Economy & Market Week Ended 11/26/2010

Ireland was pushed towards a bailout not of its own choosing as the European Monetary Union and the EU sought relentlessly through the ECB to protect European and other international banks on the impressed bodies of the Irish people.  There was so much information and speculation as to what would or could or should happen from default and retreat from the euro to years of austerity, low economic growth, and debt, as the result of Cowen, the Irish head of government having been persuaded by Trichet, the head of the ECB, demanding in 2008 to not let the Irish banks fail no matter what had to be done, inappropriately creating public debt out of private debt in an amount that overwhelmed the Irish government's ability to fund without its own currency or direct EMU participation.  I found myself spending over parts of two days just trying to organize the week's information and finding myself with the awareness that I would have to try to write three different articles at the same time.  The Irish politicians, knowing the government's days are numbered, have worked over time as lawyers tried to justify the government investing new money in the Irish banks without making senior bond holders share the burden as would have happened in a private bankruptcy reorganization.  I find this argument of pari passu, the senior bond holders having the same status of the depositors, under the Irish Constitution to be not worthy of consideration as the the depositors were covered by insurance and only the amounts above insurance would have been subject to the same treatment as the senior bond holders, who are predominantly European banks.  The Irish politicians sought to dress up and disguise any forthcoming bailout as anything else, while knowing full well that the foolish attempt to assume the private debt of the Irish banks without adequate knowledge of the extent and value of their toxic assets was doomed to failure.  Meanwhile, the IMF drones had descended and, combined with EU operatives and ECB coercion, were busy designing what Ireland must do in their usual elitist attitude oblivious to the rights or needs of the Irish people.  The IMF and EMU are ignoring the political fallout and the inevitable collapse of the Irish government and new elections after the December 7th budget vote --- and we in the United States know how disastrous the 7th of December can be --- as the EU and the IMF essentially run the economy of Ireland for the next three years, without respect to the will of the Irish people, preferring to protect and serve the interests of the European private financial institutions (exposure information is mixed, but bank by bank breakdown would seem to indicate Germany is the most exposed followed by the UK which I will show in another article) with continuation at any cost of the Zombie Irish banks.  It appeared that about an 85 billion euro bailout was being designed and that turned out in this following week ending 12/3/2010 to be the case with 35 billion to go to the Irish banks of which 17.5 billion euro was to be taken from the Irish pension funds with unknown interest rates for the IMF and EMU loans which appeared to average around 5.8%, but the IMF loan was supposedly in the 3.5% range which had many people asking if the EMU was demanding over 7%, despite the bailout being financed on the back of the Irish citizenry in the form of reduced services and social safety nets and increased taxes.  One commentator equated the bailout with an economic occupation of Ireland forcing the people of Ireland into a decade or more of grinding poverty which will safeguard the profits of the banks of Europe.

This mishandled bailout of the Irish banks to save the banks of Europe did not stop the awareness that the euro without a fiscal mechanism will continue to be exposed to currency crisis in the form of international lack of confidence.  Even the cost of swaps and bonds of countries like Germany and France started to go up.  The United Kingdom will participate in lending money, because they need to protect Ireland as a large export market as well as UK banks bur, as we have previously written, there are those in the UK who do not believe it is in the best interests of Ireland to stay in the euro.

During the whole mishandled process of bailout or no bailout, haircuts for bondholders or not, German politicians playing to their electorate and not seeming to care if they were creating international economic and market turmoil, and Irish politicians being pushed around and manhandled as if they were children, the pressure on bond costs, spreads, and swaps continued to grow.  Speculation on who would be next became a parlor game acknowledging that the structural weakness of the euro made continued pressure on all member nation bonds unavoidable.  While poor Portugal was being picked on as the smallest, Spain was also taking its licks.  Spain geared up its proactive stance and made several moves to encourage international confidence in Spain's banks and budget spending cuts.  Portugal tried to draw a line in the sand and huff and puff that the EU could not force them to take money, but economic concerns that their budget is not accurately estimated abound.  While Spain may be the keystone as where the cascade of declining confidence in the euro can be stopped, Italy is the elephant in the room whose debt comprises approximately one-fourth of the debt of EMU countries and much of which has been bought by Italian banks, but which provides very significant exposure for other European banks (Table 9D - Italy on the left and then page through).  The situation has given plenty of room for people to hyperbolize and even suggest the currency contagion will extend to the UK as a misperceived debt contagion as many people remain confused by debt which has been used to frame public debate away from the structural weakness of the euro in not having a fiscal mechanism.  The UK has its own currency and can provide fiscal stimulus if it has the political will.  Given the growing disenchantment and failure of austerity in the UK as inflation grows anyway, the current coalition government may not last to the end of 2011.

The G20 conference was inconclusive and provided no real assistance to the global trade imbalances or the developing problems of the euro which many, such as the author of this article, want to confuse with a debt crisis as exemplified but the article's citation of the Asian debt crisis in the 1990's without reference to it being caused by the Russian currency crisis.

The Pragmatic Capitalist wrote of three things he thinks he thinks which were the recession is over but which recession citing mixed economic data and the euro crisis, corrects Rosenberg on why the stock market rallied in September as not the result of quantitative easing but improving economic data after a technical bottom on August 25th, and his reiteration with cautions that gold and treasuries will continue to be a trading hedge with the growing euro crisis, although I continue to warn that piling into gold on the high end is a magnificent way for the market sharks to harvest the fish.  Gold is a crisis hedge, but it will not maintain its inflated value when crisis abates and economic growth kicks in for real for the 99% of people who are not wealthy.  Interestingly, Treasuries were heading for the second monthly decline.  But long term U. S. Treasuries and intermediate corporate bonds should still remain diversifiers in portfolios.

The Baseline Scenario had a guest post on unemployment, student debt, and college graduate employment bleak prospects entitled, "How are the kids? Unemployed, Underwater, and Sinking".

The Economist's view cites David Cay Johnston at length in his appeal to President Obama to call the deficit hawks bluff when they hypocritically demand continued tax breaks for the rich, which will raise the deficit and slow economic growth.  Brad Delong, in the same vein, took on the flawed logic on tax provisions in the Bowles-Simpson Deficit Reduction Proposal.  The Republican economic commentator, Bruce Bartlett, again takes on the misguided economic concept of Starve the Beast is nonsensical and did not work in the George W. Bush administration where it did not restrain spending much less bring it down.

U.S. bank earnings increased 600% in Q3.  If you pay attention to John Hussman, you know this is something to raise your defensive data mining efforts.  As I and others have been pointing out they have been reducing reserves by lowering their loan loss provisions; this is exactly the wrong time to be doing that.  In fact, under the Basel III reforms, U.S. banks will need to raise $100 billion in capital to meet new 8% capital ratio guidelines.  The continued dispensation from the FASB mark-to-market rules which would require banks to report assets held at fair value allows the banks to legally present fraudulent balance sheet statements which hid true asset value and risk.  I continue to look with disfavor upon mutual fund portfolios with financial institution holdings and concentrations, despite bank stocks going up in value.  Cooked financial books are always risky.

Court testimony has shown that Countrywide never sent mortgages to trust ignoring a proper securitization legal process.  Yves Smith at naked capitalism has been hammering away at the mortgage fraud mess almost every day.

Meanwhile rich bankers, who get wealthy making risky investments and trades inconsistent with a well risk managed bank and regulated financial system, creating systemic risk, and get the government to pass their losses off to you and me while they always rake the profits in, are starting to live the glamorous party life of the rich and special people who's elite status exempts them from the constraints of a democratic society, which is becoming since the 1960's increasingly polarized with historically high wage inequality between the top 1% and the rest of humanity.

Elizabeth Warren is being given credit for the failure of Congress to override the President's veto of the bill which would have made the improper titling process used in the mortgage fraud mess retroactively legal.

The Federal Reserve Open Meeting Committee minutes for the October meeting were released and the raised their projections on unemployment, expect slower growth, and lower inflation. They saw output and employment improving slowly, but the current rate of output is more likely to increase unemployment.  While they do not expect the economy to slide back into recession, it is vulnerable to shocks.  The housing sector remains depressed.  They noted that financial institutions risk losses if misrepresented mortgages are put back to the sellers.  Inflation has tended lower as has nominal wage growth.  Inflation is expected to remain below levels consistent with maximum employment and price stability.  The participants were very divided on quantitative easing in form and consequences but only Hoenig voted against it.  The Fed will buy $600 billion of longer term U.S. Tresuries at $75 billion a month through the second quarter of 2011.  The Econbrowser provides suggestions to the Fed on how it could communicate to the public more effectively by providing the public with a clear explanation of how it plans to do when it returns the interest rate to something higher than zero and the limits of what monetary policy can be expected to do.  The public is confused and worried about inflation and does not really understand the role of inflation in growth and the need to both encourage it and control it.  The quantitative easing program of the Fed is viewed by many economists as ineffective in creating economic growth and employment and by others as a threat of increased inflation.  It has every appearance of primarily creating liquidity and allowing financial institutions to increase their reserves and I have been maintaining that will be its primary result.  We need a stimulus providing targeted programs to increase employment and economic growth in the short term.  The money supply is low and trending lower.  The Fed is deserving of legitimate criticism, but many people are confused about inflation, monetary policy, what the Fed has done and not done, and what the Fed can and cannot do.  Many people have seen the video of the bunnies trying to explain to each other what the Fed is, does, and how quantitative easing works, but the video is not completely accurate as Econbrowser explains.

Actual PCE (Personal Consumption Expenditures) Inflation was only .1% annualized in October and the core PCE fell 3 tenths to .9%.

A proposed Federal Trade Commission rule which is supposedly aimed at protecting families of people who have died in debt is being questioned by consumer advocates as possibly unleashing aggressive collection tactics.

Michael Pettis believes European bank stress tests were not rigorous enough and that Ireland is under such pressure from the ECB, EMU, IMF, and the EU to take a bailout, because European banks could not be successfully restructured.  He also believes that if Spain were to come under pressure to take a bailout, it would leave the euro rather than give sovereignty to Germany.  He also thinks a junk bond market will spring up in Europe as it did in the 1980's in the U.S.  With respect to China, he is skeptical that China's banks will be able to keep within loan quotas, inflation is rising faster than rising interest rates, and he is concerned that raising interest rates may increase inflation rather than reduce inflation as one might intuitive think.  The pegging of the Chinese currency to the U.S. dollar is directly related to the increase of China's trade surplus and raising interest rates, according to BNP Parabas, would increase capital inflows into China.  U.S. quantitative easing effectively reduces the value of the dollar against other free floating currencies, but the renminbi is pegged to the dollar and has generally fallen in value, particularly against the currencies of other emerging market countries, even though the peg has increased 3.1% in the last five months.  On Friday the 26th, the Chinese 3 month yuan bill auction failed to attract sufficient demand for the first time since June, attracting only 11.6 billion yuan ($1.7 billion) from a 20 billion yuan offering and yielded 2.7372% and this is seen as signaling tightening to come.   If China takes liquidity out of the market, it will probably mean that Australia may see its unemployment rate increase, its interest rates not go as high as expected, and it trade terms with China peak.  On the other hand many people think a contraction in China's trade surplus would be a global positive.

The eurozone, emerging Europe, and China are economic sectors which require careful attention.

Sheila Barr, head of the FDIC, weighed into the deficit debate in the Untied States in a disappointing display of not really understanding the problem.  Too many public officials are pandering to a public disaffection with government not getting things done that really help people and are using the deficit as a mask for not providing the stimulus the economy needs to create jobs and improve lives of its citizenry.  Even President Obama appears to have fallen into the deficit hawk pit.  Social Security is not part of the Federal debt and opposition to health reform betrays the fact that health costs are the one of the largest parts of the increase in Federal debt.  Those who would deny unemployment benefits and demand lower taxes for the wealthy while demanding deficit reductions are hypocrites at best.  Ataxingmatter has torn the deficit argument apart in detailed fashion and places the problem on politicians and media, who avoid rigorous analysis.

Krugman bemoans the intellectual, political, and financial instability of moderation in the perception of history after this last Recession as detailed by Brad Delong in his macroeconomic disappointment that, despite economic history, any developed nation would allow a business cycle to wreak havoc to the extent of continued and prolonged high unemployment.  Politicians are playing crowds and public disaffection with inefficient government to advance political agendas that favor the financial interests and wealthy rather than the interests and needs to the people.  Brad Delong also gave a speech in which he reviewed the financial crisis and Recession and how we have become side tracked and economic recovery has been put on the back burner as politicians churn public resentment.

John Hussman in his 11/22/2010 weekly commentary said investors have not learned that historical evidence shows that consistently low yields and elevated valuations are followed by dismal subsequent returns over the next decade.  S&P 500 yield is 1.95% which means one could expect 2.2% annually over the next decade, although his use of normalized earnings result in a projection of 4.8%.  Using forward operating earnings, the projection result would be 4.7%.  This is not a dividend story.  He still is opposed to the Fed's QE2 and cites several economist's with whom he agrees, including Stiglitz, who are opposed or would be opposed and also again affirms the need for targeted investment stimulus.  He also goes into detail on why he thinks the Maiden Lane vehicles created by the Fed to hold toxic securities bought outright from the financial institutions and held for over two years are illegal under The Federal Reserve Act.

In dealing with global imbalances, and imbalances within the eurozone, one of the problems is the focus on current account balances control by using target current account levels when the problem is actually one of fiscal policy and exchange rates.  To correct a deficit current account balance really requires international and national investment, austerity damages investment and nominal wage and price adjustments are not going to create sufficient competitiveness improvement.  Jan Kregel and Rob Parenteau have argued for the European Investment Bank to step in and make investments to create competitive output and I have maintained that it is necessary to invest to create competitiveness internally and with exports.  Unfortunately, the EIB does not provide these types of loans, does not believe it is empowered by the EU to do these types of loans, has a history of infrastructure improvement loans, and does not have the business experience or psychological disposition to make loans that are not consistent with how they do business as bankers. The problem is no one wants to make the necessary investment loans and the euro and austerity deprive EMU member countries of the ability to make efficient internal investment.  This is why a fiscal mechanism (and the relinquishment of national sovereignty to create a fiscal union is not a political reality and it will be necessary to construct without loss of sovereignty --- some, such as Edward Harrison, have suggested fiscal stabilizers) and European bond (Germany is against this type of bond and believes it would require a treaty change) to provide funding is functionally created.  Such a fiscal mechanism will not work if designed to respond to budget deficits rather than investment needs (encouragement or discouragement) to create competitiveness and efficiencies or to cool a nation's economy.

Market: No banks failed the week of 11/26; the problem bank list is 919.
                         DOW/Volume                      Nasdaq/Volume
Mon:             <24.97>/down 16.8%               13.90/down 1.9%
Tue:             <142.21>/up 11.7%                 <37.07>/up 3.7%
Wed:              150.91/down 19.2%                48.17/down 13.1%
Thu:                                         Holiday
Fri:                 <95.28>/down 48.2%             <8.56>/down 60.6%

Total                     <111.55>                               16.44

Mon: Oil down 24 cents to $81.74; Dollar stronger but weaker against the yen; banks down on insider trading raid; eurozone contagion worries; U.S. banks need $150 billion more capital under Basel II.

Tue: Oil down 49 cents to 81.25; Dollar stronger but weaker against the yen; Korean fighting.

Wed: Oil up 2.61 to 83.36 (December contract); Dollar stronger; commodities market ignored oil supply up ; oil price up on Pre-Holiday short covering; weekly jobless claims were down 34,000 to 407,000, 4 week moving average was down 7500 to 436,000, continuing claims were down 262,000 to 4,660,000 -- these are positive news but may reflect seasonal adjustment assumptions that claims increase between Veteran's Day and Thanksgiving Day; oil supplies were up 1 million barrels, gas was up 1.9 million barrels, and distillate was down 500,000 barrels.

Fri: Oil down 10 cents to 83.76 (January contract); Dollar stronger; only half day market; Europe fears of contagion on talk of senior bond holders haircut; Korean conflict; Ireland's banks downgraded.

United States: Agricultural exports are creating an economic boom in parts of the Midwest.

ECRI WLI (Weekly Leading Index) is up to <3.1> from <4.5>.

Mishkin, a former Fed governor, said the Fed is under unprecedented attack for being unable to clearly articulate monetary policies and its credibility has been damaged by its failure to put monetary policy in a long term context and internal dissension.

CoreLogic reported shadow housing (pending supply) inventory of about 2.1 million with total visible and shadow inventory of approximately 6.3 million.

Chicago Fed National Activity Index was up to <.28> October from <.52> with 3 month average down to <.46> from <.33> which is the lowest since November 2009.

Three hedge funds were raided on Monday in an insider trading investigation: Diamond Capital Management, Level Global Investors, and Capital Management.

Kocherlakota (Minneapolis Fed) voiced support to QE2 as "move in the right direction", but he warned that uncertainty over tax policy drags on growth.  He believes inflation is not a concern and that unemployment is dragging the economy.

Health insurers are required to spend 80% of premiums on heath costs and no more than 20% on administration under newly released Federal regulations.

Commercial property prices were up 4.3% September for the biggest monthly gain in the ten years records have been kept.

Mortgage delinquency rate was down to 6.44% Q3 from 6.67% Q2 and up to 6.25% vs year ago (historical average is 1.5-2%) according to Trans Union. 

Q3 GDP was revised up to an annualized rate of 2.5% from 2.0% and real PCE from 2.6% TO 2.8%.  State government expenditures were revised up from <2.%> to .8%.  Continued high unemployment is expected to lower growth.  Non-residential construction investment was revised down to <5.7> from 3.9 as expected.

Existing home sales were down 2.2% October with inventory up 8.4% vs year ago.

Illinois unemployment was down October to 9.8% from 10.9% a year ago.

Richmond Fed Business Activity Survey was up 4 to 9 in October; finished goods inventory was up 10 to 16; raw materials were up 5 to 15; new orders were up 2 to 10.

U.S. PCE was up 1.0% September annualized (2.3% August) with core PCE up .3% (.8% August).

Fannie Mae and Freddie Mac will resume sale of foreclosed home.

Sheila Blair, head of FDIC, wrote a Washington Post opinion piece asserting the next debt crisis could be the U.S. with Baby Boomers impacting government spending, special interest tax codes, military spending, and tax subsidies for housing and health as misallocated resources.  She predicted the debt to GDP ratio could rise from 62% to 185% in 2035.  We have already commented on our disappointment in her display of economic illiteracy.

U.S. durable goods orders were down 3.3% October and down 2.7% ex-transportation in the largest drop since March 2009.

International: The EU has drafted a strategy to obtain continuing sufficient supplies of raw materials.

Estonia PPI (Producer Price Index) was up .3% in October.


Despite a 2.3 bid to cover on 3 and 6 month Spanish bonds, Spain sold less that the 4 billion euro minimum it offered (4-5 billion) indicating the bids received were too low and rejected.

China ordered local governments to ban hoarding of oil, coal, and other key commodities to keep prices from climbing.

Union strikes against austerity measures have shut down public services in Portugal.

Irish government majority fell to two votes with the election of an anti-austerity candidate in special election.

China protested U.S. and South Korea military exercises.

India is expanding its bribery probe among bankers and developers.

Peru GDP was 9.5% Q3.

China will rely next year on fiscal stimulus to maintain economic growth at 8%, set inflation target of 4% up from 3%, further cut bank lending target, and be less reliant on exports.

German inflation was up on food and energy to 1.6% (expected 1.4%) November from 1.3%.

United Kingdom students have renewed educational fee protests.

The People's Bank of China will use price tools (interest rates) and other measures to curb growth.

India arrested 8 bankers and brokers for bribery triggering the biggest one day jump in swaps.

The Australian Central Bank said interest rates will remain steady for the next several months.

Japanese deflation slowed as consumer prices continued to fall for the 20th month, because the increase of tobacco taxes impacted prices.


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