Friday, March 30, 2012

Weekend links

1--Grim Housing Data Shows We Have Not Hit Bottom, Fiscal Times

Excerpt: “We’ve still got millions of foreclosed homes waiting to come on the market, so we’re not going to see any dramatic rebound in house prices,” cautioned Paul Ashworth, chief economist at Capital Economics. He predicts over the next few months that home prices will slowly start to rise, which will slowly nudge homebuyers back into the market and lead banks to start loosening lending criteria. “But property is a slow-moving asset, unlike stocks or equity where things can go up or down ten percent in a day. We’re not going to get a rapid rebound after the housing bust we just went through.”

Other economists expect home prices to plunge further. “Our view is that foreclosures, excess supply, and weak demand will drive home prices as measured by the Case-Shiller indices down at least another 5 percent,” said Patrick Newport, a U.S. economist with IHS Global Insight....

A new string of grim housing data confirms what economists and analysts have long predicted: the housing market has yet to hit bottom, and once it does, it will be a long slog back to health and stability.

The nation’s heap of completed foreclosures remained steep, barely budging to 65,000 in February compared to 66,000 one year earlier, according to new data released by CoreLogic Thursday. The percentage of American homeowners more than 90 days delinquent on their mortgage payments, including those in foreclosure, rose to 7.3 percent in February compared to 7.2 percent a month earlier.

According to today’s report, 3.4 million properties have gone into foreclosure since the financial crisis in September 2008. About 1.4 million, or 3.4 percent of all properties with a mortgage, were in the foreclosure process in February—a 0.2 percent drop from February 2011.

That follows new data from the S&P/Case-Shiller Index that U.S. home prices sank in January for the fifth straight month to the lowest level since 2003. Additionally, separate reports from the National Association of Realtors and CoreLogic show existing home sales and previously owned homes under contract shrank in February. The number of bank-owned homes either in the foreclosure process or seriously delinquent—the so-called shadow inventory—remained unchanged from six months earlier at 1.6 million units.

“We’ve still got millions of foreclosed homes waiting to come on the market, so we’re not going to see any dramatic rebound in house prices,” cautioned Paul Ashworth, chief economist at Capital Economics

2--Abigail Field: Mortgage Settlement Institutionalizes Foreclosure Fraud, naked capitalism

Excerpt: The mortgage settlement signed by 49 states and every Federal law enforcer allows the rampant foreclosure fraud currently choking our courts to continue unabated. Yes, I realize the pretty servicing standards language of Exhibit A promises the banks will completely overhaul their standard operating procedures and totally clean up their acts. But promises are empty if they’re not honored, and worthless if not enforceable.

We know Bailed-Out Bankers’ promises are empty, so what matters is if the agreement is enforceable. And when it comes to all things foreclosure fraud, the enforcement provisions are laughable. But before I detail why, let’s be clear: I’m not being hyperbolic. The bankers running and profiting most from our bailed-out banks are totally dishonest when dealing with the public, and their promises are meaningless....

the bankers don’t limit their lying, cheating and stealing to homeowners. They abuse their clients the same way. Most broadly damaging, the bankers steal from taxpayers on a federal, state and local level and practically everybody else too. Fraud is just how they do business....
Just meeting the “thou shalt not lie when taking thy neighbor’s house” language I quoted would require fundamental process overhauls at all major mortgage servicers. And yet it’s just the start of 11 pages aimed at ending document fraud (42 pages of detailed provisions overall). Given how much bankers lie, driving those process overhauls requires a mighty big incentive, i.e., penalties for non-compliance....In theory, unless these metrics are treated like a back door ongoing liability release. In which case it’s not a release at all: it’s foreclosure fraud immunity.

3--Fixation with QE3 Tells You The Market Sweet Spot Is Ending, credit writedowns

Excerpt: A growing number of indicators suggest that the market is running out of steam. Equities have been in a temporary sweet spot where investors have been factoring in a self-sustaining U.S. economic recovery while also anticipating the imminent institution of QE3. This is a contradiction. If the economy were indeed as strong as they say, we wouldn’t need QE3. The fact that market observers eagerly look forward toward the possibility of QE3 is itself an indication that the economy is weaker than they think. We can have one or the other, but we can’t have both....

The U.S. economy has benefited over the last few months from the inability of seasonal adjustment factors to account for an exceedingly warm winter and the distortions introduced by the fact that the worst of the recession in 2008-2009 occurred in about the same months. Although it is difficult to put a number on this, we suspect that the seasonal adjustments made the economy appear much stronger than it actually was, and that the payback is about to come.

Adding to these distortions, Fed Chairman Bernanke recently pointed out that Okun’s Law may have been a factor in the improving unemployment numbers. Okun’s Law, based on empirical observation rather than theory, states that for every 2% change in GDP, unemployment changes 1% in the opposite direction. Bernanke stated that at the worst of the last recession, unemployment increased by far more than it should have based on the decline in GDP. Recently, however, unemployment dropped by far more than it should have in relation to the increase in GDP, and that this was payback for the prior distortion. The takeaway is that the unemployment rate will not improve much in the period ahead, an assumption that is undoubtedly a major reason for the Fed’s continued caution on the outlook and promise of near-zero rates into 2014.

In just the last two weeks it has been noticeable that expectations have become so high that a number of indicators have started to disappoint. The list includes core durable goods orders, the Richmond Fed Manufacturing Survey, the Chicago Fed National Activity Index, initial weekly unemployment claims, pending home sales, new home sales and existing home sales. In addition, corporate earnings also show signs of peaking. The recent ratio of negative to positive earnings revisions is the highest since the first quarter of 2009. First quarter S&P 500 earnings growth is now estimated at only 0.7%, significantly down from the 16% estimated about a year ago and the 5% estimated as late as January. We think that when first quarter earnings are reported in a few weeks management guidance will take estimates down even more for the full year.

The economy is also facing the so-called "fiscal cliff" beginning on January 1, 2013. This includes expiration of the Bush tax cuts, the payroll tax cuts, emergency unemployment benefits and the sequester. Various estimates placed the hit to GDP as being anywhere between 2% and 3.5%, a number that would probably throw the economy into recession, if it isn’t already in one before then. At about that time we will also be hitting the debt limit once again. U.S. economic growth will also be hampered by recession in Europe and decreasing growth and a possible hard landing in China.

Technically, all of the good news seems to have been discounted by the market rally of the last three years and the last few months. The market is heavily overbought, sentiment is extremely high, daily new highs are falling and volume is both low and declining. In our view the odds of a significant decline are high.

4--Personal Income increased 0.2% in February, Spending 0.8%, calculated risk

Excerpt: The BEA released the Personal Income and Outlays report for February:

Personal income increased $28.2 billion, or 0.2 percent ... in February, according to the Bureau of Economic Analysis. Personal consumption expenditures (PCE) increased $86.0 billion, or 0.8 percent.
Real PCE -- PCE adjusted to remove price changes -- increased 0.5 percent in February, compared with an increase of 0.2 percent in January. ... The price index for PCE increased 0.3 percent in February, compared with an increase of 0.2 percent in January. The PCE price index, excluding food and energy, increased 0.1 percent, compared with an increase of 0.2 percent....

Note: The PCE price index, excluding food and energy, increased 0.1 percent.

The personal saving rate was at 3.7% in February.

This was a sharp increase in spending in February (and January spending was revised up). Using the two-month method, it appears real PCE will increase around 2.0% in Q1 (PCE is the largest component of GDP); the mid-month method suggests an increase closer to 2.9%.

5--Fed Watch: Inflation: Still Nothing to See Here, Tim Duy, economist's view

Excerpt: The Februrary Personal Income and Outlays report came out this morning, and with it a fresh read on the Federal Reserve's preferred inflation measure, the PCE price index. On a year-over-year basis, headline inflation is trending down to the 2% target, while core is settling in just below that target....

Bottom Line: Inflation remains contained - by itself, price trends provide no reason for the Fed to turn hawkish. Moreover, there is nothing here to stop Federal Reserve Chairman Ben Bernanke from easing policy should the US recovery falter.

6--Goldman Bets on Property Rebound With New Fund: Mortgages, Bloomberg

Excerpt: Goldman Sachs Group Inc. (GS), which survived the subprime mortgage crisis by making bets on a housing decline, is raising money for a new fund that will buy home-loan bonds to benefit from an improving real-estate market.

The U.S. Housing Recovery Fund is expected to finish its first round of capital raising and open April 1, according to a marketing document obtained by Bloomberg News. It will focus on senior-ranked securities without government backing, many of which now carry junk credit grades.

Stabilization in U.S. housing fundamentals is creating an attractive investment opportunity,” the New York-based bank said in the document dated this month. “Many of the ingredients are in place for continued improvement in housing,” including near-record affordability, a better supply-and-demand balance and policy makers’ renewed focus on bolstering real estate.

Goldman Sachs Asset Management is joining hedge-fund managers Kyle Bass and Metacapital Management LP in seeking cash for new mortgage funds. They’re following firms including Cerberus Capital Management LP, CQS U.K. LLP and Canyon Partners LLC that started similar investment pools after prices slumped last year. Values in the $1.1 trillion market for so-called non- agency mortgage securities are soaring this year after Europe’s sovereign-debt crisis eased and the Federal Reserve was able to sell $19.2 billion of the notes, underscoring demand.

Selected By Fed
Goldman Sachs was among a handful of banks selected by the Fed to bid on the mortgage bonds acquired in the bailout of American International Group Inc., drawing complaints from others on Wall Street who were shut out of the process. The firm bought $6.2 billion of the debt in a Feb. 8 auction. Unlike Credit Suisse Group AG, which won a Jan. 19 auction, the bank failed to immediately flip most of the securities to clients bidding through it, regulatory data on trading volumes showed.

Andrea Raphael, a spokeswoman for Goldman Sachs, declined to comment on the fund.

Home-loan debt that isn’t backed by government-supported Fannie Mae and Freddie Mac or U.S. agencies includes so-called option adjustable-rate mortgages and Alt-A ARMs issued during the housing boom that peaked in 2006. The securities later sunk in value amid a property slump and record defaults.

Typical prices for the most senior bonds tied to option ARMs rose to 57 cents on the dollar last week from 49 cents in late November, a 16 percent gain, according to Barclays Plc data. Bonds backed by Alt-A ARMs (BBMDA60P) increased 8 percent to 52 cents on the dollar, from 48 cents in December.

Paring Bets
Those securities remain below their 2011 highs of 65 cents and 68 cents, respectively, after falling as low as 33 cents and 35 cents in 2009. Option ARMs allow borrowers to pay less initially than the interest they owe by increasing their balances, while Alt-A loans often went to borrowers who didn’t document income.

Some firms have pared their bets in non-agency securities after this year’s gains. Western Asset Management Co., which oversees about $443 billion and started 2012 among the most bullish on the debt, sold some investments after “an intense rally,” said Paul Jablansky, co-head of the Pasadena, California-based firm’s mortgage group. The Legg Mason Inc. unit is replacing the debt with notes such as high-yield company bonds, though it remains “long-term attractive,” he said.

Senior non-agency bonds may yield 12 percent for some option ARM debt to 4.5 percent for certain securities backed by larger ”jumbo” mortgages, under a “base scenario,” according to a Bank of America Corp. report. The option ARM notes could pay 14.5 percent if losses per defaulted loan are 20 percent lower than projected, or 9.2 percent if 20 percent higher, according to the lender’s calculations.

7--Paul Krugman: Broccoli and Bad Faith, economist's view

Excerpt: Nobody knows what the Supreme Court will decide with regard to the Affordable Care Act. But ... it seems quite possible that the court will strike down the “mandate” — the requirement that individuals purchase health insurance — and maybe the whole law. Removing the mandate would make the law much less workable, while striking down the whole thing would mean denying health coverage to 30 million or more Americans.

Given the stakes, one might have expected all the court’s members to be very careful... In reality, however,... antireform justices appeared to embrace any argument, no matter how flimsy, that they could use to kill reform.

Let’s start with the already famous exchange in which Justice Antonin Scalia compared the purchase of health insurance to the purchase of broccoli... That comparison horrified health care experts ... because health insurance is nothing like broccoli.

Why? When people choose not to buy broccoli, they don’t make broccoli unavailable to those who want it. But when people don’t buy health insurance until they get sick — which is what happens in the absence of a mandate — the resulting worsening of the risk pool makes insurance more expensive, and often unaffordable, for those who remain. As a result, unregulated health insurance basically doesn’t work, and never has.

There are at least two ways to address this reality... One is to tax everyone ... and use the money raised to provide health coverage. That’s what Medicare and Medicaid do. The other is to require that everyone buy insurance, while aiding those for whom this is a financial hardship.
Are these fundamentally different approaches? ... Here’s what Charles Fried — who was Ronald Reagan’s solicitor general — said..: “I’ve never understood why regulating by making people go buy something is somehow more intrusive than regulating by making them pay taxes and then giving it to them.” ... (By the way, another pet conservative project — private accounts to replace Social Security — relies on, yes, mandatory contributions from individuals.)

So has there been a real change in legal thinking here? Mr. Fried thinks that it’s just politics — and other discussions in the hearings strongly support that perception. ...

As I said, we don’t know how this will go. But it’s hard not to feel a sense of foreboding — and to worry that the nation’s already badly damaged faith in the Supreme Court’s ability to stand above politics is about to take another severe hit.

8--Euro Area Credit: Did the ECB Wait Too Long?, economonitor

Excerpt: The ECB released its February report on monetary developments in the Euro area. This is an important report, since it will highlight whether or not the ECB’s LTRO is ‘working’, rather if the new liquidity is passing through to the real economy via new lending. On balance, it’s probably too early to tell, since there are long lags in monetary policy – however, early signs are not good for the real economy.

Ostensibly, the ECB LTRO did its job, as interbank credit has re-emerged in aggregate. Repo credit increased 4.2% over the year in February – this followed an 11.5% annual surge in January. Furthermore, short-term debt holdings jumped at a 21.3% annual pace. Banks and sovereigns have seen relief in the short-term credit markets, a product of long-term funding from the ECB.

But credit availability to the broader economy is more challenged. The chart below illustrates the working-day and seasonally adjusted lending by Monetary Financial Institutions (MFIs) to the household and non-financial corporate sectors. I use the 3-month/3-month average growth rate to illustrate the credit impetus over the LTRO period. In the three months ending in February, household lending fell 0.18% compared to the average spanning September through November 2011. The drop in quarterly lending did slow, but remains in decline. Loans to non-financial corporations fell a larger 0.82% in the three months ending in February. For non-financial corporations, the pace of decline quickened since the three months ending in January....The usual suspects are seeing large declines in household and non-financial corporate lending, including Spain, Portugal, Greece, and Ireland....

9--Who captured the Fed, NY Times

Excerpt: A hundred years ago, monetary policy – control over interest rates and the availability of credit – was viewed as a highly contentious political issue. People on the left of the political spectrum feared the central bank would be used to prop up Wall Street banks; those on the right thought it would unduly expand the role of government, giving too much power to politicians.

In the 1980s we entered a phase in which the Federal Reserve, along with other major central banks around the world, was seen as independent and run by technocrats supposedly immune from political pressure.

But in the light of the crisis of 2008 and its aftermath, we have to ask: Has our central bank fallen back under the influence of special interests?...

At the dawn of the republic, Thomas Jefferson railed against the risks posed by government backing for concentrated power in the financial sector. President Andrew Jackson fought to abolish the Second Bank of the United States in the 1830s, the leading private bank of his day, which helped manage public finances and the banking system. Consequently, there was nothing resembling a central bank in the United States for much of the 19th century.

The Federal Reserve System, created in 1913, was a uniquely American compromise, trying to balance public and private interests. Banks controlled the boards of the 12 regional Feds – with big Wall Street firms holding great sway over the New York Fed, which had a disproportionate influence within the system as a whole — and still does....

Increasingly, however, it seems that technocratic policy-making is just a myth. We have come full circle, and the Wall Street banks are calling the shots again....

We have lost track of the number of research notes from major banks pleading for easier credit, lower capital requirements, delay in implementing financial reforms or all of the above.

In recent decades the Fed has given way completely, at the highest level and with disastrous consequences, when the bankers bring their influence to bear – for example, over deregulating finance, keeping interest rates low in the middle of a boom after 2003, providing unconditional bailouts in 2007-8 and subsequently resisting attempts to raise capital requirements by enough to make a difference.

As the American economy begins to improve, influential people in the financial sector will continue to talk about the need for a prolonged period of low interest rates. The Fed will listen.

This time will not be different.

10--The fundamental imbalance in the U.S. economy is the trade deficit, CEPR

Excerpt:...the fundamental imbalance in the U.S. economy is the trade deficit. This deficit is in turn caused by the over-valued dollar. The latter is a direct result of the decision of developing countries to accumulate massive amounts of foreign exchange reserves (i.e. dollars) in the wake of the East Asian financial crisis.

Developing countries saw the harsh treatment of the East Asian countries following the crisis and decided that they did not want to be in the same situation. Their protection against this event was the stockpiling of huge amounts of reserves. They acquire the reserves by running trade surpluses, which they use to acquire dollars. The decision of foreign central banks to buy and hold dollars keeps up the value of the dollar against their own currencies. If they didn't buy dollars, the value of the dollar would fall relative to their currencies.

This matters for our trade deficit because the higher valued dollar means that imports are cheaper for us, which leads us to buy more imports. In addition, the high dollar means that our exports are more expensive for people in other countries. Therefore they buy less of our exports. If we import more and export less, then we get a trade deficit.

This matters for the budget deficit story because if the United States runs a trade deficit, then it means that the United States has negative national savings. This is definitional; as a country we are buying more than we are selling

11--FHA: "We're not broke"-- Bailout Risk Looming After Guarantees: Mortgages, Bloomberg

Excerpt: The Federal Housing Administration won’t be able to earn its way to financial health this year, increasing the chance it will need a taxpayer bailout, based on an updated forecast from Moody’s Analytics, which provides the agency’s housing-market analysis.

The U.S. government mortgage-insurer, which guarantees $1.1 trillion in home loans, had been counting on “robust growth” in home prices to help rebuild its insurance fund after paying out $37 billion to cover defaults the past three years, according to its annual report to Congress, filed in November...

The FHA’s economic projections are surreal,” said Andrew Caplin, a New York University economics professor who has testified to Congress on the agency’s finances. “They must believe there will be very few readers in Congress able to critically review such a complex report.”

Negative Equity
Caplin and six other researchers estimated that as many as 71 percent of FHA borrowers who streamline-refinanced in Los Angeles County, California, in 2009 owed more than their houses were worth, according to a February 2010 paper. Using the FHA actuary’s methodology, only 1.5 percent of the streamline refinanced borrowers would have had negative equity, Caplin said.

12--Why More Stimulus Now Would Pay for Itself—Really!, The Atlantic

Excerpt: Brad DeLong and Larry Summers say yes. In a provocative new paper, they argue that when the economy is depressed like today, government spending can be a free lunch. It can pay for itself.

It's a fairly simple story. With interest rates at zero, the normal rules do not apply. Government spending can put people back to work and prevent the long-term unemployed from becoming unemployable. This last point is critical. If people are out of work for too long, they lose skills, which makes employers less likely to hire them, which makes them lose even more skills, and so on, and so on. Even when the economy fully recovers, these workers will stay on the sidelines. It's not just these workers who suffer from being out of work. We all do. High unemployment is a symptom of a collapse in investment. If we don't make needed investments now, that will put a brake on growth down the line. Together, economists call these twin menaces hysteresis. And if it sets in, it reduces how much we can do and make in the future. Assuming that spending now can forestall hysteresis, then this spending might be self-financing. In other words, spending now might "cost" us less than not acting.

This doesn't mean that government spending is magic. Often, it's anything but. But this is a special case. DeLong and Summers identify three factors that determine whether fiscal stimulus will pay for itself: 1) how much hysteresis hurts future output, 2) the inflation-adjusted interest rate, and 3) the size of the fiscal multiplier. Let's consider these in turn.

13--Why this could be the bull market's last charge, CNN Money

Excerpt: ...That means Malkiel's whole argument is really rested on a prediction of analysts that corporate earnings will grow 5%. Analysts, though, are notoriously overly optimistic. They basically expect whatever happened in the past to happen in the future, especially when the recent past has been pretty good. Recently, earnings have been rising rapidly. That's not likely to continue. And while 5% might not sound like much, at a time when the GDP is only growing 2%, and profit margins are at an all-time high, 5% looks like a stretch. Rob Arnott, for one, thinks we have hit peak earnings. So not much of a reason to buy stocks at all.

14--The balance sheet recession, charted, FT Alphaville

Excerpt: Nomura’s Richard Koo has been banging on about the similarities between Japan’s balance sheet recession and the current financial malaise for a long while.

His main point has always been that the financial system won’t recover unless corporates and households complete their deleveraging journey.

On Wednesday he provides some charts to help illustrate the journey’s progress thus far. (see charts)

Thus what we can see here is that up until the Japan’s bubble collapsed in 1990, the country’s corporate sector was growing at rapid pace with liabilities growing faster than assets. Or as he puts it “businesses were borrowing large sums of money to purchase financial assets and real assets.”

After the bubble burst, that growth in financial liabilities slowed sharply, even turning negative in 1997 — indicating that corporates had actually started to pay down debt. This deleveraging continued until 2004, even though interest rates were at zero, indicating “just how desperate corporates were to repair their balance sheets”.

The paying down of debt only stopped in 2005. But instead of taking on new liabilties they moved to restore the pool of financial assets that had been depleted during the difficult years.

A similar story can be observed in Japan’s household sector, despite the fact that financial asset growth far outpaced the growth of financial liabilities....

As Figure 2 shows, financial asset growth in Japanese households greatly exceeded the growth in financial liabilities through the first half of the 1990s, reflecting a history of high savings rates. But growth in financial assets (savings) fell steadily after the bubble burst and had dipped nearly to zero by 2003. This was attributable more to sluggish incomes than to aging demographics, in my view. It was during this period that employment and wage adjustments began and “restructuring” became a buzzword, pushing many households into a tight financial corner. Financial assets did not resume growing until 2004, when improvements in the job market enabled households to start saving again.

Growth in financial assets slumped again as the global financial crisis depressed incomes, but picked up sharply last year following the March earthquake and tsunami. The disaster—and the subsequent problems at the nuclear plants—fueled widespread concerns about the future, prompting people to cut consumption and increase savings.

Growth in household financial liabilities fell sharply after the bubble burst, and from 1998 onward households not only stopped borrowing money but in most years were paying down existing debt. I attribute this largely to sluggish demand for home mortgage loans as land prices fell. The combined private savings surplus for Japan’s household and corporate sectors is now running at 9.5% of GDP. At a time when the strong yen and overseas economic weakness prevent Japan from boosting its exports, these savings could easily shrink GDP by 9.5% a year if the government did not step in to borrow and spend the surplus....

As Koo himself notes:

Let us now look at the situation at US households with their damaged balance sheets. As Figure 4 shows, their behavior since 2008 has mirrored that of Japanese households and companies over the last decade and a half: they are both reducing financial liabilities (paying down debt) and increasing financial assets (savings) in spite of zero interest rates. Together, the household and corporate sectors are now net savers to the tune of 5.8% of GDP. That this surplus of private savings is occurring at a time when interest rates are at zero is a clear indication the US is in a balance sheet recession triggered by the first crash in house prices in seven decades.

15--Investment banks ramp up risk trades, IFR

Excerpt: The dramatic resurgence of secondary equity markets in the US – up 11.5% in the first quarter, and 21% from the lows in November – caught most market participants off-guard. How much so was evident by short interest on the S&P 500 that peaked at post-crisis highs in September 2011, and that almost all fund categories were underweight equities and long cash entering the new year.

The equity capital markets have been a beneficiary of short-covering and a move toward fuller allocations. Initial public offerings provided an obvious means to close performance short-falls. Less apparent is the use of sizeable secondary offerings to source liquidity at a discount.

“We’re in a stock-pickers’ market. If you’re a fund manager, you can’t generate alpha by hugging an index,” said the head of equity syndicate at one US bank. “Liquidity in the secondary markets has been anaemic. Market volumes over the past two years are running at 70% of historical levels.”

16--US market breaks new records, IFR

Excerpt: The US high-yield market had its largest quarter ever at US$91.94bn, while investment-grade volume of US$294.25bn was the largest first quarter on record and the fifth largest quarter ever, according to Thomson Reuters Data.

The investment-grade total exceeds the US$272.3bn recorded in the first quarter of 2007 – before the onset of the financial crisis. The previous high-yield record was US$85.254bn, set in the fourth quarter of 2010.

“A lot of opportunistic issuers [have been] stepping in to take advantage of market conditions,” said Maureen O’Connor, a director on the high-grade syndicate desk at Bank of America Merrill Lynch.

The market environment has created the perfect storm for high-yield. On the supply side, record low rates have encouraged issuers to continue to refinance debt, setting their sights on their 2014, 2015, 2016 or even longer maturities. Last week, for example, Cimarex refinanced its 7.125% notes due 2017, pushing the maturity out by five years and saving 125bp on its cash coupon.

And if issuers are not refinancing outstanding notes, they are refinancing bank loans, locking in rates for longer terms with less restrictive covenants at levels not much higher than they could get in the loan market.

And while M&A activity has been slow, the favourable environment has allowed some larger M&A financings to get done, including the refinancing of several of hung bridge loans from the euro market

17--The Obama recovery, WSWS

Excerpt: While the United States remains mired in the deepest slump since the Great Depression, President Barack Obama is touting a modest improvement in employment over the past several months to boost his electoral prospects in November.

The three-month period from December through February has, according to the Labor Department, seen a net gain of 744,000 jobs, the largest for any three-month stretch since 2006. The official jobless rate has fallen from 9.1 percent in September to 8.3 percent in February.

It is necessary to place these gains within the context of the catastrophic collapse in employment that followed the Wall Street crash of 2008, which has left the US economy with 5 million fewer jobs than at the official start of the recession in December 2007. At the height of the crash, US businesses were cutting more than 744,000 jobs every month.

While the US economy added 335,000 net new manufacturing jobs in 2010 and 2011 combined, it lost 1.6 million manufacturing jobs between January 2008 and March 2009, a reduction of 10 percent. The current level of 12 million manufacturing jobs is down 7.5 million from its peak in 1979....

What Obama has been doing is spearheading an intensified assault on the working class. He has escalated the attack on working class living standards that has been underway for more than three decades, focusing on a drastic and permanent reduction in wages and benefits....

The results of this government-corporate offensive are reflected in statistics on wages, labor costs and income. According to a census report released in September 2011, real median household income fell 2.3 percent in 2010, to a level 7.1 percent below that reached a decade before.

US manufacturing labor costs per unit of output in 2010 were 13 percent lower than a decade earlier....

The overall result of the Obama recovery, besides the impoverishment of ever wider layers of the working class, is a further staggering growth of social inequality. One stark metric of the decline in the social position of the American working class is the fact that in the third quarter of 2011, the share of the US gross domestic product going to corporate profits was at its highest (10.3 percent) since the 1960s, and the share going to wages was at its lowest (45.3 percent) on record.

In officially announcing the AFL-CIO’s support for Obama’s reelection earlier this month, the union federation president, Richard Trumka, denounced the frontrunner for the Republican nomination, Mitt Romney, declaring, “Everything he’s done helps the 1 percent.”

A Reuters article published March 15 provides statistical proof that when it comes to helping the top 1 percent at the expense of everyone else, Obama takes a back seat to no one. The article notes that the movement of US incomes during the Obama “recovery” contrasts sharply with that which occurred in 1934, during the Great Depression.

The 1934 rebound saw strong income gains for the bottom 90 percent of earners and a decline for the super-rich (the top 0.01 percent). The year 2010, saw the opposite. The income of the super-rich ($23.8 million on average) rose by 21.5 percent over the previous year, while that of the bottom 90 percent fell by 0.4 percent.

National income rose overall in 2010, but all of the gains went to the top 10 percent. Just 15,600 super-rich households pocketed an astonishing 37 percent of the entire national gain.

The article further reports that the top 1 percent’s share of real income growth has increased with each economic expansion, regardless of whether a Democrat or Republican was in the White House. The top 1 percent captured 45 percent of Clinton-era income growth, 65 percent of Bush-era growth, and 93 percent of Obama-era growth, through 2010.

These facts demonstrate the existence in the US of a plutocracy that controls the Democrats and Republicans and the entire political system. Its deadly grip can be broken only by an independent political movement of the working class, fighting for workers’ power and socialism.

Tuesday, March 27, 2012

Today's links

1--Does inequality lead to a financial crisis?, VOX

Excerpt: Did inequality in the US lead to the global financial crisis? This column presents evidence from 14 countries between 1920 and 2008 and argues that while inequality can be blamed for many things, the global crisis is not one of them.

In his 2010 book, Fault Lines, Raghuram Rajan argued that rising inequality in the past three decades led to political pressure for redistribution that eventually came in the form of subsidised housing finance. Political pressure was exerted so that low-income households who otherwise would not have qualified received improved access to mortgage finance. The resulting lending boom created a massive run-up in housing prices and enabled consumption to stay above stagnating incomes. The boom reversed in 2007, leading to the banking crisis of 2008. Along these lines, Kumhof and Rancière (2011) explore the links between inequality, leverage and crises within the context of a DSGE model. They motivate their model with examples from the US in the 1920s and the more familiar events leading up to the subprime crisis.

There is reason to pause before accepting the generality of this new view.
Credit and crises

On the other hand, we do agree with Rajan et al that financial instability and banking crises often follow above-average growth in credit. Our evidence, which reproduces that found in Schularick and Taylor (forthcoming), finds a fairly strong relationship between growth in real credit and the probability of a banking crisis. This is consistent with many different models of financial instability, but we take no stand on this in our paper. What can be said is that inequality is not significantly related to systemic banking crises in our large sample. Since income concentration is not a good predictor of credit growth, it is hard to see how it can be related to crises by the channels proposed in the work cited above.

History, credit, and crises

Historical evidence from several major credit booms finds scant support for the inequality/crisis hypothesis. In the 1920s in the US, consumer and mortgage debt did indeed rise as the top 1% share in total income climbed from 15% in 1922 to 18.42% in 1929 (Piketty and Saez 2003). In that period, consumer credit was closely related to the rise of new, big-ticket consumer durables in the 1920s such as automobiles, washing machines, and radios. The rise of consumer credit arguably came from supply-side innovations rather than from increased household demand to maintain consumption in the face of stagnant incomes as in Kumhof and Rancière (Olney 1989). The housing boom that ended in 1926, well before the Depression started, reflected a significant amount of postwar pent-up demand, higher quality housing, and a favourable interest-rate environment (White 2009). It appears to have had little to do with the subsequent Depression and series of banking crises that would begin in mid-1929.

Time series evidence from other countries is not consistent with the inequality link either....
Conclusions and lessons

If income inequality drove the credit boom that preceded the subprime crisis in the US, the event was an outlier by historical standards. Comparative evidence from the last century shows little relationship between rising inequality and credit booms. Even in the US, a more plausible interpretation of events in the first decade of the 21st century is that interest rates were at historical lows. That situation coupled with financial innovation allowing low-income workers to buy houses at unrealistic prices given forecasts of permanent incomes and the likely reversion in interest rates.

If there is a policy lesson in all of this, it might be related to the fact that market-determined rates of leverage can lead to a systemic financial crisis and ensuing negative spillovers. But an increase in the supply of credit that generates a financial crisis has very different policy implications from those that might be prescribed by an increase in the demand for credit that allegedly arose to maintain consumption in an increasingly unequal society. In the former case, financial regulations and reforms to limit leverage and systemic risk that have been discussed and enacted since 2008 are potentially more appropriate remedies to achieve financial stability. While inequality is arguably problematic for many other reasons, we remain sceptical of claims that it engenders financial crises.

2--SEC alleges Wells Fargo ignored MBS subpoenas, Housingwire

Excerpt: The Securities and Exchange Commission seeks to enforce subpoenas it filed against Wells Fargo for alleged failure to produce documents in the SEC's mortgage-backed securities probe.
The SEC filed a subpoena enforcement action in a California federal court against the bank.
The commission is investigating possible fraud in connection with Wells Fargo’s sale of nearly $60 billion in residential mortgage-backed securities to investors, according to court documents. The SEC said it filed subpoenas with Wells Fargo that date back to September 2011.

"The bank was obligated to produce (and agreed to produce) documents to the commission, but has failed to do so," the SEC said in a statement Friday.

The commission’s action relates to its investigation into whether Wells Fargo made material misrepresentations or omitted material facts in a series of offerings between September 2006 and early 2008.

"The staff in the commission’s San Francisco regional office issued several subpoenas to Wells Fargo since September 2011 seeking, among other things, materials related to due diligence and to the bank’s underwriting guidelines," the SEC said in a statement. Wells Fargo agreed to produce the documents, and set forth a timetable, yet failed to produce many of the materials, the commission said.

The SEC seeks a court order compelling Wells Fargo to comply with its subpoenas. The commission noted that it is in a fact-finding inquiry and has not concluded that anyone has broken the law.
Wells Fargo could not immediately be reached for comment.

In February, Wells Fargo and Goldman Sachs received Wells notices over mortgage-backed securities disclosures, according to regulatory filings.

Other banks also face potential government probes over whether they misrepresented the quality of loans placed into mortgage-backed securities.

During his State of the Union address in January, President Barack Obama announced the formation of a mortgage fraud task force to look into fraud involving mortgage-backed securities.

The new federal task force, led by New York Attorney General Eric Schneiderman, sent subpoenas to the 11 largest financial institutions in late January.

3--Goldman hoses its own clients with toxic MBS, Reuters

Excerpt: As I read through Marrero's decision, I kept thinking of the movie Margin Call, in which Kevin Spacey suffers a crisis of conscience as he oversees a sell-off of his bank's MBS portfolio, at the expense of the clients buying the securities. Goldman, like the unnamed investment bank in the movie, came to a sudden realization that it had to shed MBS exposure. But its bankers were much smarter than their counterparts in Margin Call. They didn't just sell off their portfolio, according to the Marrero ruling. They created doomed CDOs, hedged against the (inevitable) failure of their own instruments, and gladly accepted fees from the clients they allegedly duped into buying the securities. It was a breathtakingly brilliant campaign, if you're of a ruthless bent. Goldman's secret MBS short, as Marrero depicts it, tricked not just its own clients but the entire MBS marketplace....

With those caveats, Marrero portrays a scheme he describes as "not only reckless, but bordering on cynical." As early as 2005, he said, Goldman began to understand through its own underwriting and its relationship with the outside mortgage appraiser Clayton Holdings that mortgage lending standards were deteriorating. Goldman Sachs had bet heavily on the continued success of mortgage-backed securities, and by the summer of 2006, knew that was a bad bet. The problem, according to the co-manager of the bank's structured products unit (quotes in Marrero's ruling), was that there were "few opportunities" to shed Goldman's MBS risk. The market believed the bank was "very long for the foreseeable future," according to another Goldman official Marrero cited.

Nevertheless, in December 2006, CFO Viniar directed the structured finance group to begin aggressively ridding the bank of subprime risk and positioning Goldman to take advantage of "very good opportunities as the market goes into what is likely to be even greater distress." Thus was born the program of shorting Goldman-devised (and Goldman-sold) CDOs based on mortgage-backed securities.

The program was so successful that according to filings Marrero cited, Goldman had a net short position of $2.1 billion in credit default swaps on mortgage-backed instruments by March 2007. By August 2007, Goldman told the SEC, it had reduced its overall exposure to subprime mortgage backed securities from $7.2 billion to $2.4 billion. Through what Marrero called "the fine art of financial transubstantiation," Goldman (in the words of one of its bankers) managed "to make some lemonade from some big old lemons."

The Hudson CDO offerings came smack in the middle of Goldman's risk reduction campaign, context that was crucial to Marrero's decision not to dismiss most of the investors' case. Goldman's own actions -- "selecting the referenced (residential) MBS and then betting heavily against them" -- indicated to Marrero that the bank well understood the risks of its subprime exposure and "maneuvered" to offload it. "All Goldman needed for the success of its venture was large 'sophisticated' investors (to) drink up the bittersweet potion despite Goldman's boilerplate warnings," the judge wrote. "Goldman thus managed to shift its significant subprime risk over to its own clients."

4--More on austerity, Paul Krugman, NY Times

Excerpt: ...if allowing an economy to remain persistently depressed reduces long-run growth prospects — and there’s pretty good evidence to that effect — then austerity in a depressed economy has enormous costs, and may even lead to a vicious circle of shrinking potential leading to even more austerity and so on. Indeed, maybe that’s happening to the Cameron government right now.

5--Comstock is still bearish, pragmatic capitalism

Excerpt: The S&P 500 earnings (as most of our regulars viewers understand-we prefer using “reported” earnings, but since all of Wall Street focuses on “operating” earnings we will use “operating”) are also just starting to show some weakness as the first quarter will be the first slowdown (earnings growth about 0.5%) in a couple of years as the profit margins were at peak levels and have always reverted to the mean in the past. Also, every single time the S&P 500 was expected to earn $100 or more, the investors were always disappointed. In fact, the 2008 earnings estimates were over $100, but when the actual number came in for “operating” earnings it was a disappointing $49.50. The 2012 earnings estimates for the S&P 500 this past fall for were up around $114, but have subsequently dropped to about $105 and will probably disappoint again. The present earnings estimates for 2013 are $119 (bottom up) and will probably be revised down sometime soon. Also, if oil continues rising, not only will earnings be affected negatively, consumer sentiment will drop and that could affect the consumer spending almost as much as the debt overload in the household sector.

We understand the jobs picture has improved, but let’s put the improvement into perspective. The unemployment rate has declined to 8.3%, but at least half of the decline is explained by many of our older citizens who have dropped out of the labor force (as well as many other discouraged workers dropping out). And if we continue to generate jobs at the same rate as the past couple of years it would still take 13 years to get to full employment. Keep in mind that we have fewer jobs presently than we had 11 years ago. Housing is dependent upon a vigorous jobs market and, with all the debt the household sector has built up, we don’t expect the housing market to bottom before the prices decline to the trend line of normal prices (taking out the bubble prices of housing from 2002 to 2007) and we still have 10% to 15% more decline left. The NAHB (National Association of Home Builders) February confidence index was just released at a disappointing 28, unchanged from January, and keep in mind anything under 50 is considered negative.

We are also looking at what Ben Bernanke called a “Fiscal Cliff.” He was referring to the Bush tax cuts expiring at the end of the year and if they expire on everyone it will essentially be a tax increase of about $450 billion/year, or $4.5 trillion over 10 years. The payroll tax holiday expires and that could be another $100 billion/year and the “super committee” will be forced to sequester another $100 billion of spending. Also, we have the winding down of the $787 billion fiscal stimulus package that was initiated in 2009. This will turn out to be as onerous to the U.S. as the austerity programs imposed on Greece and other European countries more recently....

So, the bottom line is that the technical position of the market looks very weak to us (and the swings from up about 100% and down about 50% we believe will continue, with the next move down) and the global economy is not what we would call supportive to U.S. growth. Also, the U.S. debt will be an anchor around our necks until we figure out a way to grow our way out, pay it down (deleveraging), or inflate our way out.

6--Europe and China PMI dip into the red, pragmatic capitalism

Excerpt: Commenting on the flash PMI data, Chris Williamson, Chief Economist at Markit said:
“The Eurozone economy contracted at a faster rate in March, suggesting that the region has fallen back into recession, with output now having fallen in both the final quarter of last year and the first quarter of 2012. The downturn is only very mild at the moment, with the PMI signalling a drop in GDP of approximately 0.1-0.2%, and an upturn in business confidence in the service sector provides hope that conditions may improve again later in the year. However, firms are clearly focusing on cost reduction, with employment falling at the fastest rate for two years as inflows of new business continued to deteriorate, reflecting weak demand across the region.
And on China:

Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & CoHead of Asian Economic Research at HSBC said:

“Weakening domestic demand continued to weigh on growth, as indicated by a slowdown in new orders which came in at a four-month low. External demand remained in contraction territory, but the decline was at a slower pace, implying that there are no improvements in the demand outlook. More worryingly, employment recorded a new low since March 2009, suggesting slowing manufacturing production was hindering enterprises’ hiring desire. The soft-patch in manufacturing was in line with the recent downside surprise in industrial production growth. Growth momentum could slow down further amid a combination of sluggish export new orders and softening domestic demand. This calls for further easing steps from the Beijing authority.”

7--Since budget deficits have been driving corporate profits; wwhat happens now?, pragmatic capitalism

Excerpt: The key takeaway from the Montier piece is that corporate profits have been largely driven by budget deficits in recent years. This has been the single most important understanding of the balance sheet recession. If you understood that large budget deficits would help offset the de-leveraging process then you had a huge advantage over those who thought we were in for one sustained depression. Unfortunately, the risks are mounting in this regard and corporate profits are at the top of the list.

As both Montier and Richard Bernstein have recently noted, the outlook for profits is looking tepid at best...

The key point here is that without a big debt boom and an enormous and probably historic investment boom the corporate profits picture is likely to come under more pressure as we head into 2013. And if the budget cuts are sharper than expected we can expect a substantial hit to corporate profits. Stay tuned. Budget updates will continue to play heavily into this outlook as the year plays out….

8--How much Iran premium in oil prices is justified?, sober look

Excerpt: The folks at Capital Economics believe that there is too much "Iran premium" built into crude oil prices. They argue that the oil markets have gotten ahead of global growth. And with global growth expectations overdone, the premium is now mostly due to the Iran disruption risk. So the question becomes is the Iran premium built into oil prices too high?

The chart below compares trends in equity prices vs. Brent crude. It does seem to indicate that there may be a material gap between the two with oil prices overshooting. Based on this chart, Brent should be some $5 -$10 cheaper. That would not represent a high Iran premium

9--US student debt surpasses $1 trillion, WSWS

Excerpt: Total student loan debt has grown by 511 percent, or more, over the past dozen years. In the first quarter of 1999, a mere $90 billion in student loans were outstanding. That figure had soared to $550 billion in the second quarter of 2011, which may turn out to have been an underestimation. Between 1999-2000 and 2007-2008, private student loan borrowing grew four times, from $4.5 billion to $21.8 billion per year. The College Board reports that, adjusted for inflation, students are borrowing twice what they did a decade ago.

According to the Project on Student Debt, some two-thirds of college seniors graduated with loans in 2010. Those graduates also faced the highest official unemployment rate for young college graduates in recent history, 9.1 percent. The Economic Policy Institute estimates that between 2000 and 2011, wages for college-educated men and women entering the workforce saw their inflation-adjusted earnings fall 5.2 percent and 4.4 percent, respectively.

A recent study by NERA Economic Consulting points out that the 37 million people in the US currently holding student debt are “concentrated in the younger segment of the population, as more than 60 percent of the total is between the ages of 18 and 39.”

The consulting firm adds, “One of the most worrisome student borrowing trends is the increase in the number of high-debt borrowers who carry debt loads far above $25,000, the national average amongst undergraduate student borrowers. Student debt loads of $50,000, $100,000, and $200,000 are still the minority, but those high figures are becoming more common, and with unknown consequences for the individual debtors or the economy as a whole.”

Moreover, private and public lenders have “broad collection powers, far greater than those of mortgage or credit card lenders. The debt can’t be shed in bankruptcy” (USA Today).

10--Iran Nuke Threat Far Off,

Excerpt: Solid, in depth intelligence confirms with high confidence Iran has no weapons program, but peace is still rejected

The United States, European allies, and Israel all agree that Iran does not have a nuclear weapon, has not decided to build one, and is several years away from having a deliverable nuclear missile. Still, aggressive postures towards Tehran continue.

In 2007, the U.S. intelligence community concluded that Iran had halted weaponization of its nuclear program back in 2003 and has not restarted it since. That conclusion has been repeatedly reaffirmed in recent years, but some further details of the secret intelligence have been released.
According to Reuters, U.S. intelligence intercepted telephone and email communications from late 2006 or early 2007 in which Mohsen Fakhrizadeh, a leading figure in Iran’s nuclear program, and other scientists complained that the weaponization program had been stopped. This was one piece of the puzzle that led to the 2007 finding....

One primary type of intelligence the U.S. has on Iran’s nuclear program is what is called “measurement and signature intelligence,” or MASINT. These are “sensors on satellites, drones, and on the ground” measuring “everything from the electromagnetic signatures created by testing conventional missile systems to disturbances in the soil and geography around a hidden nuclear facility to streams of radioactive particles that are byproducts of the uranium enrichment process.” The U.S. “knows what Iran has and doesn’t have,” writes journalist Marc Ambinder.

These and other forms of intelligence have made current and former U.S. officials highly confident that Iran has no secret uranium-enrichment site outside the purview of U.N. nuclear inspections.
11--Montier on Peak Earnings, The Big Picture

Excerpt: Currently, U.S. profit margins are at record highs according to the NIPA data (see Exhibit 1). More freakish still is that these record high profit margins are coming during the weakest economic recovery in post-war history: see chart

Whilst we at GMO fret over evidence of the strained nature of profit margins, the ever bullish Wall Street analysts expect profit margins to continue to rise! Witness Exhibit 4. In our search for evidence of a structural break, this simple-minded extrapolation gives us some comfort because the Wall Street consensus has a pretty good record of being completely and utterly wrong...

12--The ECB swallowed the market, Golem

Excerpt: The problem is this. The Central banks have chosen to lend to insolvent private banks and to the nations that already bankrupted themselves trying to bail out their unbailable banks. In an attempt to make their lunacy seem sensible, the central banks assured everyone that they would only accept as collateral for the money they were lending out, the best assets the banks possessed. So the best of the insolvent banks’ assets were sucked in and cheap central bank loans flooded out.

The central banks said that ‘now the banks were stabilized’ they hoped the banks would lend to the market and to each other thus allowing the broader economy and the banks themselves to be funded ‘by the market’. Neither happened. Why? Well the banks continued not to trust the quality of the assets they were offering each other as collateral. Not entirely surprising since the banks had already pledged the best of them to the central banks. Without trust-able assets as collateral – no loans.

So the banks were forced back to the ECB and the Fed for more loans. Of course they had already pledged their best assets. So began the gradual but inexorable loosening of criteria for what the ECB would accept as collateral. At first it was only AAA rated. Then it was bonds from ailing nations. Then it was anything that came to hand. Which made the ‘market’, AKA other banks, even less keen on accepting as collateral whatever was left. And so on round and round. We have long since reached the point where the central banks like the ECB, either directly or washed first through a national bank such as The bank of Greece or Spain, has begun to accept almost anything as collateral.

When I say washed what I mean is the national bank in Spain or Greece or Ireland may accept some asset which is thoroughly sub-prime in return for a sovereign bond. That bond is then acceptable to the ECB as collateral because it is a Sovereign bond, which as we all know are AAA rated, for sure, for sure never going to default. However the more sub-prime, stinky, slimy paper the national banks are stuffed with, the more the sovereign debt is backed by a national bank which resembles a sewer of rotting rubbish, a nation in the grip of austerity and a contracting economy. Whatever pretty prime-time fictions you get hosed with each evening, this is the reality that dare not be reported. And we all know it. Ireland is in recession, Spain’s economy is contracting and so is Portugal’s. That is why ‘the market’ keeps hiking the interest it insists upon for lending to National banks.

The result is that the private banks have already pledged anything good they had. They will not therefore lend to each other because they know none of them has any assets left which are worth anything. Thus they are forced to go back to the ECB and Fed for more money and those institutions are forced to take even more ropey assets in return for issuing even more loans. Each time round, each new QE and new lot of money, sucks in more bad assets and makes any possiblity of private funding even more remote. The Central banks have swallowed the market. All debt and debtors are being drawn into ever tighter orbit. None will escape.

Now you might object that I have simply missed the point of the official policy. Certainly the National banks and the Central Banks have removed huge amounts of the toxic loan/assets from the private banks… and this we are assured is a good thing. This is called ‘cleaning up’ the banks. The rubbish is removed and in its place ‘good’ national and central bank bonds are put in their place, giving the private banks lots of good assets. And it does sound possibly OK when you hear it put that way and don’t think too hard about it.

But we have to remember a couple of things. First the bad assets have not ‘gone’. They still exist. They are still money which was lent out, which itself was often borrowed and thus has to be repaid, but which is not now bringing in any profit. Those losses are still warm and moistly rotting, just doing it in National and Central bank vaults now. Second, for all that the banks do now have sovereign and Central bank bonds to pledge, they are still, all of them, coming back to the ECB and the Fed for more QE easy money loans. This is because even though the banks have used that QE money to speculate on commodities and currencies to try to make a fast and out-sized profit – still chasing high risk and return – they still have huge liabilities (money they owe) not being paid for from income which is not coming in from yet more bad assets which are nevertheless still being held at imaginary values so as to make the assets side of the balance sheet look like it might balance out those liabilities. Imagine a very long turd tied into a knot.

But I digress. My main point is that the banks, despite 4 years of never-quite-materializing recovery, still need loans from the central banks and still need to pledge assets to get them. How many more assets do they have? Probably many hundreds of billions. But they are increasingly awful. Which means we have an alleged recovery that must increasingly be fueled by the very debts and worthless dross it is trying to recover from.

Now just for fun imagine how many times any assets were re-hypothecated before they got to the ECB and how many times the ECB bond issued in return for those assets will itself be re-hypothecated. And then feel good about the solidity of the banks, the system and the recovery.

My guess is that as this year progresses banks will quietly bring rubbish back on to their balance sheets from off-balance sheet vehicles just so they can be slipped into the ECB. These would be assets that were declared worthless and written off for a tax rebate in the country of origin, before being moved to an SIV in Ireland where they would be declared at face value so as to be written down again and then pledged to the ECB at far above their real market value in return for an ECB bond which can be used to speculate against various nations and their debts.

13--Joe Weisenthal Quotes Sven Jari Stehn on Delong And Summers, grasping reality with both hands

Goldman On New Paper From Delong And Summers: Spending Cuts Now Will Be A Disaster: Goldman's Sven Jari Stehn is out with a new note spotlighting new research from economists Larry Summers and Bradford DeLong…. The gist: When interest rates are at zero, spending more to stimulate the economy has a long-run effect of helping the fiscal situation…. Here's Stehn:

In a study presented at the Brookings Panel on Economic Activity on March 22-23 in Washington D.C., Bradford DeLong and Lawrence Summers examine the effectiveness of fiscal policy in a depressed economy. Specifically, they use a simple model to explore the effects of fiscal stimulus in an environment when (1) monetary policy is constrained by the zero bound on nominal interest rates; and (2) a boost to output today brings longer-run benefits for the productive capacity of the economy (for example, by avoiding "scars" or "hysteresis" in the labor market). They call such an environment a "depressed" economy.

They reach two conclusions. First, while the fiscal multiplier is low, perhaps as low as zero, in a normal situation, fiscal stimulus today would be highly effective in affecting output both now and in the future. Second, temporary fiscal stimulus could be self-financing (and may well reduce long-run debt-financing burdens) when one takes into account the effects of present stimulus on the evolution of future output and debt-to-GDP ratios.

Stehn then backs up their work, pointing out that Goldman's own research shows deleterious effects of fiscal consolidation in times like these…

14--The Public Is Still Not Buying Equity Mutual Funds, Big Picture

Excerpt: “Goldman screams it is a generational buy, Larry Fink goes all in stocks, Notorious BIGGS is 90% long, anchors on comedy-financial fusion channels are channeling the producer in their earpiece and screaming at the teleprompter to “sell bonds and buy stocks”, even as stocks are at their highest in nearly 5 years and… what happens? In the latest week, ICI just reported that domestic equity retail funds just saw another $2.9 billion outflow, the 4th consecutive in a row, and the 23 of out 27 outflows during the entire parabolic blow off top phase the market has undergone since October, and instead put another $9 billion in fixed income funds “soaring” yields be damned.

What does this mean? Probably that the stock ramp is about to get uber-parabolic for the simple reason that this is the only thing left in the status quo’s arsenal – to keep doing the same old same old, hoping for a different outcome, because this time it’s different. Only this time the dumb money either doesn’t have the cash to burn, or just doesn’t want to participate in a rigged, corrupt, centrally-planned market. Whatever the case, the Primary Dealers and the Fed will just have to keep hoping more central banks pull a Bank of Israel and sell the hot grenade axes to them, since Joe Sixpack is done being the “dumb money.”

15--Bernanke Sees Need for Higher Household Spending to Fuel Growth, Bloomberg
Excerpt: Federal Reserve Chairman Ben S. Bernanke said the U.S. economy is operating below its level prior to the financial crisis, and that increased household spending is needed to sustain the expansion.
“Consumer spending is not recovered, it’s still quite weak relative to where it was before the crisis,” Bernanke said yesterday in the second of four lectures on the history of the Fed that he plans to deliver at George Washington University. “In terms of debt and consumption and so on we’re still way low relative to the patterns before.”...
The conference will first consider a research paper by New York University Professor Mark Gertler saying the Fed’s asset purchase programs will help spur growth by reducing interest rates rather than by increasing the amount of reserves in the banking system.

Gertler, an adviser to the Federal Reserve Bank of New York who has co-written research with Bernanke, said in an interview yesterday that the economy may not need such a stimulus program at all.

“Inflation still appears to be contained so that’s good,” Gertler said in a phone interview. “Employment growth is picking up, so that’s good. It seems like the controls are at the right setting now.”

16--Chart Attack: Following the Corporate Cash Hoard, Bloomberg

Excerpt: video (amazing!)

17--Sales of New Houses in U.S. Decrease for Second Month: Economy, Bloomberg

Excerpt: Purchases of new homes in the U.S. unexpectedly fell in February for a second month, a sign the recovery in the housing market may be uneven.

Sales dropped 1.6 percent to a 313,000 annual pace, the slowest since October, from a 318,000 rate in January that was weaker than previously reported, figures from the Commerce Department showed today in Washington. The median estimate of 78 economists surveyed by Bloomberg News called for 325,000.
Residential real estate is struggling to gain momentum as property values remain depressed by the threat of more foreclosures. Nonetheless, a pickup in hiring, growing incomes and mortgage rates near a record low are making houses more affordable, which may help underpin the market.

“There are signs of life in the market in certain regions, but we’re not seeing a broad-based recovery,” said Michelle Meyer, a senior U.S. economist at Bank of America Corp. in New York, who projected a 310,000 sales pace. “Builders are still competing with existing inventories. The spring selling season should show some modest improvement, but it will be limited.”

18--Is Deflation the Biggest Risk to the Economy?, The Big Picture
Excerpt: video --Robert Precter

19--1--Firms’ Cash Hoarding Stunts Europe, WSJ

Excerpt: Across Europe, banks, households and governments are pulling in their horns at the same time.

Banks are struggling to rebuild capital and repair the damage wrought by poor lending and investment decisions they made before the financial crisis, and are wary about new lending.
In many countries, households are struggling to pay down the heavy debts they built up in the boom years, and cutting back on consumption.

Governments are retrenching, too. For some, it is the price of aid from Germany; for others, it is out of fear that if they don’t, bond investors will cut their access to finance. A minority, including Germany—whose government approved plans on Wednesday to balance its budget in 2014, two years earlier than planned—are doing it because they think it’s a good thing.
It is a depressing recipe for a classic “balance-sheet recession” as the public and large parts of the private sector try to repair the excesses of the boom and rebuild balance sheets.
One part of the economy, however, is an important exception to the rule: companies, particularly large ones. Across Europe, corporations are sitting on a mountain of cash. The trouble is, they aren’t spending much of it. This means one possible way out of Europe’s economic crisis—a big boost in business investment—is closed off.

It’s not only in Europe that companies are hoarding piles of cash. According to the Institute of International Finance, the same is true across a number of mature and emerging economies. In January, the Washington-based organization that speaks for financial institutions world-wide estimated that corporations in the U.S., the euro zone, the U.K. and Japan held some $7.75 trillion in cash, or near equivalents, an unprecedented sum. Apple Inc.’s decision this week to pay investors from its own $97 billion cash balance won’t make much of a dent in that.

In Europe, the problem is particularly acute. According to Simon Tilford, chief economist at the Centre for European Reform think tank in London, the ratio of investment to gross domestic product in Europe is at a 60-year low even as companies pile on cash. Corporate cash holdings are now €2 trillion ($2.64 trillion) across the euro zone and an extraordinary £750 billion ($1.19 trillion) in the U.K.

ch in September, Adam Posen, a U.S. economist who sits on the Bank of England Monetary Policy Committee, depicted the corporate cash piles in the U.K. as a symptom of the private sector’s unwillingness to take enough constructive risks. That is a response in part, he said, to an excessive accumulation of debt by households and bank losses. “Some correction from the risk-taking behavior of the boom years is justified, but this has gone too far and persisted far too long,” he said.

Companies are piling up cash for a combination of reasons, say analysts. One is a reaction to the financial crisis. Companies that built excessive debts before the crisis are paying them down. Firms also are hoarding cash because of broken banking systems: Banks have retreated from lending and companies are building cash buffers to compensate. For continental Europe, where companies still draw a majority of their finance from banks rather than from the capital markets, the retreat of bank lenders is significant.
Mr. Tilford argues that another reason is government policies. “Excessive fiscal austerity,” he says, “has snuffed out Europe’s tentative economic recovery and threatens a swath of the euro zone with a slump.” Why invest to produce goods and services for economies that have little prospect of growing?
Other factors may play a role. Lower corporate tax rates and labor-market reforms aimed at reducing the power of trade unions have boosted the income of the corporate sector versus the household sector.

This suggests, Mr. Tilford argues, that policies aimed at further depressing the share of labor in national income will further undermine economic growth. He suggests increasing corporate income won’t help spur investment—while squeezing households by cutting wages will damp growth.
This argument is being made in Brussels by the Greek government, which is seeking to head off pressure from the country’s official lenders for further wage cuts as a way to increase the competitiveness of the Greek economy.

Greece has cut its minimum wage by 22%—and 32% in the case of young workers—but further efforts to trim wages to boost the international competitiveness of the Greek economy are likely. Further depressing Greek wages “is unnecessary and potentially destructive,” said one senior Greek official this week. If more cuts are imposed, “the recession in Greece will be double-digit,” he added.
The other implication is that cutting corporate taxes won’t help spur investment. That view doesn’t seem to be held by the British government: Chancellor of the Exchequer George Osborne lowered corporation tax from 26% to 24% in his annual budget speech on Wednesday, in the first step of a plan to cut it to 20%.

There is, Mr. Tilford suggests, another factor helping to build corporate cash piles: distorted incentives for senior executives. With their remuneration linked to short-term performance, senior executives have little incentives to embark on big, long-term investment projects that won’t yield benefits until after the executive has moved on. “Firms are being run for cash rather than growth, with damaging implications for economic activity,” he says.

Friday, March 23, 2012

Weekend links

1--Record China Bank Profits to Be Overshadowed by Bad Loans, Bloomberg

Excerpt: China’s biggest banks, set to post record profits for a fifth year, may report 2011 results marred by an increase in bad loans as an economic slowdown and faltering property market trigger defaults by borrowers. ...

China’s efforts to bolster banks’ risk buffers and curb inflation following a two-year, $2.7 trillion credit boom have pushed up funding costs, slowed the economy and triggered defaults, prompting Standard & Poor’s to warn March 12 that a jump in bad loans may curb profitability. Fresh evidence of mounting defaults may clip the average 42 percent rally in shares of the banks in Hong Kong over the past five months.

“It’s time to take profits off the table,” said May Yan, a Hong Kong-based analyst at Barclays Capital Inc., who cut her rating on the industry to “neutral” last month, citing weakness in the economy and banking sector. “The rebound of NPLs is not temporary. It’s the beginning of a worrisome trend.”...

The earnings have been driven by accelerated loan growth after China’s government unveiled a 4 trillion-yuan stimulus package to bolster the economy following a slump in global equity and credit markets in 2008. That triggered an explosion in credit to local governments and property developers, and a surge in investments in infrastructure such as roads and bridges.

A year after the boom ended in 2010, defaults began to climb. Bad loans at China’s five largest banks rose to 299.6 billion yuan as of Dec. 31, from 287.9 billion yuan at the end of September, according to data from the regulator in February. The non-performing loan ratio remained at 1.1 percent, it said.

The actual increase in defaults is probably higher than the official data because lenders write off the worst assets at the end of the year, China International Capital Corp. analysts Mao Junhua and Luo Jing wrote in a note last month.

2-- The supercycle is so over, iron ore edition, The Big Picture

Excerpt: The country can’t keep building airports, railway lines and apartment buildings at its recent run rate, forever. Even the Communist Party has openly acknowledged that the economy is imbalanced, with too high a proportion of capital investment versus consumption. Party leaders may even become pro-active about changing that in the new five-year plan, but either way, eventually things will change…So, about this supercycle. Credit Suisse’s analysts published a view of their internal debates over the China outlook, after Dong Tao, their chief regional economist for Asia ex-Japan, came out with a rather bearish take on the China outlook, stating that the commodities supercycle is over.

3--A technical recession in the eurozone?, FT Alphaville

Excerpt: On Thursday morning, a flash estimate for March’s purchasing manager’s index suggested that the eurozone is in recession. The composite output index was 48.7, down from 49.3 in February, and is the sixth decline in business activity over the last seven months. The weakness was primarily in manufacturing, which saw its eurozone index fall from 49.0 to 47.7, rather than in services.

The PMI figures tend to lead GDP changes and are released significantly in advance (hence why they are valuable). If the relationship holds, the GDP figures will reveal two consecutive quarters of falling output.

4--Is Draghi's LTRO working?, FT Alphaville

Excerpt:...In February, European banks lapped up €530bn of funding from the ECB, for a three-year term. In November, they’d taken €489bn. ECB president Mario Draghi called the operations an “unquestionable success”.* That’s nice.

But how can we objectively measure the success or failure of this unprecedented support by the central bank of so many diverse nations?

Elwin de Groot of Rabobank starts with the theory of what the Long-Term Refinancing Operation (LTRO) was meant to do. Which is to say, what things would have to happen for the operations to successfully aid the restoration of the transmission mechanism of monetary policy

The effectiveness of the LTROs, and other extraordinary operations of the ECB, can at the moment be judged by some metrics (and general sentiment) positively. However, it seems a bit rash to call them an “unquestionable” success until the liquidity is actually shown to improve bank funding markets, and ultimately land in the real economy.

But what if… it doesn’t work? Back over to de Groot (emphasis ours):

…if such an improvement does not materialise, the ECB may get under renewed criticism for having addressed a solvency problem with a liquidity solution. Indeed, it may actually reduce the chances of a third LTRO, forcing the ECB to rethink its unconventional policy strategy.

5--Third Consecutive False Dawn for Stocks & Economy, Trim Tabs

Excerpt: The stock market is up over 11% so far this year benefiting from the Fed printing press, this time called Operation Twist.... Meanwhile the big year to date move in stock prices apparently has almost everyone else convinced that the US economy has to be growing much faster then it really is, or else stock prices would not be up so much.

If only that were the truth. There is only one reason the stock market is rising and that is that the Federal Reserve has given away so much free money that the public companies are using their balance sheet cash to buy back many more shares than they and the public are selling.

Remember in both 2010 and 2011 the stock market was up over 10% and believe it or not the consensus among Wall Street professionals and the financial media was that the US economy was on the road to a sustainable recovery at the beginning of both 2010 and 2011. In neither case was the US economy in a sustainable recovery and that mistaken belief is what is again happening this year.

Last year, at the start of 2011, the stock market was boosted by the impact of QE2, and after rising just over 10% year to date by the end of April, two months before QE2 ended, the stock market started to sell off eventually dropping more than 20%. Two years ago in 2010, after a similar seemingly healthy 10%+ gain to start the year, stock market also started to sell off by the end of April, also plunging by more than 20%.

How quickly we forget the past. This year, the bulls are hoping that this time the US is in a real recovery. Unfortunately it is not. The job market is growing, by about 100 to 150,000 new jobs per month, but no where near the 250,000 bogus jobs reported by the Bureau of Labor Statistics. Similarly wages and salaries so far this year are growing by about 3% year over year, a rate of gain roughly equal to inflation, but no where near the 5% nonsense number estimated by the Bureau of Economic Analysis.

Finally the housing market is also reportedly improving numbers based upon seasonally adjusted numbers boosted by an exceptionally warm January and February. The reality, as I have previously reported on my video blog, is that the housing market is still at least a year away from a bottom, let alone a recovery.

To repeat, the only source of new money with which to buy stock is coming from companies buying back many more shares then they are selling. However, that could be changing.

While companies are continuing to buyback shares, which is why we are still bullish, there are some reasons to worry about that trend. First of all insider selling is surging. The rate of insider selling to buying went from a 5 to 1 ratio in January to a 14 to 1 ratio of insider selling to buying in February to 35 to 1 starting the second week of March.

Similar, there have been none, zero, new cash takeovers announced so far this month compared to monthly rate of $15 billion last year, and the pipeline of companies wanting to sell new shares is ramping up big time. To me that says that while lots of buybacks are still happening now, that trend could be ending sometime soon, particularly now that Operation Twist is approaching its end.

6--Student-Loan Debt Reaches Record $1 Trillion, Report Says, Bloomberg

Excerpt: U.S. student-loan debt reached the $1 trillion mark, as young borrowers struggle to keep up with soaring tuition costs, according to the initial findings of a government study.

The figure, which is higher than the country’s credit-card debt, was probably reached “several months ago,” Rohit Chopra of the Consumer Financial Protection Bureau, said in a posting yesterday, excerpted from a speech he made at the Consumer Bankers Association meeting in Austin, Texas.

“Young consumers are shouldering much of the punishment in the form of substantial student-loan bills for doing exactly what they were told would be the key to a better life,” Chopra, the bureau’s student-loan ombudsman, said in the posting.

More students are taking out loans to pay for college as tuition increases. Undergraduates are limited by the amount they can borrow in federally backed loans. Students also take out private loans, which lack the income-based repayment and deferment options of federal ones, Chopra said.

Excessive student debt could slow the recovery of the housing market, as young people repay money for their education rather than buying homes, said Chopra, who called the results “sobering.”

‘So Many Borrowers’

“Federal student-loan debt isn’t growing just with new originations,” he said. “With so many borrowers unable to keep up with interest payments, debt is growing even for many who have left school.”

7--As Portugal and China remind us, the crisis is far from over, IFR

Excerpt: Today’s strike action in Portugal reminds us that the European debt crisis is far from over and the Flash PMI figure from China – the reading was at 48.1 – also reminds us that the economy there is slowing.

So the main driver of the world economy is no longer driving quite so hard and some of this is down to the continuing problems in the eurozone.

The leadership in Beijing has made it clear that it is aiming to facilitate a soft landing but that it is not in the mood to inject stimulus just for the sake of it. We have been watching their real estate bubble for several years with both fear and awe, but as it begins to deflate we are pinning huge hopes on the Chinese government being able to manage it down in a controlled fashion.

To do so, it must (and will) resist the temptation to ease monetary conditions and to simply effect the construction and completion of ever more empty buildings. However, soft landings are a fairly rare event although Beijing’s response to the post-2007 crisis in the West was exemplary and I guess most markets are expecting them to be able to pull the trick off again.

The Portugal situation is also supported by the markets’ belief that with the European authorities having pulled the rabbit out of the hat in the case of preventing Greece from dragging the eurozone into the abyss, that they will be able to do the same again for Portugal and, if needed, Ireland and Spain as well.

These are all round big asks but markets are bored with hating themselves and they won’t let a few details like a slowing China or a struggling eurozone periphery spoil the fun. There is little doubt that the early signs of economic recovery in the West have taken root although one should be cautious in expecting a straightforward and linear recovery. The path ahead remains crooked and stony.

Lessons from Japan

Nevertheless, as fancy as the recovery might look in terms of quarterly GDP figures and falling unemployment, much of it is still feeding on the benefits of quantitative easing and near-zero interest rates. Central bankers are very gently and very carefully beginning to let loose the first warnings of incipient inflation risks although I must say that personally I am still pretty sanguine on that front. The lesson from Japan in the 90s is that it is hugely dangerous to tighten monetary policy too early and some economists argue quite convincingly that the lost decade was as much due to the BoJ jumping the gun as it was to the busted banking system and the struggling real estate sector. My thinking is that barking policy setters don’t bite.

Alas, I regard the pull-back which we have seen in risk assets in the past few days as nothing of significance and reckon that one should be buying the dips here. I would also feel tempted to re-weight away from emerging markets and back into core developed markets. Is that derisking or adding risk in the new global environment? I wonder…

8--IFR Comment: UK retail sales plunge, QE back on BoE agenda?, IFR

Excerpt: Whatever way one wants to look at the UK retail sales data they were weak. This might provide the first indication that households squeezed to the limit and are now cutting back further on their spending.

Spending power has been hit by high inflation and wage growth that has failed to keep track as well as fuel prices that have dampened discretionary purchasing power.

For February, total retail sales volumes were down 0.8% compared to -0.4% expected by the market with Jan revised to +0.3% from +0.9% in the initial estimate. When we strip out the impact of fuel the picture is just as bleak with sales down 0.8% m/m for Feb with Jan revised lower form +1.2% m/m to +0.6%.

The revisions made the headline news that much worse especially as the revisions were as a result of taking into account smaller stores where earlier estimates were certainly more optimistic.

The fall in February showed a large drop in non-food items and thus supports the view that beyond the basics of feeding oneself and paying for fuel there is little left in the pot to make discretionary purchases.

At the margin the odds of QE in May have increased but still remain below 50%. Having already fired an additional £125bn we would need to see more in the way of downside risks to see BoE opt to provide further QE in May.

9--IFR Comment: A wakeup call from global growth risks, IFR

Excerpt: The economic outlook was supposed to be getting better, wasn’t it? We would reiterate that what we have seen with risk markets and bond yields of late is a post-Greek world where tail risk was being priced out. That is, it was not that things were going to get better, but that the risks of more messy outcomes has been severely reduced.

The price action of higher bond/t-bill yields and a risk market that was moving higher had the potential to force players form safety/liquidity into risk and was something that we saw the potential to happen. Such a shift can still occur with the markets currently taking on corrective tone after some spectacular gains over the last few sessions. What we need to keep an eye on is where we go from here and how the market reacts to the correction that is currently in progress.

The Chinese flash PMI or even the French/German PMI weakness serve to highlight that the downside risks to global growth remain. The focus on the type of landing for China (hard or soft) and a Eurozone walking toward a fiscal austerity based recession.

For the Eurozone the potential for downside surprises on growth especially for Spain and Portugal places them at the forefront of the crisis now that Greece is no longer injecting the same sort of volatility. The correction higher on Portugal yields after LTRO2 and the continued widening of the 10-year Spain/Italy spread point to a market that is increasingly cognisant of the risks.

Growth risks remain to the downside and the PMI data are only reinforcing the importance of the growth outlook for a market that had got carried away with some rosy lagging/coincident economic numbers.

10--Two Charts On Why The LTRO Is A 'Real' Failure, zero hedge

Excerpt: While financial and sovereign spreads in the most optically sensitive entities has rallied magnificently for the last few months – helped and extended by LTRO 1 and LTRO 2 – the weakness of the last week or so in both of these critical systemic risk indicators (Sovereign spreads in Spain and Italy and the LTRO Stigma that we noted earlier) should be worrisome for many of the leaders who are using market action as a corollary for their actions. What is most worrisome however is the absolute and utter lack of impact to the ‘real economy’ of Europe as PMIs have continued to slip and sentiment stumbles – nowhere is this more evident than in charts of Corporate Credit Demand and Corporate Credit Availability, which as Morgan Stanley notes today, suggest the deleveraging balance sheet recessionary impacts felt in Japan and the US are now writ large in European minds as minimizing debt dominates maximizing profits (or living standards). Demand for credit is sliding for both large and small firms and bank lending standards continue to tighten aggressively for both large and small firms. As austerity continues and credit contracts, it seems apparent that the much-hoped for shallow recession in Europe will be deeper and longer than most currently believe.

Demand from small firms for credit - just as we saw in the US - is lagging notably now. Large firms also are showing falling demand but at a shallower rate but with jobless rates so high already and the smaller firms (as in the US) as the engine of job creation, it seems problems are playing out in a similar path to the other deleveraging regions of the world...

And lending standards have only become tighter even as banks have supposedly been flodded with encumbered cash...

11--11 out of 13 economic indicators "miss", zero hedge

Excerpt: From David Rosenberg:

It is truly amazing how many people out there believe the economy is improving just because the S&P 500 managed to get to 1,400 this past week. The market doesn't always get it right.

But a look at the data flow suggests that beauty is in the eyes of the beholder.

Much emphasis is being put on the employment data. Outside of that, only auto sales really managed to surpass expectations regarding the U.S. data flow that has been released since the start of the month.

Meanwhile, personal income, consumer spending, ISM, net trade, NFIB, IBD/TIPP economic optimism, industrial production, NAHB, housing starts, University of Michigan consumer sentiment, and now, existing home sales, all came in below consensus estimates. So 11 indicators have missed, just 2 have beat, and supposedly we have some sort of nifty growth spurt going on. Incredible....

Speaking of the "auto sales recovery", we have previously demonstrated that this is purely on the back of yet another record month of channel stuffing by GM. Alas, just as the AOL coasters, pardon AOL OnLine activation CDs, channel stuffing always ends up in catastrophic failure. And this time around we doubt that the US population will have the stomach for yet another bailout of the insolvent automotive company whose crowning post reorganization moment has been the retraction of the Chevy Volt.