Tuesday, October 22, 2013

Today's Links

1---China’s Wake-Up Call from Washington, Stephen Roach, Project Syndicate

The days of its open-ended buying of Treasuries will soon come to an end....

A seismic shift is at hand, and America’s recent fiscal follies may well be the tipping point.
China has made a conscious strategic decision to alter its growth strategy. Its 12th Five-Year Plan, enacted in March 2011, lays out a broad framework for a more balanced growth model that relies increasingly on domestic private consumption. These plans are about to be put into action.  An important meeting in November – the Third Plenum of the Central Committee of the 18th Chinese Communist Party Congress – will provide a major test of the new leadership team’s commitment to a detailed agenda of reforms and policies that will be required to achieve this shift.
The debt-ceiling debacle has sent a clear message to China – and comes in conjunction with other warning signs. Post-crisis sluggishness in US aggregate demand – especially consumer demand – is likely to persist, denying Chinese exporters the support they need from their largest foreign market. US-led China bashing – a bipartisan blame game that reached new heights in the 2012 political cycle – remains a real threat. And now the safety and security of US debt are at risk. Economic alarms rarely ring so loudly. The time has come for China to respond with equal clarity.
Rebalancing is China’s only option. ...
Long dependent on China to finesse its fiscal problems, America may now have to pay a much steeper price to secure external capital.

As recently as 2000, China owned only about $60 billion in US Treasuries, or roughly 2% of the outstanding US debt of $3.3 trillion held by the public. But then both countries upped the ante on America’s fiscal profligacy. US debt exploded to nearly $12 trillion   And China’s share of America’s publicly-held debt overhang increased more than five-fold, to nearly 11% ($1.3 trillion) by July 2013. Along with roughly $700 billion in Chinese holdings of US agency debt (Fannie Mae and Freddie Mac), China’s total $2 trillion exposure to US government and quasi-government securities is massive by any standard.
China’s seemingly open-ended purchases of US government debt are at the heart of a web of codependency that binds the two economies. China does not buy Treasuries out of benevolence, or because it looks to America as a shining example of wealth and prosperity. It certainly is not attracted by the return and seemingly riskless security of US government paper – both of which are much in play in an era of zero interest rates and mounting concerns about default. Nor is sympathy at work; China does not buy Treasuries because it wants to temper the pain of America’s fiscal brinkmanship.
China buys Treasuries because they suit its currency policy and the export-led growth that it has relied on over the past 33 years. As a surplus saver, China has run large current-account surpluses since 1994, accumulating a massive portfolio of foreign-exchange reserves that now stands at almost $3.7 trillion.

China has recycled about 60% of these reserves back into dollar-denominated US government securities, because it wants to limit any appreciation of the renminbi against the world’s benchmark currency. If China bought fewer dollars, the renminbi’s exchange rate – up 35% against the dollar since mid-2005 – would strengthen more sharply than it already has, jeopardizing competiveness and export-led growth
2---The Leveraged Buyout of America, web of debt blog, Ellen Brown

How Banks Launder Money Through the Repo Market
In an illuminating series of articles on Seeking Alpha titled “Repoed!”, Colin Lokey argues that  the investment arms of large Wall Street banks are using their “excess” deposits – the excess of deposits over loans – as collateral for borrowing in the repo market. Repos, or “repurchase agreements,” are used to raise short-term capital. Securities are sold to investors overnight and repurchased the next day, usually day after day.

The deposit-to-loan gap for all US banks is now about $2 trillion, and nearly half of this gap is in Bank of America, JP Morgan Chase, and Wells Fargo alone. It seems that the largest banks are using the majority of their deposits (along with the Federal Reserve’s quantitative easing dollars) not to back loans to individuals and businesses but to borrow for their own trading. Acquiring a company or a portion of a company mostly with borrowed money is called a “leveraged buyout.” The banks are leveraging our money to buy up ports, airports, toll roads, power, and massive stores of commodities.
Using these excess deposits directly for their own speculative trading would be blatantly illegal, but the banks have been able to avoid the appearance of impropriety by borrowing from the repo market.
 (See my earlier article here.) The banks’ excess deposits are first used to purchase Treasury bonds, agency securities, and other highly liquid, “safe” securities. These liquid assets are then pledged as collateral in repo transactions, allowing the banks to get “clean” cash to invest as they please. They can channel this laundered money into risky assets such as derivatives, corporate bonds, and equities (stock).

That means they can buy up companies. Lokey writes, “It is common knowledge that prop [proprietary] trading desks at banks can and do invest in a variety of assets, including stocks.” Prop trading desks invest for the banks’ own accounts. This was something that depository banks were forbidden to do by the New Deal-era Glass-Steagall Act but that was allowed in 1999 by the Gramm-Leach-Bliley Act, which repealed those portions of Glass-Steagall.

The result has been a massively risky $700-plus trillion speculative derivatives bubble. Lokey quotes from an article by Bill Frezza in the January 2013 Huffington Post titled “Too-Big-To-Fail Banks Gamble With Bernanke Bucks“:

If you think [the cash cushion from excess deposits] makes the banks less vulnerable to shock, think again. Much of this balance sheet cash has been hypothecated in the repo market, laundered through the off-the-books shadow banking system. This allows the proprietary trading desks at these “banks” to use that cash as collateral to take out loans to gamble with. In a process called hyper-hypothecation this pledged collateral gets pyramided, creating a ticking time bomb ready to go kablooey when the next panic comes around.
That Explains the Mountain of Excess Reserves
Historically, banks have attempted to maintain a loan-to-deposit ratio of close to 100%, meaning they were “fully loaned up” and making money on their deposits. Today, however, that ratio is only 72% on average; and for the big derivative banks, it is lower yet. The unlent portion represents the “excess deposits” available to be tapped as collateral for the repo market.

The Fed’s quantitative easing contributes to this collateral pool by converting less-liquid mortgage-backed securities into cash in the banks’ reserve accounts. This cash is not something the banks can spend for their own proprietary trading, but they can invest it in “safe” securities – Treasuries and similar securities that are also the sort of collateral acceptable in the repo market. Using this repo collateral, the banks can then acquire the laundered cash with which they can invest or speculate for their own accounts.

Lokey notes that US Treasuries are now being bought by banks in record quantities. These bonds stay on the banks’ books for Fed supervision purposes, even as they are being pledged to other parties to get cash via repo. The fact that such pledging is going on can be determined from the banks’ balance sheets, but it takes some detective work. Explaining the intricacies of this process, the evidence that it is being done, and how it is hidden in plain sight takes Lokey three articles, to which the reader is referred. Suffice it to say here that he makes a compelling case.

Can They Do That?
Countering the argument that “banks can’t really do anything with their excess reserves” and that “there is no evidence that they are being rehypothecated,” Lokey points to data coming to light in conjunction with JPMorgan’s $6 billion “London Whale” fiasco. He calls it “clear-cut proof that banks trade stocks (and virtually everything else) with excess deposits.” JPM’s London-based Chief Investment Office [CIO] reported:
JPMorgan’s businesses take in more in deposits that they make in loans and, as a result, the Firm has excess cash that must be invested to meet future liquidity needs and provide a reasonable return. The primary reponsibility of CIO, working with JPMorgan’s Treasury, is to manage this excess cash. CIO invests the bulk of JPMorgan’s excess cash in high credit quality, fixed income securities, such as municipal bonds, whole loans, and asset-backed securities, mortgage backed securities, corporate securities, sovereign securities, and collateralized loan obligations.
Lokey comments:
That passage is unequivocal — it is as unambiguous as it could possibly be. JPMorgan invests excess deposits in a variety of assets for its own account and as the above clearly indicates, there isn’t much they won’t invest those deposits in. Sure, the first things mentioned are “high quality fixed income securities,” but by the end of the list, deposits are being invested in corporate securities [stock] and CLOs [collateralized loan obligations]. . . . [T]he idea that deposits are invested only in Treasury bonds, agencies, or derivatives related to such “risk free” securities is patently false.
He adds:
[I]t is no coincidence that stocks have rallied as the Fed has pumped money into the coffers of the primary dealers while ICI data shows retail investors have pulled nearly a half trillion from U.S. equity funds over the same period. It is the banks that are propping stocks.

3---Repo definition provided by reader in banking industry: name withheld (no link)

Repo is short for repurchase agreement.  The repo market is where primary dealers borrow and lend securities to banks and other financial intermediaries. For example:  Let's say that  dealer A wants to borrow $100 from the ABC money market fund, so, they borrow the $100 and pay them back tomorrow plus interest. But before ABC agrees to lend dealer A the money, dealer A  must post collateral, equal to the value of the cash plus a haircut for safety.  . That's how repo works. It's a collateralized loan. Should the repo be for longer than overnight and the value of the collateral happens to deteriorate because the market declines, then dealer A must send additional collateral for a margin call.

 During the financial crisis of 2007 and 2008  the broker-dealers who were trying to get funding using their mortgage-backed securities (MBS) for collateral found that the value of these securities were far less than advertised, and in fact were of questionable value. Therefore, The money markets funds and other cash-heavy investors turned off the lending spigot, , which precipitated massive fire sales of these distressed assets that could no longer be funded.  These were dumped on the market pushing prices further and further down wiping out trillions in equity and locking up the financial system since the dealers could no longer fund these positions. That's why the Fed stepped in, became the lender of last resort, and backstopped the system with explicit guarantees for both regulated and unregulated financial institutions.   As a result, since these securities could no longer be funded and no one wanted to buy them, the Fed ended up buying huge quantities of these securities itself in order to support the primary dealers and all the investors holding these type securities.  The Fed has not stopped since and each month prints billions of dollars of paper money to continue purchasing these questionable securities, and the taxpayer ends up owning all these securities. 
Therefore, it is the taxpayer that takes the losses while the primary dealers and big investors get bailed out at our expense.  Profits remain with the dealers and loses are foisted on us.

4---Dismal Jobs Reports Sends S&P To New All-Time High, zero hedge


5---Why I’m So Worried About Japan’s Ballooning Trade Deficit , Testosterone Pit

Exports rose 11.5% in September from prior year, according to the Ministry of Finance. It disappointed the wishful thinkers. Given that the yen lost about 20% of its value over those twelve months, export volume actually declined. But imports soared 16.5%, and the trade deficit hit ¥932.1 billion ($9.5 billion).

It was the worst September trade deficit ever. It continues a steep trend: August was the worst August ever, July the worst July ever, June the worst June ever, May the worst May ever. And so on! A trend that has been getting worser and worser, as they say. At a dizzying rate.
It was the 15th month in a row of trade deficits, the worst such sequence since anyone started counting, worse even than the 14-month series in 1979-1980. And there is nothing whatsoever on the horizon that signals a turnaround.

6---We're all Toast! Paradigm breakdown, The key elements of the current system are no longer viable, naked capitalism

Cognitive regulatory capture, meaning the regulators have adopted the industry worldview, which makes them reluctant to act.

Extortion, meaning that the financial services industry controls infrastructure that is essential to capitalism, and cannot be displaced except at very high cost. Think of what happened to the civilization at Ur when the king shut down the overly powerful lenders.

State capture, meaning the financial services industry now has the status of oligarchs in third world countries, having used its economic clout to buy so much political influence that they largely dictate policy regarding its interests.

Paradigm breakdown, meaning key elements of the current system are no longer viable, but that is a possibility that no one is prepared to face, since the old system seemed to work well for a protracted period. Thus the authorities reflexively put duct tape on the machinery rather than hazard a teardown.

7---Crisis in Europe; It ain't over til it's over, naked capitalism

Heisbourg also reminds reader of how grim the fundamentals are:
Prof Heisbourg does not accept the latest claim by the EMU Gang of Five that Euroland has turned the corner, or that crisis policies are “beginning to deliver results.”…
He calls it a “cancer in remission”. The attempt to cut debt by fiscal austerity – rather letting growth erode the burden over time, a l’Americaine – and to do so without monetary stimulus, has been the “fatal choice”. The debt ratios are punching higher, towards the point of “non-linear rupture”.

Depression and mass unemployment in southern Europe is not a stable equilibrium…Starkly different narratives of the crisis are emerging among creditor and deficit states, which he compares to the split in attitudes after World War One when twisted views fed an ideological backlash….

The current course will lead to “serial crises ending in a nervous breakdown and an uncontrolled disintegration of the euro with all its consequences” – he writes – invoking a direct parallel with the sudden unravelling of the Soviet Union, a denouement with which he was closely associated and which caught almost everybody by surprise.
There’s a tendency, particularly in recent years, to discount the political component of economic crisis, particularly since the recent record is that government officials eventually prostrate themselves before the Bond Gods. The hated TARP was eventually passed. The US debt ceiling was increased, with altogether more high drama than international observers thought was necessary. The Trokia has repeatedly stumbled through crises and debt restructurings.

Yet these patch-ups are still fraught, and every time the principals come to the table, it seems that tempers and trust are wearing more and more thin.

It no doubt will seem like an extreme comparison, but I keep thinking about the set of circumstances that led to the collapse of Creditanstalt in 1931, which produced an international financial crisis and bank failures all across Europe. Mind you, I’m not predicting a Creditanstalt-type collapse, but to make the point that the trigger was political, not economic, and so it is important not to underestimate the possibility that political frictions can be the detonator for major financial dislocations.

8---Why I Will Never, Ever, Go Back to the United States , Niels Lohman

9---The Rise of an American Debtcropper System for the Young, naked capitalism

10--Predatory lending and subprime, NBER

We measure the effect of an anti-predatory pilot program (Chicago, 2006) on mortgage default rates to test whether predatory lending was a key element in fueling the subprime crisis. Under the program, risky borrowers and/or risky mortgage contracts triggered review sessions by housing counselors who shared their findings with the state regulator. The pilot cut market activity in half, largely through the exit of lenders specializing in risky loans and through decline in the share of subprime borrowers. Our results suggest that predatory lending practices contributed to high mortgage default rates among subprime borrowers, raising them by about a third.

11---American Debt, Chinese Anxiety, menzie chin

Though a potential global financial crisis was averted at the last minute, one notable development has been a string of warnings by Chinese officials. Prime Minister Li Keqiang told Secretary of State John Kerry that he was “highly concerned” about a possible default. Yi Gang, deputy governor of China’s central bank, warned that America “should have the wisdom to solve this problem as soon as possible.” An opinion essay in Xinhua, the state-run media agency, called “ for the befuddled world to start considering building a de-Americanized world.”

These statements, unusually blunt coming from the Chinese, show that repeated, avoidable crises threaten the privileged position of the U.S. as issuer of the world’s main reserve currency and (until now) risk-free debt.
It is unlikely that China would provoke a sudden, international financial calamity — for instance, by unloading U.S. Treasury securities and other government debt. Nonetheless, the process of repeated crises and temporary reprieves will only solidify the Chinese government’s determination to diversify its holdings away from dollar-denominated assets. ...

Foreign entities — governments, companies and individuals — hold nearly half of the publicly held debt owed by the United States. Of China’s $3.6 trillion in foreign exchange reserves, about 60 percent is estimated to be held in U.S. government securities. ...

So, imagine a US economy close to potential GDP five years hence, with a considerably smaller demand for US Treasurys, partly because we have made US government debt less attractive. This will result in some combination of a weaker dollar and a higher long term interest rate. Not a good outcome

12---Abenomics: Signs of a turnaround, IMF

The strength of the recovery in the first half of this year has surprised many. The rebound in equity markets, yen depreciation, and new public spending all contributed to a remarkable turnaround, with growth reaching almost 4 percent in the first six month of the year. That said, the transition to a private demand-led recovery is still at an early stage. Private investment has not taken off and labor markets, while tighter, have not generated much wage growth. A good start, yes, but not a homerun.
What about prices? Inflation turned positive in June helped by higher energy import costs, and long-term inflation expectations have risen. But most core prices are still falling and monetary easing is slow to transmit to the economy: most of the liquidity pumped into the economy is flowing right back to the BoJ in the form of growing bank reserves. Some banks have begun to rethink their investment strategies and bank lending has begun to rise, but in aggregate the new easing has not lead to substantial portfolio rebalancing or capital outflows, contributing to a relatively stable exchange rate since July.

Probably the most noticeable achievement has been continued low and stable long-term interest rates, despite the rise in inflation expectations and a steepening of yield curves, overseas, especially in the US. This has helped bring real interest rates down.

13---Designed to fail: FHA single-family mortgage guarantee program squeezes taxpayers, Housingwire

Program is no longer saving money as borrower defaults increase


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