Leftovers -- Radio Show 2/27/2010

Tyler Cowan and Felix Salmon both commented on Gary Gorton's new paper, "Questions and Answers about the Financial Crisis", with regard to the use of repos creating fragilities in the banking system.  Banks no longer just use deposits as funding sources.  The use of repos as funding sources creates a systemic risk, because the bond market depends on the denial of risk and when risk becomes questioned, the bond market comes to a grinding halt.  We should not try to guarantee repos as we guarantee deposits, but all systemic risks should be regulated and decisions made on how commercial banks function and investment/trading banks function.

China's banking regulator told commercial banks to restrict new lending to local governments and stop lending to those projects backed only by expected fiscal revenues.

China has performed some stress tests of potential yuan appreciation.  The tests which concentrated on the textile, shoe, garment, and toy exporters found that every percentage point of yuan appreciation would erode one percentage point of their profit.

While derivatives traders are still betting the euro will continue to slump, any speculation that the euro is doomed or will fade away is misplaced.  It is here to stay, although the EMU needs to restructure its trade and monetary policies, as well as how it applies the Stability and Growth Pact.

The Greek central bank governor said the Greek balance of payments gap is unsustainable.  As we have been saying, a crucial part of the current problem is the fixed trade exchange rates between the Eurozone countries, which create competitiveness gaps.  The Greek central bank governor said, "The balance of payments deficit is not sustainable. A policy mix which will bring back the macroeconomic and microeconomic imbalance and improve the economy's competitiveness and productivity is needed to restore sustainability."

The economist, Carlo Bastasin, has written that the IMF cannot help Greece, because it is less able to address the problem of restoring equilibrium  in the current account balances within the Eurozone.  The Greek fiscal deficit and the loss of competitiveness are connected, because a current account deficit (imports over exports) will make it more difficult for the Greek government to raise taxes to cover the public deficit.  "...If Greece's growth prospects are more limited, its existing debt burden is more onerous."  To avoid this, the domestic demand of Greece's trade partners needs to increase.  "In other words, the Greek problem is the mirror image of the 'hidden' German problem", which needs to increase domestic demand and lower labor costs.  You cannot solve the Greek imbalances without correcting the German imbalances.

The role of large banks and hedge funds in threatening the survival of Greece and the value of the euro in order to make short term derivative trading profits is drawing the attention of other European countries and there is a growing consensus that regulatory action may be necessary as the credit default swaps are increasing systemic risk. 

The ECB refuses to release information as to how many Greek bonds are on its balance sheet as the results of its repo operations.  It is speculated that many of the Greek bonds, of which there are approximately 270 billion euro total, which were held by European banks are now in the possession of the ECB and 37 billion held by Greek banks.

After the EU commission visit, the Greek prime minister said that the worst fears of the Greek economy had been confirmed and the Greece would miss its deficit reduction efforts if it did not carry out more spending cuts which have already sparked demonstrations.  The EU commission indicated that Greece may be able to cut its deficit by 2% rather than the 4% goal. There is increased antipathy between Germany and Greece, which will hinder Greece's ability to obtain EU support for its deficit reduction program.

Portugal has said it is under no pressure to speed up bond sales as 20% of its financing needs have been met for the year.  Portuguese bonds are the worst performing in the region.

The Bank of Spain is considering raising the minimum amount banks must hold in provisions of potential losses in property assets.  Many experts believe Spanish banks will face a new housing crisis in the coming months.  They may have to absorb between 100,000 and 150,000 homes immersed in foreclosure cases.

The Irish government is being forced by the EU to take a 15.7% stake in the Bank of Ireland PLC in lieu of a 250 million euro cash dividend due the government despite the need to contain government deficits.  The government holds 25% preference shares in both the Bank of Ireland PLC and Allied Irish Banks.

Italy has the second largest debt and is considered to the economy of the Eurozone according to the economist Robert Mundell, who won the Nobel prize in 1999 for research which lead to the creation of the euro.  Italy's economy contracted .2% in Q4 and risks falling back into recession.  It has 1.8 trillion euro in debt, which is five times that of Greece and one-quarter of the Eurozone debt.

US Treasury auctions: 
30 year TIPS, $8 billion, yield 2.229%, bid-to-cover 3.33, foreign 42.4%, direct 15.1 in what was seen as a weak, soft demand.
2 year Treasury, $44 billion, yield .895%, bid-to-cover 3.33, foreign 53.6% (high) and 100% filled, direct 8.2%.
5 year Treasury, $42 billion, yield 2.395, bid-to-cover 2.75, foreign 40.3%, direct 12.8%.
7 year Treasury, $32 billion, yield 3.078%, bid-to-cover 2.98%, foreign 40.3%, direct 17.2%.



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