Thursday, February 25, 2010

Dysfunctional Governance

The subtitle of this post is: Or why Elizabeth Warren should be the first female Secretary of the Treasury Now.

In my prior post, Corporate Socialism vs Regulatory Reform, I made the case that the need for meaningful financial regulatory reform is crucial to the maintenance of democracy.  Capitalism is not the privatization of profit and the socialization of risks and losses further enriching an elite group of profiteers at the expense of the common citizen.  When corporation governance has become so corrupt that corporations are run for the benefit of the managers at the expense of the shareholders, there is something more than fundamentally wrong.

When Brooksley Born sought to have derivatives regulated in 1998, during the Clinton administration, and was crushed by Bob Rubin, Larry Summers, Alan Greenspan, and Arthur Levitt, the current global financial crisis was born and began to grow.  With the financial crisis threatening to bring down banks worldwide and hurl the world into financial oblivion, the opportunity of crisis to provide decisive regulatory reform was decapitated by Tim Geithner, Hank Paulson, and the heads of the very banks and shadow banks which had perpetrated the crisis.

While the regulators and the government should have followed the successful Swedish example from the 1990's and seized the banks and shadow banks, stripped the toxic assets out and placed them in a resolution authority as had been done in the savings and loan crisis, dismissed the management, and then, after proper capital ratio improvements, spun the banks back into the private sector as financially stronger financial institutions, the American Congress was, instead, deceived into appropriating bailout money which was then used not as legislated but rather to fund the very banks and management which had caused the crisis.  As a result the largest US banks have grown from 55% of GDP, pre-crisis, to 63% of GDP.  Their concentration of the financial market has grown to the point where four banks have half the market in mortgages and two-thirds of the market for credit cards.  Five banks control 95% of the derivatives market.  Three US banks have over 40% of the global market for stock underwriting.

The very financial institutions which, by their risky conduct, created this global financial crisis have been allowed to become more powerful and more systemically dangerous, when they should have been broken up with a modern Glass-Steagall division between retail and investment banking, a transparent and regulated derivatives market should have been created, mark-to-market rules enforced, off balance sheet SIVs either prohibited or properly included in balance sheets, management and directors replaced, shareholder ownership reinforced, a consumer protection agency created, bank capital ratios raised, shadow banks formally identified and regulated as systemically dangerous financial institutions without respect to their original business structure,  and systemically dangerous business and investment practices, including disproportionate salaries and bonuses not in the best interests of shareholders, penalized by transaction taxes on the business and the individual (with respect to salaries and bonuses).

As it is, the balance sheets of banks are not financially accurate, because they have been exempted from proper accounting rules.  Citigroup wrote the new credit card "reforms" which became law and raised interest rates to 29.9% prior to its implementation and sent letters to its demand deposit account holders informing them the bank reserved the right to require seven days prior written notice of any withdrawal from a checking, savings, or money market account, while still being majority own by the United States government.

The Federal Reserve has failed to get banks, insurance companies, and hedge funds to agree on what derivatives should be transparently traded through a clearinghouse with proper collateral.  The Administration has failed to decisively create proper regulations and a transparent market.

Purposefully complex and overly complicated mortgage loan, credit card, and other consumer loan agreements have been buried as a cause of the current crisis under the lobbyist's rosy picture of free market buyer beware fairy tales in which the wolves are victims.  The unethical practices of banks, such as Goldman Sachs and J. P. Morgan have been increasingly chronicled and complex financial instruments and practices explained again and again only to have the PR people and lobbyists insist the public is not smart enough to understand finance. While Matt Taibbi has rigorously documented past Goldman Sachs and AIG dubious transactions and activities, some might think his recent article in which he uses the literary metaphor of different criminal con games to describe financial business practices was too factually loose, but the power of literature to transform truth into a universal visualization is not to be derided, as Emile Zola proved.  Is an article any less powerful in its message against the spin of hundreds of lobbyists and the inaction of government just because it is published in Rolling Stone rather than the New Yorker?   When elected officials fail to act and protect the citizenry, should public mockery of the obvious not be expected and escalated?

The recent announcement of a proposed Volcker rules which would limit the size of banks and a proposed ban on proprietary trading was seen as a ray of hope, although it left the banks as is without any reduction or limitations other than proprietary trading.  The issue is really not size, as we have repeatedly said, it is systemically dangerous conduct and activities.  Yet, Geithner has being preaching financial reform this week while recanting on proprietary trading saying it should be limited not banned.  Fixing banks has become a question of power and the banks have been given more power by the very government which should be minimalizing their power through regulation. Protecting the banks has become more important than putting America to work and growing the economy, because the toxic assets were not stripped from the banks and the next financial crisis is peering around the corner at us.

Elizabeth Warren has been one of the few public officials focused and committed to financial regulatory reform and consumer protection.  Canada has had a consumer protection agency for years and banking regulations in place which allowed it to weather this global financial crisis better than the United States and other countries.  Yet, in the United States lobbyists have killed the proposed Consumer Financial Protection Agency and continue to dance on the grave of its aborted fetus with a "just another bloated government bureaucracy" headstone as testament to the power of money to create acceptable lies.  The financial predators do not want anyone protecting the public; it is not profitable.  Elizabeth Warren continues to promote the need of a CFPA as necessary to preserve the middle class which is growing smaller every day as the financial elite become even richer.   She has made it perfectly clear that the battle has come down to the lobbyists versus American families and the lobbyists are winning.

The lobbyists are winning, because people, like Larry Summers and Tim Geithner among others, are helping the financial lobbyists to win.  While Paul Volcker continues to be optimistic about the Volcker Rule while being marginalized again, he still is adamant that the real crisis facing the American people is the present bipartisan dysfunctional governance in which nothing gets done for the people.  What chances of regulatory reform are there if it is completely acceptable for financial institutions to purposefully mislead investors and deceive markets while being paid a great deal of money to mislead people?  What chances do we have that banks will be required to control leverage, improve their capital ratios, and operate with accurate balance sheets if the banks are allowed to be more powerful than the government?  This should be an obvious need in any free society and should not require the financial innovation of more investment products, such as hybrid securities for contingent capital.  All risks should be properly collateralized and proper capital ratios maintained.  The Fed, the SEC, FDIC, OCC, and Treasury Department failed to do their jobs preferring to defer to their financial constituents. 

President Obama was given and took advice to make Larry Summers his chief economic adviser, to make Tim Geithner his Secretary of the Treasury, and to make Rahm Emanuel his chief of staff.  None of these individuals were a part of his campaign nor, by their actions, do they believe in what his campaign said to the American people.  They support the financial interests, with which they have been intimately involved, and nothing is going to change.  If there is going to be corrective action and if President Obama is going to be true to his beliefs, there need to be decisive changes that send a clear message to the the lobbyists and the American people.  The President needs to replace Larry Summers with Christina Romer, Tim Geithner with Elizabeth Warren, and Rahm Emanuel with Evan Bayh.

I must admit that I knew Rahm Emanuel when he was still a college student and working in the Congressional campaign of a high school friend of mind.  I am disappointed, but I wonder if he might be better suited to be the President's lobbyist.

This would be a clear message that shakes the walls of money.  Otherwise, the corporate socialists love dysfunctional governance, not just in the United States, but worldwide in any country.  Will their corporate flags become feudal flags?


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Wednesday, February 24, 2010

Fed Exiting & Supplementary Financing

Recently, we talked about the possible scenario of the Fed exiting its MBS positions by transferring them over an extended period to Fannie May and Freddie Mac with the assistance of Treasury support of Fannie and Freddie. We have seen the Discount Rate increase as an exiting return to normal lending programs by the Fed.

Now, we have been quietly presented with the resumption of the Treasury's Supplementary Financing Program which was initiated in 2008 and shrunk in 2009 with the intent to unwind it.  In the words of the Fed, the purpose of the Treasury Supplementary Financing Program was to create deposits at the Fed which would "serve to drain reserves from the banking system, and will therefore offset the reserve impact of recent Federal Reserve lending and liquidity initiatives."  The resumption announced yesterday will increase the current $5 billion level to $200 billion and the first of 8 weekly $25 billion 56-day SFP bill auctions will begin today.

This will restore the SFP to the level maintained between February and September 2009.  This again raises the question of does the Federal Reserve intend to exit its enormous balance sheet positions by selling them in an orderly fashion in the future or does it have more creative plans in mind?  The Econobrowser correctly points out that the Fed could drain its reserves by selling MBAs, doing reverse repos, selling T-bills, or with the Term Deposit Facility.  Supposedly, the Fed wants more flexibility in managing its balance sheet.  This announcement comes at the same time the Fed is making its final MBA purchases for a total of $1.25 trillion and ceasing future purchases. The addition of $200 billion in deposits would certainly improve the Fed's balance sheet.  Or will it?

As the Econobrowser reports, there is a discrepancy in the the purchases of MBAs reported by the New York Federal Reserve and  the Atlanta Federal Reserve, which is reporting them at $152 billion more than New York.  Is this significant and a factor in the decision to re-expand the Supplementary Financing Program or is the SFP renewal just providing improved balance sheet flexibility to the Fed.  If the later, why are all comments anonymous and for background only?



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Sunday, February 21, 2010

Leftovers --- Radio Show 2/20/2010

In the show we covered the Fed's Federal Open Market Committee minutes from January in which it was apparent the Fed is struggling with the meaning and economic impact of currently high unemployment, despite employment being one of the two mandates of the Federal Reserve.  One quandary they were having is whether extended unemployment benefits were "... encouraging some who have lost their jobs to remain in the labor force."  I found this whole paragraph to discouraging in that it tends to validate my long voiced opinion that the Fed is using unemployment to hold inflation down as the the banks recapitalize and adjust their balance sheets.

The whole paragraph is as follows:  "Though participants agreed there was considerable slack in resource utilization, their judgments about the degree of slack varied. The several extensions of emergency unemployment insurance benefits appeared to have raised the measured unemployment rate, relative to levels recorded in past downturns, by encouraging some who have lost their jobs to remain in the labor force. If that effect were large—some estimates suggested it could account for 1 percentage point or  more of the increase in the unemployment rate during this recession—then the reported unemployment rate might be overstating the amount of slack in resource utilization relative to past periods of high unemployment. Several participants observed that the necessity of reallocating labor across sectors as the recovery proceeds, as well as the loss of skills caused by high levels of long-term unemployment and permanent separations, could reduce the economy’s potential output, at least temporarily; historical experience following large adverse financial shocks suggests such an effect. On the other hand, if recent productivity gains were to be sustained, as some business contacts indicated they would be, potential output currently could be higher than standard measures suggested, and the high level of the unemployment rate could be a more accurate indication of slack in resource utilization than usual measures of the output gap."

In conjunction with those passages, we also noted that a recent speech by the Minneapolis Fed President Kocherlakota included the statement: "The point, though, is that the fall is not spread uniformly across all people. Some workers—those who lose their jobs—suffer much bigger falls in income. For this reason, many macroeconomists now believe that the true cost of a recession is not the fall in GDP per se, but the associated increase in the risk of people becoming, and staying, unemployed. "  I have been saying this for over a year in trying to explain how serious the high unemployment rate and the fact that 21.5 - 22% (if you use the formula from the 1990's for determining discouraged workers) of the population is unemployed is in determining if this technical "jobless" recovery is sustainable and how destructive a long, slow growth recovery will be to the structure and membership of the American middle class while income inequality will continue to grow at the benefit of the top 1%.

In that Kocherlakota's speech devolved into a defense of the Fed's role as a necessary regulator of the banking system, it is unfortunate that the Fed did not get the job done.  My opinion is that the Fed needs to continue having that responsibility as a member of a council of regulators.

Greece may (it has not been formally announced) attempt a bond auction this coming week.  The EU has provided no commitments of assistance preferring to ratchet demands for austerity program plans and reports by March 16 and May 1.  The Greek PM has indicated they are ahead of schedule.  They have raised taxes, but they also have an aging population with a low birth rate.  I pointed out that the EU rules for determining debt to GDP ratios is not based on national debt but also includes local government debt.  The causes of the problems in Greece, Spain, Italy, and Portugal, if not Ireland also, goes directly to the formation of the euro, the exchange rates, low ECB interest rates, competitiveness gaps between Eurozone nations, and trade imbalances within a single monetary union of sovereign nations.  If the EU refuses to deal with the problems of the euro and the lack of appropriate tools for the ECB and attempts to ignore the problems with political compromises and hard line positions, the economic consequences could snow ball from country to country.  If the political compromise approach stimulates social protest and disruption in Eurozone countries, who have not enjoyed the benefits of the economic trade imbalances as Germany has, the question could devolve into one of sovereignty.  How much sovereignty must EU nations, who have economically suffered from the adoption of the euro, surrender to please the more economically dominate EU member nations?

Interestingly, the Greek PM made a public statement that Greece did not need assistance from the EU and could handle the problem itself.  He also indicated that if Greece did want help it may seek it directly from the IMF without the cooperation of the EU.  I was struck by how much this was similar to the recent suggestion of Simon Johnson that Greece bypass the EU and approach the IMF for assistance unilaterally and in so ding put immense political pressure on the EU and particularly France, because French President Sarkozy sees the head of the IMF, Strauss-Kahn, as a potential political opponent for president of France.

Spain, which is seen by some as a potentially larger problem than Greece as it has a much larger economy, is struggling with growing unemployment and a EU imposed austerity program, but this last week it had a bond auction in which it offered 5 billion euro 15 year bonds which priced at a 12 basis points premium and an over subscribed book of 12 billion euro orders.  Over all, it was an encouraging auction.

Iceland will hold its Icesave referendum on March 6tt.  We have documented the Iceland, UK, and Netherlands dispute and various proposals for resolution.  The question is not should Iceland make payments, but what constitutes fair payment under EU law and when payments should be made.  The interest rate of 5.55% has already been denounced by many commentators as excessive and unfair.  Anna Sibert of Birkbeck College, London, and a member of the Monetary Policy Committee of the Central Bank of Iceland has published an article on the legal background of the debate and posits that, if the likely recovery of Landsbanki's assets is close to 90%, it will not be crippling to Iceland's taxpayer's who have already experienced an unprecedented fall in disposable income at 3600 euro per capita or 14% of Iceland's GDP at end of 2015 with the average payment burden from 2016 to 2024 less than 1% of GDP per year.

The economist Thorvaldur Gylfason has written "Eleven lessons from Iceland", in which he lays down eight lessons requiring financial regulatory reform, a tenth that government needs to protect jobs and incomes in such financial crises, and an eleventh that the need for financial regulation and separation of government and private banking does not negate a capitalist approach.

Philly Fed business activity index up to 17.6 January from 15.2 (expected 17.0); new orders up to 22.3 from 3.0; inventory up 5 points.

Citibank, whose majority shareholder is the United States government, which has sent letters in the recent past jacking credit card rates up to 29%, has sent letters to deposit account holders in Texas that Citibank reserves the right to demand 7 days notice in writing before money could be withdrawn from checking accounts, money markets, or savings accounts, which are demand deposit accounts.  While they insist this applies to Texas only, the actual disclosure statement is not limited in its application. 

Remember, Citigroup also wrote the new credit card federal legislation which just took effect.  You will find going forward that the fees, increased minimum payments, and lack of any prohibition of usury will not be the informative disclosure and consumer protection promised.

Capital One annualized credit card write offs rose to 10.41% in January from 10.14% and 30 day delinquent only increased to 5.8% from 5.78%.

Humana will reduce its workforce by 5%.

Morgan Stanley may hand over its $2.4 billion investment in a Japanese hotel chain it bought in 2007 to creditors when debt comes due in April.

AIG has said it plans to keep 25% of its derivatives portfolio, with a notional value of $300-500 billion, as its Financial Products unit winds down saying the derivatives have been "derisked" and have upside potential.

Japan Q4 GDP was 1.1%.

All UK MPC members voted not to expand QE citing the likelihood that inflation will be below target for the next 3 years (below 2% medium term) and further QE might increase asset prices (bubble).

Barclays allocated more in pay bonuses as a percent of revenue than Goldman Sachs by setting aside 38%.

Walmart sales disappointed but were up 4.6% to $112.82 billion (expected $114.36 billion) and profit was $1.21/share vs 96 cents/share a year ago.  EPS, after exclusions and tax benefits, was $1.17/share (expected $1.12).

Simon Property made a hostile offer of $10 million for bankrupt General Growth after a private offer was ignored and is promising that $7 million of that will pay in full unsecured creditors.

RIM (makes Blackberry) warned of a bandwidth crisis in urban areas which requires software developers to come up with better applications and efficient services to conserve bandwidth.

Kraft posted 48 cents/share Q4 profit, which is up 12 cents vs year ago.

Merck, which has merged with Schering Plough, had $2.34/share Q4 profit vs 78 cents year ago.

Abercrombie posted 53 cents/share Q4 profit which is down from 79 cents; revenue fell 4.6%; sales fell 13% down 12% in the US but up 86% internationally.

UK consumer prices were up 3.5% January -- a 14 month high -- supposedly from the implementation of VAT and will fall to normal later this year.

Kansas City Fed President Hoenig said, if interest rates are kept low, major inflation could ensue.  While arguing the Fed needs to remain independent of political pressure, he then ventured into the government's fiscal policy and asserted that the politicians should cut spending and increase revenue (taxes?).

Eurozone trade surplus was $6 billion in December, because exports contracted less than imports.

US gasoline demand is down 1.3% vs year ago.  Refinery capacity is 79.8%

UK business loans fell 8.1% in December vs year ago in the sharpest drop since records began in 1999.

UK retail sales fell 1.8% in January but it is up nine tenths vs year ago.

Spain estimates its economy will contract 5 tenths in 2010.  GDP fell 3.6% in 2009.

Russia cut its interest rate for the 11th time in less than a year by 25 basis points to 8.5%.




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Normalization and Transfer Exiting

In our last post in which we discussed the Discount Rate, we indicated this was not monetary tightening but just another step in the Fed's announced actions to normalize liquidity and lending programs.  Econobrowser has succinctly summarized the probable meaning of the 25 basis point hike in the Discount Rate with no hike in the Fed Funds Rate, which is unlikely to happen anytime soon.  I do know if there is any significance in the fact the last time the Fed raised the Discount Rate after 24 months of unemployment was 1931; this could be just interesting rather than profound.

In discussing the Fed exit strategy in our last post, I asked who would buy the Mortgages Backed Assets on the balance sheet of the Fed once the Fed is ready to sell.  John Hussman in his last Monday commentary suggested the possible scenario that the US Treasury could issue another $1.5 trillion in debt over the next few years (matching the amount of purchases on the Fed balance sheet) and periodically transfer the proceeds to Fannie May and Freddie Mac to cover continuing balance sheet losses enabling Fannie and Freddie to "redeem" the mortgage securities from the Fed without the need for liquidation or any other unwinding operation.  This would make the securities disappear from the Fed and reappear as an obligation of the American people while protecting the lenders.

This would not be right, but it is almost beautiful in its logical plausibility.

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Friday, February 19, 2010

Discount Exiting & Inflation

After the stock market closed yesterday, the Fed announced it would raise its discount rate on emergency loans from 50 basis points to 75 basis points.  This move had been well floated by Bernanke and several Federal Reserve District presidents since at least the tenth of February.  If you have been listening to the radio show and/or reading the Leftover posts, this is no surprise to you.

What was unusual, but not a total surprise if you have been following the public statements of Fed officials, was the Fed funds rate was not also raised.  Traditionally, the Discount Rate and the Fed Funds Rate are raised or lowered together.  However, the minutes of the FOMC January meeting clearly indicated that the Fed Funds Rate will not be raised for an extended time, although there was dissension by Hoenig, who has been joined publicly since by Plosser.  The concern of these Fed presidents is the expectation of inflation. 

We have made it perfectly clear in the past that we think the Fed lowered interest rates too low too fast and now has three significant problems in executing an exit strategy.  First, unemployment has been used to hold inflation down, high unemployment is acknowledged as a long term reality, and interest rate increases are usually in step with improvement in employment.  Once we are twelve to eighteen months into this "jobless" technical recovery one would expect the Fed to begin raising interest rates, but this slow growth recovery will not show significant employment recovery by that time.  Second, the Fed has added significant Mortgaged Backed Assets to its balance sheet not to mention the 3 Maiden Lane funds of distressed assets, it will cease purchases in the near future with an unknown impact on the housing market, and it does not envision selling these assets for some time at a desirable price to willing buyers.  Are these on the Fed's balance sheet at a fair mark-to-market price?  They do not appear to be.  When will it be able to begin a non-disruptive sale?  Third, given the slump of Q4 2008 and the deflation that came with it, monthly CPI inflation figures should increase going forward as they have begun to do since December 2009.  This should ratchet up the expectation of inflation going forward.  Yet, it will all be in the timing and co-ordination and it cannot be expected to be perfect.  Quick recognition of a step to far or a step too slow will require decisive reaction and/or prudent retrenchment.  Let the leash out, correct undesirable behavior, pull the leash in, and then let the leash out again until the desired behavior is achieved.

Pulling back lending facilities, normalizing the discount window, the possible use of reverse repos and other means of draining reserves, such as offering depository institutions term deposits (CDs for banks) have all been discussed and are to be expected in slow increments as the water is tested.  A full exit implementation is actually a long way from the present time.  Timing the sell of Fed balance sheet assets will be difficult balancing act in and of itself, but even more difficult with long term unemployment and a growing expectation of inflation and the still precarious economy which could easily double dip or slide into stagnation.

January CPI came out this morning and close look only raises questions.  Tom Iacono has asked if there is a math problem at the Department of Labor in relation to the weighting of lodging away from home in the determination of core housing prices, which are shown as declining 2.1%.  In fact, the methodology was changed last month as stated in the December 2009 CPI release:  "Effective with the release of CPI data for January 2010 scheduled for Friday, February 19, the BLS will introduce several item structure and other publication changes into the CPI. 
"Shelter. The expenditure weight for second homes will be moved from Lodging away from home to a
new, unpriced stratum under the Owners’ equivalent rent expenditure class. As such, the expenditure
class index for Owners’ equivalent rent will now include both primary and secondary homes, and the
title of that expenditure class index will change from Owners’ equivalent rent of primary residences to
Owners’ equivalent rent of residences. Both the expenditure class (Owners’ equivalent rent of
residences), and the Owners’ equivalent rent of primary residence stratum within it, will be published.
Current Structure
Lodging away from home
  Housing at school, excluding board
  Other lodging away from home including hotels and motels
Owners’ equivalent rent of primary residence
  Owners’ equivalent rent of primary residence*
New Structure
Lodging away from home
  Housing at school, excluding board
  Other lodging away from home, including hotels and motels
Owners’ equivalent rent of residences
  Owners’ equivalent rent of primary residence
  Unsampled owners’ equivalent rent of secondary residences"

But Iacono is correct to question a change and its calculation, when it results in the first decline (.1%) in core prices since December 1982.  In fact, in the most recent January minutes of the Federal Open Market Committee, "One participant noted that core inflation had been held down in recent quarters by unusually slow increases in the price index for shelter, and that the recent behavior of core inflation might be a misleading signal of the underlying inflation trend."  The above changes would appear to have aggravated the effect.

What I found interesting in the just released CPI was Energy went up 2.8%, Energy commodities went up 4.9%, Gasoline went up 4.4%, Fuel oil went up 6.1%, and Utility natural gas went up 3.5% with all CPI-U items up only .2% for an annualized 2.63%, which is down from the 2.76% annualized rate last month.

Still, if the 1990 calculation for CPI were still being used, the annualized rate would be approximately 6.0% and, if the 1980 formula was still being used, the annualized rate would be approximately 9.9%.

Yesterday, the PPI (wholesale prices) leaped 1.4%, which was more than 3 times the December increase of .4%, on an increase of 5.1% in Energy goods.  Core PPI went up .3%.  

PPI leaped on energy increases but CPI did not.

The debate within the Fed on when to raise rates and when and how to sell mortgaged backed assets is going to become more public.


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Monday, February 15, 2010

Leftovers --- RADIO SHOW 2/13/2010

We spent a considerable amount of time explaining the pan-European debt crisis and its potential effects on Europe and the world.  We also spent time on one of our favorite topics, which is the need for substantive financial regulatory reform and how financial sector lobbyists are not only being very successful at defeating reform but also very successful at rolling back current regulations to less stringent standards and further diluting the legal protections American citizens should expect and demand.

Lobbyists for the insurance and banking companies have been particularly strident in eliminating any proposal which would make them more accountable to their clients through stronger fiduciary standards.  The very use of "adviser" as a title by their employees who are salespeople is a purposefully misleading marketing ploy.  The current SEC laws and regulations make it very hard and almost utterly confusing for the consumer to distinguish between a real financial adviser with no conflicts of interest, an "unavoidably" conflicted financial adviser, and a broker.

The current regulations even allow financial advisers who are dependent on a direct relationship with a broker/dealer advisory service and consequently have a conflict of interest in serving their clients, to call themselves fee-only, when it should be clear that their broker/dealer advisory service is not providing multitudinous support out of the kindness of their heart.

The financial industry wants nothing changed and, if changes are going to be proposed, they want the SEC to be the agency which delineates and defines the rules, because the SEC is viewed by the financial industry as their ally against the unruly demands of consumers.  Without the SEC's determination to purposefully confuse the consumer as to who different advisers and brokers serve and their duties to their clients, the financial industry would have to conduct itself as a responsible member of a democratic society and clearly and simply provide the information necessary for a person to make an informed decision which is in the client's best interests.

LPL Financial, SIFMA, and Morgan Stanley along with other well known names are hard at work trying to water down existing fiduciary standards much less stop new and stronger fiduciary standards.

Elizabeth Warren, the chairman of the Congressional TARP Oversight Panel, wrote an op-ed in the Wall Street Journal illuminating the banks' lobbying effort to beat the proposed Consumer Financial Protection Agency into oblivion.  The banks are using ""bureaucracy" and "big government" to confuse citizens into accepting a continuation of the current business model, i.e., screw the consumer again and again.  If Corporate Socialism is okay, then consumers need no protection.  While the whole financial regulatory reform legislation is going no where, the CFPA is the only proposal which would directly help American families.  However, it may be too late to stop an oligopoly with implicit government guarantees from doing anything they want.

San Francisco Fed President Yellen has written a report on her visit to China and Hong Kong in which she acknowledges that the current US Federal Reserve monetary policy is likely to cause excessive stimulation for their economy and currency.  She sees the need for China to allow an appreciation of its currency to mitigate growing inflationary concerns.  Because the Chinese currency is pegged to the US dollar, she sees China and Hong Kong as both "stuck" with the Federal Reserve's policy course.  She also thinks this will cause China to "recognize" it must abate its export economy to a more "balanced" economy.  We have been discussing for months the growth of leverage in China, spending bubbles, and real estate asset bubbles.  China has been taking the steps towards tightening lending and other monetary policy and we have seen how those small, reasonable steps have shaken the global markets.  While China may have to allow a small, controlled appreciated of the yuan to control inflation, it is not likely that it will give up export share to live in a more balanced international economy beneficial to the United States.  At what point does the pressure on China to appreciate its currency and the continued zero interest rate policy of the Federal Reserve not constitute the active conduct of a trade war?

The stock market appeared to be somewhat concerned about Bernanke's comments on how the Fed will exit from its current stimulus by ceasing to purchase assets, to eventually begin to sell assets on its balance sheet, to control bank lending, maybe raise the discount rate, and eventually raise interest rates.  There is nothing unexpected in these comments and possibilities.  It will all come down to the timing and the coordination.  Given the length of zero interest rates, the extent of quantitative easing, unemployment, and the perception of inflationary pressures, the timing and coordination will be very difficult and undoubtedly need pullbacks and refinements without pushing this slow, long "jobless" recovery back into a more serious recession.

Dallas Fed President Fisher said the Fed must find non-disruptive ways to withdraw the unprecedented monetary accommodation and the Fed must remain independent to do it.  When not defending the Fed from its critics, he saw many impediments to recovery, because business will have to regain confidence to expand and consumers will have to start doing their "share" by spending (the rest of this sentence is my opinion) their hard earned money rather than save it or pay down debt.

St. Louis Fed President Bullard sees mortgage reform as the central regulatory reform need and it is a mistake to not focus on the housing market.  Yet, he makes no mention of derivatives and how those synthetic instruments provided the greedy tsunami that surged the coffers of the banks and threatened the world.  It is as if he wants the Fed to wash its hands of the housing/derivatives bubble and say it is up to the government to do something.  He wants the Fed to get its balance sheet down before the next recession hits.  At the same time he sees the current housing market as flat this year and just hanging around at low levels.

What would cause a sovereign credit default swap trigger?  One would be a failure to pay coupon or principal, another would be a debt restructuring which affects obligations, and a third would be a repudiation/moratorium of obligations.  This sounds more like Dubai than Greece.

In an article, "Obama must resist 'deficit fetish'", Joseph Stiglitz focuses on how, when banks get government money, the deficit  is acceptable to the banks, but when the government is providing money to the public then the banks are upset about deficits.  It is self-serving for the banks to be opportunistic deficit hawks when the money is not going to them.  "It was a mistake to give in to the banker's pleas for deregulation before the crisis; a mistake to give into their demand for a bailout without constraints and without appropriate compensation for the government during the crisis; and even more wrong now to give into demands for unfettered deficit reductions, including an end to stimulus."  He goes on to say how money is spent makes a difference.  Some government expenditures stimulate an economy more than others.  Yet, worrying about deficits can be good, because it should cause us to ask what kind of spending yields high returns, what kind of spending has targeted multipliers, are there tax increases which will not harm output and employment, and are there other ways to stimulate an economy, such as eliminating problems in access to credit, and inducing banks to lend for job creation rather than creating asset bubbles, even if it means getting tough with banks.

Dubai is proposing a 6 month standstill on $22 billion of debt and their CDS costs are up sharply.

Estonia's GDP is down 9.4% 2009, but that is a significant improvement.

Latvia's Q4GDP was down 17.7% vs a year ago and unemployment in December was 22.8%.

US 30 year Treasury auction this past week was considered by some analysts to be a weak failed auction, because it had a very high yield, reduced number of foreign buyers, and an unusually high number of direct buyers.  Primary dealers (large banks and investment firms) are also upset at the increasing percentage of direct buyers as it increases prices and lowers the primary dealers' profits.

US trade deficit was up $40.2 billion (highest since October 2008), which was a 10.4% increase, with exports up 3.3% ($142.7 billion) and imports up 4.8% ($182.9 billion).

US wholesale inventory was down 8 tenths in December; sales were up 8 tenths but below expectations; inventory ratio is now 1.12 months.

 Oil supplies increased 2.4 million barrels; gas supplies increased 2.3 million barrels; distillate supplies declined 300,000 barrels.

Fed asset (the purchase of which will stop in March) sales, according to St. Louis Fed President Bullard, may start later in 2010.

Japanese bank lending  fell 15% in January vs year ago -- biggest decline in 4 years -- on over capacity and slow economic outlook.  Exports are expected to pick up.  Machinery orders were up 20.1% in December; wholesale prices were down for 13th straight monthly drop on weak demand.

Bank of France estimates French GDP to be 5 tenths in Q1.

US Treasury, which is doing $81 billion in auctions this week, has made the decision to stop increasing the size of debt auctions.

UK retail sales were down 7 tenths in January vs year ago.

German exports were up 3% in December vs November but imports were down 4.5%.

UK industrial output was up 5 tenths in December but down 3.6% vs a year ago.  Bank of England Governor King said further cash injections (quantitative easing) may be needed to bolster the economy.

Chinese exports were down 16.3% January vs December but up 21% vs a year ago.

French production was 1 tenth in December and Italy's was down 7 tenths.  German machinery orders were up 8% in December.

US business inventories were down 2 tenths in December; excluding auto they were up 2 tenths.  The inventory ratio is 1.26 months (lowest since June 2008); sales were up 9 tenths.

1 in 5 US mortgages are underwater according to the Zillow Real Estate Market Report.

Prime jumb RMBS which are 60 days delinquent are at 9.6% in January.

Fitch says US high yield corporate bond defaults are at 13.7% in 2009.

Illinois' fiscal budget gap is approximately 47.3% of revenue as of 1/8/2010.

US corporate borrowing costs are rising at the fastest pace in 2 months.

PIMCO prefers German bonds to US Treasuries.

S&P revised the outlookof  Bank of America and Citigroup to Negative from Stable.

The Federal trial judge has questioned the new SEC/Bank of America $150 million settlement asking if it still unfairly punishes shareholders.  The settlement also includes improvements in corporate governance and disclosures as well as executive pay.  The judge had rejected a prior settlement of $33 million as too low and unfair to shareholders who pay the fine.  This $150 million settlement will be paid into a fund and distributed to shareholders, but the judge has asked why shareholders should pay shareholders.

John Thain has been named the new CEO of bankrupt CIT and will have a compensation package of $500,000, $2.5 million in one year restricted stock, $5 million 5 year restricted stock, and a possible incentive award from the Board of Directors capped at $1.5 million.

Canadian housing prices increased for the 7th month in a rapid housing recovery -- some say too rapid.  Canadian banks reset the adjustable rate mortgages every few years and the Bank of Canada warned in December that, if interest rates increase by mid 2012, 9% of Canadian households could be financially vulnerable.

India's GDP is estimated to grow 7.2% in 2010.

Australia will end bank deposit and bank funding guarantees.

US Treasury auctions:

3 month Treasury, $13.3 billion with 17.3% direct buyers (normally 7.3%).
6 month Treasury, $11.9 billion with 18.2% direct buyers.

3 year Treasury, $40 billion, yield 1.377%, bid-to-cover 2.84, foreign 51.8%, direct 10.07%.

10 year Treasury, $25 billion, yield 3.692%, bid-to-cover 2.67, foreign 33.2% (average 43.27%), direct 13%.

30 year Treasury, $16 billion, yield 4.72%, bid-to-cover 2.36 (average 2.50), foreign 29% (weak), direct 24% (high).


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Sunday, February 14, 2010

Leftovers --- Radio Show 2/6/2010

We discussed the burgeoning European debt crisis with details on the problems in Greece and Spain, the growth of public debt, the euro, high leverage levels in the private banks, the asset bubbles that formed in the Eurozone countries, how the low interest rates of the ECB and the overvalued exchange rates which fueled the asset bubbles, and unemployment in these countries.

We are late in writing this post, because the week following was filled with the unfolding of the pan-European debt crisis.

We did not get to these items during the show.

On February 10, FINRA will hold a closed meeting to discuss charges that the former chairman of FINRA and now the chairman of the SEC, Mary Shapiro, acted negligently and incompetently in failing to warn investors about Lehman, Bear Stearns, and Merrill Lynch as well as about Auction Rate Securities, despite liquidating FINRA's own ABS holdings in mid-2007 and in not taking action against the Ponzi schemes of Bernard Madoff and Robert Stanford.  Under her administration FINRA suffered almost $700 million in investment losses and paid its senior executives nearly $30 million dollars.  Mary Shapiro has never been able to comprehend that her job was --- and is --- to protect the American public.  She has always ended up representing her perceived salesmen constituency.

The TARP Inspector General, in his quarterly report to Congress, stated the government's concerted efforts to support housing prices risk re-inflating the housing bubble and the government has effectively taken over
the housing market, directly or implicitly, through purchases and guarantees of nearly all residential mortgages.

The TARP Inspector General is reported to be investigating insider trading not only on the lower foot soldier level but the executive level of eight of the largest banks with respect to TARP information and actions.  He is also investigating gaming of the Public Private Investment Partnerships, such as selling a security form a non-PPIP fund and buying it back at a slightly higher price with a tax payer supported PPIP fund minutes later.

The FHA and Fannie May are pushing foreclosure sales with the FHA lifting bans for one year and allowing investors to buy a home and then flip it within 90 days, but their profits will limited to 20% and transactions must be arms length.  Fannie May will offer 3.5% seller assistance for buyers of its Homepath properties, which are properties Fannie May already owns.  There have been approximately 2.8 million foreclosures in 2009.

Fannie May and Freddie Mac both face an uncertain future with many, including Barney Frank, wanting to do away with them as the financial community has long sought to extinguish the competition which some advocates still maintain made owning a house a legitimate reality for more middle class citizens.  It is amazing how the forces which seek to destroy Fannie and Freddie rather than reform the GSE concept conveniently forget it was the mortgage and banking interests that lobbied to get Fannie and Freddie to lower their standards and take on more mortgages, which the financial community could then bundle into derivative securities, from which the profits drove the greed which propelled the housing market into an asset bubble.

Mortgage insurers, such as MGIC Investment, have rescinded or refused to pay approximately $6 billion in claims from banks on delinquent home loans since January 2008 and the bond insurers are also trying to recover more than $4 billion for breaches of representation and warranties on residential mortgage-backed securities they guaranteed.  Bank of America and Wells Fargo may be particularly exposed, but all of the large banks are increasing their reserves for the potential costs of being forced to repurchase these troubled home loans.  J. P. Morgan's first quarterly loss in two years was partially the result of these reserves.

Italy seized $102 million of Bank of America assets in a police investigation of the losses from derivatives linked to the sale of 870 million euro of bonds sold by regional governments in 2003 and 2004 on the grounds the bank mislead the municipalities on the economic advantages of the transactions and concealed their fees.  The police have also segregated and sequestered another 30 million euro Bank of America would have managed for one municipality.  Swap derivatives arranged to create funds to repay the bonds were skewed to the the advantage of the bank and to hide their fees.

Trim Tabs has reported that the mysterious large volume buyer of S&P 500 futures has dropped 6.6% in eleven trading days starting the day before President Obama announced he wanted to restrict the proprietary trading of banks.  There has been speculation the buyer could have been the Federal Reserve or the U. S. Treasury.  The question now has the mysterious buyer stopped buying?

It has been suggested that the UK and Netherlands demands on Iceland for repayment of their reimbursement of their citizen's for investment losses on interest bearing deposits in Icelandic banks are unreasonable.  The UK has even put Iceland on the list of international terrorists.  It would be in the interest of all three countries to compromise and agree for Iceland to compensate the UK and Netherlands for any shortfall in recovery from the assets of Landsbanki when it is wound down.  Iceland cannot afford to pay now with their economy in deep recession.

A Swiss administrative court has ruled that data belonging to an UBS client cannot be given to the United States, although UBS must provide information on at least 10,000 of 14,700 US clients to the IRS.  However, the IRS has also refused to give any indication how many UBS client information it has received.  The Swiss Justice Minister said that the Swiss economy and job market would be adversely impacted if UBS lost its US license.  UBS shares fell on those comments.

St. Louis Fed President Bullard said deflation is no longer a worry and it is too early to tighten monetary policy, although the Fed could increase the discount rate.

At Davos, Roubini said the outlook for US growth is dismal and more than half of the current growth has been from replenishing inventory while consumption was dependent on monetary and fiscal stimulus.  Stiglitz again reiterated that the prior stimulus was not enough, although in the right direction, and there has to be a second stimulus focusing on investment

In a public presentation of his new book Freefall, Stiglitz asserted  the US botched the economy over the last eight years.and that is the reason we got into this mess was banks.  Banks misallocated capital, took on excessive risk, and charge transactions fees which were so high that financial service companies accounted for more than 40% of US corporate profits in 2007.  The financial system failed and the regulators, the Fed and government, failed to constrain them.  Regulatory reform has failed to materialize and the banks are free to destabilize the global economy again.  The need for a second, better targeted stimulus is urgently needed.  Stemming the tide of foreclosures by addressing the 25% of mortgages which are underwater is necessary.

Paul Volcker, citing the conflicts of interest in commercial banks being involved in proprietary trading, said the risks taken by banks need to be curbed and there needs to be international consensus that banks should be regulated to avoid being treated as too big to fail.

Rather than have banks increase risk retention from 5% to 10%, the Comptroller of the Currency said regulations should be formulated requiring minimum underwriting standards which would apply to all loan originators.  While he supports the return of securitizations to balance sheets properly aligned with risk, he is worried it will impair the development of a robust securitizattion market.

Primary dealers (big banks and investment firms) are complaining that the increase in direct purchasers at Treasury auctions hurts their margins, because it drives up the price and spreads and hurts their margin in subsequent resale.

The FDIC has proposed to change the requirements for a securitization to be treated as a true sale, which means investors could not go back to the originator for recourse.  The FDIC proposed mortgages must be seasoned 12 months before  they can be securitized, the originator must retain at least 5% interest in the credit risk, the interests of all parties must be clearly disclosed, resecuritizations, i.e., CDOs, are not permitted, and compensation to servicers will include incentives for loss mitigation.  The FDIC also made various proposals to insure transparency for investors.

Oil supplies up 2.3 million barrels, gas down 1.3 million, distillate down 1.0 million.

Personal consumption up 2 tenths of a percent; income up 4 tenths; disposable income up 4 tenths; real; PCE (after adjustment for revenue changes) up 8 tenths; savings up to 4.8% December (4.5% in November).

January ADP private survey -- large business down 19,000 jobs; small business down 12,000 jobs; non-farm service sector up 38,000; total private sector down 22,000 but businesses plan to layoff 71,482, which is largest since August 2009.

ISM non-manufacturing index service sector up to 50.5 (below estimates) from 49.8.

ISM manufacturing index up to 58.4 in January from 54.9, construction down 1.2%.

Weekly jobless claims up 8000 to 480, 000; 4 week moving average up 11,750 to 468,750; continuing claims up 2000 to 4,602,000.

December factory new orders up 1%, shipments up 1.6%, unfilled orders down 1%, inventory down 1 tenth.

Consumer credit down to annualized rate of 4.75% January -- 12 months off 4% -- consumer credit dropped $1.8 billion in January.

German factory orders down 2.3% in December.

Bank of England did no asset purchases for the first time in 11 months but reserved the possibility to resume.

Russian GDP 2009 was <7.9%>;  -- for largest contraction in 15 years.

IMF said it would help Greece if asked while saying it is confidant Greece will take steps to head off the debt crisis.

NY Fed President Dudley is worried the recovery is weak but sees double dip chances as low.

Kansas City Fed President Hoenig said interest rates cannot remain low as the economy recovers.

GMAC wrote down bad mortgage assets for $5 billion Q4 loss -- $10.3 billion loss for year.

While the S&P 500 rose 63%, S&P 500 earnings (inflation adjusted) have fallen below 10% while the financial sector is up 173%.

Bankruptcy filings are up 15% vs year ago January.

Pending home sales were up 1% in December but empty, privately owned houses up 2.7% in Q4.  Home ownership rate is 67.2%, which is the lowest since 2000.  This suggests there are over 1.8 million excess housing units.

UK manufacturing activity was up to 56.7 in January from 54.0 -- fastest pace in 15 years.

Greece will need to refinance 50 billion euro of debt in 2010.

Portugal reduced 500 million euro Treasury bill offer to 300 million and still had a poor sale with yield 50 basis points higher than two weeks ago.

ECB holds interest rate at 1%.  Trichet is looking to 2nd Quarter for exit strategy.

Bank of England holds interest rate at 5 tenths.

Investors have turned bearish on the euro.

European producer prices (factory gate) fell 2.7% in December vs year ago -- 12 months of monthly decline.

UK producer prices rose 4 tenths in January, wholesale costs up 3.8% vs year ago.

French economy is estimated to be up 3 tenths - 4 tenths in first half of 2010.

German industrial output down 2.6% December vs November.

China GDP estimated to rise 11.5% Q1 (10.7% Q4 2009).





 

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Thursday, February 11, 2010

Denial and the Pan-European Debt Crisis

As if the euro Trojan Horse was not being prominently offered, the European Union today issued a statement offering solidarity with Greek austerity measures but with no commitment to a solution to the pan-European debt crisis which is unfolding.  And the European and US stock markets went whistling along as if no solution was the shadow of a solution.  Hope driven stock markets which ignore reality are very unhealthy signals. 

In fact, the solidarity but no commitment statement implied that if there is any assistance to Greece it will not be in any form which acknowledges the euro as a multi-national currency which inhibits its euro nations from exercising a complete sovereign fiscal policy within their nations and the failure to provide the ECB with the economic tools, available to any national central bank with its own currency, to respond to the economic conditions of individual euro nations.  The design failures of the euro and the ill-conceived economic restrictions imposed by the Stability and Growth Pact were destined to yield a financial crisis.

German sentiment continues to be very divided, because it has enjoyed a positive euro exchange rate in comparison to other countries, such as Greece, Spain, and Portugal.  The Frankfurter Aligemeine today editorialized that Germany should return to the deutschmark and denies any European Union responsibility for the economic stability of its members.  This is a position which denies the reality of German banks exposure to the euro nations with significant leverage problems:  "German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan."

It is estimated that two-thirds to 77% of Greek debt is held outside of Greece: France with $75 billion, Switzerland with $64 billion, and Germany with $43.2 billion.  The contagion has already affected Greek banks ability to roll over repo debt. On the European banking scene, the exposure risks also include those of the Baltic states who have their own currencies, but the currencies are pegged to the euro.

It appears if any patchwork assistance is provided to Greece, it may well require a further surrender of national sovereignty rather than creating a European bond as I and others, such as Marc Chandler, have suggested.  Brussels is proceeding down the road of political compromise rather than seizing the problem by its causes and solidifying a core Eurozone with a currency and an ECB that acknowledges the exchange rate competitiveness gaps, the need for a European bond, the need of individual member nations to exercise sovereign fiscal policies,  and the need of an ECB with the economic tools to assist individual member nations and coordinate within the European Union.  At the present time we have a 20 billion euro liquidity problem, but the Eurozone will need to finance approximately 1.6 trillion euro of debt in 2010.  Ineffectual political compromise will engender a pan-European debt crisis which would ripple across Europe and around the world.


In discussing Greece, which has a relatively small economy, Spain, which has a much larger economy, is often mentioned as a possible next focus of the pan-European debt crisis, but Italy and Ireland are right up there with Spain with significant public and private bank debt.  They all have excess leverage and are suffering from public fiscal problems which have been facilitated by a negative euro exchange rate and inhibited by the Stability and Growth Pact.  Which will be next?  Greece could just be the training exercise as the derivatives traders hone their skills to wind the deficit hawks up and harvest larger CDS trading profits.

The rest of the world should not be waiting.  The UK had a failed bond auction in March of 2009 and has recently stated it may need to inject more cash into its economy.  Germany had a failed bond auction in January.  The 30 year United States treasury auction with its high yield and 24% direct buyers is considered by many as a weak failed auction today.

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Tuesday, February 9, 2010

The Unfolding Pan-European Debt Crisis

The stock market, desperate for any irrational exuberance, is trading up today on the "hopes" of a European solution to the Greek economic troubles, while the actual information is extremely conflicted and indicative that a European solution is not yet nascent.

Trichet is returning early from the Australian conference of central bankers fueling speculation that the EU would have a special meeting, although ECB governors were again reaffirming the ECB does not have clear bail out authority and any decision to help Greece must be a political one.  The constant refrain is Greece must carry out its EU austerity plan.  In the meantime, a new EU economic team has been formed and there is speculation that the ECB unannounced exit plan may have to be delayed if it threatens to further destabilize market concerns about Greece, Spain, and other euro monetary countries.

We have previously documented that the banking problems in Greece, Spain, Portugal, and Ireland have all led to budgetary deficit problems and called for the EU and ECB to create Euro bonds to help solve the problem, because we do not think the IMF possible solution will be acceptable to the EU or Greece, because it also does not address the problem of a multi-national currency with no monetary policy to correct national competitiveness gaps which significantly limits national fiscal policies.  Greece has publicly said an IMF solution would send the worst possible signal.

The global debt controversy, which swings between deficit hawks and the efficiency of targeted economic spending, is overplayed even to the extent of what would be a proper Keynesian action plan.  German sentiment clouds both economic debate and what is best for the EU as a whole.

The EU needs to get its member nations to put the problems in perspective.  It is an opportunity for the EU to stand up and directly address the problems caused by a multi-nation currency in individual euro countries, who no longer have monetary policy options available to coordinate with fiscal policy.  The fact that the Eurozone is not an optimum currency area is obvious, but the creation of a two-currency European Monetary Union does not solve the multi-nation individual country economic problems relative to the multi-nation currency; it would only be a synthetic end run around a crumbling bridge.

Joseph Stiglitz is calling for national authorities to teach the derivatives speculators a lesson.  As Stiglitz has documented, another part of the problem is how Goldman Sachs helped the prior Greek government hide debt.  Yet, the primary hedge funds involved in driving the derivatives attack on Greece and Spain, which also drives the CDS costs of other nations up globally, are those of Goldman Sachs, J. P. Morgan, and three other hedge funds.  These attacks on sovereign debt for transitory profit are an example of a systemic risk which could throw the global economy into a double dip and depression.

While the myths and facts of this Eurozone debt crisis are many and not being fully debated and addressed for long term solutions, the final analysis is that failure to deal effectively and efficiently with the debt crisis risks sovereign debt contagion fueled by derivatives speculators and a global double dip into recession of unknown length.  The banks in each of these euro countries are intimately involved in the creation of this debt crisis which was facilitated by the euro and its effect on each individual country's economy in creating either asset bubbles or negative competitiveness gaps requiring public spending to pick up the slack of private spending or both. The excess leverage in the banking systems of these countries, and Ireland is the large powder keg in the background, is symptomatic of the difficult balancing act which must be done if a multi-national monetary policy is to work for the benefit of all member nations.  The leveraged banking problem is deep and significant; it is the problem which should be addressed urgently and is being masked by European Union monetary policy and the sovereign debt issues.  The creation of Euro bonds would be a step towards putting some flexibility in EU monetary policy and providing some teeth in individual member nation's ability to properly control their fiscal policy.  The alternative is a pan-European debt crisis which spreads from nation to nation around the world.  Ireland's bank debt dwarfs Iceland and the United Kingdom's debt level is even higher with government guarantees.  The EU and ECB need to come up with an end game that acknowledges the banking and sovereign debt as economic problems requiring monetary, regulatory, and fiscal coordinated responses, which facilitate fiscal policy responses appropriate for each member nation, and effectuate the euro as a true multi-nation currency.

Attempts to provide loan guarantees or otherwise put a thumb in the dike will not protect other EU nation's banks from the fundamental leverage problem and how it is acerbated by the euro.  Until a real, substantive coordinated plan actually emerges, the rumor mills will grind away.

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Monday, February 8, 2010

Links in Fast Moving Times 2/8/2010

The European debt problem could turn into contagion with immediate global impact.
Greece: The Eu needs to develop an anti-crisis policy, a monetary endgame, and act as a cohesive unit.
               Do we want a global margin call?
               Who are the derivative traders attacking Greece?

Portugal, Spain, and US Deficits:  How it all weaves together with Greece, Germany's desire to profit, and the lack of European Monetary Union response to the economic needs of member nations.

Do not forget Ireland and the effect of the EMU.

China: Loan defaults within China are increasing.

Systemic Risk:  We have discussed the concept of a Tobin tax to penalize and control systemically risky behavior in the the financial industry.  Why should banks not be taxed in order to discourage systemic risks?

In each of the countries above, the banks in those countries have contributed directly to the current problems and they need to be regulated.  Derivatives trading needs to be regulated on a transparent recording market.


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Sunday, February 7, 2010

Links - What Others Are Saying in Fast Moving Times 2/7/2010

I normally use links to substantiate or provide other views in my posts, but events are moving very fast and I want to follow up to my last post on Greece and Spain, China, AIG/Goldman, and the need for financial regulatory reform.

China:  This past week saw the US and China butting heads over trade restrictions and the whether the yuan should be allowed to appreciate or remain pegged to the US dollar.  Just recently, President Obama said he wanted to double US exports within five years.  Just which other countries of the world would have to contract their exports to accommodate the United States?  China is the obvious target.  Given labor costs and other competitive cost constraints, the United States cannot possibly double its exports in five years, but it can initiate international protectionist trade wars.

On China's asset bubbles, inflation expectations, and cash reserves.
On China's currency.
On China's price pressures and tightening of bank reserve requirements.
On China's loan rate's and new loan restrictions.
What to watch for in China -- the risks.


As I said on the Radio Show yesterday, you have to have been watching China for some time.  The connection to Latin America, particularly Brazil, is obvious and Latin American mutual funds and ETFs are showing the danger.  The recent refusal of the Australian central bank to raise interest rates a fourth time citing a need to evaluate the past raises and what is going on in China was significant.  Australia has developed China as an Australian export market.  Even if China does everything right going forward and does it slowly, the global impact of even that soft landing will be shuddering, just as we have begun to witness in the last two weeks of China's preliminary tightening moves.

Greece and Spain will continue to come under derivative trading attack and it will continue to be a potentially larger European problem.  Our last post, "Greece, Spain, and the Euro Trojan Horse", documented the multiple causes, the need for financial reform, a more effective monetary policy, and the need for the EU and ECB to formulate a program of EU bonds.

Greece and why the IMF will not be the answer.
While the failure of Greece to provide accurate economic data in the past and its corruption are widely known, the problem of the losses on Spanish banks books has been relatively muted.
The market pressure will continue.
While bailout doomsday scenarios abound and demands for budgetary cuts grow, the real problem is the need for financial regulatory reform and the economic impact of the euro on the 16 countries which use the euro.
While budget cuts are necessary to remove ineffective accumulation of public debt, targeted spending and the effective accumulation of public debt to spur economic growth and job creation is the most fiscally responsible governmental path, but the 16 EU countries which use the euro do not have the monetary and fiscal policy options of countries which have their own currency.  
The risk remains that the speculative attack of the derivative traders could create a European and global debt contagion.
Meanwhile 10 billion euro have been pulled out of Greece.

The connection between Goldman Sachs and AIG continue to simmer and escalate, because it goes straight to what was wrong with the bank bailouts and how that bailout actually made the sources of the current global financial crisis larger, more powerful, and more systemically dangerous.

How Goldman Sachs pushed AIG to the edge and profited.
Just how much did AIG not understand the true market values, credit rating, and risks of its CDOs?
If the relationship between AIG and Goldman Sachs been fully disclosed publicly, should the United States government have nationalized AIG and then dealt with Goldman Sachs?

Economic Solvency:  What we do now will have a direct impact on whether we have an economic crisis twenty or thirty years from now.  When you look at China, Japan, Australia, the United States and other countries with respect to population growth and immigration, some have started to ask if there is a population growth solution to sovereign solvency.
Another example is the relation of savings in China to population growth and the one child family.

Economics to be properly applied needs a very multidisciplinary approach.

Financial regulatory reform: We have in the past listed the failure of the US Congress to move real financial regulatory reform forward and the role of financial lobbyists in neutering, gutting, and making proposed "reforms" actually less effective than the one's currently on the books.  Greece, Spain, etc have shown the need for financial reform in their countries also.  Some have tried to delay financial regulatory reform by calling for coordinated global financial reform regulations.  Each country needs to act now.  Global coordination should be pursued, but it is not an acceptable excuse to delay needed reforms in individual countries.  One only has to look at Canada to see how financial regulations there significantly controlled the impact of the current global financial crisis.  In fact, a case could be made that past global coordination agreements are directly inhibiting financial regulatory reform. 

I have repeatedly stressed that these, as well as other, macroeconomic issues not only have a direct effect on economic and political decisions but investment decisions and portfolio management.




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Friday, February 5, 2010

Greece, Spain, and the Euro Trojan Horse

We have written and commented on Greece and Spain as well as Iceland, Italy, Ireland, and Portugal.  This week saw a rash of sovereign debt credit default swap speculation driving the costs of CDS for Greece, Spain, and Portugal higher as well as other countries, including the United States.  The speculation is another example of the need for derivatives regulation and a transparent trading and recording market.  The fear of sovereign debt default by a European Union Euro currency nation is a wasted exercise, unless you are profiting from the same type of unregulated speculation which helped bring Bear Stearns and Lehman down and drove Merrill Lynch and Morgan Stanley into larger, more systemically dangerous relationships.

The problems in Greece and Spain are vastly different, but both are derived from the Euro.  Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate.  Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate.  The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands.  Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.

Spain has more immediate problems.  The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution.  In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation.  Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency.  When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up.  The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future.  This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%.  The unemployment situation places a much more immediate pressure on the Spanish problem.

If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions.  Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits.  These enforced budget austerity programs are both reducing public sector wages.  This will fuel deflation.  Prior to the global financial crisis, Spain had a surplus.  The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion.  Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.

In Greece, it is another story.  General strikes are already planned for February 10 and 24.  It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;.  Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result.  Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government?  Greece is raising its fuel tax.  Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries.  Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs.  Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis.  To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable.  Are we to allow the derivatives speculators to become the new terrorist overlords?

There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation.  In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary.  All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country.  To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil.  To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending.  The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.

Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos)  the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have.  Currently, there is every expectation that market pressures will continue and, perhaps, grow.  All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.

Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF.  In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece.  Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap.  The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.

If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.

The possibility of default is speculative hoopla and deficit hawk destructiveness.  While deficits need to be controlled,  targeted public spending grows an economy and the withdrawal of public spending constricts an economy.  At the present time, Greece and Spain need targeted spending and financial regulatory reform.  Default is not a plausible option given the domino effect.

Note:  I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.


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Tuesday, February 2, 2010

Krugman and Canada

In my last post, I said Canada was one of the developed countries that weathered the current global financial crisis better than the United States, because Canada had a more effective financial regulatory system.  Yesterday, Paul Krugman, in an op-ed column entitled "Good and Boring", said Canada is a country which did it right and is an important role model of stability from which we need to learn.

Canada has an independent Financial Consumer Agency and Canada sharply restricted sub-rime lending.  Krugman characterizes the Canadian banking system as boring, because they kept banking safe by strictly limiting banks' leverage while the United States, since Reagan, has lived dangerously on the path of deregulation.  Canada limited the process of securitization.  In the United States the process of securitization was unfettered and became a cash cow for banks to make ever increasing risky bets with other people's money rather than a means to reduce risk by spreading it.

Krugman takes issue with Paul Volcker's assertion that the "... crisis lay in the scale and scope of our financial institutions --- in the existence of banks 'too big to fail' ", because there are only five banking groups in Canada and they are all "too big to fail".  Krugman is not correct in his assessment of Volcker.  Volcker has consistently said derivatives were not only misused but possibly unnecessary financial innovations.  He has called for regulatory reform and breaking up banks which inappropriately combine commercial retail banking with investment/trading banking.  In that Volcker has used the phrase "too big to fail", he is as sloppy as most commentators and media.  As Joseph Stiglitz has repeatedly said and which I have explained for months, the issue is not size or just banks but whether any financial institution of any size without respect to whether it is a big bank, small bank, insurance company, mortgage company, hedge fund, equity investment group, or some other shadow banking firm is systemically dangerous.

In as much as the so-called currently proposed "Volcker" Rule uses the phrase "too big to fail" while keeping the financial system, in actuality, just as it is, Mr. Krugman would be correct in his criticism.  "Too big to fail" is a bogus , if not purposefully misleading, concept which deflects the public from the need to regulate systemically dangerous financial institutions of any size.  In 1998, a single hedge fund, Long-Term Capital Management, came very, very close to causing a systemic failure.  And the United States made no attempt to correct that crisis with financial regulatory reform.

Krugman also is not correct in his assertion that Canada proves that keeping low interest rates over a long period of time does not aggravate and lengthen the recession (I also believe it keeps unemployment high).  In fact, Canada has had a more active intervention with the use of their overnight rate and it has been at a higher rate, 25 basis points as opposed the US federal funds rate of zero to 25 basis points, for a shorter period of time.  Krugman does not believe the Fed lowered interest rates too low too fast.  I do not agree.

Here is a comparison of the Federal Funds Rate and the Canadian Overnight Rate:

6/30/05                                   3.25                                                  2.50
7/9/05                                                                                              2.75
8/9/05                                     3.50
9/20/05                                   3.75                                               
10/18/05                                                                                          3.00
11/1/05                                   4.00                                               
12.6/05                                                                                            3.25
12/13/05                                 4.25                                 
1/24/06                                                                                            3.50
1/31/06                                   4.50
3/28/06                                   4.75                
4/25/06                                                                                             4.00
5/10/06                                   5.00
5/24/06                                                                                              4.25
6/29/06                                   5.25
7/3/06                                                                                                3.75
7/10/07                                                                                              4.50
9/18/07                                   4.75
10/31/07                                 4.50
12/4/07                                                                                               4.25
12/11/07                                 4,25
1/22/08                                   3.50                                                     4.00
1/30/08                                   3.00
3/4/08                                                                                                  3.50
3/18/08                                   2.25
4/22/08                                                                                                3.00
4/30/08                                   2.00
10/8/08                                   1.50                                                      2.50
10/21/08                                                                                              2.25
10/29/08                                 1.00
12/9/08                                                                                                1.50
12/16/08                                  0 - .25
1/20/09                                                                                                1.00
3/3/09                                                                                                    .50
4/21/09                                                                                                  .25

The Fed has made its quantitative easing nest and will have a much more difficult series of exit strategies to execute if they are to sustain even a slow recovery which is why the recession will be long and drawn out and unemployment will remain high.  How difficult will it be to exercise monetary policy to control inflation and output gaps in a slow recovery with high unemployment?

The United States must learn from Canada as well as Australia and France.  The United States needs an independent Consumer Financial Protection Agency, transparent derivatives markets, regulation of securitizations, a modern version of Glass-Steagall separating commercial retail banking from investment/trading banking, and financial regulations which limit, if not prevent, the existence of systemically dangerous financial institutions of whatever size and regardless of whether they operate in transparent daylight or the shadows.


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