanding that we emulate Europe’s failure.

And if this year’s election brings the wrong ideology to power, America’s nascent recovery might well be snuffed out.

9--Euro races higher, credit writedowns

Excerpt: financials are again leading the European equities higher. The bank index of the Dow Jones Stoxx 600 is at 3-month highs, up over 20% since early January.

Reluctant at first, the market is recognizing the significance of the ECB’s 3-year financing, even though overnight deposits at the ECB remain near record levels. The LTRO may support the sovereign debt market marginally, but more importantly, it appears to be supporting bank debt. European banks have not been issuing secured senior debt, but have been issuing largely levels of covered bonds, which the ECB is also buying in the secondary market.

The Greek PSI negotiations have also been about brinkmanship tactics and both sides seek the best possible deal and that force each to push the edge of the envelop. The key is not the notional haircut of 50%, but rather the impact on net present value. The media continues to play up the coupon of the new bonds as the key sticking point, but there are numerous moving parts.

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