Friday, July 5, 2013

Today's links

1---American teenager jailed as “terrorist” for Facebook post receives broad international support, wsws (Ridiculous overreaction by fascist US law enforcement)

2---Mortgage funds hit with worst quarter in two decades, Reuters

Funds that focus on U.S. home loans recorded their biggest quarterly loss in nearly two decades as investors fled out of bonds in the past six weeks on fears that less stimulus from the Federal Reserve will push up interest rates.
The 62 open-end, close-end and exchange-traded funds which specialize in mortgage-backed securities and tracked by Lipper - a unit of Thomson Reuters - on average posted a 1.87 percent loss in the second quarter, the steepest decline since the first quarter of 1994, Lipper said.

A global bond market sell-off started in late May after Fed Chairman Ben Bernanke said the central bank might make a decision whether to pare its $85 billion monthly purchases of U.S. government and mortgage bonds later this year.
The stampede out of bonds globally intensified some three weeks later when Bernanke laid out a blueprint on how the Fed might reduce its third round of quantitative easing, nicknamed QE3.
The market sell-off propelled U.S. benchmark yields and mortgage rates to near two-year highs last week.

3---Housing Finance Is Still Broken, and the Corker-Warner Bill to Abolish Fannie and Freddie Won’t Fix It, Dave Dayden
Senators Corker and Warner can give you the full details of their plan themselves. But to briefly review, Fannie and Freddie provide liquidity to the mortgage market by buying mortgages directly and bundling them into mortgage-backed securities (MBS). Lenders can use the proceeds from the sales to reinvest in more lending, expanding opportunity for homeownership.

Corker-Warner would scrap both agencies within five years, and end the purchases and securitizations, but would create a Federal Mortgage Insurance Corporation (FMIC) to re-insure MBS above the first 10% of private losses, and cover costs with fees imposed on the issuers. But Fannie and Freddie currently assume the credit risk on the loans they purchase, for which lenders pay a “guarantee fee”. So there’s little difference between lenders paying Fannie and Freddie a fee to assume the risk, or paying the FMIC a fee to insure the risk. Indeed, private mortgage insurers already take a first loss position on most GSE loans they insure, so even that detail is largely the same.

But all this is all rather beside the point. The big problem with the assumptions embedded in Corker-Warner can be seen in this line from the Reuters writeup: “the bill would require (emphasis mine) private entities to buy mortgages from lenders and issue them to investors as securities.”

But nobody is going to buy these securities, for two reasons. First, the private MBS market is rotten to the bone. This is why Fannie and Freddie now own or guarantee 9 out of 10 residential mortgages in America. Private investors lost world-historical amounts of money on these kinds of MBS, often because they were deceived about the quality of the underlying loans. Not a week goes by without some group of investors – be they private firms or public pension funds or mortgage insurance companies or even other banks – suing the issuers of MBS for falsely dealing them loans that did not meet prescribed underwriting guidelines. The settlement payouts to investors in these cases have typically been pennies on the dollar, and insufficient to cover the losses.

In the ensuing years since the crash, while financial reform has touched on regulating the origination and servicing of mortgages, pretty much no effort has been put into cleaning up securitization. This isn’t for lack of trying, either. The Federal Deposit Insurance Corporation proposed a serious plan in February 2010, which would have incorporated several tough investor protections. Issuers would have had to hold mortgages 12 months before they could be securitized; the originator would have retained 5% of the credit risk in the loans; compensation to servicers from investors would have included incentives to modify loans over foreclosure; full disclosure would have been mandated on all sides of the transaction (no more selling to investors with one hand and shorting the security with the other); and re-securitizations like CDOs would have been banned. This would have fixed most of the problems with securitizations. Originators would have had the incentive to make good loans and servicers would have had the incentive to manage them well; the likelihood of dirty dealing would have been massively reduced; and excluding derivatives would have stopped the magnification of losses upon losses in a crisis. Investors would happily have returned to a market that included these features.

You can probably guess what happened next. The “sell side” of the industry, the big bank issuers of MBS, killed the proposal. This made investors leery of purchasing mortgage bonds on the private market; the sell side was basically telling them that they wanted to retain the capacity to screw them over....

So whom exactly do Corker and Warner expect to purchase these products? The same investors who have been endlessly defrauded and abused for their purchases for the past several years, in a market that has seen no reforms? Or a new band of dupes, blithely offering up their capital to be stolen?

Banks love securitization because it’s cheaper for them than holding loans on their books, and having to pay for them in equity capital and FDIC insurance. But those requirements are precisely what make a market safe and fair. They are buffers against risk, which in securitization gets transferred to investors. The market proved incapable before and during the crisis of properly pricing that risk, and now everyone knows it. So the investors are wisely staying away. And if these markets no longer work, then perhaps it’s time to rethink the wisdom of the 30-year fixed rate mortgage (which most other countries don’t have) and come up with a way for lenders to retain the risk while still protecting themselves against catastrophe.

In any case, we can dream up alternatives to a government-financed mortgage system all day, but as long as private investors get fleeced by everyone else in the housing finance system with relative impunity they’re going to stay far away from that market

4---A Financial Power Grab---From the Bubble Economy to Debt Deflation and Privatization, Michael Hudson, counterpunch

....from 1945 until interest rates rose to their peak in 1980, there was an almost steady 35-year downturn in bond prices. The Bubble Economy was fueled by interest rates being rolled back down to their 1945 levels and even lower. Credit flowed into the financial markets to buy stocks, peaking in the bubble in 2000, and then to inflate the 2001-2008 real estate bubble.

So we are now in is the Bubble Economy’s legacy. We can think of this as Phase 2: repayment time, along with foreclosure time. That is what happens in debt deflation. The Obama Administration has broken its 2008 campaign promises to Congress and to voters to write down mortgage debt to the ability to pay or to market prices reflecting realistic rental values. The debt legacy has been kept in place, not written down.

Carrying this debt overhead has caused a fiscal crisis. The financial and real estate bubble helped keep state and local finances solvent by providing capital gains taxes. These are now gone – and properties in default or foreclosure are not paying taxes. And whereas public pension funds assumed an 8+% rate of return, they now are making less than 1%. This has left pensions underfunded, and prompted some municipalities to engage in desperate gambles on derivatives. But the Wall Street casino always wins, and most cities have lost heavily to the investment banking sharpies advising them.

In place of a new bubble, financial elites are demanding privatization sell-offs from debt-strapped governments.

5---U.S. Stocks Fluctuate as Jobs Data Spur Stimulus Concern, Bloomberg

Payrolls rose by 195,000 workers for a second straight month, the Labor Department reported today in Washington. The median forecast in a Bloomberg survey projected a 165,000 gain after a previously reported 175,000 increase in May. The jobless rate stayed at 7.6 percent, while hourly earnings in the year ended in June advanced by the most since July 2011.

Fed Stimulus

Economic growth amid monetary stimulus from the Federal Reserve has helped send the S&P 500 up 139 percent from its bear-market low in 2009, including a 13 percent rally so far this year. The index has slipped 3.1 percent from its last record on May 21 after Fed Chairman Ben S. Bernanke said the central bank could begin to reduce bond purchases should the employment market show sustainable growth

6---Convulsions in Egypt signal new era of world revolution, wsws

"Together with the thoroughness of the historical action, the size of the mass whose action it is will therefore increase,” wrote Karl Marx and Friedrich Engels in 1844 on the eve of the first great revolutionary struggles of the European working class (in 1848-49). The new “historical action” that is drawing tens of millions into struggle is the emerging international working class revolution against globally-integrated capitalism.

Recent years have seen mass strikes and protests worldwide—in European countries devastated by austerity such as Greece, Portugal and Spain; in industrial regions of Asia such as China and Bangladesh; in the Middle East, including mass working class protests in Israel; and more recently in Turkey and Brazil. The successive waves of mass struggles in Egypt are the most intense expression of an international process.

Claims that the collapse of the USSR in 1991 signified the end of history and the final triumph of liberal democracy are being exploded by the global economic crisis and the new upsurge of the working class. The Egyptian upheaval gives a sense of what is to come: the entry of hundreds of millions of workers and oppressed people into revolutionary struggles that will dwarf the revolutions of earlier periods.....

Writing in 1938, one year before the eruption of World War II, Trotsky explained that the objective preconditions for socialist revolution had matured. The historical crisis of mankind, he declared, “is reduced to the crisis of the revolutionary leadership.”

At the time, Trotsky was writing against the Stalinist, social democratic and labor bureaucracies that devoted all their energies to blocking socialist revolution. The result of their betrayals was a series of devastating defeats of the working class, fascism and world war.

The mass struggles of today have once again brought to the fore the crisis of revolutionary leadership in the working class. The objective conditions for socialist revolution are emerging rapidly. But the problem of political leadership equal to the demands of a new revolutionary epoch remains to be solved

7---Surprise! Inflation is too low almost everywhere on earth, WA Post

The leading economies of the industrialized nations may not have a lot in common, but they are all afflicted by this: Inflation is too low.

That was the astoundingly consistent theme out of a range of data released Thursday. Prices rose 1.1 percent over the 12 months that ended in April in Germany, 0.8 percent in France and 1.3 percent in Italy. In the United States, the consumer price index rose 1.1 percent over the last year. Japan reported surprisingly strong first-quarter growth this week as its aggressive new stimulus policies took effect, but that came against a backdrop of continued falling prices; its consumer price index fell 0.9 percent in the year that ended in March

The below-trend inflation is partly attributable to falling commodities prices, and just as policy shouldn’t overreact when a short-term commodity blip causes inflation, it shouldn’t make the same mistake in reverse. But even excluding food and energy, U.S. CPI was up only 1.7 percent, still below the level of inflation the Federal Reserve is aiming for. And the situation in Europe is particularly worrisome; if the euro zone is going to have any hope of rebalancing its economy without a prolonged depression, it will need higher inflation in core European countries like Germany and France, offset by lower inflation in countries like Greece and Spain. Instead, prices are rising too slowly even in the core, and there is deflation, or falling prices, in Greece.

The biggest conclusion to draw from all of this is that warnings that massive quantitative easing efforts would spark explosive inflation are turning out to be as wrongheaded as can be. In the United States and Japan, central banks now have open-ended policies of printing money to buy assets. But while the money seems to be finding its way into asset markets, such as for stocks and corporate debt, it isn’t being circulated so widely as to drive up prices for consumers.

This is the opposite of what the currency war alarmists have warned about. Instead of  creating rounds of vicious inflation while trying to expand the money supply in a race to the bottom, central banks are all trying to get inflation up to their target and coming up short. Deflation is looking like a greater risk that inflation, despite the extensive hand-wringing over the latter in the last several years. It’s a currency war in which almost every country is losing.

8---Roach vs Pettis, Humble student of the markets

Regardless of what happens next, the consensus expectations that China's economy will grow at roughly 7 percent over the next few years can be safely ignored. Growth driven by consumption, instead of trade and investment, is alone sufficient to grow China's GDP by 3 to 4 percent annually. But it is not clear that consumption can be sustained if investment growth levels are sharply reduced. If Beijing can successfully manage the employment consequences of decreased investment growth, perhaps it can keep consumption growing at current levels. But that's a tricky proposition. In other words, Pettis estimates that the consumer-led Chinese economy can only grow at 3-4%. If the Chinese economy changes the tone of its growth from investment and infrastructure to consumer led growth, the consensus of growth in the 7% range is unrealistic.

In addition, what happens to all the leverage in the system? Who eats the non-performing loan (NPL) losses from all of the infrastructure spending by the SOEs and local governments? In past eras, the Chinese government had taken the brunt of the NPL losses through classic financial repression - through artificially low interest rates that repressed the household sector and blew an property asset bubble.

Now that the Plan is to grow the consumer sector, the old trick of household sector financial repression won't work. In a separate interview with Ron Rimkus of the CFA Institute, Pettis stated:
You can only resolve a bad debt problem by assigning the cost to some sector of the economy. In the past it was the household sector that implicitly paid to clean up the debt, but if we expect rapid growth in household consumption to lead the economy going forward, and this is what rebalancing means in the Chinese context, we cannot also expect the household sector to clean up the bad debt in the same way it has done so over the past decade.
So who pays? In the worst case, it could lead to a disorderly unwinding of the excess leverage in China which, given how the global financial system is inter-connected, spark a global financial crisis.
In addition, Kyle Bass sounded a warning on China (via Zero Hedge) [emphasis added]:
The speed and depth of the Chinese policy response will help determine the severity and duration of this crisis. If the Chinese address the issue quickly and move decisively to rein in credit expansion and accept a period of much lower growth, they may be able to use the government and People’s Bank of China’s balance sheet to cushion the adjustment in the economy. If, however, they continue on the current path and allow this deterioration to reach its natural and logical limit, we will likely see a full scale recession as well as a collapse in asset and real estate prices sometime next year.
Even Stephen Roach sounded an implicit warning of potentially higher interest rates as China transforms itself:
But there is another twist. As China shifts to consumer-led growth, it will start to draw down its surplus saving and current-account surplus. That could lead to a reduction in its vast $3.4 trillion foreign exchange reserves, thereby dampening China’s demand for dollar-based assets. Who will fund a seemingly chronic US saving shortfall – and on what terms – if America’s largest foreign creditor ceases doing so?
China's transformation from investment led growth to consumer led growth is a story of short-term pain for long-term gain. The only questions are:
9---Japan's conflicted policy, GEI

 The government of Japan under Shinzo Abe is following policies that are self-contradicting.  The recent headlines have focused on monetary expansion with that will put the U.S. to shame for sheer size of the effort.  Less attention has been given to the seemingly draconian tax increases on consumption.  Taxes will increase by 60% in April 2014 and a total of 100% from current levels by October 2015.  While pouring money into the financial system with one hand Abe will be draining it from consumers with the other....

Japan introduced a consumption tax (CT), the equivalent of the European Value Added Tax (VAT), in 1989.  Initially the tax was  3%.  In 1998 the tax was increased by 67% to 5% where it remains currently.  The two tax dates coincide with the start of serious economic disruption in Japan:  (1) 1989 was the peak of the Japanese expansionary bubble and (2) 1998 was the start of Japan's most serious post-peak recession until The Great Recession of 2007-2009.

The CT changes may not have "caused" the two contractions, but it would be hard to argue that they did not exacerbate them.
Now the government is planning to introduce a negative consumption shock even greater than the first two over an 18-month time span, up from 5% to 8% CT in less than a year (April 2014) and another hike to 10% in October 2015.

Perhaps it could be argued that consumption will be spurred over the next 10 months as consumers anticipate the tax hike.  But that would largely be "selling forward" consumption that would otherwise have been seen after the tax hikes start.  Just when the impact of QE could be waning the consumer could be withdrawing.
Japan is presumably undertaking a massive QE program to counter years of depressed consumer demand.  Here is how financial analyst John Brown put it in the Pittsburgh Tribune-Review:
Responding to a decade of depressed consumer demand, Haruhiko Kuroda, governor of the Bank of Japan, announced this spring a program of quantitative easing of about $1.4 trillion by 2014 to boost the island nation's economy.
The magnitude of the Japanese QE relative to GDP is equivalent to the U.S. Fed continuing the $85 billion per month asset purchases for almost four years, or until  well into 2016.  Unless the talk of taper is a smoke screen the Fed will be out of this liquidity program well before then.  Japan is headed for uncharted territory, even more so if their QE continues beyond 2014.

And if this is aimed at stopping deflation by increasing consumer demand, what is the logic of increasing the "take" of the government from the consumer by increased taxation in the amount of about $30 billion a year in increased consumption taxes by the end of 2015?  When the current tax is included the CT will be decreasing demand by more than $60 billion a year if the amount of spending remains constant.  At constant spending for 20 years the total taken out of the economy will be $1.2 trillion.  Of course Japan wants spending to increase so the total could be hgher.
How conflicted can you get?

10---Dean Baker on Housing, CEPR

Taking the national data first, there is probably not too much to worry about in the most recent numbers. Using the Case-Shiller national inflation-adjusted house prices were about 17 percent higher in the first quarter of 2013 than they were in the first quarter of 1996, before the bubble had begun to boost prices. They are almost exactly the same as they were in the first quarter of 2000. By comparison, they are still down by more than 35 percent from the peaks reached in the summer of 2006. As with the stock market, crystal balls are not so accurate as to tell us exactly what house prices should be. But even if the 1996 values are closer to what fundamentals might dictate, it would be difficult to view an increase of 17 percent as a bubble, especially with mortgage interest rates at their lowest levels in more than 50 years.....

It is worth noting that the risk is not to the health of the national economy, as was the case in the bubble years. Housing construction is recovering but is still well below normal levels. If prices were to again collapse in these markets it would not have enough of an impact on construction to be felt in the national data. Similarly, the impact of any wealth effect from this run-up would be too limited to affect national consumption data. And there is no reason to believe there is the same sort of house of cards financing that we saw with the explosion of subprime and Alt-A lending during the last decade.
If these bubbles burst the immediate losers will be the people speculating in these markets. This will include many hedge funds and private equity funds that have been buying up blocks of homes with the hope of renting them out for a period of time and then reselling them, or in some cases just fixing them up and reselling them. There are also many small-time speculators doing the same thing, just as was the case in the housing bubble years. When the music stops, these folks will all take a big hit. That will be bad news for them, but they should know the risks of this sort of investment.

the implication of more interest sensitive house prices is that if interest rates rise in the next few years, as is almost universally expected, then house prices will fall.
That is likely to be less of an issue in the United States than in countries like Canada, Australia, and the United Kingdom, all of which have average house prices more than 50 percent higher than in the United States. It is likely that the extraordinary price levels in these countries are in large part the result of low interest rates. This fact is likely to pose a serious problem for these economies as the world economy recovers. Higher interest rates could send house prices in all three countries plummeting, which will certainly dampen their recoveries, if not actually throw them back into recession.

11---Rates jump on taper news, DeLong

If, as James Hamilton claims, the recent jump in the forecasts of future short-term interest rates implicit in long bond rates were due to shifts in expectations of "the term premium, long-run economic growth rate, and global saving and investment decisions… farther beyond those things that the Fed can hope to control", he and I would both have expected the rise in ten-year Treasury rates to be accompanied by a smaller rise in ten-year TIPS and thus a rise in the inflation forecast provided by the ten-year break-even.

That ain't what happened: since winter, the inflation break-even has fallen from 2.5%/year to 2.0%/year, while the ten-year Treasury has risen from 2.0%/year to 2.5%/year:
Screenshot 7 4 13 11 01 AM
That's a monetary tightening!

If, as Jeremy Stein claims, the rise in ten-year rates was not due to the Fed's signals leading to changes in expected future policy but rather "changes in either investor sentiment or risk aversion, price movements due to forced selling by either levered investors or convexity hedgers, and a variety of other effects that fall under the broad heading of 'internal market dynamics'", then the movement in the inflation break-even tells us that the market thinks that the Federal Reserve is not going to respond appropriately to these "internal market dynamics

12--Legislators fail to implement down payment requirements, OC Housing

“The Fed is looking at the qualified mortgage rule and saying, ‘Already there’s potential for a dampening effect on the mortgage market,’” said Anthony Sanders, a housing-finance professor at George Mason University in Fairfax, Va. While low down payment loans weren’t the sole cause of the housing bust, “they clearly had a role,” he said, which is why Tuesday’s roll-back of the tougher capital rules “kind of took me by surprise.” …

13---Soaring rates impact housing apps, realty check

Mortgage rates are moving so fast and so dramatically that even reports from barely a week ago seem suddenly outdated.
The average rate on the 30-year fixed conforming loan moved to its highest level in two years last week, according to the Mortgage Bankers Association weekly survey. That had a direct effect on consumers shopping for mortgages. Applications to refinance fell 16 percent and applications to purchase a home dropped 3 percent week-to-week.

That comes one day after another report from Zillow, an online real estate company, showed mortgage rates moving off their highs, although not that far off....

Rates seem to be in a new, higher range for the time being," said analyst Mark Hanson. "However, if the market still 'works' as it should, the weakening housing and mortgage markets caused by the higher rates—which will be very noticeable once June, July and Aug data finally rolls out—should precipitate lower rates closing out the year at the latest. Between now and then, however, I expect much higher volatility than we have been used to."

14---Why Deflation will Cause Oil Production to Slow, oil price

...economies operate on two kinds of escalators–an up escalator, and a down escalator. The up escalator is driven by a favorable feedback cycle; the down escalator is driven by an unfavorable feedback cycle.
For a long time, the US economy has been on an up escalator, fueled by growth in the use of cheap energy. This growth in cheap energy led to rising wages, as humans learned to use external energy to leverage their own meager ability to “perform work”–dig ditches, transport goods, perform computations, and do many other tasks that machines (powered by electricity or oil) could do much better, and more cheaply, than humans.

Debt helped lever this growth up even faster than it would otherwise ramp up. Continued growth in debt made sense, because growth seemed likely for as far in the future as anyone could see. We could borrow from the future, and have more now.

Unfortunately, there is also a down escalator for economies, and we seem to be headed in that direction now. Such down escalators have hit local economies before, but never a networked global economy. From this point of view, we are in uncharted territory.
Many economies have grown for many years, hit a period of stagflation, and ultimately collapsed. ...

Because of the downward escalator the economy is on, wage-earners don’t really have enough money to pay the higher prices that are needed for increasingly costly extraction of oil and other minerals.

 Instead, prices tend to be volatile. The general trend can be expected to be downward, because even if  oil prices rise when the economy is functioning fairly well, at some point, the higher price leads to adverse feedbacks, such as consumers defaulting on debt and cutting back on discretionary purchases. The result can be expected to be recession, and again lower oil prices.

The big danger is that lower oil prices will lead to lower oil production, and this lower oil production will become a problem for business and commerce around the world....

Investment in a capitalistic system does not work on a down economic escalator. Who wants to invest, if it is probable that the economy will shrink, leading to increasing diseconomies of scale?...

How about Quantitative Easing?

Quantitative Easing (QE) represents an attempt to reinflate the economy by making more credit available to the economy, at lower interest rates. It also has the effect of reducing the interest rate the government pays on its own long-term debt, thus holding down that taxes the government needs to collect.

In terms of inflation/deflation effects QE has, its primary effect seems to be to artificially inflate asset prices–stocks, bonds, home prices, and agricultural land prices. The announced goal of the Japanese QE attempt was to try to raise the inflation rate (generally) in Japan to 2%, but it has not had that effect. In fact, the same link shows that in general, QE has not led to inflation.

In my view, the primary effect of QE is to create asset price bubbles. The price of bonds is raised, because of the artificially low interest rates.  The price of stocks is raised, because people switch from bonds to stocks, to try to get yield (or capital gains). To get better yield, businesses find it worthwhile investing in homes, with the idea of renting then out on a long-term basis. Very little of QE actually gets through to wages, which is where the major shortfall is.

QE will at some point stop, and the asset price bubble will deflate. (Crunch Time: Fiscal Crises and the Role of Monetary Policy by David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin points out that QE is not viable as a long-term strategy.) This is likely to add to deflation woes. The higher interest rates and the need for higher taxes to cover the higher interest the government needs to pay will add to the down escalator effects, making the trends noted previously even worse

15---Is the Fed fueling another housing crash, Dr Housing Bubble

homeownership rate
Let us spend a couple of minutes on this chart.  The homeownership rate peaked at 69 percent at the height of all the easy money in the market.  5 million foreclosures later, we are down to 66 percent.  But I would argue that we are closer to 62 percent if we factor in all the Americans that are simply not paying their mortgages.  Do you even own your home if you have zero to very little equity and flat out are not paying your mortgage?  Would you consider someone delayed by three payments on their mortgage as truly a homeowner?  You miss one rent payment and you are out on the street.

The idea that somehow this housing recovery is benefitting your average American family is hard to find in the data.  Sure, equity is up but what does that mean?  If you are a family looking for a rental rents have gone up with no subsequent rise in income.  Is that a benefit?  If you are looking to buy, you are being crowded out by investors in many areas.  Is that a benefit?  Supply is low because of every gimmick from suspending standard accounting rules to basically using the Fed as some pseudo-mega bad bank.  Is this a benefit?  And those all-cash purchases are distorting equity.

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