Thursday, January 26, 2012

Today's links

1--How Larry Summers' memo hobbled Obama's stimulus plan, The Guardian

Excerpt: The Obama administration's economic blueprint was fatally flawed: it led to a weak stimulus and premature deficit reduction...

Those still wondering why the Obama administration surrendered so quickly on the drive for stimulus and joined the deficit reduction crusade, got the smoking gun in an article by the New Yorker's Washington correspondent Ryan Lizza. Lizza revealed a 57-page memo drafted by Larry Summers, the head of the National Economic Council, in the December of 2008, the month before President Obama was inaugurated.

The memo was striking for two reasons. First, it again showed the economic projections that the administration was looking at when it drafted its stimulus package. These projections proved to be hugely overly optimistic.
They showed that even without stimulus, job loss would peak at around 5 million in the 4th quarter of 2009. They projected that the economy would then begin to add jobs at a fairly rapid pace, regaining all the lost jobs by the end of 2011. In this non-stimulus baseline scenario, the unemployment rate never rose above 9.0%, which it would hit in the winter of 2010.

In reality, the economy had already lost almost 7 million jobs by May of 2009, the month when the first stimulus dollars were going out the door. The job loss didn't stop until February of 2010, at a point where the economy had lost 8.5m jobs. Even with the benefit of the stimulus, the economy is still down by more than 6m jobs from its pre-recession level.
The unemployment rate had already hit 9.4% when the stimulus first started to be felt in May of 2009. It eventually peaked at 10.0% in October of 2009.

In short, the economy was clearly in much worse shape than was implied by the projections that the Obama administration used in crafting its stimulus. In fairness to the Obama administration, these projections were in keeping with the consensus among economists at the time.

2--Perverse Austerity, The Economist

Excerpt: THE International Monetary Fund sharply lowered its global economic outlook today and warned that an intensified euro crisis could tip the world back into recession. Its latest forecast is for the world to grow 3.3% this year and the advanced countries 1.2%, sharply lower than it saw just four months ago. Those numbers, it warns, are predicated on a comprehensive solution to Europe’s crisis.

More interesting, and disturbing, are some findings in the IMF's accompanying Fiscal Monitor. Last year was one for fiscal hawks to celebrate as fiscal consolidation proceeded apace. Throughout the advanced economies, budget deficits fell by about 1% of GDP. Only a little of that was due to the cyclical economic improvement. Most was structural, i.e. through discretionary spending cuts or tax increases. That should continue this year, led by America where, even if the payroll tax cut is extended, the structural deficit will decline by 1.4 percentage points.

In the euro zone, Germany, France, Spain and Italy all managed to reduce their structural budget deficits, the latter three thanks to austerity. All are expected to reduce those deficits further this year. But this is not the good news it seems. Austerity, the IMF has found, could be making Europe’s crisis worse, rather than better....

Got that? Cut the deficit too aggressively, and the negative impact on growth and the rise in the cost of debt service from higher spreads could result in a higher, not lower, debt-to-GDP ratio.

It is not clear if the IMF thinks that has actually happened, and it recommends caution in interpreting these results. The analysis examined behavior across countries rather than across time, and thus the results may reflect circumstances unique to 2011.

Still, the findings are sobering and explain the IMF's advice that countries that have not been cut off from the markets must avoid further discretionary austerity. “Decreasing debt is a marathon, not a sprint,” observed Olivier Blanchard, the fund’s chief economist. “Going too fast will kill growth.”

3--Keynes on Austerity and Extremism, NY Times

Excerpt: Does this sound familiar?

Central bankers who are so concerned about the threat to their currency that they demand that austerity be imposed upon angry citizens. Political leaders who, facing a deep recession that has led to large-scale unemployment, insist that the only route to recovery is to cut public spending, pay off national debt and impose higher taxes.

How about this? Economists, doubting the wisdom of bankers and lawmakers, argue that the best way to avoid a decade of lost jobs and economic stagnation is to borrow and spend to promote economic growth. They are ignored in favor of a creed that deems government intervention damaging to business confidence and the self-restoring effects of the market....
Keynes proposed a revolutionary way of reviving a flagging economy. He argued that the Bank of England should keep interest rates low so businesses could borrow cheaply, and that taxation should be sharply cut to promote spending. He also advocated putting the unemployed — at the time, 11.4 percent of the labor force — to work building roads and housing projects

To the faint hearts afraid that such measures would run up crippling government debt, Keynes said there would be time enough to pay down the borrowing when the economy was booming again. There was no need to worry about the long term, he famously wrote, for ‘‘in the long term we are all dead.’’

4--First Act of Greek Default Proceedings Drawing to a Close, credit writedowns

Excerpt: Global stock markets are up about 10% since the beginning of the year, volatility has collapsed, US economic data continue to defy even the mild slowdown proponents and the ECB seems to have backstopped the European banking system.

Yes, my dear reader. This is how quickly you move away from the apocalyptic abyss and back to normal. My base case is that we are close to excess complacency in equity markets and a sell off is overdue, but it is exactly also under these circumstances (where smart money start to hedge) that the market may deliver one final run up to get everyone and the postman in before hosing everyone.

In the short term, one of the only remaining stumbling block in the form of the ongoing default proceedings in Greece seem to be no match for the ongoing positive animal spirit of the equity market. Only a week ago, we got news that talks in Greece had stalled, but most recently we have been reassured that talks are back on track.

5---The hangover, The Economist

Excerpt: America is recovering from the debt bust faster than European countries. Why?

ALMOST half a decade after the onset of the rich world’s credit bust, depressing evidence of its after-effects is visible in everything from feeble output figures to swollen jobless rolls. But for a truly grim picture, read a new report on deleveraging by the McKinsey Global Institute. It points out that in many rich countries the process of debt reduction hasn’t even started. America has begun to pare its debt burden, although the drop is small compared with the build-up in 2000-08 (see chart). But many European countries are more, not less, in hock than they were in 2008. There the hangover could last another decade or more.

These transatlantic differences stem from the trajectory of private debt. Government borrowing soared everywhere after 2008 as government deficits ballooned. But in America the swelling of the public balance-sheet has mirrored a shrinking of private ones. Every category of private debt—financial, corporate and household—has fallen as a share of GDP since 2008. The financial sector’s debt is now at its 2000 level. Corporate indebtedness, never very high, has shrunk. So, more importantly, has household debt. America’s ratio of household debt to income is down by 15 percentage points from its peak in 2008, after rising by over 30 percentage points in the eight preceding years. McKinsey reckons America’s households are between a third and halfway through their debt-reduction process. They think the household-debt hangover could end by mid-2013.

In Europe private debt has fallen much less and in some cases even risen. In Britain the financial sector’s debts have grown since 2008. In Spain corporate debt, far higher as a share of GDP than in most rich countries, has barely budged. But the biggest difference is among households. Even countries which saw the biggest surges in household debt during the bubble era, such as Britain and Spain, have scarcely seen a dent since 2008. McKinsey’s analysts reckon it will take British households up to a decade to work off their debt burdens.

It’s not that American households have been more frugal or disciplined. Household debt has fallen largely thanks to defaults, particularly on mortgages. America had a bigger housing bust; in some states non-recourse lending rules make default easier (people can walk away from home loans without fear of losing other assets). Some two-thirds of America’s $600 billion decline in household debt is due to defaults. With another $250 billion of mortgages in the process of foreclosure, further reduction is likely.

Europe’s post-bubble economies, in contrast, have seen smaller drops in house prices, lower mortgage costs thanks to variable interest-rate mortgages, and gentler treatment from banks. The Bank of England suggests that around 12% of British mortgages receive some kind of forbearance. Fewer people are turfed out of their homes, but the millstone of debt weighs for longer.

America’s private-sector debt reduction has also taken place against the backdrop of loose fiscal policy. Although state and local governments have been cutting back, the federal government has (at least until now) put off most fiscal tightening. In Europe, however, the sovereign-debt crisis means governments have been forced, or chosen, to undertake swingeing budget cuts long before the private sector’s deleveraging is done.

Note the Nordics

That stands in stark contrast to most successful bouts of debt reduction. The McKinsey report pores over two episodes that it considers most relevant for today: the experiences of Sweden and Finland following their banking busts in the early 1990s. Debt reduction took place in two stages. In stage one, the private sector reduces its debts; the economy is weak and public debt soars. In stage two, growth recovers and the longer-term process of reducing government debt begins. In both these cases growth was buoyed by booming exports, a boon that seems unlikely this time. But it is telling that Sweden did not begin its budget-cutting until the economy had recovered; and that when Finland tried an early bout of austerity, this worsened its recession.

The McKinsey analysts carefully avoid suggesting this means Europe’s austerity is misguided. Circumstances today are different, they argue: European governments began with higher debt and deficits, leaving them with less room for manoeuvre. But the message is clear: America is closer to Sweden’s successful template than Europe is. Debt reduction is very difficult without economic growth, and the scale of Europe’s austerity makes it hard to see where that growth will come from.

That’s all the more true because Europe’s governments have been remarkably timid, compared with the Nordics, in exploiting another avenue to growth—structural reform. The report underscores just how dramatically Sweden and Finland overhauled their economies in the wake of their debt crises. Banks were nationalised and restructured; whole sectors, such as retailing, were deregulated. Thanks to a slew of efficiency-enhancing reforms, productivity soared and investment boomed.

Nothing so bold has been attempted this time. America has not managed much in the way of growth-enhancing structural reforms and has a long to-do list, from improving worker training to reining in health-care costs. But it is in Europe where the potential gains from structural reforms are greatest and where the policy focus has nonetheless been overwhelmingly on austerity.

That may change. With much of the euro zone in recession, structural reforms are getting higher billing. Spain’s new government began with an extra dollop of austerity; it now wants to accelerate the freeing of its rigid labour rules. Italy’s prime minister, Mario Monti, first raised taxes and cut spending; now he is about to take on the unions. Angela Merkel, the German chancellor, is saying that Europe’s leaders need to focus on growth. But a shift in the policy mix will not stop many European countries’ debt burdens from spiralling yet higher. Depressing, indeed.

6--Bernanke near inflation target prize, but jobs a concern, Reuters

Excerpt: The Federal Reserve could take the historic step this week of announcing an explicit target for inflation, a move that would fulfill a multi-year quest of the central bank's chairman, Ben Bernanke.

An inflation target would be the capstone of Bernanke's crusade to improve the Fed's communications, an initiative aimed at making the central bank more effective at controlling growth and inflation. It would, at long last, bring the Fed into line with a policy framework used by most other major central banks.

Bernanke has made clearer communications a hallmark of his leadership, and bit by bit, he has worked to cast light on what for years had been purposefully opaque and secretive deliberations.

He has even given the campaign a personal stamp, contrasting his plainspoken and unaffected persona with that of his predecessor, Alan Greenspan, whose ruminations were notoriously oblique and who was associated with an aloof cadre of policy mandarins....

By announcing a target, the Fed could smooth the path to another round of bond buying should the recovery falter.

"It's a good idea whose time has come," said Marvin Goodfriend, a professor at the Tepper School of Business at Carnegie Mellon University in Pittsburgh and a former senior Fed policy adviser

7--Obama's SOTU, Nomi Prins

Excerpt: Big banks. The largest firms continue to grow their asset bases and fee extrapolation strategies from their captive customer base (If you’re say, a JPM Chase customer, it costs you $5 to extract your own money from a Bank of America ATM – both banks get a cut). It was Obama that re-confirmed Fed Chairman Ben Bernanke for another fourteen years (and yes, a bi-partisan Congress agreed), and who still keeps Treasury Secretary, Tim Geithner around. Both men were gung-ho about the merger mania that dotted Wall Street in the fall of 2008 and making the ‘too-big-to-fail” banks bigger, as they now are.

5) Small banks. President Obama didn’t address the smaller bank closings occurring because the big banks got disproportionate subsides;, 389 smaller banks (with $297 billion in assets) failed from 2009 to 2011. Like during the early years of the Great Depression, this means less choice for individuals, less loans for local businesses, and consolidation of influence and market share for the big banks – which comprise Obama’s largest bundling base.

6) Borrowers. Despite a few tepid programs to help homeowners, the sheer number of foreclosures is higher today than it was in 2008. There were a record number of foreclosure filings: 2.9 million in 2010 and 2.7 million in 2011. These are predicted to rise in 2012 amidst default surges and more lender notices than in 2011.

Why? Because Obama’s program (that was supposed to help 5 million borrowers, and helped half a million) had to be approved by the banks. Banks don’t like citizen aid programs, even if they screwed citizens to begin with by fueling a $14 trillion toxic asset pyramid repackaging risky (for people), high interest-bearing (for them). Obama said, “The banks will repay a deficit of trust”? What?! When?! Where?!

Banks hoarding. Obama neglected to mention the $1.6 trillion that banks are stashing at the Fed in the form of excess (and interest-bearing) reserves, which do nothing for the Main Street economy. Meanwhile, small business loans are at a 12-year low, having shrunk continuously since 2008.

10) Obama conveyed that we dodged a bullet by getting the banking system under control. He didn’t note the rising risk in the banking system: the largest four US banks (JPM Chase, Citibank, Bank of America and Goldman Sachs) control nearly 95% of the US derivatives market, which has grown by 20% since just last year, to $235 trillion. JPM Chase holds 11% of the world’s derivative exposure, Citibank, Bank of America, and Goldman comprise about 7% each. Goldman has 537 times as many (from 440 times last year) derivatives as assets and it’s still considered a bank holding company (as per Bernanke) that gets federal backing.

8--Some Americans preparing for ‘civilization’s collapse’, Reuters

Excerpt: When Patty Tegeler looks out the window of her home overlooking the Appalachian Mountains in southwestern Virginia, she sees trouble on the horizon.

“In an instant, anything can happen,” she told Reuters. “And I firmly believe that you have to be prepared.”

Tegeler is among a growing subculture of Americans who refer to themselves informally as “preppers.” Some are driven by a fear of imminent societal collapse, others are worried about terrorism, and many have a vague concern that an escalating series of natural disasters is leading to some type of environmental cataclysm.

They are following in the footsteps of hippies in the 1960s who set up communes to separate themselves from what they saw as a materialistic society, and the survivalists in the 1990s who were hoping to escape the dictates of what they perceived as an increasingly secular and oppressive government.

Preppers, though are, worried about no government.

Tegeler, 57, has turned her home in rural Virginia into a “survival center,” complete with a large generator, portable heaters, water tanks, and a two-year supply of freeze-dried food that her sister recently gave her as a birthday present. She says that in case of emergency, she could survive indefinitely in her home. And she thinks that emergency could come soon.

“I think this economy is about to fall apart,” she said.

A wide range of vendors market products to preppers, mainly online. They sell everything from water tanks to guns to survival skills.

9--Banks Hoarding ECB Cash to Double Company Defaults: Euro Credit, Bloomberg

Excerpt: Corporate defaults may almost double in Europe as companies struggle to refinance debt and banks hoard cash borrowed from the European Central Bank or use it to buy government bonds.

Europe’s default rate may soar to 8.4 percent or more, from 4.8 percent at the end of 2011 as the recession bites and company financing dries up, according to Standard & Poor’s. Petroplus Holdings AG (PPHN) became the latest victim of the tough stance banks are adopting when the region’s biggest independent oil refiner said this week it will file for insolvency after losing access to $2.1 billion of credit lines.

“It’s very challenging for anyone to raise money from lenders right now,” said Andrew Cleland-Bogle, a Frankfurt- based director at corporate finance specialist DC Advisory Partners. “Combine that with increased bank capital requirements and you can see that although banks are getting money they’re very selective when it comes to lending it. 2012 is going to be a very, very tough year.” ...

Banks are using the 489 billion euros they borrowed at 1 percent from the ECB under its three-year longer-term refinancing operation to scoop up government bonds yielding more than 2.5 percentage points extra instead of lending the money to companies.

Italian Yields
Italian bonds due in three years, the maturity of the ECB loans, now yield 4.37 percent, down from 7.36 percent at the end of November. The country’s 10-year bonds have declined to 6.11 percent from 7.02 percent. Spanish three-year notes now yield 3.04 percent, down from 5.51 percent in November, while yields on 10-year bonds have fallen to 5.29 percent from 6.23 percent.

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