Wednesday, October 9, 2013

Today's Links

1---Weekly Drop in U.S. Economic Confidence Largest Since '08, Gallup
Decline of 12 points to -34 is largest since Lehman Brothers collapsed

Americans' confidence in the economy has deteriorated more in the past week during the partial government shutdown than in any week since Lehman Brothers collapsed on Sept. 15, 2008, which triggered a global economic crisis. Gallup's Economic Confidence Index tumbled 12 points to -34 last week, the second-largest weekly decline since Gallup began tracking economic confidence daily in January 2008.
Gallup's Economic Confidence Index has plunged 19 points since the middle of September and is now, at -34, at its lowest level since late December 2011. Confidence is significantly worse than it was in late May and early June of this year, when it peaked at -3.
Gallup Economic Confidence Index -- Weekly Averages, January 2008-October 6, 2013
While the economy is, in many respects, stronger than it was during the 2011 debt ceiling crisis, the current budget debate and government shutdown clearly show that partisan brinksmanship and the uncertainty it causes on Wall Street can negatively affect consumer confidence. Thus, Congress' inability to reach a compromise to end the government shutdown and raise the debt ceiling could negatively affect U.S. stock prices, America's credit rating, and, ultimately, the nation's economic recovery.


2---Fed Watch: Credibility on the Line, economist's view

I have long suspected the Federal Reserve was increasingly biased against QE, suggesting the bar to tapering was much lower than would have been implied by the data flow. This is particularly the case with inflation, which has remained well below the Fed's official target. Moreover, the talk of tapering seemed ill-timed given the calendar. It was basically impossible to believe that the Fed could even begin to have sufficient evidence about the impact of fiscal tightening to justify tapering within the Fed's framework of "stronger and sustainable" before the final quarter of this year. The data flow simply didn't permit it.
Now we know, however, that a cadre of governors was pushing for the end of QE due to financial market concerns. From Hilsenrath:
Privately, Mr. Stein and two other governors, Jerome Powell and Elizabeth Duke , were a driving force behind efforts to limit the program's growth, according to people involved in the deliberations. All three supported Mr. Bernanke's efforts to charge up a weak economy but were uneasy about the program's potential side effects and the growing size of the Fed's holdings.
Mr. Stein, a Harvard finance professor, focused on the risk that the Fed might stoke a new credit bubble. Mr. Powell, a former Wall Street executive, talked at meetings about developing a "stopping rule" for the program to ensure the Fed's portfolio of securities didn't get too big. Ms. Duke, a former banker, was likewise wary of making an unlimited commitment.
So policy was in fact separated from the data flow. Or was it?....
Whether you agree with QE or not, several points seem evident at this point:
  1. Obama is stacking the Federal Reserve Board with anti-QE candidates.
  2. The anti-QE contingent has been heavily influenced by the asset bubbles of recent years and is concerned about the financial stability implications of monetary policy. The dual mandate is becoming a triple mandate. 
3---Americans Despise Congress, Their Economic Confidence Plunges, And Now They Slash Spending , Testosterone Pit

Congressional approval ratings plunged from an already abysmally low 19% in September to 11% in October, just a notch above Gallup’s all-time low of 10%. Republicans punished Congress in a relatively modest way, cutting their approval rating from 18% to 15%. But Independents slashed their approval rating from 19% to 13%. And Democrats went ahead and demolished Congress, chopping their approval rating from 20% in September to 5% now.
 
Democrats are unified in how much they despise Congress. More specifically, Gallup says, they despise the Republican-controlled House due to what is perceived to be its extortionary attack on the Affordable Care Act, after all other democratic and legal measures, including a Supreme Court challenge, have failed to dismantle it.
 
That screaming disapproval of Congress is likely to get worse...
It’s starting to show up in metrics the count dollars: After running up their spending all year, from $80 on average per day just after the holidays to $95 per day in August – not seen since the glorious pre-Lehman days in 2008! – Americans suddenly reported to have slashed their spending in September to $84 per day.
 
How huge is the $11 per day drop in August-September spending? It compares to a $3 to $4 drop for the years 2010-2012 and a $1 to $2 gain in 2008 and 2009. Other current retail indicators such as weekly sales at chain stores are also dropping
 
(Blackstone, the biggest owner of single family homes in the US?)
 
Ben Bernanke and the US Federal Reserve have done all that mere mortals can do to repair the housing market post-financial crisis, but despite tarting up the mortgage industry like Cinderella for the ball, buyers are not jumping into the golden carriage to attend the best party ever staged.
How can this be, when house prices are supposedly climbing across the States? The latest Case-Shiller Index was up more than 12 per cent over the past year. The devil is in the detail – the most recent month-on-month increase slowed to just 0.6 per cent, and it is who is buying that is relevant.
Those who can afford to upgrade or buy a second home are doing so, with private equity and hedge funds bolstering transactions. But the average American is still cleaning up their balance sheet, using cheaper 30-year fixed mortgages to refinance. Insiders say the balance between those taking out mortgages in the purchase money market to buy properties versus refinancing is far from healthy, with a skew to the latter.

Others not on the property ladder are having hopes of home ownership dashed as interest rates and prices climb. Many now hand over a regular rental cheque to the likes of Blackstone, the biggest owner of single family homes in the US.

5---Labor angered by Obama's willingness to cut Social Security in debt ceiling deal, The Hill (archive)

President Obama’s apparent willingness to discuss Social Security cuts in the debt-ceiling negotiations with Congress has angered labor unions and could cause them to withhold support for Democrats in the next election.
Press reports say President Obama is considering a proposal to change how Social Security payments are calculated by chaining payments from the program to the Consumer Price Index. That change would help bring down the national debt but would likely reduce benefits for retirees

6---Amid government shutdown, Obama signals cuts to Social Security, Medicare, wsws

US President Barack Obama restated his support for cutting Social Security and Medicare in a press conference Tuesday, reassuring congressional Republicans of his willingness to agree to these cuts if the Republicans vote to increase the government’s debt limit....

Obama made a stark admission of his broader goals in the debt negotiations during the press conference, when, in response to a reporter’s question, he said, “Whenever I see John Boehner to this day, I still say, you should have taken the deal that I offered you back then, which would have dealt with our long-term deficit problems, would not have impeded growth as much, would have really boosted confidence.”
Obama’s 2011 proposal, according to documents leaked in 2012, included over $1 trillion in cuts to Medicare and Social Security as part of $2.8 trillion in total cuts....beginning of the US government shutdown.
The borrowing costs of the US government, meanwhile, hit the highest level in five years Tuesday, while the cost of insuring bonds against a possible default grew by up to ten percent.
During the press conference Obama repeatedly stressed his administration’s debt-cutting credentials, gloating, “Our deficits are falling at the fastest pace in 60 years.”

7---Fed: Hedge Funds, Banks Sell Crappiest Debt To Small Investors (Before Credit Bubble Blows Up) , Testosterone Pit (Today's "must read")

In its report on shadow banking, the New York Fed buried some nuggets: Hedge funds and banks are bailing out of the highest-risk “opaque” but now relatively low-yielding loans – low yielding thanks to the Fed’s repressive monetary policies – by selling them to small investors via harmless-sounding and conservative-appearing mutual funds and ETFs.
 
Shadow banking loans are estimated to have reached $15 trillion in the US. And among them is a particularly hot category: lending to highly leveraged companies with junk credit ratings. Sophisticated investors with a big appetite for risk who know how much yield to demand to compensate them for these risks might see these “leveraged loans” as an opportunity. But the NY Fed found that these loans are increasingly issued in a loosey-goosey manner, with low underwriting standards. And issuance has soared.
 
In 2007, issuance of these “leveraged loans” peaked at $680 billion but then totally collapsed in 2008. Since 2009, according to NY Fed, “it has rebounded very quickly, and is now at record levels of volume, projected to be larger than $1 trillion in 2013.”
 
Layered into these crappy and risky loans are the crappiest and riskiest of all loans, namely “covenant-lite” loans. Their covenants are so watered down and so full of holes that investors have few if any protections in case of default. If the Fed ever allows reality to set, and these companies stumble under their load of debt or can’t refinance it at ridiculously low rates, investors can kiss their money goodbye. In 2010, 0% of the leveraged loans issued were “covenant lite.” This year, they ballooned to 60% of the issuance, or about $600 billion.
 
“One area of concern,” is how the NY Fed called this phenomenon.
For sophisticated investors, it’s a gamble worth considering. In normal times, they’d demand yields deep into the double-digits before touching covenant-lite loans with their ten-foot pole. But these are not normal times. The Fed, with its QE and zero-interest-rate policies, has been immensely successful in annihilating any link between reality and financial assets. Now, no one is getting compensated for risk – neither at the low end, with many Treasuries yielding below the rate of inflation, nor at the high end, with junk “covenant-lite” debt yielding as little as FDIC-insured CDs did not that long ago.
 
But the Fed has systematically vaporized these CDs. Conservative retail investors, such as retirees and millions of others, watched their income streams get confiscated by the banks. To do something about their loss of income, they have embarked on an all-out search for yield elsewhere – and they have stumbled upon junk, including these “covenant-lite” leveraged loans. They’re doing exactly what Chairman Bernanke, out of the goodness of his heart, has wanted them to do for years: invest their life savings in super risky assets without being compensated for these risks. And they don’t even know it.
...
The NY Fed notes in its dry manner: These high-risk, loosely underwritten leveraged loans have come “hand-in-hand with an increased presence of retail investors in the leveraged loan market, through both CLOs [collateralized loan obligations] and prime funds, as relatively sophisticated investors, like banks and hedge funds, are exiting the asset class.”
 
It could be an indictment of Chairman Bernanke’s policies. But that would be wishful thinking. The NY Fed isn’t worried about small investors getting stuck with landmines that will later blow up in their portfolios. It’s worried about things like shadow credit intermediation: “The funding of long-term opaque and risky loans through mutual funds and exchange-traded funds, which engage in liquidity and maturity transformation, help to define this activity clearly as shadow credit intermediation.”
 
The Fed printed $3 trillion and handed it to banks and hedge funds. The top echelons became immensely wealthy in the process, but some of this wealth is now tied up in crummy overvalued financial assets – from these leveraged loans to stocks. To preserve their wealth, they have to dump these assets before the rest of the hot air hisses out of the biggest credit bubble in history. But they have to do so in a disciplined manner to avoid causing a sudden implosion of the credit bubble, which would end it all – or, more likely, produce another Fed bailout.
 
And small investors are lining up to buy this junk. Assets at mutual funds that deal in leveraged loans have doubled from two years ago to $145.7 billion, according to the Wall Street Journal. Without knowing what they’re buying – they’re just buying a fund symbol along with a vague description – these small investors have bought one-third of these leveraged loans in 2013 for an average yield of 5.3%.
 
That’s about what their five-year FDIC-insured CDs had yielded before the Fed killed them.
For the same yield, these desperate small investors, after having seen their income streams get confiscated by the banks, have unknowingly made a quantum leap in risk – allowing the smart money, which hears the hot air hissing from the credit bubble, to bail out. This must be one of the proudest moments in Chairman Bernanke’s glorious tenure.
 
New York Stock Exchange, BBH Analysis
Are bullish stock investors getting overly greedy?
 
Clemons says he’s started paying more attention to margin debt, but that it’s part of a larger dashboard of indicators that indicate stocks could be due for a setback. Those indicators include slowing earnings growth and valuations that appear “full” at current levels.
 
(No one minding the store...."The two agencies would be the government's first line of defense if lawmakers don't raise the borrowing limit and send markets into a tailspin. (But) The two market regulators depend on annual appropriations, however, and one is largely shut down because of the funding lapse."  Nice, eh?)
 
Regulators are monitoring the effects of a possible U.S. default on short-term lending markets, including repurchase agreements and money-market mutual funds, according to a person familiar with the matter.
The Financial Stability Oversight Council, which includes the Federal Reserve as well as other banking and markets agencies, met privately to consider a looming Oct. 17 deadline, when the Treasury says it will exhaust its borrowing authority. The Treasury said it will have about $30 billion in cash on hand after that but will quickly run into a cash crunch as a series of interest payments and Social Security and Medicare payments come due.

"Failure to raise the debt limit by October 17 would place the United States government in the untenable position of operating with only the cash on hand and could severely impact financial markets and the broader economy," Treasury spokesman Anthony Coley said in a statement with brief details of the meeting.
If the Treasury falls behind on interest payments it could cause serious turbulence in financial markets. Treasury bonds play an important role in day-to-day funding of many financial institutions. For instance, Treasury securities are used as collateral for short-term loans that firms take out, known as repurchase or "repo" financing.

Failure to make good on those obligations could cause serious turbulence in repo markets where financial firms secure their funds. This market became unstable during the 2008 financial crisis, and the Federal Reserve and other regulators now monitor it closely for early warning signs of stress in the financial system.

Securities and Exchange Commission officials are also concerned money funds could break their $1 share price if the Treasurys and other short-term securities they hold rapidly decline in value, former regulators said.

The SEC and Commodity Futures Trading Commission briefed regulators Tuesday on how they are handling oversight of markets during the partial government shutdown, which began last week.
The two agencies would be the government's first line of defense if lawmakers don't raise the borrowing limit and send markets into a tailspin. Their ability to monitor the markets could prove critical in the coming days as the U.S. teeters on the brink of default.

The two market regulators depend on annual appropriations, however, and one is largely shut down because of the funding lapse. The CFTC is operating with a skeleton staff of 28, and the SEC has been able to continue operating only because of unspent money from the prior fiscal year. Its ability to remain fully operational in the wake of a prolonged shutdown is uncertain, according to people familiar with the matter.

A spokesman for the SEC said the agency's operational status could change if the shutdown lingers.
In an interview after the meeting, CFTC Chairman Gary Gensler said his agency is only doing minimal market surveillance during the shutdown. "We have no real ability to oversee these markets until we're back up and running," Mr. Gensler said. Mr. Gensler said the CFTC staffers who are still working meet every afternoon at 4 p.m. to report on what is happening in enforcement, technology and operations.
Mr. Gensler said the agency has three people in the technology department making sure data is still coming in from exchanges.
After the shutdown, the CFTC will have to look back at the data from the shutdown period, Mr Gensler said.
 
 
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