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.


Print Page