Sunday, November 28, 2010

Economy & Market Week Ended 11/19/2010

The problems of the euro nations as magnified in Ireland have created a whirlwind of concern and doubts among international investors increasing debt costs, bank access to liquidity lending, withdrawal of corporate (foreign?) deposits in Ireland, and currency crisis pressure on the euro.  The amount of research available is almost overwhelming and much will have to be overlooked given time constraints.  As you do go through the overview we are providing, please understand that I use the links in paragraphs to provide substantive information which should not be skipped.

Over a week ago in the week ending 11/19/2010, Ireland, the ECB, EU, and IMF were going back and forth and the rumors were flying with Ireland denying bailout talks and the ECB and IMF supposedly demanding bailout for Ireland.  What the focus on Ireland has done is more brightly expose the problems of the European Monetary Union  and its failure to construct a fiscal union, of which Munchau wrote during the week, structure which would allow it to respond to the particular fiscal needs of its individual sovereign nation members and how this is creating a growing, and potentially, cascading currency crisis which is reflected not only in debt and swap prices but in the declining value of the euro.  While the banks in Ireland created, with the help of foreign investment,  serious financial problems through the profitable misallocation of resources until the mismanagement and/or fraud caught up to them in the financial crisis of 2008 and the debts and losses of the banks suddenly became those of the common citizenry rather than the bankers and senior bond holders who want the profits and not the losses.  Then, having taken on the private bank debts and guaranteeing the senior bond holders and earning accolades for its austerity program, the government of Ireland met the inevitable in reduced revenue and less economic growth aggravated by austerity programs and bank toxic assets worth far less than estimated rolling around in an ill conceived bad bank, which made government issued bonds a problem for the ECB, and nationalized framework compounded by growing loss of faith by foreign investors.  Rather than focusing on the banks and their financial participants, the people of Ireland are being told they have too much debt and its their fault the government budget has a growing deficit gap.  While the government has made political spending mistakes and cultivated some inefficient policies, the primary cause of their present dilemma is private bank debt assumed as public debt as the Irish government curried favor with the European Union and the European banks who are among the senior bond holders of the Irish banks.

The bailout debate revolved around whether the bailout would provide funding for Irish banks only or the sovereign government of Ireland or both.  The formal process of bailout application and consideration was much touted but pushed aside as the IMF, ECB, and EMU sought a forced bailout to stem the loss of faith in eurozone debt and failure of fiscal policy response within the eurozone as the result of how the euro was created as well as concern the EMU emergency funding mechanism (ESFS) has not been funded.  The bailout figures were rumored to be 80 billion to 140 billion euro with EU "partner" enthusiasts voicing approval of a bailout which would provide support and those who saw a bailout as the only hope for an austerity deprived country without its own currency, weak banks with liquidity problems, rising debt costs, and only limited authority to exercise normal fiscal policy.  While members of the Irish government kept insisting Ireland is well funded and does not need a bailout, the Governor of the Irish central bank was publicly adamant there was no choice.  Given the ruling political party has been in charge during the growth of bank financial abuse and mismanagement prior to the 2008 financial crisis and readily assumed the bank's private debt as public debt, the current political situation appears to be leading to new parliamentary elections.  Many are pointing out that Ireland is not Greece and it may have the economic strength to default, withdraw from the euro, give bank equity, through the issuance of contingent convertible bonds or the use of debt as legal tender, for bank debt (bondholders), or form a monetary union, as Samuel Brittan has in "Conventional Wisdom, the Royals, and the Republic", with the United Kingdom.  Attempts to get Ireland to raise its corporate tax, even though it is not substantially different from other corporate tax rates in Europe, have been seen as yet another attempt to destroy Irish independence.  Much of this anger has been directed at Germany which continues to insist that future bailouts must include bondholders sharing in the losses, which is not an unreasonable request except that, at this particular point in time, it is increasing international doubt about the euro and encouraging increases in debt costs.  Given the exposure of German banks to Irish private and bank debt, Germany's insistence on bondholders sharing in the losses, while politically popular in Germany, is counter productive to Germany's own economic stability, which it clearly understands would not be served well by failure to support Ireland.  If this credit crisis is allowed to fester and move from country to country on growing doubts the European Monetary Union will continue to refuse to allow the currency to support appropriate fiscal policy, it will spread beyond Portugal to Spain, Italy, Belgium, and even Germany as the costs mount towards 1650 billion euro of untimely and austere responses.  If the eurozone were to act with any reasonable degree of fiscal unity, or even just move towards a mechanism of fiscal unity involving support of fiscal policy relevant to each individual sovereign member ( some people might call these fiscal stabilizers), the demonstration of compromise and a common benefit would do more to stabilize international doubts than bailout after bailout.

While the European Council has agreed to consider a sovereign debt default mechanism, but the politics of its construction may very well make the eurozone more fragile, much like the failed Exchange Rate Mechanism and its incentives for speculation, by an acceptance of continuing financial crisis.  It has also accented the possibility of default and bond haircuts at a time of current interest rate pressure on debt.  A monetary union requires fiscal assistance between its members rather than a reliance on moral hazard, in which the inconsistencies of the European Monetary Union are excused in the name of debt vigilantism austerity and the necessity to protect banks at the expense of the people.  Despite Ireland's insistence it is well funded into 2011, the banks in Ireland have seriously limited access to interbank lending internationally; this has aggravated the Irish banks long term liquidity in a threat from bank funding constraints.

Yet, the financial forces in Europe and the world are insistent it would be preferable to have sovereign default in which private bank debt has been made public debt rather than banks failing and bankers losing money.  On the one hand Germany is pushing for a sovereign default mechanism and bondholders sharing in the losses as if Germany does not have a clue that German banks followed by UK banks have the most exposure to Irish bank and private debt.  Germany's leadership is bringing the question of whether the euro can survive into ever more contention and that contention is costing other euro nations more and more in debt costs.  In the meantime, the myth of German prosperity under austerity belies the large fiscal stimulus program which buffered Germany in the 2008 financial crisis.  Of more concern is the refusal of German politicians to acknowledge the success of their fiscal stimulus program and continue to assert austerity as the only economic path.  Germany is headed back to a record current account surplus despite its captive eurozone market countries debt problems, which have been partially caused by the different exchange rates and the effect of those rates over the years to create seriously out of balance current accounts within the single currency eurozone.  This can bee seen most clearly in Greece, in which the loss of competitiveness as the result of these current account imbalances and exchange rate dynamics, may demand Germany extend its credit to Greece in order to stimulate the divergence in the cost of capital with the emergence of counterparty risk.

As the austerity infection multiplies worldwide, the United States is proving itself an increasingly willing victim as politicians avoid getting things done, such as creating jobs and reducing excessively high unemployment and creating regulations which will make bankers responsible for systemically dangerous, however profitable, business conduct, as it is easier to join the crowd which proclaims the bailout of banks as enlightenment and the very fault of the people upon whose backs the cost of the bank bailouts is being foisted as shared sacrifice; people who obviously cannot properly manage the debts placed on their backs by bailouts as well as the banks can shift their losses to the people and become larger and more powerful.  There are those who would rewrite history, and President Obama has fallen into this trap, and insist President Franklin Roosevelt did not take action until riots forced his hand in 1934 which is patently false.  Unlike President Obama, President Roosevelt was not persuaded by the financial interests and outgoing President Hoover to reaffirm the status quo commitments to a gold standard, support of the private banks, and austerity.  With the recent report of the Deficit Commission, which reads like a litany of its members vested interests and historical prejudices, the economic debate may be pushed back even further from public debate as blame is transferred from bankers and financial traders to the irresponsible people and any government which provides programs to serve people.  As this report is analyzed going forward, it is obvious that it just places more of the burden on the backs of the citizenry, even proposing a national sales tax., and the diminishment of that troublesome middle class.  But when it comes to tax breaks for the wealthy, the economic cost to government is thrown out the window as we have demonstrated in past articles with false arguments that such tax breaks will stimulate the broader economy.  President Obama appears willing to cave, yet again, to the financial elite.

The mortgage mess continues despite financial institutions attempts to throw the problem back onto the victims of the fraud who are just trying, in the version put forth by the banks and mortgage servicers, to put off foreclosures resulting from their deadbeat life styles.  The problem with these fraudulent documents is not just a subversion of contract law and due process but the possible risk of billions of dollars in losses, as we have reported previously.  The Congressional Oversight Panel has issued a new report on the mortgage processing problems with detailed analysis of different scenarios depending on the depth of the legal problems involved.  Congressional hearings have not gone well for the bankers and the mortgage servicers.  But public hearings do not always translate into real governmental action as the public performance is always easier than the delivery of service to the public good.  Already a backdoor attempt is being made to retroactively make the whole mortgage processing mess and lack of legal documentation legitimate, although many financial bloggers have sniffed it out and raised the hue and cry of the hunt, despite PR attempts to dress the proposed legislation as just a modernization of the Interstate Commerce laws.  Still the lobbyist and lawyers are hard at work to build a see no evil, hear no evil, speak no evil defense.

Federal Reserve Chairman, Bernanke, gave two speeches in Europe: one on "Rebalancing the Global Recovery" and the other on "Emerging from the Crisis: Where do We Stand?" in which he recognized the need for fiscal stimulus (by government) to impact high unemployment to enhance long term growth, criticized China for its undervalued currency and use of capital controls noting the long term effects on the world economy are negative, and noted slower expansion in the United States, declining inflation, and continued high employment while defending QE2.  With China's internal concerns with rising inflation and lending bubbles, it is unlikely they will do more than allow the renminbi to slowly appreciate within a trading range as they adjust the middle point slowly up and will concentrate on interest rates, price controls, and industrial production for internal consumption.  Many view the Chinese monetary policies and the Fed's QE2 as both promoting inflation in other countries and as self-serving exchange rates in trade, defacto devaluation, and favored monetary credit position.  The G20 meeting did nothing to defuse the confused global monetary systems and exchange problems flirting with currency trade wars, despite the growing awareness that what we have now does not work and will be replaced one way or another.  The political scare mongering in the United States that QE2 will cause inflation is so hyper unrealistic as to deny the factual reality of the economic data.  I have been very vocal that QE2 will have little effect on the economy and will primarily benefit bank liquidity as the banks continue to build cash reserves.  The political attacks on the Fed and QE2 have gone beyond monetary policy debate and have become a construction project in which the mess created by the banks and their political supporters is being excavated and transported to the door step of the Fed alone rather than taken to Wall Street and Washington, D.C. where the dirt belongs.  QE2 is a basic acknowledgment that the yield curve on short term Treasuries had no room for movement and lowering the rates of longer term Treasuries, through Fed purchase on the secondary market, might spur new investment and consumption.  The thinking is correct, but the situation is such that the consumers pocket is under pressure and corporations only spend money to make money and if not enough people are buying than no one is going to be spending as much as the economy needs to revive itself from this most recent sacking by the financial vandals who grow fatter as their failures are are sugar coated with profitable bailouts.

More analysts are predicting a Chinese real estate supply shock within a year which might destabilize prices short term but this could be seriously aggravated by how the inventory wave comes to the market, i.e., how fast and how large.  China has been tightening interest rates, lending policies, and increasing down payments.  China is fully aware that this potential real estate bubble exists and must be controlled as we have written in the past.

Michael Pettis wrote an interesting analysis of the need for China's growth to slow and what the effect of that slowing down will have on the world economy and to China internally in which he took exception to the commonly voiced concerns that a Chinese slowly would mean a sharp downturn in global growth and cause social and political instability within China, because he believes the impacts will be very dependent on how China actually rebalances.  He uses the Japanese slowdown, which began in 1990, as a detailed example of what might happen in China.

Eggertsson and Krugman wrote an economics paper on Debt and Deleveraging which attracted vast attention for an economics paper which created a model and economic logic in which a temporary deficit is shown to be necessary and beneficial during a balance sheet recession.  Like all model and economic logic constructs it includes assumptions which are worth investigating and has caused much comment.

John Hussman in his November 15th commentary again stressed the need to evaluate the market with in the full context of conditions and indicators as well as the historical relationship between current high profit margins and poor earnings growth going forward over five year periods. The failure to adjust richly valued stocks with high P/E multiples for the level of profit margins ignores the measures of sustainable, long term, full cycle financial performance.  He is concerned that the "economic recovery" with high unemployment and stagnant personal income with huge amounts of debt hidden under rugs and dressed up for balance sheets is illusory and festering until it reignites.  He believes the only way to deal with a major debt crisis is through debt/equity swaps, restructuring, and writedowns.  His example is the failure to resolve the mortgage problems equitably for both lender and borrower.  He wants to see swaps of principal for pooled property appreciation right administered, but not subsidized, by Treasury.  "...until our policy makers wake up to the need to restructure debt, so that the obligation is modified for both the debtor and the creditor ... we are racing toward the financial equivalent of a mathematical singularity, where the quantities become so large and the outcomes become so sensitive to small changes that the whole system becomes unstable."  He finds the market climate for both stocks and bonds to have become unfavorable.

Market: 3 banks failed = 149; unofficial problem bank list = 903

                           Dow/Volume                                             Nasdaq/Volume
Mon:           9.39/down 13.1%                                     <4.39>/down 16.1%
Tue:      <178.47>/up 51.9% market in correction  <43.98>/up 21.2%
Wed:           <15.69>/down 28.5%                          6.17/down 18.8%
Thu:             173.35/up 27.2%                                        38.39/up 12.6%
Fri:                22.32/down 9.1%                                       3.72/down 10.0%

Total                  10.90                                                               <.09>

Mon: Oil down 2 cents to $84.86; Dollar stronger; day ended flat after being up most of the day; retail sales were up moderately but the New York Fed Empire State Index (manufacturing) was surprisingly down; Ireland and EU in talks despite Ireland's denial of bailout need.

Tue: Oil down 2.52 to 82.34; Dollar stronger; European "debt" problems and Ireland resisting aid; Chinese expected to place inflation curbs on food, etc by end of week.

Wed: Oil down 1.90 to 80.44; Dollar weaker; lower volume rally ends slightly down and mixed; oil supplies were down 7.3 million barrels, gas supplies were down 2.7 million barrels, and distillate was down 1.1 million barrels.

Thu: Oil up 1.41 to 81.85; Dollar weaker but stronger against the yen; GM IPO surges world markets but ends day at lower end of GM trading range; Ireland assistance expected; weekly jobless claims were up 2000 to 439,000, 4 week moving average was down 4000 to 443,000, and continuing claims were down 48,000 to 4,295,000.

Fri: Oil down 34 cents to 81.51; Dollar stronger but weaker against euro; very low trading for an options expiration day.

United States:
The Consumer Price Index for October was up .2 for an annualized 1.2% rounded.  Core CPI for October was zero with an annualized rate of .6, which is the smallest 12 months in the history of the index which dates to 1957.  If the 1980's calculation for CPI was used the annualized rate would be approximately 8.3%; if the 1990's calculation was used the annualized rate would be approximately 4.4%.

The ECRI Weekly Leading Index is up to <4.5> from <5.5> and, just as last week, this is the highest in 5 weeks.

We have repeatedly emphasized the large contribution of inventory rebuilding in the growth of GDP in recent quarters.  Given the build up over those quarters and the $110 billion inventory increase in Q3, it is possible that Q4 GDP will see a negative impact even if there is a strong inventory increase but substantially less than Q3.  With the mismatch between new orders and inventory levels, it is conceivable growth will be negatively impacted in coming quarters.  Despite other indicators, the mathematics of inventories could expose a recession.

California intends to restructure the sell of $`14 billion in bonds in the face of a sell off in the municipal bond market.  California will sell $10 billion in revenue anticipation bonds due May and June, then $2 billion in Build America Bonds, and then $1.75 billion in tax exempt bonds.

30 year AAA muni bonds rose 15 bps points in the week ended 11/12; largest increase in 18 months.

Goldman Sach's plan to repay Berkshire Hathaway has been delayed as the Fed reviews the process for setting a dividend increase policy for banks.  By Wednesday, the Fed announced it would examine large bank holding company's ability to absorb losses and meet new capital requirements under Basel III when deciding whether banks may increase dividends or buy back shares.

The government amended the regulation on grandfathered status under the health law to allow group health plans to switch health insurers providing similar coverage at a lower cost without losing their grandfathered status.

U. S. retail sales in October were up 1.2%.

New York Fed Empire State Index (manufacturing activity) was down to 11.7 from 15.7 --- unexpected --- for first time in more than a year; new orders were down to <24.4> from 12.9; inventory was up to zero from <11.7.

U.S. business inventory was the highest since October 2008 up .9% to $1.4 trillion; sales were up .5%; inventory to sales ratio was unchanged at 1.27 months.

EMC will buy Isilon for $2.25 billion; Caterpillar will buy Bucyrus for $8.6 billion.  Is this a wise use of cash?  When companies buy another company, are they investing for synergistic growth or are they using idle cash not worth using to increase sales?

BHP is abandoning its Potash bid and will do a $4.2 billion stock buy back.  This is another possible misuse of idle cash depending on the fair value of the company's stock making the buy back.

Lowe's sales missed analyst's expectations with Q3 earnings of $404 million or 29 cents per share; sales were up 1.9% to $11.59 million (expected $11.75 million) and up .2% same store.

Home Depot beat Q3 EPS estimates on tighter cost controls, but softened its full year sales forecast; net income was $834 million or 51 cents per share; sales were up 1.4%.

Wal-Mart Q3 earnings were 95 cents per share (expected 90 cents) up from 82 cents a year ago; sales were up 2.6% vs year ago (below expectations); U.S. same store, ex fuel sales, were down .7%.

CapitalOne credit card charge offs in October were to to 7.26% from 8.38%; 30 day delinquencies were down to 4.45% from 4.53%.

Lacker (Richmond Fed) said the Fed's new monetary easing is potentially dangerous and likely to be ineffective.  "Trying to keep unemployment lower than it otherwise would be is a recipe for continually accelerating inflation."  He does not believe Fed QE2 is designed to weaken the dollar and is not currency manipulation.

Dudley (New York Fed) said QE is not aimed at weakening the dollar; the Fed has no dollar value level target; it is just trying to ease financial conditions.  QE2 will not have a powerful effect on the U.S. economy, but even a little nudge will help according to Dudley.  He said the Fed is trying to avoid a "stall speed for the economy".  He rejected the idea the Fed should target a higher inflation rate.

GM raised the price range of its IPO to $32-33.  We have already written that it is oversubscribed and not offered through several discount brokerages, which means individual investors will have a very difficult time buying and that may be just as well.  It might be better to see how it is trading six months after the IPO.

Paulson & Co. hedge fund sold 100% of its Goldman Sachs holdings, 18% of its bank of America shares, 16% of Citi, and 11% of Wells Fargo as the result of regulatory changes and the mortgage mess.

FHA auditors said its capital reserve ratio was down from .53 to .50 primarily as the result of more conservative assumptions of future housing values.


PPI (Producer Price Index) wholesale prices were up .4% (expected up .8%) and core PPI was down .6% (expected up .1%).  These were considered deflationary.

Federal Reserve reported October capital utilization was flat at 74.8 with industrial production unchanged at 74.6.

Senator Corker wants the Fed to forget about price stability and full employment and focus on inflation, which is price stability.

Bank of America was ordered to $500 million of deposits seized from Lehman.

Bullard (St. Louis Fed) said that "to extent possible" the U. S. needs to let the private sector provide the bulk of U.S. housing financing and he wants lower income financing support separated.

Rosegren (Boston Fed) said U.S. needs short term fiscal stimulus to boost jobs and complement the Fed's moves.  He said that without QE2, there was a risk of further disinflation.

CoreLogic reported housing prices in September (3 month average) was down 1.8%.  According to the Census Bureau, housing starts were down 11.7% in October from September, which is an 18 month low.

Foreign ownership of U. S. Treasuries was up $39.5 billion in September; China's purchases were up 1.7% to $883.5 billion in the third monthly increase.

19 banks will have new stress test by the Fed in early 2011.


The FDIC is probing at least fifty cases of possible fraud and other criminal conduct at failed banks.

Mortgage applications were down 14.4% the week ended 11/12 to a four month low; 30 year mortgage was up 18 bps to 4.46%, which is a two month high.

Two million people will lose unemployment benefits by the end of December if Congress does not renew extended benefits.

Bank of America modified 52% more mortgages in October than September.

Philadelphia Fed business activity index was up to 22.5 November from 1.0 October --- the highest since last December --- and new orders were up to 10.4 from <5.0>; inventory was down to <18.6> from <5.9>.  This is in direct contrast to the New York Empire State Index.

S&P 500 earnings since Q1 2009 low have increased over 900% (see the Hussman commentary above) to just over the level at the peak of the last dot com bubble.

SEC will consider a proposal to require registration of advisers to hedge and private equity funds with more than $150 million in assets under management.  With the CFTC, they are working out the details of what and how swap trade data will collected and stored.

Mortgage delinquency rate was down .72% Q3 to 9.13%; the foreclosure pipeline was down .18% to 4.39%.

U.S. has found 13 million metric tons of rare earth deposits.

After the market closed Friday, Green Mountain Coffee said it will restate its financial statements for the last 4 years to correct reporting errors.

Fuel prices are expected to be the highest in 3 years this Thanksgiving despite oil prices dropping.  Fuel prices are expected to fall after the Holiday.

International:
United Kingdom inflation was up to 3.2% October on increased taxes, fuel, bank/mortgage fees, and computer games.  Core was unchanged at 2.7%.  Next Plc, the second largest clothing retailer, indicated prices are going up approximately 8%.

There is originator support of structured finance deals in Spain which are enabling the banks to maintain collateral eligibility for repo with the ECB.

Benedicto Marzinotto argues that the G20 definition of the 27 member EU as a single region, including the eurozone, makes the trade imbalance seem better than it really is for the member nations.  She also argues that the EU commission's position that trade imbalance are the result of competitiveness issues and can be controlled by wages and prices and exports ignores much more complicated nation by nation problems.

Austria is insisting Greece has not met its commitments and Austria is refusing to release its contributions to the Greek bailout.

Goldman Sach's has a sixteen page analysis of Ireland which sees more upside than downside.  By the end of the week much was being made about the corporate account withdrawals (foreign?) from Irish banks, which was being hyper characterized as a "bank run" when there is no evidence domestic demand deposits are being withdrawn, and about the contradictions and counter productive actions and policies within the EU and eurozone.

Japanese GDP Q3 was 3.9% annualized, but Rebecca Wilder says it is not sustainable and has a decent chance of turning negative in Q4 2010.  On a side note, Rebecca Wilder subsequently announced she will not be blogging any longer due to work and family commitments, her intelligent observations will be missed and hopefully she will post from time to time.  She is a very intelligent economist and any objection or question I may have had in the past about the use of a term is to me a normal part of educational discussion and debate.

German Landesbanken (savings banks) have refused German government offers of recapitalization and have only until year end when the offer terminates.

Bank of Korea raised its 7 day repurchase by 25 bps to 2.5% to curb inflation.

Spain Q3 GDP was flat to Q2 as the result of austerity cuts.

Strauss-Kahn (IMF) said Germany's recovery will not last long if conditions do not improve elsewhere.

Singapore GDP was 10.6% Q3, but expects it will slow sharply next year with lower U.S. and European demand.

The OECD expects 2.8% growth for its 33 member nations (4.6% for the world) as households and firms reduce debt.

South Korea is considering a tax on foreign investment in its government bonds.

Spain sold 3.6 billion euro of 10 year and 30 year bonds, both of which were up 50 bps in yield.  This auction was essentially a positive investor response.

China, for the second time in two weeks, ordered bank reserves raised 50 bps to 18.5% to strengthen liquidity management as they continue to manage price pressures cautiously. The frequency of these announcements spooked the market which went down as did the price of oil.

The OECD expects Germany's current account balance surplus will back to 7.2% by 2012, which would be close to the record 7.6% in 2007, and sees Germany going back to the same pre-crisis pattern.

Allied Irish Bank says customers, but made no attempt to specify what kind of customers, have pulled 13 billion euro this year and mortgage problems worsened in Q3.

Samuel Brittan suggested Ireland withdraw from the euro and form a monetary union with the United Kingdom.  Gavyn Davies wrote of the need for Europe to compromise if financial crisis and the fiscal problems of the eurozone are to be solved. Wolfgang Munchau wrote of the failure of the eurozone to structure a fiscal union, which is a problem I have also written about on more than one occasion.  All of these were linked in the Irish paragraphs at the beginning of this article, but I am repeating them here because they are important.

Strauss-Kahn of the IMF said, "Europe needs a holistic growth strategy. where every country benefits from the efforts of all others."


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Friday, November 19, 2010

Economy & Market Week Ended 11/12/2010

Ireland Ireland Ireland.   Of growing concern is the potential mortgage default torrent building up in Ireland as families struggle to pay bills and keep up on mortgage payments.  At least one in eight, or approximately 100,000 are under water.  In a country where losing your home is a deep shame, there is a growing feeling that the homeowners played by the rules, but the banks did not.  Now the banks are being saved and the homeowners are not, while their government has chosen insolvency to aid the banks but not its citizens.  Ireland had until September to renounce the bank guarantees on the grounds they had withheld material information and turn the approximately 75 billion euro debt held by the government into shares.  Instead, the Irish government chose to repay 55 billion euro of bank bonds maturing in September, primarily to other European banks.  Are the Irish politicians beginning to be perceived by the Irish as more concerned about their eurozone partners than the Irish people?

The material this week on the crisis in Ireland and the EU has been voluminous and we used much of it in this post on "Ireland Betrayed".

Just as they did in January during the Greek crisis, Germany casts doubt on European fiscal solvency again with Ireland and the cost of debt and bond spreads went up just as they had in January.  These increased costs and doubts have spread not just to Portugal but also to Spain and Italy.  Still, Germany persists in raising the debate on restructuring debt resolution, private creditor participation, and the bailout mechanism.

As students protested in London over austerity cuts in education, the proponents of austerity are still arguing that austerity is a proper reaction to financial crisis, because it destroys access to capital markets making it harder for countries to issue debt.  It is interesting how these papers and viewpoints always seem to pick narrow periods of time and discreet time examples within a country and ignore the more complete time line and different situations, responses by different governments, and the which were the most successful.

When Sweden discontinued emergency loans a month ago, short term interest rates began going up putting pressure on covered bonds, which are composed of mortgage revenue, and creating a sell off in the mortgage market. Swaps and spreads increased creating liquidity pressures.  This should serve the ECB and Trichet as a case study of what might happen when the ECB withdraws emergency measures.

At the G20 meeting in South Korea, Geithner backed away from current account targets and China endorsed the Fed QE2 (quantitative easing) in an easing of tensions.  This did not stop other, particularly emerging, countries from criticizing QE2 as an attack on their currencies, as promoting inflation in their countries, and, by Germany, as delays in belt tightening, while others in the United States praised QE2 as promoting the need for global fiscal expansion and financial reform.  Wolfgang Munchau took German economic and financial leaders to task for philosophical intransigence on QE2 while they ignore economic policies which have created European and global current account problems which directly benefited German trade, reaping the huge financial rewards which was very much needed in the difficult process of integrating East Germany into a unified Germany.  Munchau also criticized the German leaders as basically wrong in their perception and application of common economic thought on monetary policy and real exchange rates as opposed to nominal exchange rates.  The World Bank said other countries may need to resort to capital controls as QE spurs asset bubbles in equity, currency, and property.

Asian Pacific economies (APEC), including China and the Untied States, are laying the groundwork for a vast free trade area despite currency disputes and geopolitical rivalries.  At the same time, the United Kingdom was seeking increased trading ties with China. Cameron and Obama were both traveling the world to promote trade (exports) just as the countries they visited want to export more also.  Could their time be better spent promoting the development of  products at prices others want to import?

Fisher, Dallas fed President, said that QE2 could create a bubble in U.S. private equity.  Bank of America and J. P. Morgan are leading lenders in doubling leveraged-loan sales.

In the United States the debate ( even Fed officials are split) on the effectiveness of QE2 continued with Roubini calling it a necessary evil and advocating that the ECB needed to exercise monetary easing in Europe despite German objections.  Alford has characterized QE2 as an attempt to make two wrongs into one right by trying to increase GDP and employment via asset price increases and wealth effects while devaluing the dollar.  Alford argues that the Fed does not know how to deal with external shocks and should refocus on regulation and offsetting swings in popular anticipation of economic movement contrary to actual economic conditions, such as anticipating inflation when the economy is disinflationary.  Stiglitz is concerned that QE2 will do little to help the economy, but it may trigger currency and trade wars leaving the U.S. alienated and the world worse off, because competitive devaluation comes at the expense of others.  Stiglitz would prefer that world leaders enter into a growth compact and cooperation of efforts.  He would like countries to discourage short term inflows and encourage long term investment by regulation.  Tom Duy notes that despite some positive economic data the economy still appears to be stagnating at the potential level when we need dramatic faster growth.  This would mean that potential output rather than growth should be the target and the Fed should step up its quantitative easing, but Bernanke has made it obvious that he has no such plans.  At the same time, Duy acknowledges that the QE plan is ineffectual while monetarily risky with the persistently low levels of labor utilization as the dark side.  It comes down to the need of the government to deploy fiscal programs  necessary for economic growth.

Econbrowser demonstrates that the run up in commodity prices is correlated with a monetary phenomenon such as a weak dollar and a fixed trading range renminbi.  More importantly, he feels that the Fed needs to pay attention to commodity prices in the exercise of their monetary policies, particularly if the price of oil approaches $90.  Interestingly enough, commodity prices fell during this week as China made several announcements on interest rates and how housing purchases are financed which caused the international markets to believe economic tightening is coming to China.  China has been making such announcements for some time as it slowly attempts to control inflation, but these were more than usual and even included multiple announcements in essentially the same economic areas.

Prior to the G20 , the head of the World Bank intimated that the world should consider a return to the gold standard letting loose a barrage of criticism against him as the gold standard has been seen as a driving reason the Great Depression lasted as long as it did.  Zoellick back pedaled later and said that was not what he meant, but Bill Mitchell took him to extensive task in very detailed fashion as to why Zoellick must have had a "brain attack".

Daniel Gros succinctly details the monetary consequences of a reserve currency, a free floating currency, and a managed currency with capital controls.  Emerging nations now and Germany with the Deutschmark in the 1970's want and wanted no part of being a reserve currency with wide exchange rate swings which do not help exports.  When the Deutschmark became a reserve currency in the 1980's, just such swings had a large impact on the German economy and the adoption of the euro allowed the reserve currency effect to be spread over a wider area with Germany benefiting from favorable exchange rates within the eurozone.  The United States benefits with low debt costs and has never relied on exports (exports and imports average only about 15% of GDP).  China benefits from a competitive advantage of being able to set the exchange rate for its currency.  This has created a situation in which the United States envies China for its jobs and China envies the Untied States for its investment opportunities.  While the United States could prohibit China from buying U.S. debt and thereby impose capital controls, it could also destroy the U.S. position as the financial center of the world.  For Gros, the choice the U.S. has is between job creation and a more competitive exchange rate or the privilege of cheap debt financing.  Europe is stuck in the middle with all of the disadvantages of the U.S, and none of its privileges.

In a letter to the Financial Stability Oversight Committee, Simon Johnson explained the importance of the proper implementation of the Volcker Rule in controlling systemic risk in financial institutions which financially motivated to not practice proper risk management.  In an interview, James Gorman, the chief executive of Morgan Stanley, said financial institutions which are failing as the result of reckless mismanagement should be allowed to fail and went to express concern that the Volcker Rule could cause financial institutions to not be able to make markets resulting in market liquidity problems, depending on how it is implemented.  The financial sector, as we have indicated in the past is attempting to neuter the Volcker Rule through lobbyist efforts in this implementation process.

Questions have arisen as to whether Citi's auditors, KPMG, have provided inadequate advice which has resulted in Citi putting only $1 billion in reserves against repurchase risk when it has a half trillion dollars in mortgages with put back exposure.  The banks want the foreclosure mess/fraud to just go away, but documents are being found defective and some state attorney generals, such as Ohio's Richard Cordray are actively seeking settlements.  The sale of derivatives to local and state governments has cost taxpayers over $4 billion as the interest-rate bets turned sour.  Meredith Whitney expects increased financial regulation to decrease regional banks profitability and has characterized the foreclosure mess as similar to the tobacco lawsuits that have been going on for over forty years.  G20 nation Banks got a one year relief from tighter risk management rules, because the study on how it is to be done will not be complete by the end of 2010 and will take another year until the end of 2011.

The deficit Commission report has made quite a splash as people have begun wading through it, but it has been highly criticized as very muddled in its analysis of what is a long term debt problem and its failure to address the cost of health care as a major driver of increased spending.  It did go after social security, defense spending, retirement plans, Medicare, taxes, "tort reform", discretionary spending, and federal salaries and workforce without substantive scenarios documenting actual efficiencies.  The blog, ataxingmatter, did a good analysis of the report and came up worried that it does nothing to solve the current economic problems and would probably be counter productive to creating growth and jobs.  Mark Thoma listed several commentaries and reactions.  Do not be surprised as this unfolds and more time is spent looking at this report that it just may raise taxes for the middle class and lower taxes for the wealthy.

Cisco disappointed on its Q3 results and the weaknesses were attributed to local and state government austerity.

The Kauffman Foundation released a new study on ETFs characterizing them as sources of significant market disruption.  It accuses the ETFs of setting the market prices rather than the underlying stocks in the ETF.  Industry commentators immediately took exception in which the study was characterized as just plain wrong,  a big lie, and a rambling diatribe.  The news release, the actual study, and the three responses cited are embedded in this paragraph for you to read and draw your own conclusions.  ETFs have been traced to the market flash disruptions, although primarily in the way they are traded by market makers, and I have often pointed out that, although they track indexes, they have a pattern of volatility which requires them to have a stop-loss limit order in place just as you would treat a stock.  I have not found them particularly comparable to mutual funds, or as well diversified, as a whole.  It is tedious digging out the tax consequences and distribution policies, which should be transparent to any investor, of a ETF or ETN

John Hussman in his weekly commentary (Monday 11/8) accuses the Fed of treating the symptoms rather than the disease with QE2 and an attempt to replace one economic bubble with another.  In his opinion we have allowed the Fed to assume the role of creator of bubbles when it should be concerned about the level and need of liquidity.  He thinks it is misguided for the Fed to be concerned with unemployment and the cause of inflation is always the expansion of unproductive government spending.  In the sense that the Fed's ability to influence unemployment is directly contingent on the fiscal policy of government, Hussman is correct.  In the sense that unproductive spending by both private and public sources is inefficient and likely to increase leverage in inappropriate sectors and to inappropriate levels, he is correct.  However, inflation is not solely caused by unproductive spending and price stability is a legitimate monetary policy concern.  Hussman is concerned about unemployment and its drag on economic growth, but he sees it improving gradually in 2011 and is more worried about the vulnerability of the housing and financial markets.

Consumer Metrics Institute in its November 9th commentary sees a possible bottom in the contraction event of the current economic event despite its extended duration.

SIFMA, which is a securities industry association, has changed its opposition to a fiduciary standard to one in which a fiduciary standard would put broker-dealers out of business and result in the loss of low cost financial advice to consumers.  This is essentially the same position of the insurance industry and sees fiduciary duty to the best interests of the consumer as impediments to selling. The CFP board (Certified Financial Planner) has passed a 80% increase in dues to be used in a public relations campaign to influence the American consumer that the financial planning designation, with the lowest educational and experience standards and a long and current history of an inability or unwillingness to enforce strong ethical standards of conduct  conducive to serving the fiduciary interests of clients which would be contrary to the best interests of many of its commission based members, is the "only" financial planning designation.  The majority of retirement plan sponsors and retirement plan consultants want mandatory enrollment on defined contribution programs, immediate vesting, government incentives, and tough loan provisions.  While I favor participation in retirement plans, the automatic enrollment and other issues tied to it are often pushed by the very people who are providing the products and earning money managing money, while the employees automatically get enrolled in the most conservative investments which will not finance retirement.  It is all about salespeople in whatever garb making more money at the expense of the sheep.

Market:3 banks failed = 146; unofficial problem banks list = 898

                             DOW/ Volume                                   NASDAQ/ Volume
Mon                     <37.24>;/ down 26.8%                           1.07/ down 14.1%
Tue                       <60.09>;/ up 22.2%   distribution day   <17.07>/ up 20.3%
Wed                        10.29/ up .6%                                      15.80/ down 7.7%
Thu                        <73.94>/ down 14.8%                         <23.26>/ down 25.1%
Fri                         <90.52> / up 6.2% Dow distribution day <37.31>/ down 11.4%

Total                        <251.50>                                            <60.77>

Mon: Oil up 21 cents to $87.06; Dollar stronger but mixed against the yen; little economic news; cyclical stocks up; gold topped $1400.

Tue: Oil down 34 cents to 86.72; Dollar stronger; commodity stocks hurts the most on dollar rally; margin raised on silver positions; gold hit new high and fell; home builders down on bank lawsuits.

Wed: Oil up 1.09 to 87.81; Dollar stronger but mixed against the pound; afternoon rally saved the day; weekly jobless claims down 24,000 to 435,000, 4 week moving average down 10,000 to 456,500, and continuing claims down 86,000 to 4,301,000; oil supplies down 3.3 million barrels, gas supplies down 1.9 million barrels, and distillate down 5.0 million barrels.

Thu: Oil unchanged at 87.81; Dollar stronger; Cisco disappointed on lower capital spending by local/state government austerity.

Fri: Oil down 2.93 to 84.88; Dollar weaker (yen weaker U.S. but stronger Asia); hopes for Ireland bailout but China tightened and commodities sold off; gold ($1365.50) and silver down.

United States:

President Obama was in India on Sunday to drum up trade.

Warsh, Fed Governor, said it is necessary to monitor weak dollar and rising commodity prices to see if Fed asset buys inflationary and the U.S. needs to resume trade leadership.

U.S. mortgage delinquencies were 2.7% Q3 up from 2.6% Q2; 457,000 foreclosures.

Consumer debt was down .9% Q3 to $11.6 trillion; almost one trillion below Q3 2008.

McDonald's same store sales were up 6.5% beating expectations of 5.4%; European stores up 5.8% (expected 4.2%) on France, UK, and Russia; U.S. stores were up 5.6% (expected 6.1%); Asia, Mideast, and Africa were up 5.3%.

Fed survey shows banks eased some criteria for business ad some consumers Q3, but demand for loans stayed weak and is not expected to return to normal levels until after 2012.

The NFIB Small Business Economic Survey showed business optimism up 2.7 to 91.7, which is still a recession reading; sales were up 4 to <13>; <16%> of owners reported inventory increases.

The SEC is very interested in program trading which becomes disruptive and it also issued rules effectively prohibiting "stub quotes" (default one penny trades by market makers).

U.S. wholesale inventory was up 1.5% September; biggest increase (surge?) in more than two years matching July; wholesale sales were up .4% (less than expected).

Ambac filed for Chapter 11 bankruptcy as expected.

Goldman Sachs has suspended foreclosures in all states with judicial review and others as it reviews its Litton Loan Service unit procedures.

FDIC has changed assessments for it insurance fund as required by the Dodd-Frank legislation and large banks will pay more as the assessment will now be based on total liabilities and not the amount of deposits held.

J.P. Morgan faces two class action lawsuits on the mortgage mess.

Ally Financial is being sued by Cambridge Place Investment Management to recoup subprime losses.

PNC Financial is being sued by FHLA Chicago for misrepresentation and omissions on MBS sales.

Schwab joined those suing Bank of America.

Geithner backed away from numerical limits on current account balances prior to the G20 meeting; IMF endorsed the numerical limits idea and Germany dismissed the idea.

Gasoline demand is down .4% for week ending 11/5; down 1.2% vs year ago as retail prices climb prior to holidays.

Volcker said he does not know how to cut unemployment near term as economic growth is likely to remain weak for another year (did he mean if one only used monetary policy?).

IRS set deductible limits for LTC (long term care) purchased in 2011 at <=40 years old --- $340, <=50 --- $640, <=60 --- $1270, <=70 --- $3390, and >70 --- $4240.

GM Q3 profit was $2 billion.

U.S. exports September were up .4%; imports were down 1%; trade gap was down to $44.0 billion from $46.5 billion.

Prudential priced $1 billion stock offering to finance the purchase of two Japanese life insurance units from AIG with 18.3 million shares @ $54.50.

Fed began QE2 with the purchase of $7.23 billion U. S. Treasuries; bond prices lower; yields on 7 and 5 year up.

Individual investors may have difficulty purchasing GM IPO next week as 31 brokers have not been allocated shares, including Schwab, E-Trade, and Ameritrade.  The IPO has drawn $60 billion in orders or 6 times the offering.

Commodities down the most in 18 months on speculation China will boost rates (borrowing costs) to dampen inflation.

U.S. postal service lost $8.5 billion in its most recent fiscal year - for the fourth straight yearly loss.

Intel dividend will be 15% higher in Q1 to 18 cents a share.


30 Year fixed mortgage is down to 4.17%; the lowest since records began in 1971.

October bank repossessions fell 9% from September as faulty paperwork halted the foreclosure process.
The National Association of Realtors reported Q3 home prices were up in 77 of 155 metro areas, which is down from 100 in Q2.

ECRI Weekly Leading Indicators were up to <5.7> by end of week from <6.5> last week.  This is a 24 week high.

U.S. Treasury auctions:
3 year Treasury, $32 billion, yield .575%, bid to cover 3.26, foreign 35.01%, direct 39.72%.

10 year Treasury, $24 billion, yield 2.636%, bid to cover 2.81, foreign 56.6%, direct 9.37%.

30 year Treasury, $16 billion, yield 4.320%, bid to cover 2.31 (worst in year), foreign 38.4% (weak), direct 10.16%.

International:

Brazil's central bank engineered a rescue of mid-sized lender, Banco PanAmericano, which presented no systemic danger but needed $1.45 billion in the form of a loan from the country's deposit insurer.  It generated some panic selling of similar bank shares on the 10th.  The bank had evidently sold some loan assets and kept them on its balance sheet and some may have been sold more than once.  Here are the details and also information on the twenty top Brazilian banks.

South Korea has found an undetermined deposit of rare earths.

Prime Minister Cameron, United Kingdom, was in China to talk trade.

Commerzbank Q3 profit was $158 million (113 million euro) with a drop in bad loan costs on their income sheet.  Analysts expected a profit of 148.4 million euro.  Dresden Bank acquisition operational profit was down 40% vs year ago on weak securities business.

The OECD said China, Britain, France, and India are slowing down while U.S., Germany, Japan, and Russia are picking up economic steam.

Juncker has called for a common eurozone bond, which is a concept I have proposed in past writings on the Pan-European Debt Crisis.

German industrial output was surprisingly down .8% September (expected to go up .5%).  German exports September were up 3% and imports were down 1.5%.

China expressed willingness to help Portugal but did not commit to buy bonds.

China's pension fund chief, Dai Xianglong, has proposed the the U.S. dollar should trade within a fixed trading range like the renminbi.

China auctioned 1 year bills at a higher rate than last week at 2.3497% (prior 2.2913%) and caught the market by surprise.  It is seen as tightening.

Barclay's is confidant is twill achieve Tier 1 capital ratio of 11.5% by the end of 2013.  It cited shrinking bad debts (expected to decline 30%) despite income down 14% (2.83 billion pounds) from Q2.  Q3 had a pre-tax profit of 1.27 pounds.

U.K. factory growth was down to .1% in September --- the lowest in 5 months; industrial output was up .4%.

China October exports were up 22.9%; imports were up 25.3%; trade surplus was $27.1 billion ($16.9 billion in September).

China unveiled new capital inflow curbs.

Ireland's central bank Governor, Honohan, indicated Ireland's troubled banks could be potential objects of foreign ownership.  Ireland's borrowing costs were at a record high on Thursday the 11th.

Greek unemployment in August was up to 12,2% and is projected to climb to 14.5% in 2011 and 15% in 2012.

On Thursday China hiked bank reserves again --- 50 bps effective November 16th and also told  six other banks to increase their rates another 50 bps as of November 15th: KBC, Construction Bank, Agricultural Bank of China, Bank of China, Bank of Communications, and the Shanghai Pudong Development Bank.

Moody's upgraded China's bond ratings to Aa3 from A1 and maintained a positive outlook citing resilient economic performance and balance of payments.

Dubai Group missed a payment on its $330 million loan.

Eurozone Q3 GDP was up .4% (Q2 was up 1%) and 1.9% vs year ago; Germany was up .7% on sales and 3.9% vs year ago; France was up .4% and 1.8% vs year ago; Greece was down 1.1%; Portugal was up .4%.  The full report is here

Eurozone industrial production fell in September to 5.2% (expected 7.1%) with a sharp drop in durable goods.  On monthly terms output fell in Germany, Italy, Spain, and was flat in France.  A fill can be found here.

The Financial Stability Board told the G20 it will be the end of 2011 before it can render a report on rules to prevent a collapse of systemically dangerous financial institutions which it was supposed to provide by the end of 2010.  This gives large banks a one year reprieve.

Spain's economy was flat in Q3 vs Q2.

Russia's Q3 growth was 2.7% annualized (5.2% in Q2) as the result of a severe drought.

China's inflation is 4.4%, which is a 25 month high.

Joseph Stiglitz said developing countries need to control short-term capital inflows to keep economic recovery stable, but they also need to continue to allow long-term investment to create jobs.


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Thursday, November 18, 2010

Ireland Betrayed

As the EU auditors descend on Ireland this week to examine the Irish banks, last week had more information than could be dealt with in our Ireland posts and the forthcoming Economy & Market post for last week.

There has been a general agreement with our opinion that Germany's position on debt resolution and restructuring with respect to bondholders in future eurozone bailouts led to market disruption, but we also held the view that the ECB, EU, and the European monetary Union has not supported Ireland to the extent that Ireland played the austerity poster child and protected other European banks.  Now, there is pressure to accept a sovereign bailout rather than economic support with apparently three options on the table in the form of sovereign and bank loans, banks loans, or sovereign only loans.  The bond market rallied at the very suggestion of possible assistance.

The fact remains that Ireland proves austerity has not only failed but has made the economy worse.  The ECB and EU are reluctant to move decisively to support Ireland and sort the Irish banks out.  Given the Irish bonds based on Ireland's NAMA program to guarantee bank private debt and restructure their toxic assets and balance sheets are, by many accounts, deposited with the ECB, the ECB may not have Ireland's best interests at heart.  I, and many others, have argued in the past that the EMU lacks proper fiscal policy and coordination which significantly hobbles the member nations from exercising appropriate fiscal policy consistent with monetary policy.  For all practical purposes, the EMU does not have the structure to promote fiscal unity among sovereign nations.  What the EU and ECB do not appreciate is that Ireland is not Greece and Ireland may have more cause and reason to protect its citizens by withdrawing from the euro and renouncing and restructuring Irish bank debt.  Except for the United Kingdom, Ireland has a current account surplus. If presented with the choice of joining Iceland or Greece, the Irish people may want to have a say.

There are two significant problems to such a national course of action and one is the economic consequences of credit default swaps being paid by the international banks and the other is the Irish government is the same political party which oversaw the housing bubble and poorly regulated, and highly speculative, economic expansion which went bust in 2008.  Obviously, the opposition party has not done its job as well and has indicated it would continue guarantees on private bank senior bondholders, who are primarily European banks.  Hopes that exports could drive recovery while reducing government spending defies recognition of the reality of global trading in which exporting is global and importing is national.  The ECB has bought Irish bonds and provided liquidity loans, which alone amount to approximately 130 billion euro, to Irish banks.

Still it has become obvious from the beginning of these denied negotiations that Ireland wants nothing to do with a sovereign bailout and wants the support of the EMU and ECB as an austerity team player and equal eurozone nation.  The IMF, as I have predicted, voiced its willingness to help Ireland, which undoubtedly spurred the EU to move at a faster pace amid internal debate.  Meanwhile, the current market crisis continues to unfold as a currency crisis, despite reports this week, and last, that corporations are withdrawing funds from Irish banks.  If these are foreign corporations, that would be consistent with a currency crisis and if these are predominantly Irish corporations and individual demand deposits that would be consistent with a banking crisis, but the reports have made no attempt to distinguish which corporations are withdrawing funds.  There is little doubt the euro would be strengthened by EU and ECB support of Ireland.

Ireland deserves better leadership and the European Union and the EMU need to demonstrate support despite member nations not wanting any demonstration of fiscal union however artificially fabricated.  If the ECB refuses or fails to fully support the need to unwind the Irish government from the private bank debts and guarantees of senior bondholders of those banks, because it is not in the best interests of the ECB balance sheet or other European banks, does Ireland have cause to assert its right to protect its citizens without respect of the global economic consequences?

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Friday, November 12, 2010

Economy & Market Week Ended 11/5/2010

Samuel Brittan had an excellent updated (original in May) article on "The futile attempt to save the eurozone" this week which I did not use in my post "On the Road out of Ireland" on the bubbling credit/liquidity crisis brewing in Ireland.  Using a private, subscriber available only paper published by Capital Economics and written by Christopher Smallwood, Brittan cites Germany's insistence on impossibly severe fiscal policies as reason to wonder if Germany wants the euro to continue and the fiscal tightening of Greece as an example of how to "... dampen the economy and risk creating a vicious cycle of debt and deflation."  Yet, Germany has been the prime beneficiary of the European Monetary Union's creation of exchange rate  and current account trade imbalances.

All of this has Brittan asking if the eurozone member nations might be better off with their own currencies.  While I do not believe it is necessary to abandon the euro, I find the refusal of eurozone member nations to recognize the need for monetary support of individual member nation's internal fiscal policy needs as essentially self-destructive and not salvageable by nominal adjustments alone.  Brittan is not anti-European but Ireland is on the brink of a credit/liquidity crisis.

This weekly report has become increasingly late to publication as I have been repeatedly diverted to the problem in Ireland and writing three posts this week on the subject. 


United States unemployment for October remained unchanged at 9.6% with employment up 151,000 job with a substantial decline in government layoffs/terminations.  This 151,000 job increase just barely keeps up with population growth and at this anemic rate of growth it would take until about 2030 or later to return to ful employment.  The labor participation rate was down to 64.5% from 64.7%.  The employment to population ratio was down to 58.3% from 58.5%.  Involuntary part-time workers were down 318,000 to 9.2 million.  Those unemployed more than 26 weeks  rose to 6,206,000 from 6,123,000 who "still want a job".  The U6 discouraged workers was down to 17.0% from 17.1%, but, if one used the 1994 calculation for discouraged workers, it would be closer to approximately 22%.

Retail sales were mixed, although the media emphasized growth, with soft weather related sales and significant discounting.  There is every appearance that the beginning of the Christmas shopping season is being pushed up from its traditional Friday after Thanksgiving and discounting will be a prime marketing approach.

The U.S. election brought to the forefront the failure of President Obama to clearly, consistently, and forcefully enunciate a domestic policy which focuses on reducing high unemployment.  His post election day news conference showed him at his worst as he rambled and prolonged his answers to questions, because he lacked a central focused message.  His attempts to achieve consensus at the expense of what needs to be done combined with his willingness to accept poor economic advice from discreditable economic advisers, such as Summers, who is leaving, and Geithner, has only sharpened the impression he cares more for the financial elite and little for the hardships and the imposed economic burdens of the financial bailout of the disappearing American middle class.  Austerity will not create jobs and it will dampen the economy even more with further concentration of wealth in the top 1%.  We need productive fiscal programs not pandering to delusional or self-serving politicians spewing misguided and destructive economic propaganda

The toll of unemployment continues with a job gap of 11.8 million jobs down just slightly from September at 11.9 million.  At the best average monthly rate (208,000) of job growth in the 2000's, it would take 12 years
to eliminate the job gap; at the average monthly rate (321,000) from the 1990's, it would take 5 years.  As wages decline, deflation is reinforced.  At the same time, the ratio of household debt to GDP has risen to 95% and the ratio of household liabilities to disposable personal income has risen to 135% which is creating a nation of zombie households.

Mark Thoma posted on a George Evans' paper on economic stagnation in a low interest rate environment in which the proper economic solutions are a sufficiently aggressive fiscal policy (targeted spending) of which fiscal aid to state and local governments has proven to provide quicker economic improvement and tax cuts have proven themselves ineffective unless targeted at liquidity constrained households.  Since these fiscal policies may be politically "undesirable", the Fed would maintain low interest rates in an attempt to increase consumption and start purchasing longer term government bonds, although such monetary policy may not work as it builds negative expectations.  Such approaches all have limitations in achieving timely economic impact.  While not discouraging states from balancing their budgets, the use of federal fiscal spending on productive infrastructure capital projects, which are not constrained by a balanced state budget, on the state and local level may provide a more robust approach to reviving aggregate demand future output growth.  As I have mentioned on several past occasions, China has implemented such a program in the last two years, although some of their projects, such as an empty mega mall and an entirely empty city, have been apparently wasteful.

Krugman demonstrated his position that a higher targeted inflation rate of 4% might possibly resolve unemployment and create an exit from a liquidity trap.  Since thresh holds exist in which too low or too high a rate would not be productive, the amount of inflation needs to be modeled with the level of unemployment to properly achieve full employment without credibility or inflationary problems.

The Fed announced a second quantitative easing (QE2) in which they will buy 600 billion dollars of longer tern U.S. Treasuries at a pace of $75 billion per month.  Some people saw this as slightly higher than expected although others had expected at least a trillion.  The purchases will be in the 2.5 to 10 year range.  This QE2 has already been priced into the market and now the market is speculating that a third will be needed.  This is a switch from the Fed's normal practice of buying short term bonds and reinforces its current inflation target.  There are those market analysts who believe QE2 will do nothing for the economy and, in more extreme views, may cause inflation and the destruction of the currency.  Confirming Krugman's view it reinforces the current inflation target, Bernanke asserted that QE2 will not spark unwanted inflation.  The St. Louis Fed, whose president, James Bullard, believes continued low interest rates are potentially deflationary, has published a small article on the benefits and costs of low interest rates. Yves Smith has characterized Bernanke as disengaged from reality and QE2 is nothing more than deceptive window dressing and goes on to cite El-Erian of Pimco, who says QE2 has risky adverse consequences and does nothing to resolve the need for meaningful structural reforms.  QE2 risks stoking inflation in emerging countries and putting pressure on their currencies and creating disruptive capital inflows.  In fact, emerging countries and countries preparing to attend the G20 meeting in South Korea have denounced the QE2 as a threat requiring protective responses.  On Friday, Hoenig, Kansas City Fed President, renewed his call for higher interest rates now to avoid higher future inflation from pumping liquidity into the market.

Meanwhile, the Fed continues to be viewed as raining money on financial corporations, doing nothing about unemployment, and continuing a policy which is promoting slow growth squeezing out savers and destroying retirees as middle America is left exposed and vulnerable to flap in the wind. Now, the banks have made it clear they intend to defeat the Volcker Rule inhibiting systemically risky and dangerous business activity by using the rule making process to blunt and neuter that portion of the Dodd-Frank Reform.  In the meantime, the mortgage foreclosure fraud participants continue to blow a smoke screen as they steam away from any factual discussions of the fraudulent documents, fraudulent submissions to the courts, and fraudulent process of the mortgage business and foreclosure process.  Flaws in some $50 billion of Citigroup moves of mortgages to mortgage-backed securities show it to be vulnerable to lawsuits and put-backs.  J. P. Morgan has received requests for files on $8.1 billion in mortgage loans which may be candidates for buybacks.  Six large U.S. banks are estimated to have additional exposure to $31 billion in buybacks over the already recognized $12.4 billion in losses.

Nobel Prize winning economist George Akerlof has argued that prosecution of criminal fraud is necessary for the economy to have a sustained recovery and Joseph Stiglitz agreed that a failure to enforce a equitable judicial code would result in indentured servitude.  Stiglitz is adamant in "Justice for Some" that the "rule of law" is under substantial attack in the mortgage mess with a denial of property rights, a bankruptcy process that takes rather than repairs, and a legal process that is turning justice for all into justice for those who can afford it.  As laws on campaign financing by corporations and non-profit lobbying groups, which do not have to disclose funding sources, we have seen the U. S. Chamber of Commerce become the lobbyist and conduit of campaign contributions from the international financial elite.  If you have money, you have power, while always true, is inconsistent with a free republican democracy.

The FDIC has sued executives of a failed Illinois bank to recover as much as $2 billion in losses, because they issued $11.8 million in dividends and incentive payments while masking problems in commercial real estate loans with new loans for $8.5 million of losses failing to preserve capital and provide sufficient reserves.

The attack on consumer friendly regulation in the securities and financial services business is hitting high gear with SIFMA arguing that commission based accounts are more cost effective and the "flawed" fiduciary standard would cost investors money.  These arguments all assume lumping financial salespeople with fiduciary advisers just as they are now and the objection is against disclosure and actual legal fiduciary responsibility.  Others are all upset that FINRA is contemplating an ADV like form requiring disclosure to clients from brokers of conflicts of interest and limitations of duty to the client; all of which is seen as overkill in providing information by the salespeople.  The ICI dislikes the SEC proposal to limit 12(b)1 fees, which requires a distinction between a continuing sales charge and a "marketing and service fee" and which the provider would have the choice of constructing within limits, as potentially increasing cost to the consumer.

John Hussman, in his weekly commentary on Monday the 1st, said "... greater risk does not imply greater reward if the risks investors take are overvalued and inefficient ones."  Using his forward operating earnings methodology, the ten projected return on the S&P 500 is 4.69% annually.  With the S&P 500 dividend yield at 1.96%, the ten year projection on a dividend based model would be only 2.30% annually.  On quantitative easing, Hussman believe the original QE had little effect on real GDP or inflation and what kicked the can down the road was not the QE but the guarantee of Fannie and Freddie debts and the suppression of fair and accurate financial disclosure via the FASB suspension of mark-to-market rules.  He still believes the market is overvalued, overbought, and over-bullish with a shift to neutral on not yet rising yield pressures.  He believes we have not yet cleared the recent months of economic concerns, but the economic data has been better than expected but still mixed enough to not be decisive.  The recent GDP report with 2% growth had 70% of that growth represented by inventory growth with final sales at only .6% annual gain.  The ECRI Weekly Leading Index improved to <6.5> from <11.0> in July but the same index improved from <10.8> in March 2008 to <5.9> in May 2008.  Short term activity has been reasonably quiet and modestly positive, but it is taking place over a more fragile economic structure than observers appreciate.

Market Report: 4 banks failed = 143; unofficial problem bank list = 894

                    DOW/Volume                                              NASDAQ/Volume
Mon           6.13/ down 7.3%                                            <2.57>/ down 9.9%
Tue           64.10/ down 4.8%                                           28.68/ down .1%
Wed         26.41/ up 20.6%                                                6.75/ up 4.0%
Thu          219.71/ up 23.3%                                             37.07/ up 25.5%
Fri               9.24/ down 8.6%                                            1.64/ down 15.5%

TOTAL    325.59                                                             71.57

Mon: Oil up $1.52 to $82.95; Dollar stronger but mixed against the pound; volatile price day ending flat; mixed economic reports.

Tue: Oil up 95 cents to 83.90; Dollar stronger but mixed against the euro; low volume on market hopes on election and Fed QE; Nasdaq flirted with April high again.

Wed: Oil up 79 cents to 84.69; Dollar weaker but mixed against the yen; new 2010 high for Nasdaq - best since June 2008; oil supplies were up 1.9 million barrels, gas was down 2.7 million barrels, and distillate was down 3.6 million barrels; oil was affected in part by French refinery strikes and Canadian Irving St. John  refinery maintenance.

Thu: Oil up 1.80 to 86.69; Dollar weaker; world wide stock rally on QE2 but gold and bond prices went up on inflation fears; weekly jobless claims were up 20,000 to 457,000, 4 week moving average was up 2000 to 456,000, and continuing claims were down 42,000 to 4.340,000.

Fri: Oil up 36 cents to 86.85; Dollar stronger; market turned positive at end and gold ended at $1397.40.

United States:

ECRI Weekly Leading Index was unchanged at <6.5>.

U.S. consumer spending was up .2% September (.5% in August); core PCE for 12 months was up 1.2% (lowest since September 2001); core inflation September was flat (.1 August); personal income was down .1% and disposable income was down .2%

ISM manufacturing activity was up to 56.9 October from 54.4; new orders were up to 58.9 from 51.1.

AMBAC indicated it will not pay interest on bonds as it was unable to raise capital as an alternative to Chapter 11 bankruptcy.


Pfizer Q3 missed revenue expectations by $500 million on weaker overseas sales and generic competition.

1.47 million Americans have been out of work 99 weeks or longer as of September.

Fannie Mae posted $4.1 billion Q3 loss and will be asking for $100 million more aid.

ADP private employer survey for October was up 43,000 jobs.

U.S. manufacturing new orders were up 2.1% September; ex-transportation they were up .4%; non-defense capital goods orders were down .2% (up 5.1% August).

ISM service sector was up to 54.3 from 53.2.

GM sales were up 3.5% October.

Fed plans to spend $600 billion in QE2 by the middle of next year at $75 billion per month on longer term U.S. Treasury purchases.

SEC banned brokers from allowing clients access to direct exchange trading with broker access codes without pre-trade risk controls.

In GM's IPO (seeking $13 billion), U.S. will reduce its 61% stake to 41-43% by selling at least $365 million in shares at $26-29.  Why not wait to sell?

Ford sales were up 19% October; GM sales were up 13%; Chrysler sales were up 37%; Toyota sales were down 4%.

U.S. productivity Q3 was up 1.9% (it was down 1.8% Q2); labor costs were down .1%.

Bernanke said QE low interest rates will not stoke inflation.

President Obama backtracked and indicated he may consider extension of Bush tax cuts for all income levels.

Fed may release guidelines allowing "well capitalized" banks to raise dividends.


AIG Q3 loss is $2.4 billion on asset sale losses and mixed insurance business results; operating income was up 47% to $1.07 billion.

Bank lobbyists hope to blunt the Volcker Rule during the implementation process; Representative Bacchus has warned Secretary Geithner to be careful and not be rigid.

In response to investor claims, including the New York Federal Reserve, that Bank of America should buy back mortgages improperly made, Bank of America said the lawsuit would speed up the foreclosure process and force it to evict homeowners and the losses on the mortgages sold were the result of the economic downturn and not from any underlying problem with how the mortgages were sold to investors.

Pending home sales index was down 1.8% September.

Sear will be open on Thanksgiving Day for the first time in 85 years.

Consumer credit was up $2.1 billion September in the first gain since January; August was revised down to <$4.9villion>; revolving credit (credit cards) was down $8.3 billion in the 25th straight month drop.

Berkshire Hathaway operating profit was up 28% to $1692 per share but net profit was down 8% to $2.99 billion with losses on derivatives (derivatives portfolio is about $60 billion).

REO (real estate owned) inventory for Fannie, Freddie, and FHA through Q3 is up 24% from Q2 and up 92% vs year ago.

International:

ECB has refused to release files on how the prior Greek government used derivatives to hide debt.

The Bank of Japan held interest rates at .1% and held off on further monetary policy easing, although it said it intended to buy index linked ETFs, AA or higher rated REITs, and government bonds.

The Reserve Bank of Australia raised its interest rate 25 bps to 4.75% in what some economists thought unnecessary. The Australian dollar shot up in response.  Controversy stormed up when the Commonwealth Bank of Australia, the country's largest home lender, raised its variable mortgage rate 45 bps to 7.81% in the face of profits indicating costs had risen 15%.  Analysts subsequently pointed out that nearly 50% of homeowners are suffering mortgage stress deep in the mortgage belt, but the act has cause a political firestorm

China PMI (Purchasing Managers Index) was up to 54.7 October from 53.8, which was more than expected, to a six month high; total new orders were up to 58.2 from 56.3; export new orders were down to 52.6 from 52.8.

China ordered banks to charge more interest to first time home buyers by halving the interest rate discount from 30% to 15%.

South Korea exports were up 29.9% October vs year ago; imports were up 22.4%; CPI was 4.1%, which is a 20 month high.


Distressed loans in Spanish banking system reached 102.5 billion euro in August at 5.6% of all loans, which is the highest proportion since 1996.  Some banks, including BBVA, are selling branches and then leasing them back in order to book short term gain and conceal mortgage losses.

Spanish unemployment statistics, in the complete survey, show unemployment did not drop to 19.79% by the end of September but rose to 20.8% from 20.5%.

India's Central Bank raised its interest rate for the 6th time --- repurchase rate to 6.25% and reverse repurchase rate to 5.25% --- in order to slow inflation and protect purchasing power of the poor.

BP profit was down 67% to $1.79 billion Q3 but Q2 had been <$17.2 billion>.

China's five year plan may create large changes, but a Central Bank governor said progress towards current account convertability and global yuan will be gradual.

French and Spanish car sales were down in October with the end of economic incentives.

Markit eurozone PMI was up to 54.6 October from 53.7 with Germany, France, and Italy up, Spain and Ireland struggling, and Greece declining.

German Economic Minister, Bruederle, expressed concern U.S. is trying to stimulate by injecting liquidity and using monetary policy to influence the dollar's exchange rate.

Asian and European markets liked the Fed QE move; both saw it as a willingness to support economic recovery.  How long will that view last?

China is considering setting up reserve of 10 metals, including rare earth; China has 95% of the global market in rare earths.

Canada block BHP's bid for Potash Corp as not in the national interest.

Portugal broke political gridlock and voted an austerity budget to reduce the deficit at 7.3% of GDP to 4.6% next year.

China auto sales were down in September to 1.27 million units but up 27% vs year ago.

Toyota Q2 profit more than quadrupled to $1.2 billion but missed views; sales were up 6%, but it revised down its annual forecast to $4.3 billion on lower U.S. sales.

CDS (credit default swaps) for Ireland, Greece, and Portugal were at their highest levels at the end of the week since September 2009; Spanish CDS were also up.



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