Thursday, March 8, 2012

Today's links

1--QE3? Marketwatch

Excerpt: Federal Reserve officials are considering a new type of quantitative easing that will attempt to boost the economy without accelerating inflation, according to a report published Wednesday.

Analysts said the new approach would allow the Fed to move despite high oil prices.

Under the new approach, the Fed would print new money to buy long-term mortgage or Treasury bonds but effectively tie up that money by borrowing it back for short periods at low rates, according to a story in The Wall Street Journal.

This “sterilized” quantitative easing, would use reverse-repurchase agreements to keep the money from flowing to bank reserves.

Markets reacted to the report, with stocks advancing to their strongest level of the day. Commodities also rose

2--Finally, Spain, Paul Krugman, NY Times

Excerpt: I’ve always viewed Spain, not Greece, as the quintessential euro crisis country. With Rajoy’s government balking — rightly — at further austerity, the focus is now where it arguably should have been all along.

And with Spain now front and center, the essential wrongness of the whole European policy focus becomes totally apparent. Spain did not get into this crisis by being fiscally irresponsible; here’s a little comparison. (see chart)

And while we say now that the surplus before the crisis was swollen by the bubble, Martin Wolf points out that in real time the IMF judged that surplus structural.

The question is what to do now. Clearly, Spain needs to become more competitive; maybe the labor market reforms it’s trying will do the trick, though I tend to be skeptical; otherwise it’s about gradual relative deflation — or euro exit and devaluation.

What’s clear is that even more austerity does nothing to help; all it does it reinforce the downward spiral, and bring the possibility of real catastrophe nearer.

3--Chart of the day--Growth!, credit writedowns

Excerpt: The chart below tracks the economy of the United States and selected European economies, demonstrating the varying impact of the financial crisis there. March 2007 is the reference point where Real GDP is re-based at 100. (See chart)

You can see from the chart, that the US had the sharpest fall in GDP through March 2009 when the policy response finally kicked in and the economy began to grow again. After that time, Greece, Ireland and Italy were the worst performers, with Greece showing the most marked deterioration from April 2010. Switzerland, the Netherlands and Germany have performed the best.

4--Foreclosure starts jump 28 percent in January : LPS, Reuters

Excerpt: Starts on U.S. home foreclosures shot up 28 percent in January, data provider Lender Processing Services (LPS.N) said on Tuesday in a report that suggested paper backlogs that had clogged the system were rapidly clearing.

U.S. lenders had cut back on foreclosure after accusations of faulty foreclosure practices had surfaced in late 2010.

Last month, five big U.S. banks reached a $25 billion settlement with the federal government to end a national investigation into claims of flaws in their foreclosure process, including allegations of so-called "robo-signing" of documents.

"One-month anomalies do occur, but make no mistake about it, this is a larger move than we've seen since the late 2010 period when the process reviews and moratoria really took hold," said Herb Blecher, senior vice president at LPS Applied Analytics, a unit of the Jacksonville, Florida-based company.

5--Analysis - New central bank cash glut risks "monetary anarchy", Reuters

Excerpt: The scale of money printing in the West has become so massive that the world may fall prey to "monetary anarchy," with traces of bubbles appearing everywhere...

There is a sense of deja-vu in financial markets. Just like the last time a wave of money was pumped into the world financial systems in 2011, crude oil - fuelled also this time by Middle East tensions - has jumped 15 percent this year.

As a result, riskier assets such as equities are already coming off new year highs. Rising emerging market currencies are forcing some central banks there to intervene.

The scale of money creation since the onset of the global credit shock can be seen in the size of central banks' balance sheet expansion.

JP Morgan says G4 central bank balance sheets have more than doubled since 2007 to 24 percent of combined gross domestic product and will reach 26 percent this year.

"We have Monetary Anarchy running riot, where the elastic band between the real economy and the current liquidity-fuelled markets is stretched further and further beyond credulity," Bob Janjuah, head of tactical asset allocation at Nomura, noted.

He said bubbles were visible in all asset classes because central bank balance sheets are at the core....


Kicking off its second bout of quantitative easing in late 2010, so-called "QE2," the Federal Reserve announced a $600 billion (378.4 billion pound) programme to buy bonds.

The Bank of Japan raised its asset buying and lending scheme to 55 trillion yen in October 2010 and spent a record 8 trillion yen to the currency's ascent, pumping more cash in the process.

Also in October, the Bank of England expanded the size of its asset purchase programme to 275 billion pounds. Last month, it raised it again to 325 billion.

While markets got an initial boost from this, the effect was short-lived partly because rising oil prices eventually chilled spending. And aggravated commodity and food-price inflation forced emerging economies to step up monetary tightening.

Taking stocks as a guide, the MSCI all-country world index rose 18 percent between October 2010 and April 2011, only to fall more than 26 percent from there to September.

Since then, it has gained nearly 25 percent, mainly on the ECB's three-year, cheap loan programme.

6--Monetary blanks in the Eurozone, ftalphaville

Excerpt: We think the following chart from Nomura’s Richard Koo on Wednesday is something that every inflationista and goldbug should study closely (see chart)

What it expresses amazingly well is the degree to which 2008 compromised the transmission mechanism for central banks. The standing relationship between the monetary base and the overall money supply effectively came to a halt in the days after Lehman.

From then on central banks were forced to throw increasingly gargantuan sums of base money at the economy just to keep the overall money supply in a steady state, i.e. to prevent a Depression-era money supply contraction.

As the chart also shows, however, the Eurozone has thus far been the most modest, meaning it still has more room for base money expansion.

Indeed, as Koo notes:

Compared with Japan, the US, and the UK, the ECB has supplied only two-thirds the liquidity that its counterparts did, even after both LTROs. Taking pre-Lehman liquidity levels to be 100, the Fed increased its monetary base to 321 and the Bank of England expanded its monetary base to 297, while the ECB’s monetary base stands at just 196 even after the two LTROs. The Bank of Japan increased its own monetary base to 313, although the timeframe is substantially longer. Given that the US and the UK were able to triple their monetary bases without generating inflation, I estimate the ECB could supply an additional €945.5bn in funds—enough to bring the liquidity index up to 300—without having to worry about inflation.

However, as Koo also notes, the lesson from Japan is that liquidity does not always translate to increased bank lending.

With so many European banks having the same problem at the same time, it is difficult for individual banks to raise capital in the current environment. The limited availability of capital means the new rule effectively limits the amount of risk assets that European banks can hold. Regardless of how much liquidity the ECB supplies, banks will be forced to scale back their loans to the private sector, which are treated as risk assets. The only assets banks can buy with funds borrowed from the ECB are those that are not treated as risk assets, ie, government bonds. That is one reason why European banks’ purchases of European government debt increased after the ECB’s first three year funding operation last December.

That’s to say additional liquidity in Europe is currently translating into additional government bond buying rather than real-world lending.

For recovery to take hold, Koo says, capital rules would either have to be relaxed or public funds would have to be injected into banks.

Lacking that sort of action, liquidity will otherwise continue to head into government bond markets. In fact, as long as private borrowers remain scarce, Koo believes government bond yields will continue to stay compressed.

As he sums up:

Government bonds are trading at prices that could never be justified if we were not in a balance sheet recession. I suspect many western bond investors experiencing such prices for the first time are far from comfortable and would sell their positions at the first hint of trouble. Hence there is still the possibility that some seemingly inconsequential piece of news could trigger a plunge in bonds, as happened quite frequently in Japan a decade ago. As long as the private sector remains a large net saver, however, I expect such mini-crashes to be only temporary.

The short term may bring sharp increases in government bond yields, but a fundamental shift in the market’s mood will require the private sector to overcome its aversion to debt, and that is likely to take a long time.

7--Rift Grows Between Germany's Bundesbank and ECB, Der Speigel

Excerpt: There are growing divisions among European Central Bank leadership about how to handle the euro crisis, not to mention between the ECB and the Bundesbank, Germany's central bank. While ECB head Mario Draghi is pleased with his recent decision to flood the markets with cheap money, Bundesbank President Jens Weidmann warns of the dangers....

Only two days before Draghi made his G-20 presentation, Jens Weidmann, president of Germany's central bank, the Bundesbank, spoke at the Mexico summit, and he had an entirely different message for his listeners. "The crisis cannot be resolved solely by throwing money at it," he said.

There is a rift among top-ranking officials at the ECB, and it also extends between the majority of the ECB's Governing Council and the Bundesbank. First, two leading German ECB officials -- chief economist J├╝rgen Stark and Bundesbank President Axel Weber -- resigned because the monetary authority was buying up sovereign bonds from Greece and Portugal. Then Weber's successor Weidmann objected to the ECB's purchase of government bonds from heavily indebted Italy.

Now, Weidmann is rebelling against the manner in which Draghi is giving European banks one new cash injection after another. Although Weidmann admits that the measures are basically correct, their conditions are "very generous," he complains -- and expresses his total opposition to this policy in the jargon of the central bankers: "This can particularly become a problem if banks are discouraged from taking action to restructure their balance sheets and strengthen their capital base."...

Last week, the conflict escalated to a new level. Weidmann complained in a letter to ECB President Draghi that the central bank was accepting increasingly lower-grade collateral in exchange for its cash injections. This poses a danger, he warned, as the central banks in the north of the euro zone are owed ever growing amounts of money by their counterparts in the south. If the euro zone broke apart, the Bundesbank would be left holding a good deal of its bad debt from so-called TARGET2 loans, which currently amount to some €500 billion ($660 billion), he warned.

This may sound somewhat technical to most laypeople, but among leading ECB officials the letter was seen as violating a taboo. TARGET2 refers to the central banks' internal payment system, which has accumulated massive imbalances during the course of the euro crisis. These inequalities aren't problematic as long as the monetary union remains intact. So far, the Bundesbank has always played down this risk. But Weidmann's about-face is a "disastrous signal," say ECB executives because, for the first time ever, the Bundesbank "is no longer ruling out a break-up of the euro zone."

On the surface, the wrangling revolves around loan conditions and interest rates, but in reality it has to do with the basic course of European monetary policy: the question being whether a debt crisis can be combated with even more debt, or whether it will spark the next, possibly even greater crisis.

Although debt and cheap money triggered the global financial crisis, the central banks of the US, Japan and the UK continue to reduce interest rates, flood the markets with liquidity and make it easier for companies, banks and countries to acquire new debts...

Bundesbank President Weidmann takes a similar view as he notes with concern how ECB President Draghi has emulated the lax monetary policy of the US Federal Reserve since he took office last November. One of Draghi's first official acts was to lower the base lending rate -- and when it came to drafting his bank program, he ignored all requests by the Bundesbank to limit the duration and scope of the measures. Sources at the Bundesbank say that although Draghi admittedly takes pleasure in repeatedly praising Germany's culture of stability, they contend that there's a marked discrepancy between his words and actions.

It's a similar story in major cities across Germany. Once one of the most sluggish real estate markets in the world, where prices in many areas have tended to fall rather than rise, Germany has suddenly become a hot tip for international property speculators. Andrew Bosomworth, an investment analyst for Allianz subsidiary PIMCO, is concerned about this development. "The housing market is being swept clean. Germany is now in the same situation as Spain and Ireland at the beginning of the monetary union: Real interest rates are too low and the (ECB's) monetary policy is too lax for Germany. This could be the beginning of the next bubble."

A credit analyst at a large German bank says that cheap loans are primarily driving this unhealthy development. "If we continue like this, we'll have a subprime problem in Germany in five years." Subprime loans are the mortgages that were widely granted in the US until 2007, in many cases to impoverished debtors who later defaulted in droves.

Fear breeds fear -- as is the case with the fear of inflation. Since so many people are afraid of the euro losing its value, they're investing their money in material assets, causing prices to rise -- not only for buildings and land, but also for artwork, vintage cars and timepieces. Only three years ago, for instance, Berlin merchant Falko Modla was selling watches made in the former East Germany for €85 apiece. "Now, the price range starts at €300," he says. Certain rare models go for €500 and more. "Today's market is prepared to pay the price," he says.

There's simply too much money around. Indeed, all concerns are pushed aside on the stock and commodity markets and investors are buying like mad. Ever since the announcement of Draghi's cash injections, the German stock index, the DAX, has risen by 20 percent -- and prices for copper, aluminum and zinc have also increased sharply. The price of oil has jumped by 15 percent and a fine ounce of gold costs roughly 10 percent more than it did two months ago.....

Now, the ECB balance sheets contain large quantities of the notorious junk bonds that dragged down many banks during the financial crisis. Many financial institutions have even cobbled together their own new credit derivatives from dubious real estate loans in order to trade them for new loans from the central bank.

The bankers have really put their imagination to work in coming up with a growing range of creative, new forms of collateral. For instance, with the friendly support of their home governments, financial institutions are making increasingly excessive use of a legal loophole that has long been largely ignored: They issue their own bonds and have them stamped with state guarantees in exchange for a minor fee, all for the purpose of submitting them to the ECB as collateral.

In the top decision-making circle, the ECB Executive Board, three of the six members are from southern Europe -- and two more come from the heavily indebted countries of Belgium and France.

Next in Line

The superior strength of the southern Europeans is also disquieting for other northerners. The Finns, Austrians and Germans intend to at least partly roll back this revolution.

8--Not so encouraging, Financial Armageddon

Excerpt:  "US Worker Productivity Growth Slowed in Q4, Which Could Signal More Hiring in Coming Months" (Associated Press)

U.S. companies will have to keep hiring steadily to meet their customers’ rising demand. That’s the message that emerged Wednesday from a report that employers are finding it harder to squeeze more output from their existing staff.

Worker productivity rose at an annual rate of 0.9 percent in the October-December quarter, the Labor Department said. While that’s a slight upward revision from last month’s preliminary estimate, it’s half the pace from the July-September quarter.

Productivity, the amount of output per hour of work, grew last year at the slowest pace in nearly a quarter of a century.

A slowdown is bad for corporate profits. But it can be a good sign for future hiring. It may mean that companies have reached the limits of what they can get out of their existing work force and must add more workers if they want to grow.

That trend already looks to be happening. A report Wednesday from ADP, a payroll provider, estimated that companies added 216,000 workers in February. The survey did not include government agencies, which have been cutting jobs.

A more reliable read on hiring will come Friday when the government issues its February jobs report. Expectations are high after two strong months of job growth in December and January, a steady decline in unemployment benefit applications and a jump in consumer confidence.

“The slowing trend in productivity growth has largely confirmed that the cyclical bounce in productivity that the economy typically experiences following a recession has run its course,” said Troy Davig, an analyst for Barclays Capital Research. “Future productivity gains are likely to be harder won, so firms will likely need to rely increasingly on adding to payrolls to increase output, rather than squeeze existing resources.”

Unfortunately, history suggests that's not quite correct. As the following chart shows, a relatively sharp deceleration in the rate of productivity growth -- like we've seen recently -- has, except on two occasions over the past five decades, preceded or been associated with a slowdown in the pace of hiring.

9--Did The Fed Help Banks While Ignoring The Risks?, The Big Picture

Excerpt:  Terrific NPR interview with Jesse Eisinger, whose column we referenced on Monday, Why the Fed Overruled FDIC on Dividends Post-Crisis.

The head of the FDIC warned the Fed that banks were not able to “withstand stress in an uncertain economic environment,” just as the Fed was looking at whether banks could pay dividends to their shareholders, Eisinger says.

Even though banks passed the Fed’s “stress test,” Eisinger tells Fresh Air’s Terry Gross, many regulators and Fed employees believed that the banks were not as strong as the tests might indicate.

“This was a very generous decision for the banks,” Eisinger says. “They were able to pay millions to shareholders amid huge uncertainties.”

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