Wednesday, December 23, 2009

Monetary Policy: Inflation-Deflation, Debt, Excess Reserves, Currency Volatility

The debate over the various aspects of monetary policy, how the Federal Reserve is handling the current financial crisis, and where the Fed's policies are taking us is heating up.  The Fed has allowed the banks to park excess money on deposit with the Fed to bolster reserves and this has provided the incentive to not lend.  The ECB, on the other hand, has had, for some time, an interest penalty which charges member banks for depositing excess reserves with it rather than putting those reserves to work in their respective economies by lending.

We have seen other countries taking action to protect their currencies from the weak dollar with increased central bank interest rates and capital controls to stem the build up of asset bubbles in their country and/or to protect their ability to export competitively.  China is pegging its currency to the Dollar and not allowing it to float freely.  China is trying to play both ends against the middle to their advantage.  We have had two posts on the China bubble including one with extensive links.

Edward Harrison had a post on naked capitalism dealing with currency volatility in which he argues that is all about debt control.  He has added another post on monetary and fiscal stimulus in which he argues it is really a debate on the role of government and its limitations.  In another post he has argued that the stimulus has been co-opted to protect the financial sector's status quo before the financial crisis and the monies have been "malinvested".  Paul Krugman has argued that the issues are for what purpose the debt is increased and creating the conditions by which it will be reduced.  His argument is that the causes of the deficit matter and are directly related to the efficient use of the money to create an economy that will reduce the debt more efficiently and quickly with GDP growth rather than inefficiently and over a much longer and more painful time.

Steven Keen has always been devoted to the necessity to control debt and the perils of leverage.  He recently reprinted a post by Mike Shedlock which begins with a paper by Robert Murphy that I linked to in my last Leftovers post.  Shedlocks's article concentrates on fractional reserve banking and how that approach argues that banks cannot lend because the money is really not there - it is a fictional construct.

Mark Thoma has recently written on the monetary policy with near zero interest rates and the conflict with fiscal policy and which should take the lead.  His article discusses the effect on inflation and the need for a price-level target with its reaction oriented pitfalls.  He wrote the article to explain quantitative easing to which he is basically opposed.

Bill Mitchell, the Australian anti-thesis to his fellow countryman Steve Keen, has written two articles on bank reserves.  In the first he argues that bank reserves do not expand lending and that fiscal policy is the most efficient way to create jobs.  He is very opposed to quantitative easing and is very critical of Krugman.  This article shows how economists with different beliefs can often approach the same problems with similar results for different reasons.

In Mitchell's second article, he argues that bank reserves are not inflationary.  The liquidity functions of a central bank are not intrinsic to the inflationary effect of the spending.  He addresses the excess reserve concept and the effect of near-zero interest rates on fiscal policy, relation to aggregate demand, and the necessity of government "to balance aggregate spending to match the capacity of the economy to absorb it."

In the final analysis, it comes down to central banks coordinating monetary policy with the government's fiscal policy to control inflation, provide liquidity, and directly target and control debt creation and spending with targeted lending for economic growth (like small businesses) and timely job creation.  While Larry Summers has said long term unemployment is an unavoidable component of this recovery and the Fed appears to be using unemployment to hold inflation down, the use of long term unemployment to deleverage debt and control spending  is not an acceptable fiscal policy in a republican democracy.  It will take 300,000 new jobs every month for five years to maybe get back to pre-financial crisis employment levels.  Government needs to get cracking and let Summers and Geithner go to work for Goldman Sachs (how long will it take Goldman Sachs to take the company private?).

The developing argument that lowering the minimum wage will spur employment, while the millions of dollars awarded for the short term risky behavior of investment bankers bonuses, is off limits for regulation, is corpulently corrupt.  It is the very basis of the unethical business model of an anointed elite's righteous greed.



Print Page

Tuesday, December 22, 2009

Dysfunctional Politics & the Beginning Depression

We have noted in past radio shows and prior posts how the Fed appears to be using unemployment to hold down inflation.  We have noted that the "Recovery" appears to be focused solely on the return of the financial system status quo prior to the Financial Crisis and the resumption of risky but profitable business trading.  Volcker has commented on the fact that no economy, which has 30% of its GDP from synthetic financial services, can continue without risking another financial crisis.  In fact, we have noted the "Recovery" appears to be setting the stage for the very same financial crisis.

In a long post Edward Harrison  has written on his belief that the Recession is over but the Depression has just begun.  His argument is essentially that the political process, of which Congressional actions are only one example, has created a dysfunctional economic debate, economic recovery policies, and a divisive political debate which serves the special interests but not the Nation.  He goes into some detail on what it means globally as well as nationally and what needs to be addressed.  While I do not entirely agree with him, his arguments are very worthy of consideration for anyone who is desirous of dealing with the economic conditions as they exist.

It is well known that I believe Geithner and Larry Summers need to go, because they serve Wall Street more than the Nation.  Washington'sblog has been very good at delineating Summer's insistence on his way or no way to the point where Volcker is now in Europe speaking for financial reform because Summers has muzzled and isolated him in the United States.  Still, there is opposition loyal to President Obama which are attempting to debate and contradict him, however, dangerous that may be.  Despite what Summer's says, unemployment will continue to rise and it cannot be ignored.  Read the post "Larry Summer's is like the guy who yells the Sun really does revolve around the Earth ..." and sharpen your critical skills.

In past radio shows we have talked about food shortages and riots, economic protests, and even a Joint Special Operations University faculty member's speech at a former intelligence officers conference about the possibilities that prolonged economic crisis could cause social upheaval in countries.  My first career was intended to be military and I still do extensive readings on military subjects including papers and publications at the War College and the JSOU.  It again appears that there will be food and commodity shortages with increasing prices in 2010.  There are two scenarios which could evolve with one being demonstrations, riots, and perhaps revolution in some parts of the world and the other being that the population will become so demoralized by their treatment from the elite who run their governments that they will be passive and do what they are told.  Here is one recent article that lists a variety of sources from the establishment and from the fringe for your critical review.  Here is an article about how a demoralized people can be made to be passive and do what they are told, although there are more scholarly books over the last 60 years.  Constructive political action by an educated and knowledgeable public is not something that should be suppressed in a healthy republican democracy.

James Kwak in The Baseline Scenario has also addressed his frustration with the dysfunctional qualities of the political and economic debates with a "partisan post" on the 8 things of which he is sick.

Again these links are provided for your critical review as comments worthy of being analyzed and thought about in order to peek your research interests or to form opinions which can be substantively argued.





Print Page

Sunday, December 20, 2009

Leftovers from 12/19/2009 Show

On the show, while discussing the new CPI inflation numbers, I mentioned an article by the economist Robert Murphy, who is of the Austrian School of economics and would be expected to be talking about deflation, in which he talked about the growing inflation rate going forward just as I have been.  His paper actually predicted the November inflation announced in December as 1.7% and it was 1.84%.  He indicated correctly that inflation will continue to rise, perhaps sharply, because the year to year is starting with the end of the 4th Quarter 2008 when prices had fallen significantly.  He is projecting 2.7 for December inflation announced in January; I am saying it will be between 2.8 and 2.9%  His paper can be found here.

I mentioned that Bloomberg.com and other US media have been ignoring or calling Volcker's European speaking tour in which he calling for financial reform now and the end of "too big to fail" as ineffective and meaningless.  Simon Johnson of The Baseline Scenario and a former IMF economist thinks otherwise and has had two posts demonstrating the strength of Volcker's call for reform and the attention it has gotten.  In "Paul Volcker Picks up a Bat" he lays out the strength of Volcker's strategy to influence financial reform and in "Wake Up Gentlemen" he lists Volcker's reform points and the public platform he is using more and more.  We talked two weeks ago about his UK speech and here is his interview with Der Spiegel when he gave a Berlin speech.  Larry Summers has gone to excessive lengths to limit and marginalize and muzzle Paul Volcker.  Fortunately, when you limit the options of a man like Paul Volcker you get a man who has nothing to lose and acts.

The economist Nouriel Roubini has made a comparison of the current financial crisis and the the 1930's and found that the same optimism that pervades the media and market in 1937 before a double dip is very similar to what is happening now. I have made similar historical and data comparisons on more than one occasion.  I have been talking about the weak US dollar and the carry trade it has spawned, which the Fed denies  is happening, and Roubini has been talking about it also and sees at least six months more of carry trade.  Two weeks ago we talked about gold and how a savings account over the last thirty years would have had more appreciation than Gold.  It is a matter of when one bought gold and at what price.  It is one thing to have bought it at $250 or $400 and another if you bought it at $800 or higher.  Roubini has written about the flaws in gold investing and how gold may presently be in a bubble and posed to decline in "The Gold Bubble and the Gold Bugs".He ends by indicating that if investors really fear a global meltdown then they should be buying guns, ammunition, canned food, stocking water, and other commodities which can actually be used rather than buying gold.

There has also been two studies published  on whether gold is a safe haven from equities or bonds in developed and developing nations and the results were quite mixed and disparate.  What it comes down to is it is not just correlation but the price purchased and the holding period and the country.

Greece has had recent credit downgrades and the ECB has made it clear they will not bailout member states.  The new Greek government has made cuts in its budget to address its mounting deficit and made a difficult bond placement this last week.  There have been youth riots earlier this year which have abated but various demonstrations are continuing.  Greece will have to make more cuts and it is difficult to determine how social unrest this will create.  It is a country high on our two country watch lists in an older post.

The ECB has made it clear that banks in the 16 nation union, which have already written down 2/3rds of loan losses, may have to write down another 1/3rd in the amount of $267 billion for a total of $796 billion.  The ECB also made several comments about the uneven recovery throughout the economy and from country to country.

Fitch said the US high yield corporate bond default is declining and expects 2010 to decline to 6-7% (average is 4.7%) default.


Empire State Manufacturing index fell 21 points to 2.6; new orders fell 14 points to 2.2; shipments fell 7 points to 6.3; unfilled orders fell 18 points to 21.1, lowest in 9 months; prices paid up 9 points to 19.7 while prices received fell 6.6 to 9.2; employment fell 7 points to 5.3; average work week fell 11 points to 5.3.

Philly Fed manufacturing index up to 20.4 from 16.7; prices paid up 19 points to 33.8 while prices received down .3 to1.8; new orders down 8 to 6.5; employment up 7 to 6.3; inventory up 10 to7.4.

ECB made its final tender of 12 months funds to banks($141 billion).

Canadian inflation rate 1% (1/10th % last month).

British retail sales for November down .3 from October but up 3.1% vs year ago; UK prices up 1.9% in November.

US current foreign trade account deficit up 10.3% to $108 billion in Q3 vs Q2.

China industrial production up 19.2% in November; retail sales up 15.8%; consumer prices up but down .9% vs year ago; producer prices down 2.1% vs year ago.

UK banks are voting on whether to abolish checks and require all transactions be by plastic or on-line.

The 3rd largest container shipping company, CMA CGM SA, warned bondholders that bankruptcy is an option if they do not approve plan to allow new lenders first claim on assets --- they want to raise money but need the $570 million current bond holders to modify the bond terms.

Bank of Japan held its interest rate at 1/10th percent.

Mexico S&P rating cut to BBB.

Gross of Pimco has increased the funds cash holdings to the highest level since the Lehman collapse from <7%> to 7% and reduced government securities from 63% to 51%.

Greenspan (Mr. Asset Bubble) said this last week that the stock market rally has negated any need for another "stimulus".  As I have asked previously, how has the weak US dollar carry trade not created a US stock market asset bubble?

TCF Financial TARP warrant auction went at $3/share (expected $1.82-4.89) and netted $9.45 million for the US Treasury.

CapOne credit card charge offs rose to 9.6 from 9.11; Discover rose to 8.98 from 8.54.

Home buyers are less likely to buy foreclosed properties than 6 months ago citing hidden costs according to a Harris Interactive survey.

Moody's issued an analysis in which they indicated they expect long-term rates may increase more rapidly than expected; that Aaa rated governments will probably not have the luxury of waiting for recovery before implementing fiscal consolidation plans; and Brazil, India, Russia, and China are unlikely to replace large Aaa rated countries as anchors to the global financial system anytime soon.

The US House of Representatives passed a plug the hole "stimulus" to basically throw life preservers to the states in the amount of $155 billion with 48.3 for infrastructure projects that put people to work by April 2010, 27.5 highway, 8.46 transit systems, 23 to pay teachers and repair schools, 1.2 to pay 5500 police, and 23 for the state's share of health care for the poor.  The bill also would extend Cobra 3 months to 15 and extend expiring year end unemployment benefits 6 months.





Print Page

Friday, December 18, 2009

IRS Comps Citi

In an IRS ruling this week, prior to the Citi Stock offering, Citi will be allowed to keep approximately $38 billion dollars in deferred losses when the government sells its shares.  In direct contradiction to a law passed earlier this year which reversed a ruling benefiting Wells Fargo and specifically restricted the ability of the IRS to make further changes in the Internal Revenue Code by ruling, the IRS ruling allows Citi to be exempt from the law which prohibits the use of past losses if a company changes hands in order to discourage profitable companies from buying unprofitable companies to avoid taxes.  This is lost money to the government when lower revenue is 56% of the current deficit.

The Citi stock offering subsequently failed miserably pricing in at $3.15 a share only after the underwriter stepped in and bought stock to keep the price from going below $3.  Consequently, the government did not sell part of their 34% holdings as planned, because their basis is $3.25.  Treasury will not sell any Citi stock now for at least 90 days.  The Bank of America stock offering was marginal, particularly given their determination to make no break from the way they have done business as evidenced by their refusal to consider a CEO successor from outside who would have made necessary changes.  Still, Citi's stock offering failure only reaffirms the true Zombie nature of their company.

Of course, Congress will investigate the IRS ruling, but the subcommittee is chaired by Rep. Kucinich who asks the hard questions but has no real respect from his lobbyist indebted fellow members of Congress.


Print Page

Thursday, December 17, 2009

Obama & Wall Street Controversy

In an earlier post I touched on Matt Taibbi's Obama & Wall Street article in which he attempts to show Obama is controlled by Wall Street.  His basic argument is that Obama relied upon people he knew and those people had their own agenda based on their work associations or, perhaps, as a result of their cultural biases.  Just because you know a member of the elitist class does not mean you can trust their judgment.  Yet, we are constantly being told if you have not been part of the problem you are not qualified to solve the problem.  Imagine what The President's advisers must tell him.

Consequently, I think it is important that you view the links in this post to get a perspective on how facts spin.

Here is an overview of the controversy from Harper's.  Here is the reaction to Taibbi's article by Tim Fernholz.  Here is Salmon's criticism of Fernholz.  Of course, Fernholz continued to react in clarification.

Personally, I think Obama has been played and used and it is now a matter of does he know it and what is he going to do about it.  Brad Delong provides a good nutshell analysis.

Any book, any article in a magazine or news paper, any article on the internet has to be approached with a critical analysis.  The failure to assess information methodologically is the road to poor judgment and false beliefs.


Print Page

Wednesday, December 16, 2009

Laws: Banks Don't Need Laws

It just keeps getting worse.

The Basel Committee has new international bank accounting rules scheduled for 2012, but this week they announced they are considering allowing banks a transition period of ten to twenty years to implement,  The rules would require an 8%  minimum capital ratio and stricter definition of core capital.  Remember Lehman had a Tier 1 ratio of 11% when it failed.

The FDIC is going to create a permanent safe harbor for securitizations and participations existing prior to March 31, 2010 and will consider how to treat new ones created after March 31, 2010.  This effectively removes the banks from putting over $1 trillion of off balance sheet holdings and securitizations at market value rather than par on their balance sheets.  This defeats the FASB rules scheduled to take effect 2010.

The President of the United States summoned bankers to a meeting and Goldman Sachs, J. P Morgan, and Citigroup had more important things to do than meet with the President of the United States and discuss what lending is necessary to create a sustained recovery with jobs.  They have key people in the Treasury and economic policy positions (Geithner and Larry Summers to name just two) in the government and they do not have to listen to the President.

The bankers have given lip service to financial reform, but their lobbyists have defeated and built a false facade in the House bill.  In fact the banks publicly view any attempt at regulation to be a direct threat to liquidity and the stability of interest rates, which is an argument which depends upon the poor education of the public as their real purpose is to protect high risk (and very profitable) trading and investments while they hoard money for cash reserves to bolster their capital ratios, escape TARP, and resume business as usual with renewed grotesque bonuses.  A good description of the bank's political agenda and lobbyist strategy is in a post by Yves Smith on naked capitalist.

How have banks survived the crisis?  We have all been exposed to the Financial Crisis and the necessity to rescue the banks at the expense of common citizen's retirement, savings, homes, and jobs and the victory of recovery and jobless prosperity.  However, the United Nations Office on Drugs and Crime has evidence that the only liquid investment capital banks on the brink of collapse last year had was proceeds from organized crime.  Gang money was used to save some banks when lending seized up.  Drug money funded inter-bank loans.  While these may have been marginal to Central Bank actions, marginal makes a big difference in the banking industry.  Are we to be surprised by the connections between organized crime and drug cartels with banks given the amount of money involved?  The complete Guardian article is here.

Print Page

Tuesday, December 15, 2009

Countries to Watch

In talking about Dubai on the last radio show, I briefly mentioned a few other countries.  I also questioned whether the strong US dollar last week was, rather than a possible bottoming as other analyst have speculated, was the result of seeking a safe haven from sovereign default.  This week with the welcome but inadequate $10 billion from Abu Dhabi to Dubai, the market "sighed relief " and the US dollar reverted to being weaker.  Was I right?

Moody's Misery Index listed countries with public debt in relation to sovereign default risk in descending order or risk: Spain, Latvia, Lithuania, Ireland, Greece, United Kingdom, Iceland, United States, Jamaica, France, Estonia, Portugal, Hungary, Germany, Italy, and the Czech Republic.  Take note of number 6 and number 8 on the list.

The 6th largest Austrian Bank, Hypo Group Alpe Adria, was was nationalized by the Austrian government as insolvent with 40 billion Euros in assets at the insistence of the ECB's chairman Trichet.  The  bank is a subsidiary of the German bank, Bavaria BayernLB, which had reported losses of over 1 billion Euros for the second quarter in a row from HGAA.  Austrian banks have been the subject of how much exposure they have to lending in weak Eastern European countries and some analysts consider German banks fragile as the result of reckless lending seeking high returns.  Credit Writedowns has an excellent article on the nationalization of HGPP and its relation to what is going on in Austria, Germany, Eastern Europe, and Dubai.  Sweden and Poland also have large exposure to Eastern Europe.

CMA DataVision has issued a Q4 report on the Global of countries by percentage of risk for sovereign default based on CDS prices.  It is a multi-page report but here is page 13 with a listing of countries by percentage probability of default.  The top ten are Venezuela, Ukraine, Argentina, Latvia, Iceland, Dubai, Lithuania, Romania, Lebanon, and Greece.  It should be noted that Greece has started to take serious action to curtail spending and has about a year to get its debt and budget under control.  It will be interesting to see if the public demonstrations by young people in Greece will moderate or increase.  Spain has serious economic contraction and, while the economy appears to be picking up in Italy, there have been reports of right wing reactions, particularly against immigrants.




Print Page

Sunday, December 13, 2009

Illinois Credit Rating Tanks

We are repeating the lead story on our last Radio Show, because the fact that the State of Illinois had its credit rating effectively lowered by Moody's to just above California's Baa1 making Illinois 49th out of the 50 states has, to my knowledge, received no media attention in paper, radio, or television.  Why?

General obligation bonds went from A1 to A2 citing problems from the US recession; other Illinois bonds including sales tax revenue bonds from A1 to A2.  Illinois has dropped from the middle of the pack of 50 States to next to last in one fell swoop.  Moody's said Illinois has not taken action of any sort to deal with the budget gap it is facing.  Moody's said that gap is in the order of $11 billion.  Actually, it is conservatively a deficit of $12 billion and could be closer to $15 billion depending on how you account for Federal stimulus money, funds from borrowing, and other one time monies which are not revenue.

It is well known we have made the case for State employee's Pension reform.  It is not funded and there is no economically competent system for funding Illinois pensions.  Despite a recession in which taxes should not be increased according to economic theory, Illinois has been so corruptly and incompetently run for so many years that a flat income tax increase is so imperative it has become a rotting corpse.  Illinois local governments have placed an intolerable burden of regressive taxes and levies (in Chicago 25%, approximately, of the cost of gasoline at the pump goes to taxes and Chicago has the highest sales tax in the country) that the burden on the lowest 40% of taxpayers in Illinois is unconscionable.  But no politician wants to help those people.  While cost savings should always be investigated and pursued each and every year just as private business does, cutting expenses cannot in any rational, conceivable way balance the Illinois budget.  The Democrats need to conduct rational program and employee reviews of double exempt and exempt personnel and the Republicans need to bite the tax bullet.  Given the coming Primary in February, neither political party wants to assume any responsibility for getting the job done.  They just want to be elected.  Maybe it is time to just vote against any incumbent and make the lobbyist fork out even more money to buy the new legislators and executive branch officers.

The Illinois budget situation is so beyond hope that the solutions are few and narrow.  The pretense and posturing of political purity is a poor disguise for a deadly social disease.  Represent the people and get it done.  It does not take a rocket scientist to figure out the obvious much less require the unanimity of any 13 politicians with a bag of 30 silver coins.  No Hope.


Print Page

Leftovers from 12/12/2009 Radio Show

Japan Q3 GDP up 1.3% (revised from earlier estimate of 4.8%).
Germany trade surplus up 2.5% as imposts fell 2.4%.
French industrial output fell .8% October; up .5% in Italy from 5.1% in September.

Hong Kong Finance chief publicly worried about risks of asset bubble and continuing capital inflows.

US consumer credit declined for the ninth straight month (12 out of last 13); Oct down 1.7%; Q3 down 3.3%; Q3 revolving credit down 7.4%; Sept revised down to 4.2%; Oct is down 3.6% vs year ago -- prior low record was down 1.9% in 1991.

Wholesale inventory up .3% Oct; Sept revised down to .8% from .6%>; wholesale sales up 1.2% Oct but inventory ratio still fell to 1.16 months from 1.17.

US trade deficit down to $32.9 billion Oct ($35.7 billion Sept); imports and exports were both up; oil imports dropped sharply.

Weekly jobless claims up 17,000 to 474,000; 4 week average down 7750 to 475,500; continuing claims down 303,000 to 5,170,000 (to extended benefits?).

Treasury yield curve (between 2 year and 30 year) 368 basis points -- widest in 17 years.

US retail sales up 1.3% in Nov adjusted -- 1.9% vs year ago; total sales Sept-Nov down 2.1% vs year ago -- bottomed?? --- anecdotal: retailer said 1st two days of Holiday shopping busy but now traffic is like middle of August.  Discover card survey indicated Christmas spending will be down 15%.

ECB urged IMF to pursue global tax on financial transactions to limit economic risk.

US business inventory up .2% Oct (first up since Aug '08) -- ex-auto down .2%; inventory ratio 1.3 months down from 1.31.

UK and France both considering taxing bank bonuses and have floated several % and trigger amounts -- looks like 50% over approximately $40,000.

Bair said FDIC reviews found 83% of failed banks had inadequate board supervision of risk -- in general too many banks have insider dealings with board members.

Pay Czar would limit TARP banks high paid employees (ranking 26th to 100th) to $500,000; 5 AIG executives led by AIG's General Counsel (violation of fiduciary duty?) who arranged private attorney for group as they threatened to leave if pay limited putting pressure back on pay czar in another extortion against the government.

$40 billion 3 year Treasury auction yield 1.223%, bid-to-cover 2.98; foreign interest 60.9%.  Good.
$21 billion 10 year Treasury auction yield 3.448%, bid-to-cover 2.62 (average has been 2.92), foreign interest 34.9%. Woops!
$13 Billion 30 year Treasury auction yield 4.520%, bid-to-cover 2.45, foreign interest 40.3%. Not so good.

Goldman Sachs played the media on bank bonuses by announcing they were limiting bonuses to restricted stock with one of the restrictions being that the stock cannot be sold for 5 years (good) but limited to only their 30 member management committee; what about the traders?

Early in the week Geithner talked about winding TARP down but ended this week extending TARP to Oct 2010 and indicated unspent money may be given to banks to "help" homeowners and small business lending.

Treasury expects to recover all but $42 billion of $370 billion lent under TARP --- has spent $450 billion under TARP ($290 billion to banks) -- estimated $311 billion cost may be only $141 billion.

Bank of America completed its $45 billion TARP payment in an attempt to evade the pay czar.  The question now is do they have enough cash reserves and the government has asked them what business units it plans to sell next year to raise money.

Citi is negotiating a possible TARP payment; started at $45 billion with $20 billion stock offering but the stock holders are upset at the dilution and the government is not in agreement in how much they need to raise -- the amounts to pay and raise by stock offering appear to be decreasing for this truly Zombie bank.

Geithner does not like the concept of a transaction tax to limit economically risky behavior; he thinks it may force companies to leave the US or find a way "around" (evade) tax.  He also does not like a job tax credit believing it will not influence hiring.  As Yves Smith of naked capitalist would say: Quelle Surprise!




Print Page

Friday, December 11, 2009

Geithner and Summers: Doing God's Work

It has been perfectly clear from the beginning of the Obama administration that if you have not been part of the problem, you are not qualified to understand the problem.  Geithner and Larry Summers both played significant roles in the creation and the precipitation of the current Financial Crisis and have continued their roles in effecting a "recovery" which benefits the financial sector at the expense 22% of the workforce who do not have jobs, at the expense of families who are losing their homes, and at the expense of the children of this country of whom a minimum of 25% nationwide (in some areas it is 90%) are currently on food stamps.  Meanwhile, the bankers get their salaries and their bonuses: can you imagine the horror of only getting $500,000 (26th to 100th highest paid in TARP banks) per year or being limited to only $7,000,000 salary and only $3,000, 000 in stock options (AIG CEO, who threatened to quit in disgust at the indignity).  The bankers have resumed the high risk trading which caused this crisis: they have avoided regulation with their cries of liquidity, liquidity! and raised the Ultimate Extortionist threat in the Zombie bank and the Systemically Dangerous financial institution with government guarantees: The Moral Hazard gold plated.  Even after TARP banks pay back the TARP money, they still continue to enjoy government guarantees that keep their credit rating higher than if those government guarantees were not in place.

The bankers get to keep the profits and the public gets the losses.  This "jobless recovery" has been all about saving the financial sector and continuing business as usual.  Geithner and Larry Summers were installed by the banks with the assistance of a Citigroup executive who went to college with Obama relegating all those economists you worked the campaign with Obama in secondary roles and Volcker isolated and neutered.

Not only was the AIG bailout illegal as we have discussed in an earlier post, but Geithner as New York Fed president actually had a direct role in designing the AIG bailout.  Matt Taibbi has worked hard to document the Citi connection, although there are those who would say Goldman Sachs benefited the most.  The recent AIG move to spin off two insurance subsidiaries and have their Treasury debt reduced has raised the question of how legal is it for the government to give up collateral from a company in which it has 79.9% ownership for preferred stock in the two subsidiaries and reduction of AIG debt to the government in the amount of $25 million while AIG retains the common stock of the two subsidiaries.  There is obviously no economic benefit to the government.  To these questions, Representative Grayson has sent a letter the Federal Reserve (he should have also sent it to the Treasury) asking how can these actions be justified or reasonable.  It is nothing short of an accounting boondoggle for AIG at the expense of the American people, including those who are jobless, hungry, and becoming homeless.

In yet another article on Geithner as a regulatory failure and a protector of our financial system as it existed prior to the Financial Crisis and the restoration of the status quo, William K. Black, who has actual successful regulatory experience from the savings-and-loan crisis (interestingly, the same parts of the country were effected by that housing crisis as in the current crisis) says and shows how Geithner did not protect the public, is not competent, and may not have been honest in his actions.

For eight reasons why Larry Summers should be sacked as the manipulative director of this rescue of the financial system status quo, an article by Joseph Mazza details the history of Summers in creating this Crisis from the 1990's to the present. The Australian economist Bill Mitchell has also called for the sacking of Obama's economic advisors, particularly Summers,  and for whoever is responsible for writing Obama's economic speeches citing the December 3rd speech on joblessness in which the President implied the United States is running out of money.  He finds it unconscionable that whoever is doing the writing does not understand basic economics.

Mr. Bernanke has also been a diversion from the action "heroes" of Geithner and Summers.  There is a strong move to not reappoint him, when the nation would be a lot healthier and more ethical if Geithner and Summers were the ones tarred and feathered.  Still, Mr. Bernanke has questions the people should have answered and here are ten reasons to fire Bernanke.  As I have said previously, I do not want Bernanke fired until we know who the replacement might be.  It is very unlikely that a regulatory economist is ever going to get the job, because it would not be good for Goldman Sachs and what is good for Goldman Sachs is good for America, because banks, according to the CEO of Goldman Sachs, do God's work.

Print Page

Banker's Coup over Reform

Financial Reform has failed.

What the House passed today is a banker's lobbyist triumph.  The loopholes are so numerous and big enough to drive all of GM's products through at one time.  While the bill puts a false facade of reform, the loopholes have so benefited the banks that they should assume those government posts which they do not already defacto control.  The new stories are already glossy over the loopholes to obscure them from public view.  However, Washington's Blog succinct dissected the so called reforms and even included a link to the House Amendment which was acted on today.

Economics professor L. Randall Wray further delineates the "wimpy" reforms which fail to protect society from those whose greed would destroy for profit and proposes that any regulated and protected financial institution should be prohibited from trading derivatives and a need to concentrate on the systemically dangerous.

This coup by the financial services lobbyist has been brewing as we have reported on the radio show since last Summer as this blog entry from Satyjit Das from July shows. He demolishes the proposed derivatives protections.

State authority over banks is diminished.  Investment advisors associated with a broker-dealer have been saved from regulatory oversight and inspection of their business practices, while we lowly conflict-free registered investment advisors must submit to the regulatory oversight any investment advisor should be required to accept.  Professional fiduciary duty is a "dream" while the wolves net of suitability swims and the heads bow towards the inevitability of "unavoidable" conflict of interest fiduciary "responsibility" of sales people.

Of the many Democrats and Republicans who carried the financial interest banners high from the mast of their check books, one of the more prominent is Melissa Bean of Illinois.

Yves Smith of naked capitalist has a good post on Coup by Bankers that covers the many proposed amendments diluting reform and in a later post urged individuals to call their representatives no matter how much politics sucks.

I do not enjoy negative comments, but the truth is the driver.  When you read the links above and then read the news stories tonight and tomorrow, be prepared to puck.

Print Page

Wednesday, December 9, 2009

China's Spending Bubble

In an earlier post on double dip probability, I discussed leverage and how Japan, the US, and now China appear to be moving in the same direction.  It is an area of growing discussion as the links in my prior post indicate.  Another research report has been published, "China's Investment Boom: the Great Leap into the Unknown", by Pivot Capital Management.  The naked capitalist blog has done an excellent synopsis of the study.

The Pivot research study is not as comprehensive as some of the other papers I have previously referenced, but it is succinct.  Here are a few excerpts:

"In our view investors have underestimated both the maturity of the Chinese growth cycle as well as the degree to which recent growth is a direct extension of the global credit bubble. This bubble had two major manifestations. The first, which started unraveling globally in early 2007, was evident in excesses in real estate, consumption and private equity. The second manifestation, which has yet to fully deflate, was a boom in capital expenditure, led primarily by China."

"However, the decreasing efficiency of investments will ultimately lead to a pullback in capital expenditures. In a soft landing scenario, China is likely to shift to a lower growth trajectory for the next decade. In a hard landing scenario, which is entirely feasible, there would be an abrupt decline in capital spending exacerbated by a banking crisis."

"If loans continue to grow at the current 35% rate, credit to GDP ratio will be close to 200% in China already in 2010, even with GDP expanding at 10%. This is a level similar to the pre-crisis Japan in 1991 and USA in 2008. All this points to that credit in China is not going to be able to grow for much longer without risking a
major crisis."

"In the period from 2000 to 2008, it took on average $1.5 of credit to generate $1 of GDP growth in China. This compares very favorably with the peak $4 of credit for $1 of GDP in USA in 2008. However in H1 2009 in China this ratio was already at around $7 to $1. Credit might be going into the luxury property and stock markets, but the trickle down to the real economy is very poor."

"The Chinese government also explicitly guarantees $400bn worth of debt of the three “policy banks”. In total, these off-balance sheet liabilities are equal to $1.7tn, which would bring China’s public debt to GDP ratio up to 62%, a level that is comparable to the Western European average."

"Price to income ratios have reached 15-20 times in major cities and around 10 times in regional cities. This compares with 9 times in London and 12 times in Los Angeles at the peak."

"It is hard to over-emphasize what this shift to consumption-driven economy means for China’s overall growth rates. On a simple mathematical level it means that average growth rates are going to be capped at 7-8%, so that the overall economy grows at 5-6% for the foreseeable future, and probably slowing down even more later on. It also has enormous consequences on what China imports from the rest of the world as it shifts from commodity and capital goods heavy into (most likely locally produced) consumer goods and services driven economy."

"Anything that is cyclical and dependent on Chinese investment demand would obviously be the most vulnerable to a Chinese growth disappointment. That would include industrial commodities as well as equities and credit of industrial and consumer cyclicals. There would also be a general rotation into more defensive areas taking place across most asset classes. The biggest uncertainty relates to what China means for the debate on deflation versus inflation. In principle, a Chinese slowdown should initially be deflationary, especially given the overcapacity currently building up in various Chinese industries. This should be negative for credit in general and also for most equities. However, depending on how aggressive the policy response will be in China and elsewhere, investors may very well start focusing on the inflationary risks again."

My rationale for posting is to inform and provide the means and some incentive for people to dig into issues and deal with the different viewpoints.  Proper investing is not about relying upon a financial guru or political or economic bias.  Proper investing methodology is about research and developing the ability to critically analyze information from many different sources.  Will there be a China bubble?  Given the developing pattern of credit leverage it is possible.  There is no predicting when and it could be delayed or even turned into a more positive soft landing with proper economic policies, but it would require China doing what Japan did not do in a timely fashion and acting more decisively than the authorities in the US, who are still struggling with turning the rescue of the financial sector, for the benefit of the financial sector, into a stimulus which benefits the citizens of the US whose participation is required for a real sustainable economic recovery.

Print Page

Tuesday, December 8, 2009

BIS Issues Low Interest Warning AGAIN

The Bank of International Settlements, the world's Central Banks Bank, has again issued a warning to Central Bankers that low interest rates foster risk taking.  In my post below, "The FED, Asset Bubbles, AIG, and Fraud", I referenced BIS reports going back several years that low interest rates encourage risk taking and how the Fed ignored the BIS reports prior to the current Financial Crisis and continues down the road of another new crisis which is the same as the old crisis.  The Overview of the BIS report said, "The low interest rates in the advanced economies, combined with the earlier and stronger recovery in a number of emerging economies, continued to drive significant capital inflows into emerging markets, particularly in Asia and
the Pacific. Although difficult to quantify, a related development was increasing FX carry trade activity funded in US dollars and other low interest rate currencies. The result was rapid asset price increases in several emerging economies as well as substantial exchange rate appreciation with respect to the US dollar".  The actual chapter on monetary policy and risk taking said, "Easy monetary conditions are a classic ingredient of financial crises: low interest rates may contribute to an excessive expansion of credit, and hence to
boom-bust type business fluctuations."

In the my post which I referenced at the beginning, I also referenced a Raw Finance article on "Meet the New Crisis, Same as the Old Crisis".  The New BIS report which repeats yet again the same warning they have issued for several years.  Baseline Scenario recently had an article on "Measuring the Fiscal Cost of Not Fixing the Financial System" in which Simon Johnson said, "At the heart of every crisis is a political problem – powerful people, and the firms they control, have gotten out of hand.  Unless this is dealt with as part of the stabilization program, all the government has done is provide an unconditional bailout.  That may be consistent with a short-term recovery, but it creates major problems for the sustainability of the recovery and for the medium-term.   Again, this is the problem in the U.S. looking forward."  He also said the the US crisis has worsened as a direct result of how the FED and Treasury dealt with the financial crisis and " Even more problematic is the underlying incentive to take excessive risk in the financial sector.  With downside limited by generous government guarantees of various kinds, the head of financial stability at the Bank of England bluntly characterizes our repeated boom-bailout-bust cycle as a “doom loop.”  The implication is repeated bailout and fiscal stimulus-led recovery programs."

Joseph Stiglitz has written yet again in "Too Big to Live" that the global controversy on whether banks are too big to fail and what regulations are needed, but it boils down to the bankers either swindled their shareholders and investors or they did not understand the nature of risk and reward.  The condition then becomes, if they are permitted to survive, the smaller the entity the easier it will be to regulate them for the protection of society.  Size itself is not the real issue it is whether the bank/shadow bank in its conduct presents itself as a systemically dangerous firm by its business activity: "Too-big-to-fail banks have perverse incentives; if they gamble and win, they walk off with the proceeds; if they fail, taxpayers pick up the tab.
·        Financial institutions are too intertwined to fail; the part of AIG that cost America’s taxpayers $180 billion was relatively small.
·        Even if individual banks are small, if they engage in correlated behavior – using the same models – their behavior can fuel systemic risk;
·        Incentive structures within banks are designed to encourage short-sighted behavior and excessive risk taking.
·        In assessing their own risk, banks do not look at the externalities that they (or their failure) would impose on others, which is one reason why we need regulation in the first place.
·        Banks have done a bad job in risk assessment – the models they were using were deeply flawed."

Stiglitz's recommendation is very rational: "These are not matters of black and white: the more we limit the size, the more relaxed we can be about these and other details of regulation. That is why King, Paul Volcker, the United Nations Commission of Experts on Reforms of the International Monetary and Financial System, and a host of others are right about the need to curb the big banks.  What is required is a multi-prong approach, including special taxes, increased capital requirements, tighter supervision, and limits on size and risk-taking activities."

But we are already seeing how the howling and circling packs of lobbyists are diluting and milking attempts at financial reform to benefit the large banks and the shadow banks as they have become larger, resumed their risk taking, and remain without sufficient regulation of their business and trading activities.  The stage is set for an encore performance.




Print Page

Sunday, December 6, 2009

Questioning the November Employment Report

Many economists and analysts are finding the November BLS Employment Report released this last week hard to swallow.  I went over it in some detail on the Radio Show, but the questions on the data merit posting for reader's review.

The Report showed a job loss of 11,000 jobs when the month before was 195,000 and it showed the unemployment rate going down to 10% from 10.2 despite the loss.  However, the BLS figures are usually close to the ADP private survey and the ADP showed a loss of 169,000 jobs.  Calculated Risk asked "If the Economy lost Jobs, why did the Unemployment Rate decline?"  The article used scatter graphs of one month and two month rolling averages and a 3rd order polynomial and concluded it was at best statistical noise: "The bottom line is the decline in the unemployment rate this month was noise, and the unemployment rate will probably increase further. If the economy adds about 2 million payroll jobs next year, we'd expect the unemployment rate to still be at about 10% at the end of the year."  For every point of unemployment which lasts two years, the cost is $400 billion.

GDP growth below 2.5% will not substantially change the unemployment rate.  Slower growth could mean 10% unemployment through 2012 into 2013.  Krugman has commented on this as has Calculated Risk in "Employment and Real GDP".

If you look at page five (5) of the Report, you will see that there was a 98,000 decline in the civilian labor force with a 325,000 decline in unemployment but there was an increase of 291,000 in people no longer in the labor force.  You can also see this analysis on Shedlock's blog.  U6, discouraged workers no longer in labor force is shown at 17.2% in the BLS Report, an alternative model using the same statistical definition in use in the middle 1990's indicates 22%, unchanged from last month.

Some people have tried to reconcile the BLS Report with the ADP and have found they cannot get the BLS Report to add up, but that may be because different statistical methodologie3s are used for different components of the BLS Report.  It is well acknowledged that the BLS Birth/Death Model is flawed and will be corrected in its annual review in February for an overestimate of at least 824,000 jobs filled error, although some say the error may be an overestimate of about 80,000 per month, which would be 960,000.  One attempt at the ADP to BLS figures summed up with "We are looking at a three-month ADP-BLS net jobs divergence of roughly 230%, with ISM non-manufacturing employment still deep in contraction. Again, whom are we supposed to believe?"

Trim Tabs, which is a professional fee analytical service, calculated a November job loss of 255,000 and The Money Game provided a month by month Trim Tabs to BLS comparison estimates and revisions.  It is not pretty.



Print Page

Leftovers from 12/5/2009 Radio Show

We indicated there was some speculation that Dubai World creditors may not agree to the debt payment standstill and that would cause immediate default, if it happens.  Something to keep an eye on, because the dollar futures market is already showing fears of a dollar rally as Dubai plays in the background,  There has also been speculation that Dubai Holding might be the next debt fear as it has borrowed $12 billion and $1.8 billion is due next year.  Together with Dubai World, their debt is 60-70% of total Dubai debt.  The sheik also has substantial loans outstanding, but he is legally immune from any legal action.

Some analysts have been predicting at least one sovereign debt default next year.  I have always thought any such default, if any, would most likely be in Eastern Europe, but Dubai makes you wonder.

At the end of the show I said that Australia's Central Bank had raised its interest rate 25 basis points to 3.75% for the third month in a row and the Australian Dollar immediately lost 38 cents to the weak US Dollar.  I have questioned for some time if Australia was not raising rates to protect itself against the weak US Dollar and its appreciating Australian Dollar.

Japan will set aside another $115 billion to make 3 month loans to banks at .1% (one-tenth).  They just keep compounding their 1990's stagnation rolling into the future.  The Japanese Central Bank held an emergency meeting on falling consumer prices and the yen which is at a 14 year high against the weak US Dollar, but it ended up taking no action with respect to prices or currency policy and continuing monthly purchases of government bonds.

The Federal Reserve is fine tuning its future repo program in which they would sell assets with a guarantee to repurchase as a probable part of an exit strategy.  It is designed as a means to begin pulling money out of the economy whenever the exit actually begins.  The New York Fed has already tested it once.

Five (5) bank broker-dealers were fined by FINRA for deficient supervision and procedures in the sale of VA, mutual funds, and UIT.  The bank B-D's included Wells Fargo, PNC Investments, and WM Financial Services which is now Chase Investment Services.  You should always investigate your broker-dealer for FINRA and SEC violations.

The UK, which continues to pursue a more regulatory reform than the US, will take control of the Royal Bank of Scotland's bonus pool.  The government has put 62 billion pounds into RBS and owns 70%.  The demand came as a condition to allowing RBS to join the government's troubled asset insurance program and to gain another infusion of 22.3 million pounds.

European Union finance ministers have come to a compromise on bank rules.  They had clashed on how much power the new supervisors of a European Systemic Risk Board should have.  France wanted a majority of member states to be necessary to overturn a council decision to bailout a banks and the UK wanted the council to seek a majority of member states to initiate action.  The compromise was a simple majority to reverse emergency decisions.  The Board is to make sure laws are the same in each of the 27 countries and is designed to issue warnings and recommendations.

Spencer Dale, who is the chief economist for the Bank of England, said the economy has turned, although Q3 contracted, and that inflation in the UK could rise 3% next year, but it would be temporary succumbing to the persistent downward pressure of spare capacity.

Philadelphia Fed President Plosser said the job recovery will take a couple of years and warned that the Fed must be prepared to raise interest rates before the jobless rate has fallen to an acceptable level in order to fight inflation, because he is projecting that real interest rates will be rising in the next two years as the economy grows slowly.

Richmond Fed President Lacker said, "While the outlook has brightened in recent months, we still face major economic challenges. In commercial real estate, construction is falling, vacancy rates are rising, and falling property prices are eroding owners' equity positions. Holders of commercial-mortgage-backed securities have already taken sizable losses, with more on the horizon as numerous projects are scheduled for refinancing. And some community banks have lent heavily to commercial real estate developers and are now facing rising delinquencies and losses. No one expects a quick reversal of these negative trends, and as a result, business investment in nonresidential structures is likely to be a substantial drag on U.S. growth in the near term.
"More worrisome is the extremely weak labor market. The number of people employed has fallen for 22 straight months. The unemployment rate has more than doubled, to a 10.2 percent rate. Wages are under pressure; so far this year average hourly earnings have only risen at a 2.1 percent annual rate, about half its rate in mid-2007. Going forward, as overall economic activity continues to improve, employment will bottom out and then begin to return to an upward trajectory. Even the more optimistic forecasters, though, do not expect a rapid improvement in national labor market conditions, and we will need to carefully monitor employment and earnings for an extended period."

He also said, "In fact, we have seen that even in the early stage of a recovery, inflation and inflation expectations can drift higher. The perception of inflation risk could be particularly pertinent to the current recovery, given the massive and unprecedented expansion in bank reserves that has occurred, and the widespread market commentary expressing uncertainty over whether the Federal Reserve is willing and able to promptly reverse that expansion...The harder problem is the same one that we face after every recession, which is choosing when and how rapidly to remove monetary stimulus. There is no doubt that we must be aware of the danger of aborting a weak, uneven recovery if we tighten too soon. But if we hope to keep inflation in check, we cannot be paralyzed by patches of lingering weakness, which could persist well into the recovery."

The two prior posts below go into far more detail and provide extensive links on issues we discussed during the Radio Show.


Print Page

Friday, December 4, 2009

Stock Market Double Dip Probability - Leverage, the US, & China

I have been cautioning investors about this overvalued stock market and the low volume continuation of the March rally with its recent meaningless sideways correction and current feeble attempted rally.  I have been particularly concerned that the weak US dollar and current US low interest rates have created an asset bubble in the US stock market which has been purposefully used to assist banks in issuing new debt and stock in order to recapitalize.  Additionally, there have been close correlations between the weak dollar and the upward movement of the stock market as a risk investment and carry trade.

If you read the post below in detail with all its links you can see the multiple foundations for a recurrence of the financial crisis.  Other commentators and economists are positing similar concerns for a variety of reasons.  Even Paul Krugman has finally voiced the possibility of a double dip if unemployment is not quickly and effectively corrected.  James Gagnon in an article which has attracted posts by Tom Duy, Brad Delong, and others has entered the fray with the assertion that the the Fed's monetary easing policy needs to be continued but used to create jobs.  While one might argue over the use of monetary easing policies to combat unemployment, his argument is essentially that the data indicates the economy is too weak, particularly with high continued unemployment, to not require a second, more effective stimulus.  In fact there are commentators and members of Congress talking about using the returned TARP monies to provide small business loans to create new businesses and to provide the credit small businesses need to operate and hire.

Given the Fed's use of unemployment to hold inflation down and its obvious policy, despite its public positions, to decrease lending and contract credit, I do not see anyone but large banks continuing to get low cost money while they build their cash reserves and fail to lend.  The failure of Congress to pass credit card usury laws and to allow the time for banks to jack their interest rates up, without respect to credit worthiness, in the interim (Citi says it wants to lend but it is changing credit card rates to 29.99% on consumers with high credit scores) as they also continue the arbitrary reduction in credit limits.  Is Citi's policy, which is 37% government owned, a silent acknowledgment that banks make more money driving an account holder into bankruptcy rather than placing them in a closed account fixed interest loan they could pay?  It is as if we are being conditioned to ask why waste government money on consumers by creating jobs and providing them the means to start spending again?  We are even being told saving is bad.

In fact China's savings are increasing substantially faster than those of the US.  But economists expect increased spending to fuel recovery.  It does not appear that the Fed or Treasury have a recovery plan which includes the American middle class.  However, a strong argument is being made by a variety of economist's that the excessive use of leverage is leading us right back to another financial crisis, that the US is following the example of Japan in the 1990's, and that China is not that fall behind. There are economic indicators adding emphasis to the possibility that China is tied to the global financial system and on the road to following the financial policies of the developed world in favoring its financial elite and it is creating tension between its coastal financial elite and the interior masses in China.  In fact, we are being told that the middle class is growing in China at the same time the financial elite are consolidating power in China.  There is no decoupling.

For months I have cautioned my radio show listeners that a double dip is a significant possibility, but you never fight the market.  For over a year, I have said the current stimulus is ineffective and if there is no significant improvement in unemployment by the 2nd Quarter of 2010, it will be a very long haul.  Unemployment figures today are being trumpeted as huge improvement, but if you look at the data in the BLS release, you will see that the figures are the result of people no longer in the labor force and the continuation of the collection errors in the Birth/Death Model which continues to show job growth and which is on track to be corrected in February for an overestimate of jobs filled of approximately 824,000+.

I read John Hussman's weekly commentary religiously, because his viewpoint is based on fundamental and technical analysis.  Obviously, he has been too conservative this year, but that does not negate the correctness of his interpretation of the market data and the failure of the market to reflect the fundamentals and the technical divergences.  As of this last Monday, he has moved his conservative hedge mutual funds out of TIPS, because their yields are too low.  His post last Monday said, "Frankly, I've come to believe that the markets are no longer reliable or sound discounting mechanisms. The repeated cycle of bubbles and predictable crashes over the recent decade makes that clear. Rather, investors appear to respond to emerging risks no more than about three months ahead of time. Worse, far too many analysts and strategists appear to discount the future only in the most pedestrian way, by taking year-ahead earnings estimates at face value, and mindlessly applying some arbitrary and historically inconsistent multiple to them."  He goes on, "In part, the market's increasing propensity toward speculation reflects the increasing lack of fiscal and monetary discipline from our leaders. Policy makers who seek quick fixes and could care less about long-term consequences undoubtedly encourage investors to embrace the same value system. Paul Volcker was the last Fed Chairman to have any sense that discipline and the acceptance of temporary discomfort was good for the nation."  He believes the market is 40% overvalued using both a q and CAPE analysis and said, "In my estimation, there is still close to an 80% probability (Bayes' Rule) that a second market plunge and economic downturn will unfold during the coming year. This is not certainty, but the evidence that we've observed in the equity market, labor market, and credit markets to-date is simply much more consistent with the recent advance being a component of a more drawn-out and painful deleveraging cycle. Meanwhile, valuations are clearly unfavorable here, and even under the “typical post-war recovery” scenario, we are observing an increasing number of internal divergences and non-confirmations in market action."

He said an 80% probability of a second market plunge.  The problem is when and it is only a probability not an actuality.  What we saw today was an irrational upward movement in the market that quickly met resistance.  In fact, on December 2nd, Afraid to Trade posted charts showing the choppy boundary ranged S&P (SPY) with gaps from November to that date which would indicate that there is a Failed Breakout or Bull Trap.  Bull Traps can be the precursor of a sharp downside move.

If the Fed and Treasury are merely maintaining the financial status quo and using the credit contraction, unemployment, weak dollar, and low US interest rates to grow the stock market as a risk asset bubble in order to allow the systemically dangerous to re-capitalize while they grow even larger and the American middle class dwindles as unworthy of protection, why should there not be a double dip?  After all what is good for Goldman Sachs is good for America; they are just "doing God's work" to quote the CEO of Goldman Sachs.

Print Page

Thursday, December 3, 2009

The FED, Asset Bubbles, AIG, & Fraud

For over a year I have questioned why bank executives were not removed, why toxic assets were not ripped out, and why AIG and Citi were allowed to survive in essentially unchanged form.  It has become increasing clear that it was more important to continue the financial system status quo than to establish financially strong but non-systemically dangerous banks and shadow banks.  Financial reforms in Congress have been watered down to the extent that the financial sector is likely to come out ahead in special privileges rather than reformed.  We are constantly told this reform and that reform will deter liquidity when the actual problem is insolvency and a private financial system that gets the profits and pushes the losses off to the the public.

Tom Duy in a post on the Economist's view entitled, "FED Watch: Bubbles and Policy", asks the question are asset bubbles in foreign countries any concern of the Fed and are asset bubbles better contained by monetary policy or regulatory authority.  He now believes that the Fed should be concerned about the US only and that asset bubbles should be controlled by regulation.  In coming to this conclusion, he acknowledges the effect of the weak dollar and US low interest rates on commodity prices as the proper result of monetary policy.

On the other hand, Washington's Blog, had a widely distributed post, "Questions for Bernanke's Senate Confirmation Hearing" in which he made a very detailed argument that the Fed had been repeatedly warned by the Bank for International Settlements (the Central Banks' bank) that a credit bubble was forming as early as 2005.  These excerpts show the BIS concerns:

"The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy has fueled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood...
The BIS, the ultimate bank of central bankers, pointed to a confluence a worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system."

"Indeed, BIS slammed the Fed and other central banks for blowing the bubble, failing to regulate the shadow banking system, and then using gimmicks which will only make things worse... More dramatically, BIS slammed "the use of gimmicks and palliatives", and said that anything other than (1) letting asset prices fall to their true market value, (2) increasing savings rates, and (3) forcing companies to write off bad debts "will only make things worse"...Instead, they are doing everything they can to (2) prop up asset prices by trying to blow a new bubble by giving banks trillions, (2) re-write accounting and reporting rules to let the big banks and other giants keep bad debts on their books (or in sivs or other "second sets of books") and to hide the fact that they are bad debts, and (3) encourage consumers to spend spend spend!"

"... the central bankers knew exactly what was going on, a full two-and-a-half years before the big bang. All the ingredients of the looming disaster had been neatly laid out on the table in front of them: defective rating agencies, loans repackaged to the point of being unrecognizable, dubious practices of American mortgage lenders, the risks of low-interest policies. But no action was taken. Meanwhile, the Fed continued to raise interest rates in nothing more than tiny increments..."

 The article also cited a 2005 letter from the Mortgage Insurance Companies of America, a trade association of mortgage lender, sent to the Fed: "In the letter, MICA warned that it was "very concerned" about some of the risky lending practices being applied in the US real estate market. The experts even speculated that the Fed might be operating on the basis of incorrect data. Despite a sharp increase in mortgages being approved for low-income borrowers, most banks were reporting to the Fed that they had not lowered their lending standards. According to a study MICA cited entitled "This Powder Keg Is Going to Blow," there was no secondary market for these "nuclear mortgages."..."  The Fed either did not understand what they were told or they ignored it.

Even the new President of the New York Federal Reserve has publicly stated "the causes of the crisis as the excessive use of leverage and maturity mismatches embedded in financial activities carried out off the balance sheets of the traditional banking system...this crisis was caused by the rapid growth of the so-called shadow banking system over the past few decades and its remarkable collapse over the past two years.”

Robert Alford in a post on naked capitalist entitled, "The FED, Treasury, and AIG", makes a detailed argument that the bailout of AIG was illegal.  If anything was to be done, it should have been the responsibility of the Treasury and not the Fed.  Janet Tavakoli has gone so far as to say Goldman Sachs was the primary beneficiary of the AIG bailout and it should buy the maiden lane III fund from the Fed and get those toxic assets off its balance sheet and on Goldman Sach's balance sheet.  Alford made some compromise recommendations on how the Fed should be run in the future:

"• The Fed agrees to cease and desist from lending to any capital impaired institution unless specifically authorized by law.
• The Fed agrees to cease and desist from acting in a fiscal role.
• The Fed agrees to never again assume management responsibility for a capital impaired institution unless specifically authorized by Congress
• Treasury assumes all the Fed assets related to AIG and Bear. I believe that there is enough TARP money left.
• The selection process for reserve bank presidents is left unchanged.
• The audit provisions are left unchanged."

In another Washington's Blog post, "Former Managing Director of Goldman Sachs: Accounting Fraud of the Too Big to Fails May be Worse than Enron" asks, as many of us have, how much of banks revenue is real banking vs trading (risk taking).  He cites Nomi Prins' article, "Worse than Enron", details how the banks have used re-classification and opaqueness in doctoring their balance sheets, which is an issue we have discussed on the radio show numerous times.  She waded through over 1000 pages of SEC filings and pretty well lays out how Citi, Bank of America, and Wells Fargo are playing the game.  She asks, given the long time it took to catch Enron, how long is it going to take to catch the banks.  My question is will it take another financial crisis to bring everything into the open.  There are, however, those who are more pessimistic and wonder if we are not seeing the re-institution of Feudalism.

In a Raw Finance post, " Meet the New Crisis, Same As the Old Crisis", Simon Johnson said
"The problem, in the simplest terms, is this:  the government policies that have staved off a depression have driven down the value of the dollar and lowered yields on the safest assets to near zero, while the banking system and those who run it remain largely intact and unchanged; therefore, bankers and investors are encouraged to take on extreme risk once again to achieve acceptable gains and they do this by borrowing dollars generally to buy risky assets, generally in emerging markets that have strong growth potential.  Thus, the asset bubbles that formed in U.S. real estate that caused the 2008 financial crisis appear to be forming again, but rather in non-U.S. assets (see U.S. Current Account Deficit Likely the Cause of Next Financial Crisis)."  He also proposes three best practices: 1) preventing banks from collapsing in an uncontrolled manner, 2) taking over and implementing orderly resolution for banks that are insolvent (this would include firing management and bringing in a new team), and 3) addressing immediately underlying weaknesses in corporate governance which created potential vulnerability to crisis.  Again, we have to ask what is it going to take to make the people who caused this financial crisis responsible for their actions in a way which engenders the public trust?

The Baseline Scenario had a post, "Some Questions for Mr, Bernanke" which intellectually poses three issue crunching questions: 1) what about the doom loop?, 2) how should the bailout mechanism be modified?, and 3) since history has shown that large financial institutions find ways to get around and ahead of regulators, should the large banks be broken up if they are systemically dangerous?

Many commentators are focusing on Bernanke when the actual problem is to what extent do the financial systemically dangerous entities, like Goldman Sachs, influence the Fed and Treasury.  To what extent does the Fed protect the interests of banks as opposed to the public good and to what extent does Treasury under any administration allow itself to be swayed by powerful interests and strategically placed government assistants who used to work for those systemically dangerous private entities?  Who would replace Bernanke?  Larry Summers wants the job but he cannot effectively perform his current job.  If a Fed president, would it be Yellin?  The other Fed presidents have staked ideological turf.  Will they seek another academic economist?  What would happen if they were presented with the choice of a person with a regulatory passion?

Print Page

Monday, November 30, 2009

Radio Show 11/28/2009 Leftover & Additional AIG & FED Policy Information

 We talked about AIG and Goldman Sachs and how Goldman Sachs profited in shorting mortgage backed assets while dumping them on AIG and while refusing to make collateral concessions on AIG credit default swaps which the monolines did.  Goldman got 100% in the bailout while the monolines got stuck.  Janet Tavakoli has said Goldman Sachs should be made to buy the Maiden Lane III from the FED and carry them on their own balance sheet.  Here is another good AIG/Goldman analysis in naked capitalism.

We talked about Fed policy and how Tom Duy, an economist who writes about the Fed, was upset and the comments Yves Smith of naked capitalism had on his article: here is that post for you to read in full.  And here is an earlier Duy  post on how the FED has put itself in a corner and is engendering a lack of trust from the public.

Bernanke wrote a commentary as well as gave Congressional testimony that proposed financial reforms threaten the independence of the Fed and would seriously impair the economic stability of the US and could damage the financial health of the future.  He said these measures are very much out of step with the global consensus, but in actuality the UK has been far more aggressive in seeking financial reforms and regulations to the point that Geithner has said the US would not go that far.  Naked capitalism had a very good article on Bernanke's published commentary which you should read.

St. Louis Fed President, Bullard, not only said he would support continued purchase of mortgage backed assets past the March deadline, but he also said the Fed would have a hard time raising rates in the face of worsening unemployment, but "if inflation expectations start to get out of control, that could trump the unemployment rate".

Chicago Fed President Evans is very over optimistic when he expects unemployment to peak at 10.5%, because he was also surprised to see it reach 10.2%.  I think it will go to 11%.  He sees no problem with core inflation and expects rates to remain low for an extended time.

At the end of the show I was observing that Lloyd's Bank is planning to issue $22.3 billion shares at 37 pence per share which will dilute existing shareholders by 59.5% at 1.34 to 1 existing shares as of the closing price on 11.23/2009 -- that is 36.5 billion shares.

There are a growing number of articles expressing concern about Chinese over capacity, because it wastes resources, erodes profits, deters research and development, encourages companies to but corners on health, safety, environmental impact, and quality control.  Unneeded capacity raises the risk of non-performing loans, which is the real concern of the financial world; they could live with all the rest of the negatives of over capacity.

The five largest Chinese banks have had to submit plans to the Chinese regulators on how they will raise capital after unprecedented lending has eroded their capital levels.  Earlier in the year the minimum capital level ratio was raised to 10%.

FDIC's Bair has cautioned that financial reforms which contemplate the break up of banks should be carefully and fully evaluated for safety and soundness isues.

There was a pro-con post in Economist's view on psychological sentiment  and its value in determining whether a recovery is happening.  I found it interesting but lacking as it did not fully addressed how expectations may be facticity based or fear based or over exuberant based.  Proper policy should be more important.  There is a difference between rational and irrational behavior.

The private sector economist, Dave Rosenberg, said last week that we are in a form of Depression resulting from a prolonged period of credit excess which collapses yielding asset deflation and credit contraction.  I think we have definitely seen asset sector deflation as opposed to general deflation and definitely credit contraction, but we have also seen the formation of asset bubbles globally on the weak dollar and low interest rates in the US.  The stock market is at least 20%over valued.  He went on to say that having so many people say the recession is over causes him to be nervous.  In my opinion this shows the reason many people see the possibility of a double dip just as there was in the Great Depression and could occur is any serious recession without proper job creating stimulus.

Janet Tavakoli (see above) in another publication questioned a Warren Buffet interview (she wrote a book on Buffet) in which he seemingly implied that his Goldman Sachs investment was made because the government had removed the moral hazard.  This incensed Tavakoli to write that it was as if Buffet was saying it is okay to use someone else's credit card because they won't notice it  and they will have more wealth by the time the payment is due.


Print Page

Sunday, November 29, 2009

Bank Tier 1 Ratios

On the 11/28/2009 show I mangled a Tier 1 commentary and may have ended up implying the opposite of what I meant as I was rapid firing information.

A Tier 1 ratio can be in two forms: 1) a capital ratio in which it is core equity to core capital or total assets or 2) a risk capital ratio in which it is core equity to total risk weighted assets.  It is a measure of financial strength and the higher the ratio  (2:10 is 20%) the better.

The example and information I was using on the show should have been to remember that when Lehman Brothers failed it had a Tier 1 ratio of 11%.  The median Tier 1 ratio for large and mid-cap banks is in the range of 8.4 to 10%, which is lower (riskier) than Lehman when it failed.  That means many banks are lower (worse). The higher the ratio/percentage the better

The FED/Treasury stress tests set a minimum of 4% for Tier 1 in determining tangible common equity, which yields a lower percentage than Tier 1 core equity.  What would the minimum have  been for core equity Tier 1? They should have included the core equity Tier 1 for comparison.  See this older post from Baseline Scenario for an explanation of tangible common equity.  Also banks have not had to mark to market toxic assets and some do not even include toxic assets which are government insured on their balance sheets, which brings a significant question of how accurate and comprehensive the risk weighted assets were.

I had a lingering feeling from the show that I misspoke and botched a clear conveyance of the magnitude of how fragile the current situation really is.

Print Page

Friday, November 27, 2009

Krugman and the Tobin Tax

In a 11/20/2009 post below entitled, Jobless Prosperity", I included a communication I had sent Paul Krugman and another I had sent Mark Thoma about unemployment, deficits, and the Nobel economist James Tobin.   On the 26th, Krugman published "Taxing the Speculators" in the New York Times and Thoma republished it on his blog Economist's View.  I had also mentioned the more aggressive UK program to regulate financial institutions and their executives.  Please read the article in either one of the links.

I also had in my communication a questions relating to deficits and how the are exited after sustained recovery.  In blog post today, "Deficits: The Causes Matter", Krugman discussed how the causes of a deficit are important and how the causes, to an extent, define, how the deficit must be dealt with and when.

I do not know how coincidental the article and the blog post were, but they are both greatly appreciated.  Tobin's Tax was a concept developed to decrease economically undesirable and dangerous trading by taxing the specific type of financial transactions.  And just today we are seeing that financial institutions are already trying to test how credit default swaps are settled in this article on Bloomberg,com.  The current process was designed to abnegate the need for regulation.  If they do not get it, and have all kinds of reasons why a clearinghouse is liquidity "inconvenient", then maybe a Tobin Tax is just what they should get.





Print Page

Wednesday, November 25, 2009

FED: Asset Bubbles -- We Ain't Got No Stinkin' Asset Bubbles

Last week the Fed was out in full asset bubble denial in public speech after public speech from different Fed officials.  Mr. Bernanke said "it is not obvious there are any large misalignments in asset prices today."   But El-Erian, CEO of Pimco, said, "In seeking to avoid qa depression occasioned by the financial crisis, the Federal Reserve now finds itself having inadvertently placed a large bet on a recovery driven by asset prices."

Fed Vice-Chairman Kohn said U.S. asset prices do not clearly appear to be out of line with the economic outlook and business prospects or the level of risk free interest rates.  He continued to say if asset bubbles are recognized, they should be addressed with regulation and supervision of specific markets or financial firms rather than raising rates.

Yellen, Fed President San Francisco, said further research was necessary to determine the connections between monetary policy, systemic risk,  and financial firms.  She said uncertainty remains over whether central bankers should attempt to lean against potentially dangerous swings in asset prices.  "The answer is far from clear, because the use of monetary policy for these ends necessarily compromises the attainment of other macroeconomic goals."

Yet, there were reports at the same time that supposedly knowledgeable sources were saying the Fed will be increasing scrutiny of banks to ensure they can withstand reversal of soaring global asset prices.

Yves Smith in a naked capitalist blog, said in relation to the Fed's low interest policy: 

"But the second reason for keeping rates low is explicitly to keep asset prices aloft. The bubble is an explicit goal of policy. Remember, early in the crisis, they was talk of the markets being irrationally depressed. Funny how it is only prices that are seen as inconveniently low, and not ones that are insanely high, that are criticized."

In the November FOMC minutes released this week, they  said

"However, some participants noted that the recent rise in the prices of oil and other commodities, as well as increases in import prices stemming  from the decline in the foreign exchange value of the dollar, could boost inflation pressures." 

"Members noted the possibility that some negative side effects might result from the maintenance of very low
short-term interest rates for an extended period, including the possibility that such a policy stance could lead
to excessive risk-taking in financial markets or an unanchoring of inflation expectations."

Print Page

Tuesday, November 24, 2009

Saturday 11/21 Radio Show Leftover Information

As is well known, there is no way to cover all information and topics every week.  These were leftover from last Saturday.

Treasury will auction the TARP warrants of J. P. Morgan, CapitalOne, and TCF Financial, because those banks do not want to buy their warrants back.

IMF officials made opposing public statements over whether the dollar should continue as a single world reserve currency or whether it is no longer reliable, implying the need for a basket of currencies as is already used to settle trade accounts between nations,

China said low United States interest rates threaten the world economy.

United Kingdom regulators will be allowed to tear up some bank bonus agreements --- they also are proposing to limit banker salaries and to make it easier for banks to be sued (until the late 19th Century, British bankers could be held personally liable for bank failures).

UK currency still bears "Bank of England: I promise to pay bearer on demand ___ pounds."

Lloyd's faces paying 54 million pounds tax bill on HBOS tax avoidance in which HBOS transferred swap transactions to Cayman Islands subsidiary.

Roubini, the NYU economist, said there are two economies --- a small recovery economy and a larger economy in a deep, persistent downturn; he expects lower revision of Q3 GDP from 3.5% as does Dallas FED President, Fisher.

60 day delinquent mortgage loans are up to 6.25% in Q3 2009 --- record high --- foreclosure action is at 1.42% --- there are 14.4% loans in foreclosure.

Fitch warned insurers face $23 billion loss on commercial property --- insurers hold $450 billion in commercial loans --- MetLife and Prudential have both indicated defaults will rise next year,

Japan Q3 GDP was up 1.23% but it is expected to slow to .3% in Q4 and to .1% in Q1 2010.

Some analysts are voicing a concern that a real estate bubble may be building in China (although Krugman says their population requires building --- no big deal) because their stimulus program appears to be encouraging investment in unused buildings, implying speculation.

Geithner is urging Congress to legislate financial system reforms but he only wants a single regulator --- the Fed.  Democrat Representative DeFazio has called for the resignations of Geithner and Larry Summers.

UCBH, whose bank failure two weeks ago cost TARP $298.7 million, paid $7.5 million in dividends in May and did not make their August TARP payment.

The Dodd financial reform proposals, which are functionally dead in a a puddle of pretense, would actually politicize the Fed by substituting political appointees for the 3 business sector directors and 3 public interest with no bank ownership interests of each Fed district bank.  6 political appointees combined with 3 bank member directors is a major step to dis-functional abuse.  On the other hand, it would have the boundaries of each Fed district redrawn.  This is long overdue --- San Francisco is way too big, as one example.

Bernanke said, "The flow of credit remains constrained, economic activity weak, and unemployment much too high.  Future setbacks are possible."  He also said economic headwinds have reduced bank lending.

Bullard, St. Louis Fed President, said we need a falling unemployment rate before the Fed can take action to avoid spurring inflation.

Plosser, Philadelphia Fed President, denied asset bubble in Asia and sees no concern in the weak dollar, although commercial real estate remains a problem.

Lacker, Richmond Fed President, is hopeful there will be a reasonable rate of growth, but there will not be a rapid improvement in the labor market conditions.  Patches of weakness will persist into recovery and that creates a threat that business and consumer sectors will develop a lack of confidence with respect to inflation and the necessity to continue policies to promote recovery.

Hoenig, Kansas City Fed President, said the economy faces significant weakness, financial institutions need to be allowed to fail, there were flaws in financial oversight, and credit agencies need reform.

Print Page

Share This