Friday, March 9, 2012

Weekend links

1--Lessons from Spain, Counterpunch

Excerpt: Are expansionist policies possible?

If Spain had adopted the same fiscal policies as Sweden and had invested in order to correct the enormous deficits in the social infrastructure of the country over the past 10 years, facilitating, among other things, the integration of women in the labor force, the Spanish state would be receiving 200,000 million more euros than it is today. With these 200,000 million euros, the Spanish state could have created 5 million jobs, which is the same number of people who are unemployed in Spain. The creation of those jobs would have eliminated unemployment and stimulated the economy. If the underdeveloped welfare state of Spain had 1 adult person for every 4 working in the services of the welfare state, as in Sweden, rather than 1 out of every 10, Spain would create enough jobs to eliminate unemployment.

These revenues would be obtained by taxing all those groups that benefit most from the policies of tax cuts followed during the pre-crisis period. Those tax increases would not have dampened consumption if the revenues obtained had been invested in job creation, particularly low and medium salary jobs.

This could have been done if the political will would have been there. The problem is that the Socialists did not dare enact the fiscal reforms, among others, that would have antagonized very powerful forces in Spain. That is, as it always is, the true issue.

2--Fitch sees home prices as overvalued with potential for another 9.1% drop, Housingwire

Excerpt: Fitch Ratings said U.S. home prices are still overvalued and could fall another 9.1%, despite inching toward a point of sustainability.

After evaluating data from the third quarter, Fitch said prices still have more room to fall with unemployment and gross domestic product numbers showing only marginal growth.

In addition, tightened lending standards remain a hurdle for new buyers, and the $25 billion government settlement with the nation's largest mortgage servicers is expected to prolong the liquidation of distressed inventory over the short term.

New lending standards continue to hinder housing activity with only borrowers who have equity in their property or sizeable down payments getting loans, the report said.

"The settlement’s modification and foreclosure guidelines, together with the process changes needed to meet the terms of the agreement, are expected to extend the loss-mitigation process for seriously delinquent borrowers," according to analysts. "However, Fitch does not expect the settlement to materially impact liquidation speeds for existing REO inventory."

3--TARP charts, Dealbreaker...Riskier banks needed bailouts...and then got even riskier. Go figure?

Excerpt: The conflicted nature of the TARP objectives reflects the tension between different approaches to the financial crisis. While recapitalization was directed at returning banks to a position of financial stability, these banks were also expected to provide macro-stabilization by converting their new cash into risky loans. TARP was a use of public tax-payer funds and some public opinion argued that the funds should be used to make loans, so that the benefit of the funds would be passed through directly to consumers and businesses.

So you might reasonably ask: were TARP funds locked in the vault to return the recipient banks to financial health, or blown on loans to risky ventures, or other? (See chart)...

So … not loaned then. But that’s not important! The authors are actually looking not primarily at aggregate amounts of loans but at riskiness of loans and here’s what they get:

Our results indicate that TARP had a surprising effect on bank risk-taking. In our event study and in our regression results, we find evidence that the average risk of loan originations at large TARP banks increased relative to non-TARP banks through 2009 whereas the average risk at small TARP banks decreased relative to non-TARP banks. Evidence also indicates that the interest spreads on loans from the large TARP banks increased substantially following the injections.

This may reflect the conflicting influences of government ownership on bank behavior. Although TARP money was given to increase bank stability and reduce incentives to take excessive risks, it was also given with the understanding that the funds would be used to expand lending during a period of increased risk. These two objectives have an opposing influence on bank risk-taking that may have led to a different effect of TARP on lending by large and small banks. Large banks may also have been more susceptible to the moral hazard associated with government bailout funds given to large “too-big-to-fail” institutions.

Hee hee. Also fun is that large banks reduced lending vs. non-TARP banks while increasing the riskiness of their loans....

But the data is kind of fun and maybe you can tell a story from it. I liked this aside:

It is interesting to note that the average risk rating of loan originations at the TARP banks is significantly greater than the average risk rating of loan originations at the non-TARP banks both before and after the TARP injections.

Yes! Interesting! Riskier banks needed bailouts. (And then kept being riskier.)

4--BONDS: The bubble enters stage four in Asia, IFR

Excerpt: What could have been more like an insider’s rush to the exits ahead of speculators than last year’s China property issuance frenzy? Yes, we are led to believe that the funds would be devoted to landbank acquisition and for capex needs. But the reality is that those funds were in most cases acquired in order to provide a liquidity cushion to see PRC realtors through the down-wave which is now punching through the China property market like there’s no tomorrow.

In other words the insiders knew only too well the state of their industry and decided to leverage up ahead of the downturn. What if that downturn is vicious and prolonged? Well, they can always take the restructuring route and cane investors with equally vicious haircuts. And for all we know cash leakage on a vast scale is happening across in the China property industry in the face of falling prices and rapidly diminishing contract sales....

To return to bubble anatomy, it was widely assumed that commodities giant Glencore called a top to the resource market with its mammoth IPO last March. That also looked like the ultimate piece of insider selling.

And there is credence to that view if the fall in Glencore’s stock from its £5.4 IPO price to its current level of £3.99 is anything to go by, with the stock failing to climb above the initial offering price and having declined since the start of this year, despite decent diluted earnings growth at the company in 2011 of 220%.

Could Carmen and Yanzhou be playing the same game as Glencore? It looks like it to me.

In conclusion, let’s remind ourselves of the final stage of Messrs Kindleberger and Minsky’s anatomy of a bubble. That involves “revulsion” where prices overshoot fundamental demand and scams and fraud are uncovered. I’m not suggesting anything of the sort with the above companies. Just suggesting that they are cashing in while investors and speculators still think the sectors – in which these issuers are the ultimate insiders – are sexy.

5-- Stock Prices Supported by New Buyback Activity, Trim Tabs

Excerpt: An ever rising stock market over the past six months has generated a very positive bullish psychological mood among investors due to past conditioning. In the past a consistently rising stock market almost always was related to a rapidly growing economy. That is why most investors now believe that the reason stock prices have not gone down at all recently is due to a rapidly improving US economy.

But the current growth rate of the US economy is nowhere near correlated with the growth rate of stock market wealth. The value of all stocks is up over $9 trillion from the three year ago March 2009 bottom, and is up over $3 trillion from the early October 2011 low.

At the same time wages and salaries for all tax payers is up, maybe $400 billion a year over the past three years to about $6.3 trillion a year compared with $5.9 trillion in early 2009, that is a 2%+ annual gain, less than the about 3% rate of inflation.

Since December, wages and salaries growing at about the same just a bit faster than inflation, all of + 0.3%. Does that barely positive growth rate justify a continuation of the $3 trillion gain in stock market wealth since October? Yes, but only if companies keep shrinking the float.

What really is going on is very simple. Since 2009 the US government has flooding the financial markets with $5 trillion of newly created money priced at zero. As a result public companies now have record levels of cash on their balance sheets. And with short term interest rates less than the cost of managing money, companies are using some of that cash to shrink the trading float by about $1.9 billion daily rather consistently since July 2011.

$1.9 billion daily being more than enough new cash to overwhelm the constant selling by mutual funds, pension funds and hedge funds.

6--Gillian Tett Exhibits Undue Faith in Data and Models, naked capitalism

Excerpt: We’ve harped on the fact the likely reason that Bear was bailed out was due to its credit default swap exposures. At the time of the Bear failure, Lehman, UBS, and Merrill were seen as next. The authorities went into Mission Accomplished mode rather than putting on a full bore, international effort to get to the bottom of CDS exposures. And the Greek affair suggests they’ve continued to sit on their hands.


This matters because, as Lisa Pollack illustrated in a neat little post, supposedly hedged positions across counterparties can quickly become unhedged if one counterparty fails. So a basic data gathering exercise would at least help in identifying who is particularly active and has high exposures to specific counterparties and products.

But this is of less help with big financial firms than you might think. While Lehman was correctly seen as being undercapitalized well in advance, pretty much no one foresaw Bear’s failure. It went down in a mere ten days. Confidence is a fragile thing. Similarly, while some positions are not very liquid or all that easy to hedge (think of our favorite bete noire, second liens on US homes), in general big financial firms have dynamic balance sheets...

The problem is, as we and others have discussed before, is that the financial system is tightly coupled. That means that processes progress rapidly from one step to another, faster than people can intervene. The flash crash is a recent example....

And this problem is made worse by the fact that economists have long been allergic to the sort of mathematics and modeling approaches best suited to this type of analysis, namely systems dynamics and chaos theory...

If we want to reduce the frequency and severity of financial crises, it isn’t a data problem. It’s a systems design problem. As Richard Bookstaber wrote in his book A Demon of Our Own Design, published before the crisis, the most important thing to do in a tightly coupled system to reduce risk is reduce the tight coupling. Measures to reduce risk in a tightly coupled system often wind up increasing them because the tight coupling means intervention is likely to be destabilizing. And we all know what the big culprits are. It does not take better data capture to figure this out. Tett flagged two in her piece. The obvious one is credit default swaps. They serve no social value and are inherently underpriced insurance (adequate CDS premiums for jump to default risk would render the product uneconomic to buyers). Underpriced insurance, given enough time, blows up guarantors who take on too much exposure (AIG, the monolines, and the Eurobanks like UBS who had near death experiences by being de facto guarantors by holding synthhetic/hybprid AAA CDO tranches are all proof). But has anyone in the officialdom taken the remotest interest in addressing a blindingly obvious problem? No.


Similarly, Tett mentions that a Fitch study that ascertained that banks were back to their old habit of using structured credit products as repo collateral. We’ve also discussed how problematic that is; the BIS flagged it more than a decade ago. And despite the fact that it should be bloomin’ obvious that using anything other than pristine collateral for repo is a source of systemic risk, since it was a cause of trouble before, the officialdom is loath to intervene. They’ve bought the “scarcity of good collateral” meme pushed by the banks. While narrowly that is correct, they haven’t sought to question why so much collateral is really necessary. The big driver pre-crisis, as we pointed out, was the explosion in derivatives (as values fluctuate, counterparties have to post collateral or have their position closed out). The growth in those dubious CDS was a major contributor. Moreover (and this comes from someone who has worked with derivatives firms), many, if not most over the counter derivatives (and certainly the most profitable) are used to manipulate accounting and for regulatory arbitrage. The overwhelming majority of socially valuable uses of derivatives can be accomplished via products that can be traded on exchanges, but regulators have been unwilling to push back on the industry’s imperial right to profit, no matter how much it might wind up creating for the rest of us. (We admittedly have additional drivers post crisis, such as QE eating up Treasuries, but there is perilous little critical examination of the demand side of the equation).

So the answer does not lie in better data. It lies in the willingness of the authorities to stare down the financial services industry

7--The "foreclosures are good" meme, firedog lake

Excerpt: foreclosure starts and sales have ramped up again, as the regulators eased off the pressure by agreeing to the foreclosure fraud settlement. Some would buy the bank-friendly argument that these foreclosures are necessary, that they “let the market clear.” We’ve heard this a lot, that foreclosures are good. I’m surprised any economist still tries this line of argument. A foreclosure drops property values, increases state and local government costs in the case of blight, and wrecks entire communities. One foreclosure causes $250,000 of damage to the larger economy. And a good deal of them are unnecessary, and could be avoided simply with the time-honored process of renegotiating contracts in a way that works financially for the borrower and lender. What’s more, simple supply and demand dictates that throwing more vacant properties on the market when it’s already distressed doesn’t help anyone. In fact, it robs current homeowners of their equity. Households lost $213 billion in real estate value in just the last quarter alone. More negative equity, incidentally, adds to the downward spiral of more foreclosures, more supply, and lower prices, leading to more negative equity.


Certainly the Administration wouldn’t take the public view that foreclosures are good, even if their policies privately reflect that. They claim that the settlement will provide meaningful relief to borrowers, and their new new fraud investigation will provide more. NYT isn’t buying that either.

The main component of the administration’s new efforts is the recent foreclosure settlement between the big banks and state and federal officials [...] The settlement was announced nearly a month ago, but the specific terms have yet to be released. One concern is that banks may have leeway to tailor loan modifications in ways that help them clean up their balance sheets, while leaving many homeowners deeply underwater. Another is that states may be able to use money from the settlement for purposes other than foreclosure relief

The investigation that is supposed to be the powerful follow-up to the settlement has also gotten off to a worryingly slow start. Announced in January by Mr. Obama, it still has no executive director, raising questions about the administration’s commitment to truly holding the banks accountable. The longer it takes to do an investigation, the longer it will take to secure verdicts or settlements that would include money for further antiforeclosure efforts.


And the more incidents will reach their statute of limitations.

Some housing analysts are in their fourth straight year of predicting a rebound in the market. But nothing meaningful has been done to change incentives and to deliver relief to those who need it

8--QE programs hurt pensioners big time,  Naked Capitalism
More pension funds are getting their act together and calling the British government on their dodgy pseudo-stimulative policies. The British pension provider Saga has released an excellent counterargument to the recent round of QE announced by Bank of England governor, Mervyn King (an argument that we have been pushing for some time).

Saga are seething and you would guess that pension recipients are no less enraged because the effects that QE is having on pension funds appears to be quite devastating. Dr. Ros Altmann, Director-General of Saga, made the following statement which will resonate with many:

The Bank of England has consistently ignored the dreadful damage that its QE policy has inflicted on anyone coming up to retirement. During 2012, record numbers of people will reach age 65 and many will need to buy an annuity. Around half a million annuities are sold each year and, since 2008, annuity rates have fallen by about 25%, most of which is due to the effect of QE. That means over a million pensioners will be permanently poorer for the rest of their lives, as they have bought an annuity at rates that have been artificially depressed by the Bank of England.

What’s more annuity rates – that is, the rate at which pensioners draw down income – has dropped significantly:

Annuity rates have plunged, meaning the people’s hard-earned pension savings are not giving them the pension income they could have achieved even just a few months ago..

Simply put: QE programs hurt pensioners big time – and the more QE they pump in, the more they damage pension funds. Indeed, back in October James Kirkup at The Daily Telegraph reported that the last round of QE sapped money from pensioners to the equivalent of around £3,750 a head. That’s a big chunk of change....

The real problem are the stubborn and intractable governments in the US and the UK who, despite having their own currency and hence extremely low interest rates, simply refuse to engage in real stimulus policies.


Spending policy in these countries is being run by economic vandals and so, with these thugs on her case, it’s no surprise that Grandma is too scared to take a trip down to the local shop and engage in some good old-fashioned economic-stimulating consumption.

9--Lowering our expectations for foreclosure settlement, LA Times

Excerpt: The federal government's response to the home mortgage crisis always has been an exercise in living down to one's lowest expectations.


The $25-billion settlement with five big banks over foreclosure abuses that U.S. housing officials and 49 state attorneys general announced last month was supposed to be an exception. Here, at last, was real compensation from those who played key roles in the disaster....

For each variety of mortgage relief, the banks will get a certain credit against their $20-billion target. For every dollar of balance reduction offered a homeowner who is up to 75% underwater, for example, they get a dollar credit; for principal forgiveness on delinquent home-equity lines, the credit ranges from 10% to 90%

The settlement's worst flaw may be that it's a lost opportunity. It could have been used to improve HAMP, say by mandating that the banks offer HAMP-eligible borrowers principal forgiveness, which studies show is the most effective way to keep borrowers out of foreclosure. Under current HAMP rules, such offers are optional. But such a provision would have countered the perverse incentives in the mortgage business that discourage mortgage servicers, including the five banks in the settlement, from helping homeowners avoid foreclosure.


"That would have been in everybody's interest," says Neil Barofsky, the former inspector general for the government's bank bailout, which included HAMP.

The aspect of the lost opportunity is that the settlement, to the extent it inflicts any pain on the banks, does so entirely at the institutional level.

"What's most discouraging is that you see none of the individuals who were driving these things being held in any way accountable," Wilmarth says. "The only thing that will actually change behavior going forward is for the individuals who were at the center of this to be held personally responsible and be forced to give up their ill-gotten gains. Then maybe their successors might think twice."

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