Friday, November 12, 2010

Germany's Irish Hair Shirt

The bond market fears on Ireland's guarantees of the liabilities of three Irish banks, of which the Bank of Ireland has already essentially recapitalized with only 36% government ownership, and the nationalization of  two smaller mortgage financing  banks has spread to the stock markets as Irish bank stocks sold off yesterday.

The Wall Street Journal had a good article, which was profiled by Felix Salmon, on the development of the current concerns and how the banks loans collateralization and value had been under reported and underestimated.  A blog post by one of the article's writer makes some additional observations and then veers off into lesser, minor issues with respect to mortgages, lending practices for mortgages, property leverage, and the Irish tax code as if they were major players in the current credit/liquidity crisis.  Felix Salmon also concludes that Ireland's guarantee of the liabilities was a mistake as we have written and maintained for months.  However, this is a credit/liquidity crisis and not a banking crisis which has shifted from the banks to the government of Ireland.

Of far more interest is why Ireland made the decision, or was encouraged to make the decision, to guarantee the liabilities of the banks and protect the senior bondholders as well as the depositors.  As we have written, this decision is the very core and crux of the current credit/liquidity crisis and brings into the spotlight the necessity of the European Monetary Union and the ECB to take a proactive and consistent supportive position despite the counterproductive position of Germany which wants sovereign bondholders to share in the burden of any eurozone nation bailout by the ESFS, which has yet to be activated, with a proposal which would require a treaty change.  Merkel's statements have not only created a bond market reaction, as Merkel's statements on this subject have done in the past, but Germany refuses to back away from a concept that has a legitimate point but is being put forward at a time when it cannot be considered and effectively decided and implemented in any timely fashion while significantly aggravating the current situation.  Germany's position is particularly perplexing as we have shown in "On the Road Out of Ireland" that the BIS statistics (p. 6) show German banks have the largest exposure to Irish private debt and, consequently, should be receiving the largest protection from the Irish government's guarantees on the private Irish banks' senior bonds.  Apparently, Merkel finds the unusual protection of risky private investments by German banks acceptable but finds that German bank risk assumed by sovereign debt guarantees of a nation which is not Germany unappealing.

EU leaders have sought to reassure the bond markets that sovereign bondholders would not be affected and issued a statement from the G20 meeting that the ESFS activation does not require private sector involvement.  A proposal from Breugel as commented on by the blog The Irish Economy would create a mechanism for the resolution of a sovereign debt crisis.

EuroIntelligence has been adamant in its reporting and opinion that Ireland is going down and on the verge of seeking a bailout from the ESFS.  To me this seems premature.  If the ECB and EMU do not publicly demonstrate support for Ireland, and the ECB tends to be too secretative about its support efforts, then I would expect the IMF to publicly support Ireland and force the hands of the EMU and ECB, particularly as this has had direct negative effects on the bond and swaps cost of Portugal, Spain, Greece, and Italy.

The relevant articles on Ireland and this issue have become voluminous.  Here are some for your review without additional comment:

Investor concerns hits banks
Central Bank of Ireland Governor Honohan comments
2000 billion euro contagion
Ireland on brink as beggar for aid
Irish borrowing costs hit high
Honohan wants foreign buyers for banks
Bank of Ireland profit down
repo margin increased
Irish investors head for exits
income tax rates to rise
EU commissioner sees light at end of tunnel
no confidence 3% deficit target will be reached
corporate tax revenue
make European defaults not bailouts
revised Irish risk parameters
eurozone bond records
sovereign debt doubts grow
Berlin cast doubt and spreads contagion (Spanish)
Europe ready to split in two or recover (Spanish)
wait until mortgage defaults hit home
ECB bond purchasing
bond buyers strike
Irish debt revives concern about Europe
costs rise on financing fears
sovereign risk and budget woes


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Thursday, November 11, 2010

Banking Crisis vs. Currency Crisis

It is very common for commentators, even economists, to improperly characterize a credit/liquidity crisis as a banking crisis, when a banking crisis is defined by a withdrawal of demand deposits and a credit/liquidity crisis is characterized by a withdrawal of foreign investment, lending, and deposits.  When the perception grows that the sovereign government will not undertake the necessary monetary and fiscal policy actions necessary to counteract and stabilize a credit/liquidity crisis, then, as foreign doubts increase, the risk of a currency crisis grows with the failure of the sovereign government to solve the fiscal and monetary problems behind a credit/liquidity crisis, even if it has been caused by the business activity of systemically dangerous financial institutions of whatever size.

In the case of Ireland, and any other eurozone country, it has no control over monetary policy and is reliant upon the European Monetary Union, the ECB, and the EU to provide monetary policy and backup.  Consequently, as overnight bank funding dries up and bond costs continue to escalate, the European Monetary Union and the ECB are faced with a potential currency crisis, which is a lack of faith the EMU will stand behind its member nations, which would cause a serious, roiling global credit/liquidity crisis.

The ECB, the EMU, and the European Union need to get their act together and act decisively and consistently without the counterproductive interference of member nations promoting their more immediate self-serving political and economic agendas.

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Tuesday, November 9, 2010

On the Road Out of Ireland

Ireland has been celebrated as the European Union poster child for eurozone austerity.  Yet, its efforts have received little respect from the bond market, which has become increasingly aware that austerity will not make Ireland again prosperous.  In attempting to be the good European Union partner, Ireland created a "bad" bad bank which gave government guarantees to all liabilities of three private banks which had engaged in risky investment policies and poor management.  In doing so, the government bailed out incompetent management and bondholders at the expense of the Irish people.  Rather than providing equity for toxic assets, the Irish government issued government bonds for the toxic debt of three Irish banks of which Anglo Irish, whose senior debt has become a serious international problem, had to be nationalized. While junior bondholders have had to accept subsequent haircuts and the three banks significant reductions in assets as toxic assets were stripped out, the depositors and senior bondholders have been untouched.  Questions on the guaranteed status of the senior bondholders has had detrimental effects on Ireland's ability to obtain and pay for credit as the position does not appear in the best interests of the Irish people while the bond market fears a haircut to senior bond holdings despite guarantees, because the austerity budget is viewed as too ambitious.  Some observers have even questioned whether it would be in the best interest of Ireland to default on these senior bonds as Iceland refused to accept responsibility for private bank debt and just as the Irish Free State, under de Valera, refused to pay the land annuities (an annual payment of 250,000 pounds for Britain's loans to finance land reform) to Britain in 1933, which led to the Anglo-Irish Trade War in which Ireland did not fare well.  In fact, these guarantees of Irish private bank debt have come to amount to 32% of Ireland's GDP.

The people of Ireland have endured centuries of oppression and economic servitude and a tumultuous transition to Irish Free State in 1922, Ireland in 1937, and Republic in 1949 with a bitter refusal to remain in the Commonwealth.  After a long period of poverty and out bound emigration, the 1990's saw the beginning of economic growth built on exports which lasted until the 2008 financial crisis.  Now, the Irish people face being prisoners of debt and indentured servants to the banks of the eurozone, who are the senior bondholders, almost 100 banks including Goldman Sachs, being protected by the Irish government.

Ireland is not Iceland, which has its own fiat currency, and it has sought to appease the European Union upon which it is dependent for monetary policy and economic support.  As NAMA, the Irish agency responsible for sorting the private bank mess out, has dug into the assets and finances, it has issued haircuts up to 47% on assets stripped from the banks and proposed 80% haircuts to junior bondholders, which has led the bond market to fear similar threats to subordinated debt in other eurozone countries.  While bondholders are the source of funds which keep banks functioning, the investment is one of acknowledged risk in a private bank.  It is even feared that an Anglo senior bond default/haircut would bring Ireland down.  To give bondholders immunity from losses is recognized by many as removing the assessment of risk from the investment process and increasing systemic risk.   Switzerland has required its large banks to issue contingent convertible bonds which can be used to write-off losses in cases of non-viability.

It is being argued that revenue will not be sufficient for deficit reduction and has increased concern that bond investors must not be discouraged and market perception is more important than fiscal or monetary policy.  Debt costs have jumped for Ireland and Portugal, Greece, Spain, and Italy.  European Union support has become all the more important if Ireland is to succeed.


Yet, this current chapter in the Pan-European Credit Crisis has been spawned by European Union leaders in the midst of debate on the ESFS, due to expire in 2013,  bailout continuation and political upheaval in the eurozone as Germany has pushed a proposal for orderly insolvency and debt restructuring, which has rattled the bond markets.  The Franco-German proposal would require a treaty change and a permanent debt resolution system with sanctions, but it has largely gained acceptance by the EU.  When Germany threatened to veto any financial crisis resolution authority unless a treaty change was approved, it painted the eurozone into a corner surrounded by bond vigilantes.  In an attempt at deficit economic ideological purity, Germany threw the peripheral eurozone countries to their fate while demanding that bond holders share the burden, which spread fear in the bond market and directly threatened German banks which have a significant exposure to private Irish debt.

Bond and swap prices escalated, despite proposed budget cuts  with a sense of impending doom settling in as to whether Ireland, as well as Greece, Portugal, and Spain, can execute their austerity budgets.  Even sovereign default swaps surged.  As credit costs ramped up, bond investors dumped bonds and the perception of risk spread.  Perhaps at the urging of one wealthy Russian bondholder, the Russian sovereign wealth fund took Ireland and Spain off their eligible investment list and a European clearing house warned that members might have to deposit more cash to trade in Irish bonds.  All of this has aggravated the bond market perception that the peripheral countries cannot control their European Union imposed austerity budgets.

In fact, Ireland's budgeting, as well as Spain's budget and economic forecasts, have been increasingly questioned as scary as Ireland has taken a three month holiday from bond auctions to avoid the current spreads as it has enough money to last into Q2 of 2011 and as it seeks European Union agreement and assistance with its 6 billion euro proposed budget cuts.  All of this has left the Irish wondering, if they knew all along that the budget cuts would be contractionary, what do the bond markets want?  Unfortunately, Ireland does not have its own currency and, therefore, is more at risk to market perception which may not always be in the best economic interests of a sovereign country.  Despite projections, Ireland cannot depend on substantial export growth in its budget.  As long as Germany and France pursue an irresponsible ideological exercise which threatens other eurozone countries, if not the monetary union, then the efforts of Ireland and the other peripheral countries risk nullification.

While the U.S. Federal Reserve plan to buy more Treasuries helped revive the bond market for Spain, Portugal, Greece, and Italy, the ensuing weaker dollar will not help the euro and its effect on bond prices.  While the ECB has stepped in and bought bonds from time to time to stabilize markets from time to time, it has not been easy to determine when and exactly how much and some reports have been mistaken.  Since Ireland was encouraged to protect senior bondholders, which includes eurozone banks which have a large exposure to Irish private debt as shown in the BIS September Quarterly report on international banking (page 6) with Germany followed by great Britain leading the way as of Q1 2010 with other European areas close behind and then France, it would be in the best interests of the European Union, eurozone, and the ECB to assist and support Ireland.  A failure to support Ireland or hesitation to act will endanger the very European banks Ireland got suckered, as a eurozone team player, into protecting.

The European Union needs to get beyond the ESFS temporary bailout to a permanent financial crisis resolution which does not acknowledge too big to fail banks and holds investors accountable for a share of the burden of restructuring systemically risky financial institutions rather than foisting the losses off onto government and the citizenry.  As long as the European Union and the eurozone members refuse to learn the lessons of deficit reduction in a monetary union in which the sovereign countries have no monetary control to combine with fiscal policy and member nations continue to engage in "smokestack chasing" as Germany is doing with its treaty change proposals which directly undermine other eurozone countries, if not the monetary union itself, the welfare of the monetary union as a whole and each of its members, including Germany, are endangered from within.

Given Ireland's continued attempts to please the ECB and the European Union, it may find, given its budget cuts already, the IMF a more practical partner in economic recovery, which does not say much about the ability of the ECB to act and of the European Monetary Union to assist members in order to strengthen the economy of the monetary union as a whole.  The Irish government's surrender to the private bank bondholders doomed them to bailout.  In as much as the ECB and European Union may have encouraged and supported that bad economic decision in order to protect other European banks makes it all the more necessary that the ECB and European Union, most especially those countries whose banks are being protected at the expense of the Irish people, support Ireland's unwinding of the three private banks and the Irish debt created by the banks and its investors.  Ireland faces insolvency and its people indentured servitude to the very European banks (with German banks heading the list) given immunity from investment risk, as the Irish people choose which bills to not pay in order to pay mortgages as mortgage losses mount, which will only increase the pressure on banks and the government's liability guarantees.

One has to ask, if Ireland found it unavoidable to offer equity or some other haircut to senior bondholders, would a currency crisis ensue?  Has the ECB and the European Union, with the help of Germany and France, boxed itself in to the point it has no choice but to help Ireland or abolish the monetary union?

The road out of Ireland is submerged.  The people of Ireland may have to do it all by themselves again, if they wish to remain free.


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Friday, November 5, 2010

The Fed, Printing Money, & Reserves

I sometimes find myself disagreeing with economics writers whom I respect, because they have made good arguments in an article and then make an inconsistent statement on debt, bank reserves, or net government savings with statements on debt and net government savings usually lacking stock flow consistency..

Alea wrote a much linked short piece on the Fed does not print money which is factually correct despite some economic textbooks and commonly accepted myth.  The Pragmatic Capitalist, which I find a very useful source of opinion and information, expanded upon the Alea piece by commenting that bank reserves constrained lending, when bank lending is actually constrained by the price of reserves (see answer for question #3) and bank capitalization.  Consequently, the leverage created by banks in lending can be good (stimulates growth) or bad (overheats the economy) just as the failure to lend can be bad (deflates the economy) or good (cools the economy).

When economically incorrect beliefs reach commonly held mythic proportions of an icon, the political debate becomes falsely conceived and subject to hidden agendas as the myths are manipulated to influence and control the citizenry.

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Everything You want to Know About Health Reform (PPACA) Law

As I have remarked in the past, occasionally Maxine Udall has a succinct post that needs no elaboration.

Here is her post presenting the Kaiser Family Foundation video explaining the 1000 page Health Care Reform Law (PPACA).  This is a must see no matter what your opinion of President Obama's health care reform.

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Wednesday, November 3, 2010

Economy & Market Week Ended 10/29/2010

The Q3 United States GDP was estimated this week at 2.0% of which inventory added 1.44% compared to .82% in Q2.  Without the inventory build up, Q3 would have been barely positive.  Personal consumption was 2.6% (2.2% in Q2).  This shows a slower trend growth and a generally weak (Consumer Metrics Institute October 29 commentary) and long recovery.

The unemployment rate for everyone 55-64 has more than doubled.  I have been maintaining for some time that unemployment for this age group could be a permanent condition.  At the very least it means not working at the same pay at one's full ability level.  This is a huge loss of productive talent which has nothing to do with appropriate skills for the marketplace.  It has to do with age discrimination and filling the positions with younger workers who will cost less and theoretically stay with the job longer.  At the same time the highest unemployment is among the 20-24 year old college educated who will, as a consequence of unemployment at this early stage of their careers, suffer a life long possibility of lower earnings.  This recession has the distinct possibility of creating a very negative social divide magnifying the wage inequality and wealth inequality problems which directly threaten our republican democracy and the sustainability of a market economy as opposed to a feudal corporate economy.  Every 34th wage earner in 2008 went through 2009 not earning a single dollar.   In 2009 dollars total wages have fallen $5.9 trillion.  Average wages and median wages are down and the number of idle workers grew by 6 million in 2009 with real unemployment, including discouraged workers, at 22%.  At the same time, while the number of Americans making $50 million or more fell from 131 in 2008 to 74, the average wage increased from $91.2 million in 2008 to $518.8 million in 2009 or almost $10 million per week.  Those 74 people made as much as the lowest paid 19 million workers who comprise one in every eight workers.

Econbrowser had an interesting piece on demand shocks in trade and how they manifested themselves in different countries with Japan and China showing distinct deviations from the mean, which would indicate there were alternative reasons which were not consistent with Germany and the Untied States.  It makes you wonder where all the increasing exports in the world are expected to go. The line that caught my attention was "The finding that demand shocks working through the composition of trade ... explained the bulk of the drop and recovery in trade suggests the stronger the rebound in GDP, the faster the recovery in trade in proportionate terms."  This is exactly what we are not seeing in the present recession/recovery.  The GDP is not growing fast enough to reduce unemployment and the government is not exercising fiscal policy to reduce unemployment and everyone is surprised that consumers are not spending.  Consumer spending is not going to bring recovery if unemployment remains high.  A weak dollar is not going to sufficiently drive exports when it also appreciates foreign currencies and inflation in other countries.  To lay this problem on the door step of China is disingenuous.  China has internal problems, and perhaps more complicated problems, just as the Untied State, the eurozone, Japan, and Germany have internal economic problems which must be addressed internally.  The failure of these countries and others to not address their economic problems which have a global economic impact only aggravates the tension among those who would rather blame than act.  The G20 and the PR show on currency accords and trade collapsed before the delegate departed the airport.  The failure of the G20 to address and resolve the different trade and capital needs of emerging and developed countries, foreign currency reserves, current trade imbalances, and the vastly different saving and borrowing needs of emerging and developed countries is a failure to acknowledge the differences and the necessity of each country to implement different internal fiscal policies.  It is not a global chess board which can be mended by duck tape.  It is also not resolvable by including emerging nations currencies in a new reserve currency basket.  Emerging nations do not want their currencies to be a reserve currency.  For instance, there is presently no way the Chinese renminbi can be accumulated by foreigners who are not allowed to have renminbi accounts.  It will take China a very long time to reduce its current accounts surplus and develop a deficit.  Given its internal problem of cheap capital which transfers income from households and reduces household consumption, it would be very politically and economically difficult for China to rebalance internally in the short time that a fast appreciating renminbi would demand.  It is more likely that China's capital outflows could be matched by foreign capital inflows in the form of investments, which would require a gross change in the form of ownership and governance in China.  That is an unrealistic expectation, particularly, when the Untied States refuses to deploy the fiscal policy necessary to reduce high unemployment and kick start GDP growth.

Quantitative easing (QE) is designed to lower long term interest rates, but The Pragmatic Capitalist argues that it fails historically to do so and the attempt actually increases asset prices without any underlying change in fundamental value.  QE is merely an asset swap with little real impact on the economy.  In fact, historically the market has collapsed following the end of each of the last three major QE programs.  Models and Agents cites a 2003 Eggertsson and Woodford paper and argues that its conclusion that QE is redundant and the optimal policy should be price level targeting historically based rule will not work, because the rule lacks credibility since its implementation is only a verbal intention and, consequently, only a bluff.  She wants to call a spade a spade and call the purchases "debt monetization", because the only true way, in her opinion, to boost aggregate demand at this stage is to implement a fiscal operation whose goal is to protect productive capacity and assist companies and households in their deleveraging efforts.  In such an operation, the role of the Fed would be to provide the financing.  Econbrowser believes the market has already priced in a trillion dollar QE and that the QE is being justified by the Fed as a means of combating negative real interest rates, which mean people can get a positive real return by stuffing money under a mattress, in disinflationary, deflationary times.  The Fed can help but it cannot solve the zero lower bound problem with QE and one should keep an eye on commodity prices and real rates.  A fiscal stimulus would not only target the creation of jobs now but also assisting the states and local governments who are under revenue pressures and have been reducing employees to the extent that government layoffs and terminations exceed growth in private hiring.  This could be partially accomplished by the Fed and Treasury buying state and local municipal bonds.

In a recent paper on the correlation of bonds and stocks, it found "...the changing risks of nominal bonds are related to the changing relationship between inflation and economic growth."  If the stock-bond correlation implies investors believe government bonds are a hedge against the possibility of deflation and low growth, while at the same time, despite being uncertain about the direction of inflation over the next five years, believing any increase in inflation will likely be accompanied by growth, making it less painful for their portfolios,  then bonds should carry a negative inflation risk premium and higher prices.  The question becomes whether investors are correct.  Another question is the study assumed the CAPM (Capital Asset Pricing Model) use of the stock market as a proxy for the economy, but CAPM also assumes an efficient market which is not substantiated by modern experience and more modern economic/finance models.  Consequently, in my opinion, the determination of a bond bubble could be lagging information and/or a divergence from the mean.  The use of a negative or positive trend based on the assumption of an efficient market is not enough information to make an investor decision.

When talking about the current high unemployment, low interest rate, slow growth economy and the use of quantitative easing and fiscal stimulus, political gridlock and austerity policies become all the more destructive.

In John Hussman's weekly commentary from Monday the 25th, he provides a different analysis of a liquidity trap and the inevitable failure of QE through his dislike of "unproductive" fiscal spending and the invocation of the velocity of money.  Yet, he manages to end up with the proper conclusions that QE will not induce businesses and households to spend when their gut tells them to save save save and that fiscal spending targeted at economically productive targets is useful.  Of more interest is his references to the work of Nathaniel Mass whose work involved the application of microeconomic methods to macroeconomics.  Hussman still finds the market overvalued, overbought, and overbullish with a negative trend and high risk profile which could result in a sharp downturn after a string of new highs, 2-3 day pullbacks followed by sharp recoveries.

Consumer Metrics Institute, in their October 25 commentary, shows that the current contraction has surpassed the recent "Great Recession" in length and there is no end in sight.

Wells Fargo is refiling 55.000 foreclosures, because they have found no faults with them.  This drew the immediate objection of the Ohio Attorney General, who said the quick turnaround of Wells Fargo does not speak well of the review process.  Attorney General Cordray followed with letter to several banks indicating it was not proper or sufficient to just replace false court document with new, "fixed" documents.  Of additional concern in the mortgage mess is the exposure of home builders who originated $205 billion in loans and may now face $1 billion or more in put backs.  Pulte, Hovnanian, DR Horton, and Lennar may have the most risk.

Treasury concealed $40 billion in tax payer losses on the AIG bailout, according to the Inspector General of TARP.  Treasury refused to correct the report after information was sent by the Inspector General to Treasury.  Representative Issa indicated he thought the report was misleading and, if it had been issued by a private company, it would have been subject to a SEC investigation.  At the same time Treasury has thumbed its nose at the Bloomberg FOIA request for information on Citi guarantees, which is information at least two years old.  Bloomberg has won in court, but Treasury has a history of stringing these FOIA TARP related requests out.  In this vein, it is relevant that Washington's Blog had a post on how fraud contributed to the Great Depression.

The CFTC has found repeated attempts to influence and control the price of silver in the markets.  This is a subject we have commented on in the past.  It remains to be seen if the CFTC will do anything about their findings.  Here is the complete CFTC statement.

Protests in France against an increase of the retirement age to 62 failed as the measure became law.  The retirement age is a big issue in many countries, particularly those in which have an aging population with a low birth rate.  Retirement ages are all over the map from as low as 45.  Most discussion of increasing retirement ages never touches on age discrimination in job seeking and the work place or the productive value of experience and knowledgeable workers; it is all about the cost of retirement.

Market Report  No banks failed this week == 139 (140 last year); Unofficial Problem bank list = 894

                               DOW/Volume                                           NASDAQ/Volume
Mon
                       31.49/ up 30.7%                                           11.46/ up 7.4%
Tue
                          5.41/ down 4.1%                                          6.44/ up 9.3%
Wed
                      <43.18>/ up 5.9% distribution day                     5.97/ up 7.0%

Thu
                      <12.33>/ down 1.4%                                        4.11/ sown .2%
Fri
                           4.54/ up 2.7%                                                .04/ up 2.7%

Total               <14.07>                                                        28.02

Mon: Oil up 87 cents to $82.52; Dollar weaker; chemicals offset financials; highest close since April 29th but still closed near session lows.

Tue: Oil up 3 cents to 82.55; Dollar stronger but mixed against the pound; highest close since April 26 on low volume and struggle during day.

Wed: Oil down 61 cents to 81.94; Dollar stronger; markets pummeled by worries over Fed easing but pared losses at end; oil supplies were up 5 million barrels; gas supplies were down 4.4 million barrels; distillate supplies were down 1.6 million barrels.

Thu: Oil up 24 cents to 82.18; Dollar weaker; market could not make up its mind with several economic reports due Friday; weekly jobless claims were down 21,000 to 434,000 (lowest since July); 4 week moving average was down 5500 to 453,250, and continuing claims were down 122,000 to 4,356,000 (but number of workers with exhausted benefits is increasing).

Fri: Oil down 75 cents to 81.45; Dollar weaker; market ended flat at end of higher volume day despite mediocre GDP report; trade below average for 6th day i row on NYSE -- what will happen after next week's election and Fed meeting?

United States:

Bernanke (Fed) said regulators are reviewing foreclosure practices of large financial institutions and will publish a report next month.

Freddie Mac says foreclosure pipeline is slowing down (8 months --- 2 months longer than normal).

In the last two months, the U.S. dollar was effectively devalued 14% by the market.

Chicago Fed economic activity index was down to <.33> September from <.32> ; national activity was down to <.58> from <.49>.

Core Logic August housing prices were down in 78 of 100 metro areas.

NAR existing home sales were up 10% September to 4.53 million (19.1% vs year ago) but inventory is 10.7 months, which is down 1.9% September but up 8.9% vs year ago.

Case-Schiller 20 City house prices index (3 month average) was up 1.7 vs August 2009 (slower) with 15 reporting lower prices.

Dallas Fed manufacturing activity showed production up to 6.9 from 4.0 (2nd month up); new orders were down to <4.3> from <3.0> (5th month); finished inventory was down to <12.5> from 1.0; prices paid for raw materials was up to 29.9 from 24.4 (15th month); prices received for finished goods was down to <3.5> from .5.

Volcker said inflation is not the problem and will not be the problem for several years; no possibility of deflation.

Berkshire Hathway is disputing SEC claims that their Q2 should have written down $1.9 billion in losses from Kraft, US Bancorp, and other firms; contends the losses are temporary and expected to rebound.

Bank write-offs of credit card uncollectibles were up to 10.03% August from 9.45%; 30 day past due was down to 4.7% n a small decline.

Ford Q3 EPS were up 48 cents per share ex items (expected 38 cents); sales were up 6% ex Volvo which was sold; paid $2 billion in debt and $3.6 billion to retirees health trust.

September new home sales were up to an annual rate of 307,000 from 288,000 with months of supply down to 8.0 from 8.6; still weakest September on record.

Mortgage defaults Q3 were up 18.9% from prior quarter but down 25.5% vs Q3 2009.

Philadelphia Fed State Coincident Index for September increased in 24 states, down in 14 states, and unchanged in 12 states; this shows sluggish recovery.

U.S. durable goods orders in September were up 3.3%; exclude transportation and orders were down .8%; exclude defense orders were up 2.9%; shipment were down .4% for 2nd month; inventory was up .5% for 9th month.  Capital goods new orders, non-defense, were up 8.6%; inventory was up 1.3%.

On Wednesday cotton prices were the highest since the U. S. Civil War.


Hedge funds have been advised by law firms specialists and MBS traders at a conference that the coming wave of MBS put backs will cost banks at least %97 billion.


Freddie Mac 90 day delinquencies were down to 3.89% from 3.83%.

P&G Q1 EPS were down 4% to $1.02 per share (expected $1); sales were up 2% but below views; expects Q2 to suffer from higher commodities prices and marketing costs.

Kansas City Fed manufacturing survey showed continued moderate expansion.  Increased activity was reports by 10 down from 14; new orders were up to 16 from 9 firms.

GM is preparing for an IPO; it will repay $2.1 billion to Treasury and make payments to pension and retiree health plan ($2.8 billion); after IPO it will pay $4 billion cash and $2 billion common stock to treasury and buy back preferred at a 2% premium.  It has an agreement with ten large banks for a five year, $5 billion credit facility for backup liquidity.

Institute of Supply management (ISM) Chicago PMI (Purchasing Manager's Index) was up to 60.6 from 60.4; new orders were up to 65.0 from 61.4.

Reuters survey of 80 economists project GDP in 2011 will only be 2.4%.

ECRI Weekly Leading Index was up to <6.5> from <6.9> the prior week.

Hoenig (Kansas City Fed) said there are real risks to QE; it is "very dangerous", hazardous bet which could set in motion a boom-bust cycle.

Dudley (New York Fed) said the Fed cannot wave a magic wand but can provide essential support for the long bumpy road.

U. S.Treasury Auctions:

2 yr Treasury, $35 billion, yield .40%, bid to cover 3.46, foreign 39.98%, direct 15.9%.

5 yr treasury, $35 billion, yield 1.33% (1.26% last month), bid to cover 2.82, foreign 39.5%, direct 11.7% (highest since May).

International: 

UBS Q3 was a massive miss 50% below consensus due to investment bank and wealth management results; fixed income plunged due to "negative debt valuation adjustment".

Japanese exports were up 14.4% September (slowest gain this year).

Ireland will attempt to cut $21 billion form their annual budget in 4 years; deficit set to hit 32% of GDP on the bank bailouts which favored management and bond holders at the expense of the public.


Portugal budget talks have collapsed Wednesday on political gridlock.

The French lower house voted for the Senate bill on pension reform and the bill goes to President Sarkozy.

Greece is experiencing lower than expected tax revenue growth after austerity tax hikes.

Japan cut its GDP estimate to 2.1% from 2.6% and sees 1.8% for next year down from 1.9%.

China says it will cut its trade surplus by encouraging consumer spending.

Eurzone October inflation was up 1.9% (1.8% September).

French refinery workers returned to their jobs on Friday ending the strike.

Japanese factory output was down 1.9% in the 4th straight monthly decline; consumer prices fell for the 19th month vs year ago.

A weak U. S. dollar, which will result from any new Fed QE, will hurt Europe more than it will help the U.S.


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Monday, November 1, 2010

Price Level Targeting

As began reviewing my notes for my Weekly Commentary, I noticed that a subject which was briefly noted in the 10/22/2010 Commentary seemed to more important than just reporting comments.  It is the concept of central banks using price level targeting rather than inflation targeting as a means of boosting an economy, particularly in times of near zero rate interest.

Last week Charles Evans (Chicago Fed), as we noted in the Weekly commentary, made a speech in which he said price level targeting may be something about which the Fed should be talking.  This last week, the Bank of Canada publicly discussed it was studying price level targeting and the research has been generally positive.

In price level targeting, a central bank responds to inflation above or below its inflation target, not by adjusting the inflation target, but by policy which is designed to make up the difference in the future.  CPI growth above or below the inflation target in one year is offset in subsequent years in such a way that the price level aggregate does not move.

Last week the Atlanta Fed blogged on whether this might be a good time to adopt price level targeting.  Potential problems exist in its temporary use as a central bank transitions back to inflation targeting and the blogger sees some benefits in it being a permanent, consistent policy.  The St. Louis Fed published a paper in 2009 on price level targeting and concluded that it could successfully stabilize short-run aggregate shocks and improve welfare.  By adhering to a targeted price path, a "... central bank reduces the nominal interest rate via monetary injections to expand consumption and output."  An optimal policy would work through a liquidity effect, such as a liquidity trap.  This might also remove the volatility found in New Keynesian models in which the nominal interest rate is quite volatile.

For those who appreciate a more in-depth academic research on the subject of price level targeting, here is a paper (Adobe download) by Barnett and Engineer and discussion by Boivin.

It appears that price level targeting has been, and is, picking up steam in the debate and thinking of central banks in dealing with the current near zero interest rate environment.  This debate just appears to be emerging publicly as a serious consideration.



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