Monday, March 5, 2012

Today's links

1--Reagan, Obama, Austerity, Paul Krugman, NY Times

Excerpt: (note: Turns out Reagan was more of a Keynesian than Obama) A followup on the effects of austerity at the state and local government level, which have led to a decline in government purchases of goods and services that stands in stark contrast to earlier recoveries. I pursued this a bit more, and have a startling calculation to offer.

Let’s look at the comparison between government purchases in the Reagan “Morning in America” recovery and the current recovery: see chart

At this point in the Reagan recovery government spending had risen 11.6 percent; this time around it’s actually down by 2.6 percent. So if we had followed the Reagan track, spending would be almost 15 percent higher.

Since government spending on goods and services is about $3 trillion a year, spending on the Reagan track would have meant more than $340 billion more in direct government demand, or more than 2 percent of GDP. Include the multiplier effect, and we would have expected real GDP to be something like 3 percent higher — and given Okun’s Law, the unemployment rate to be 1.5 percentage points lower, or something like 7 percent.

How does this compare with the Reagan recovery at a corresponding stage? Hmmm: see chart

So what my calculation suggests is that if it weren’t for austerity, American style — the result of the failure to provide sufficient aid to state and local governments — we might well have an unemployment rate right now that was lower than unemployment at the comparable stage of “Morning in America”.

2--What Are Repercussions If CDS Hedging Fails?, The Big Picture

Excerpt: I have no dog in this fight, other than than an interest in seeing derivatives, especially Credit Default Swaps, appropriately regulated as insurance products.

But the process for determining a payout for CDS is fascinating. The people officially determining defaults are not objective Judges or impartial observers; rather, a group of self-appointed traders, conflicted, biased, non transparent participants — with positions affected by their own decision – determine what a Greek default is and isn’t.

Who is on the ISDA committee?

Bank of America Merrill Lynch


Credit Suisse

Deutsche Bank AG

Goldman Sachs

JPMorgan Chase Bank, N.A.

Morgan Stanley


BNP Paribas

Societe Generale

Citadel Investment Group LLC

D.E. Shaw Group

BlueMountain Capital

Elliott Management Corporation


Again, I wonder loud: Why would one want to own something that has a payout determination made by this group of fucktards objective, ethical, unbiased committee members?

3--The invisible welfare state of the top one percent, Wa Post

Excerpt: The more a government social program benefits wealthier Americans, the less obtrusive it is. We design policies for the poor in ways that make it hard to escape the knowledge that the government is providing help. But richer Americans rely on programs that are “submerged.”

The Tax Policy Center estimates that eliminating all individual income tax expenditures would raise levies on the bottom 20 percent by $931. For the top 1 percent, the tax increase would be almost $280,000. (Notably, both President Barack Obama and Mitt Romney have talked about cutting back on tax expenditures for the wealthy, but neither has provided details.) Even so, many middle class and wealthy beneficiaries have no idea that they’re receiving any government assistance at all....

We’re funneling an enormous amount of money to people who, in many cases, don’t need it and don’t even know they’re receiving it. We’re designing programs to be hidden in the annual budget — tax expenditures don’t show up as spending, even though that’s what they are — and invisible to taxpayers. That’s economically inefficient and politically problematic.

If Americans who either rent or own their homes outright were asked to accept a tax increase of $150 billion in order to subsidize the mortgage payments of their indebted friends, it seems unlikely they would find that appealing. The same goes for asking Americans who don’t get health insurance through their work to spend $100 billion or so annually subsidizing the benefits for those who do. Of course, that’s exactly what’s happening right now, but it’s hidden in the tax code, so most Americans don’t know it and can’t protest it.

4--Use of lower-rated debt in repos has returned to pre-crisis levels, credit writedowns

Excerpt: As Walter Kurtz describes so well on his Sober Look blog (emphasis added):

Tremendous leverage is in fact available via repo, a market far larger than CDS. The media often misses the fact that MF Global failed because of repo based leverage. And by the way so did Lehman and Bear Stearns and Merrill Lynch – all failed because they could not roll their repo loans. That’s why repo markets are of critical importance to the financial system and need to be well understood by policy makers. It’s amazing that a typical US politician knows more about the Kandahar Province in Afghanistan than what a repo transaction is.

On the most basic terms, a repo is a short-term collateralized loan. The borrowers are the big banks and broker dealers: JPMorgan Chase, Bank of America, Citigroup and others. They’ve got fixed income securities on hand (some theirs, some belonging to their clients.) They post these bonds to the lenders, who are usually mutual or money market funds, other asset managers and custodial banks....

A report by Fitch Ratings says that the use of lower-rated debt in repos has returned to “pre-crisis” levels. And, by the way, they’re back to using bonds backed by subprime and low-quality residential mortgages. The U.S. repo market is worth around $1.6 trillion; Fitch looked at data from 10 of the biggest money market funds engaged in repos and found that 20% of the underpinning collateral consisted of structured finance, or repackaged loans, and that almost half of this is made up of repackaged subprime and subprime-like mortgages.

The ratings agencies have admitted their earlier “mistakes” of rating these risky mortgage-backed bonds too highly. And since the crisis, they’ve adjusted their models, rerun their analyses and let the downgrades fly. All the negatives are already priced in, right?

Not quite. Naked Capitalism hipped us to a face-palm-inducing report from R&R Capital from just a few weeks ago:

Realized losses declared on private residential mortgage-backed securities (RMBS), already much higher than original rating agency and investor estimates, are projected to rise substantially in the coming months [...].

On the securities performing at December 2011, a universe of approximately $1.42 trillion, R&R estimate the amount of additional losses likely to materialize is $300 billion, with one-third concentrated in ten arranger names, including Countrywide, Morgan Stanley and JP Morgan. About 17,000 tranches, or 34% of the universe analyzed by R&R, may lose up to 83% of their remaining principal.

addition, R&R estimates that approximately $175 billion of losses already incurred on the loans have not yet been allocated to the bonds in the related transactions. Failure to allocate realized loan losses could distort the valuation of related RMBS tranches.

This is not to mention the fact that the features of the Obama administration’s ever-changing homeownership help programs are getting closer and closer to inflicting pain on RMBS investors. As Yves Smith says (emphasis mine):

[RMBS] investors have sat on the sidelines during the mortgage settlement and “fix the housing market” debates, even as becomes clearer and clearer that the solution envisaged is to take from investors to make the banks whole.

What happens when the eventual losses start being reflected as lower valuations and dropped ratings for the RMBS collateral being used in the repo market? Who’s going to get hosed here? And where will this latest domino trail lead?

5--Will Wall Street Ever Face Justice?, Phil Angelides, NY Times

Excerpt: Four years after the disintegration of the financial system, Americans have, rightfully, a gnawing feeling that justice has not been served. Claims of financial fraud against companies like Citigroup and Bank of America have been settled for pennies on the dollar, with no admission of wrongdoing. Executives who ran companies that made, packaged and sold trillions of dollars in toxic mortgages and mortgage-backed securities remain largely unscathed....

The belated creation of a Residential Mortgage-Backed Securities Working Group, led by federal officials along with New York State’s aggressive attorney general, Eric T. Schneiderman, offers hope that the needed surge of investigation and enforcement may finally be initiated. But for it to succeed, the Obama administration must give the group the wherewithal to do so. ...

No one should seek or condone prosecutions for revenge or political purposes. But laws need to be enforced to deter future malfeasance. Just as important, the American people need to believe that a thorough investigation has been conducted; that our judicial system has been fair to all, regardless of wealth and power; and that wrongs have been righted.

6--Investors' Sell Signal: Surging Stocks, WSJ

Excerpt: The stock market is surging, but many individual investors aren't getting swept up in the excitement.

The Dow Jones Industrial Average has climbed 6.2% this year, and closed above 13000 on Tuesday for the first time since May 2008. Dow 13000 was short-lived, however, as the index fell below 13000 Wednesday, amid congressional testimony by Federal Reserve Chairman Ben Bernanke. On Thursday, the Dow gained 28.23 points to end at 12980.30.

The Nasdaq Composite, meanwhile, crossed the 3000 level on Wednesday for the first time in 12 years, before falling back.

Yet many individual investors, chastened by the dot-com collapse, the 2008-09 financial crisis and volatility since then have viewed the latest rally not as a "buy" signal but as an opportunity to take profits. According to mutual-fund flow tracker EPFR Global, individual investors have pulled $8.3 billion out of U.S. stock funds since the beginning of the year and sunk almost $10.6 billion into bond funds....

Although the S&P 500 has returned 103% since bottoming in March 2009, it has suffered setbacks along the way, most recently as European leaders struggled to find a solution to the Greek debt crisis. That has caused individual investors to meet this year's rise with skepticism, some observers said.

EPFR hasn't tracked a single week in which individual investors put money into U.S. stocks since last July. And since the market bottomed in March 2009, EPFR has counted just two months of net inflows from individual investors. Institutional investors, however, are buying. Including all types of investors, U.S. stock funds have seen inflows of more than $588 million this year, according to EPFR.

Now, markets may be at a tipping point, said Sam Stovall, chief equity strategist for S&P Capital IQ. If individual investors decide to dive in, they have a lot of dry powder to drive the market higher, he said. But if they don't, it will be difficult for the rally to continue much longer....

Some investors said they have seen this all before. The Dow Jones Industrial Average has crossed and closed above 13000 nine times since first breaching it in April 2007. It has crossed and closed above 11000, 12000, 13000 or 14000 a total of 74 times. That has kept many individual investors from batting an eyelash at the latest hallmark, said Susan John, chairwoman of the National Association of Personal Financial Advisors

7--China Shifts Out of Dollars, World Doesn't End, WSJ

Excerpt: China is shifting sharply away from U.S. dollars and the world hasn't ended—yet.

The threat of a disorderly unwinding of global trade imbalances kept economists awake at night until the financial crisis gave them bigger things to worry about. But China's surplus with the rest of the world has dissipated. The current-account surplus as a share of gross domestic product fell to about 2.7% in 2011, down from a high of 10.1% in 2007.

As a corollary of that, growth in China's foreign-exchange reserves has slowed. The share allocated to U.S. dollars has fallen, too. Data from the U.S. Treasury suggests the dollar share of China's $3.2 trillion stash fell to 54% in June 2011, down from 65% in 2010, and a high of 74% in 2006. In the 12 months to June 2011, dollar purchases accounted for just 15% of additions to China's reserves...

So, China has shrunk its external surplus and shifted away from dollar debt, but the sky hasn't fallen. The dollar hasn't collapsed. U.S Treasury yields remain low and Treasury chief Timothy Geithner continues to finance the deficit without kowtowing to Beijing.

Still, don't yet put away those "end is nigh" placards. China has achieved external balance only at the expense of exacerbating internal imbalance. In 2010, investment contributed an unprecedented 48.6% of China's GDP, up from 43.9% in 2008. That's substantially higher than any other major economy, including the Asian tigers during their period of rapid growth. Commodity imports driven by surging investment has been a key factor in wiping out China's external surplus

The current level of capital spending is unsustainable. Stories of wasteful investment abound. The goldilocks scenario is that China can transition smoothly from investment to consumption as a driver of growth, with imports of consumer goods replacing commodities. If that doesn't happen, though, falling investment would undermine GDP and import growth. In that case, China's current-account surplus would come roaring back to life and it would be time to get those doomsday placards out again.

8--(from the archives) Investors Place Their Money on Fed, WSJ

Excerpt: Investors have piled into mortgage bonds guaranteed by U.S. housing agencies, in a bet that the Federal Reserve will launch a third round of stimulus aimed at the housing market.

That buying has sent yields for securities backed by newly originated 30-year mortgages to record lows this week. Yields move in the opposite direction of prices. On Thursday, the rate for 30-year Fannie Mae mortgage securities hovered at about 2.66% late in New York, according to data from Credit Suisse Locus, a research platform. On Jan. 3, the yield stood at 2.96%.

have declined in recent months, driven first by the Fed's surprise announcement in September that it would start buying mortgage debt again with the proceeds of maturing mortgage bonds. More recently, investors took cues from some Fed officials publicly highlighting the importance of housing to the economic recovery. Speaking to a bankers' group in Iselin, N.J., on Jan. 6, Federal Reserve Bank of New York President Bill Dudley, considered a close ally of Fed Chairman Ben Bernanke, said "with additional housing policy interventions, we could achieve a better set of economic outcomes." Other Fed officials recently have raised the call for more action on housing.

Many bond-market strategists expect the third round of quantitative easing, in which the Fed buys bonds to increase the money supply in an effort to increase lending and liquidity, to be announced sometime in the first half of 2012. Rough estimates of the size of the program vary. BNP Paribas said the Fed could purchase $400 billion, while Morgan Stanley analysts offer a range, with $750 billion of purchases of Treasurys and mortgages at the high end.

the most recent flare-up of the European sovereign-debt crisis roiled markets in November, Dwight Asset Management Co. in Burlington, Vt., boosted its exposure to mortgage-backed securities in December.

"We know that they're not going to take their foot off the accelerator," said Paul Norris, head of structured products at Dwight Asset Management, which manages $50 billion. "We know that they're not going to want to purchase more Treasurys because they're running out of Treasurys to purchase. So that leaves mortgages."

Even though Mr. Norris expects another round of Fed bond buying, he is considering taking profits on some of his mortgage holdings on the strength of the rally.

The emerging consensus on Wall Street underscores a lack of confidence in long-term growth, as consumers and government continue to work off debt burdens. That should keep growth muted and the economy fragile....

Mortgages played a big role in the Fed's first round of quantitative easing, which was first introduced in the midst of the financial crisis in 2008. As part of that program, the Fed purchased $1.25 trillion of mortgage-backed securities through March 2010....

It is unclear how much another round of mortgage-bond buying from the central bank actually would help the economy. Mortgage rates already are hovering near historical lows. But many homeowners that could benefit from refinancing at lower rates are unable to because they are underwater on their mortgages, meaning the house is worth less than the loan, a condition that renders a loan effectively ineligible for refinancing.

But observers of the bond market view more Fed action as highly probable, with most disagreements centering around when such a program might be announced.

Bank of America Merrill Lynch analysts expect the Federal Reserve won't announce a third round of bond buying until this summer, later than the announcement expected in the first half of the year by many market prognosticators.

9--European youth unemployment, macro business ("must see" chart; the true cost of austerity)

10--The austerity recovery, VOX

Excerpt: Both Europe and the US have witnessed so far very weak recoveries from the past recession.....I plot below government consumption and investment (which are the two components of governments that enter the GDP calculations) for the last two recoveries. Here the difference is striking. While government spending was strong during the 2001 recovery growing by about 16% in the 11 quarters that follow - faster than other components of GDP; in the 2009 recovery government spending has barely grown and has remained flat or even falling over the most recent quarters.

The analysis I am doing is clearly not complete. Each of the variables I plot are not independent. The behavior of private business output depends on government spending. How private output reacts to government spending is a source of debate as the answer depends on what economic theories you believe about the fiscal policy multiplier. But that debate cannot change the simple accounting exercise that the previous three plots do. Compared to previous US recoveries, the current one is unusual in the sense that government spending (a component of GDP) has been much weaker than in previous recoveries. (see charts)

11--Spain's "Debt Crisis" Was Created by the ECB, CEPR

Excerpt: The NYT had an article on how Spain is struggling to both reduce its deficits to address its debt crisis and try to simultaneously promote growth. It would have been worth pointing out that Spain's debt crisis is almost entirely a result of the European Central Bank's policy.

By explicitly refusing to act as a lender of last resort and imposing austerity conditions on Spain and other euro zone countries, the ECB has raised questions in financial markets about Spain's ability to pay its debt. Spain had been running budget surpluses before the crisis and its debt to GDP ratio remains below that of the UK, the United States and many other countries that have no difficulty borrowing in financial markets.

12--Ireland's Economy Is Slumping BECAUSE It Is Following the ECB-IMF Bailout Program, CEPR

Excerpt: A Washington Post article on the weak state of Ireland's economy began by telling readers:

"Of all Europe’s crisis countries, Ireland has been perhaps the most adamant about pushing ahead with the budgetary, banking and other steps urged by its international lenders.

Yet more than a year into its bailout, economic growth is lagging, high unemployment seems entrenched, and households and banks remain weighed down by the debts accumulated during a heady real estate boom."

The second sentence would have been more accurate if it said:

"As a result, more than a year into its bailout, economic growth is lagging, high unemployment seems entrenched, and households and banks remain weighed down by the debts accumulated during a heady real estate boom."

The poor performance of Ireland's economy is not a surprise to people who know economics. Sharp cutbacks in government spending in the middle of an economic downturn are expected to lead to weaker growth. Ireland's economy is doing badly precisely because it has been following the ECB-IMF program so closely.

13--EU summit adopts Fiscal Pact for European-wide austerity, WSWS

Excerpt: On Friday, the European Union heads of government signed the so-called “Fiscal Pact” at a summit meeting in Brussels.

The agreement commits EU members to maintain strict fiscal discipline. They are required to adopt a constitutional debt limit along the lines of the German “debt brake.” If they exceed the specified budget deficit ceiling of 3 percent of gross domestic product they can be sued by the European Court, triggering an automatic procedure for imposing penalties. Countries that do not sign up to the pact will be ineligible for assistance from the European Stability Mechanism (ESM), the permanent European rescue fund, presently set at €500 billion, which is slated to come online in July.

The Fiscal Pact increases pressure on EU member states to cut government spending. It ensures that austerity policies are continued regardless of election results and changes of government. It effectively strips parliaments of their most important power, control over the budget, and deprives voters of any opportunity to influence fiscal policy.

German Chancellor Angela Merkel described this profoundly undemocratic treaty, which came about largely on her initiative, as a “milestone in the history of the European Union."...

On the eve of the summit the European Central Bank for the second time since December opened up the floodgates of cheap loans to the banks. The ECB offered the banks more than half a trillion euros for a three-year period at just 1 percent interest. This is a massive windfall for the financial elite, which can invest this cheap cash in government bonds with the certainty of receiving a four-fold to six-fold return.

Like the so-called “rescue package,” this measure is aimed at protecting the big banks and investors against a possible default by Greece, even as the cuts required under the Fiscal Pact drive the continent deeper into slump.

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