Irish Bank Withdrawals

In looking at bank withdrawals in the eurozone, it is necessary to distinguish between a banking crisis, in which there are bank runs, and a currency crisis, in which foreign investors and depositors withdraw money and domestic households and non-financial corporations draw down monies as the result of unemployment and a poor business loan market.

In Ireland, there was a real estate bubble and banking failures.  The ECB threatened the Irish government into guaranteeing senior bond holders, who were core European banks who had financed the real estate bubble, at the expense of the Irish people.  Did Irish households and non-financial corporations run with their money?

In looking at the May 2010 to May 2011 yearly figures and the different deposit peaks to May 2011 for Irish households, Irish non-financial corporations, other euro area depositors, and rest of the world depositors, we see vastly different transaction patterns.

The peak deposit of the rest of the world was September 2007 at 91,068,000,000 euro which declined to 43,139,000,000 euro as of May 2011; a decline of 47,829,000,000 euro or 52.52%.  The last twelve month decline was 21,666,000,000 euro or 33.43%.  The peak deposits of the other euro area depositors in Ireland peaked in June 2007 at 43,388,000,000 euro which declined to 28,984,000,000 euro as of May 2011; a decline of 14,404,000,000 euro or 33.20%.  The last twelve month decline was 6,191,000,000 euro or 17.60%.  You can see the outstanding balances and monthly transactions here in two tabs of Table A.12.2.

The peak deposits for non-financial Irish corporations was in September 2007 at 45,679,000,000 euro and the peak for households was August 2009 at 99,407,000,000 euro, because households increased deposits from 81,822,000 euro in September 2007.  From the September 2007 peak to May 2011, Irish non-financial corporations declined to 31,655,000,000 euro as of May 2011; a decline of 14,024,000, 000 euro or 30.70%.  The last twelve month decline was 5,325,000,000 euro or 14.40%.  From the August 2009 household depositor peak to May 2011, household deposits declined to 92,133,000,000 euro; a decline of 7,274,000,000 euro or 7.32%.  The last twelve month decline was 5,758,000,000 or 5.88%.  You can see the outstanding balances and monthly transactions in the two tabs of Table A.1 or Table A.11.1 in the link above.

Irish corporations are struggling for money to continue business operations in which consumers are not spending.  There is no pattern of household withdrawals until approximately February 2010 and it is not month to month consistent or accelerating; it does appear to be consistent with growing eurozone and Ireland political crisis, unemployment at 14.1%, which is the highest since 1994, declining property values decreasing home equity, where some prices are down 53%, and increased austerity.

Even with the failure of banks and ECB imposed defense of core European banks which indentured Irish citizens, Irish households and non-financial corporations are showing no runs on Irish banks.  The large withdrawals by rest of world depositors and other euro area depositors are consistent with foreign withdrawal of deposits and investments during a currency crisis, which increases liquidity problems.

I have been watching deposits throughout the eurozone countries, not just the periphery, and I intend to write a larger post in the future as withdrawals are not just occurring in the periphery.

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Waiting for Godot or Does Anyone Really Know What Is Going on with eurozone Banks?

I have been researching eurozone banks excess reserves and repo availability for a few weeks trying to work my way through muddled commentary and sort the reality from the assumptions and found myself questioning what I know.  In doing so, I have misstated to others what I am thinking and even the data, facts, and issues about which I am concerned.  Sometimes it is best to just stand back and look for the string that pulls the material together.

I have yet to write that article which will address whether eurozone banking rules to promote solvency of banks is creating a liquidity problem, because  the eurozone banking resolution authorities seem to have so badly mismanaged the Banco Popular resolution to the point of intensifying a bank run despite monitoring bank liquidity on a daily and hourly basis.

Banco Popular was Spain's 6th largest bank having been in existence since the early 20thCentury and one of the more profitable banks until about 2016.  In February 2017, it announced it had a 3.b billion euro loss on asset writedowns and Non Performing Loan sales while maintaining it still had more than sufficient quality assets on its balance sheet.

By the end of May and first days of June reports were circulating that Banco Popular had received only 3.5 billion euro on 40 billion euro collateral rather than the 9.5 billion euro it had expected one month previously and had applied to the Bank of Spain for liquidity support receiving only 10%

Michael Pettis on the Euro, Swiss Franc. RMB trading, and Chinese Debt

In a very long private newsletter received on September 13th, Michael Pettis began with "Slow growth is embedding itself solidly into the US economy and the bond mayhem in Europe continues. The external environment for China is getting worse. This will almost certainly make China’s adjustment – when Beijing finally gets serious about it – all the more difficult. With still weak domestic consumption growth, and little chance of this changing any time soon, weaker foreign demand for Chinese exports will cause greater reliance than ever on investment growth to generate GDP growth.

"Europe’s travails in particular can’t be good for exports. What’s worse, it’s now pretty much official that the euro will fail soon enough."  Pettis saw Merkel's assertion that the euro will not fail as an official government denial confirming that it could fail as in the political maxim, "The first rule of politics is never believe anything until it is officially denied."  Pettis then proceeds to discuss in depth Otto Henkel's proposal ( "A Sceptic's Solution - A Breakaway Currency") for a two currency euro.  Although Pettis thinks there is little likelihood of the creation of two euro currencies dividing the deficit and surplus eurozone countries, he likes the idea, because all the deficit countries will not adjust fast enough as long as they maintain the euro and their economies will continue to contract and debt grow until their electorate rebels.  If those countries will then leave the euro and default and the surplus countries will eat the losses, why shouldn't the surplus countries force the deficit countries to leave the euro now?  Pettis answers his own question.

If a deficit euro country leaves the eurozone and adopts its own fiat currency, Pettis believes it would be caught in a downward currency spiral such as Mexico in 1982 and 1994 and Korea in 1997 suffered, because a substantial portion of Mexican and Korean debt was denominated in foreign currency.  A deficit euro country leaving the eurozone would have its debt denominated in euro.  This would be a foreign currency.


My comment in response to Pettis on the above scenarios is the High euro and Low euro bifurcation would merely create to stage productions of the very same play; one with a short and the other a longer audience length of the play.  Both would suffer the same, inevitable fate of the exporting country economically subjugating the importing countries with no fiscal transfer mechanism to resolve the current account imbalances creating an inevitable currency crisis as the deficit countries are challenged by the bond market one by one since they cannot guarantee payment under such a system.  Any eurozone country which withdraws from the euro must default on all euro debt and immediately redenominate all public and private debt at a fixed conversion to the new fiat currency on a take it or leave it basis and then let the new fiat currency trade freely with the market deciding the devaluation, which must occur.  The euro is a foreign currency to all eurozone countries and it would be irresponsible to leave debt in euro when exiting to a fiat currency; yet, almost all scenarios of such exits assume the debt would remain in euro.  That would be a fatal economic error.


As Pettis well knows, as he continues, to leave debt in a foreign currency means the devaluation may well not be in line with estimates of overvaluation.  It could cause a devaluation of 50% or more, when the overestimate might be only 15-20%.  The external debt would rise as its fiat currency devalues, because it would remain denominated in an appreciating foreign currency.  The credibility question of bond payment would rear its ugly head again and financial distress cost would rise just as they are now.  As domestic borrowers try to hedge the currency risk, investors would flee the new fiat currency in a self-defeating currency crisis involving foreign currency debt.  Default would be unavoidable.


For Pettis, this is not an argument for a deficit country to stay in the eurozone, because, if the deficit country "stays in the euro, we will still arrive at default, but much more slowly, and mainly at first through a grinding away of wages and economic growth over many, many years and a gradual building up of debt as Germany refinances Spanish debt at interest rates that exceed GDP growth rates. The default will occur anyway, but only after years of high unemployment."  He leaves unstated the likelihood of growing social unrest and intra eurozone national distrust of the surplus eurozone countries.


This is why he likes Henkel's two euro currency idea, but with the surplus country (such as Germany) leaving the euro as Marshall Auerback has repeatedly suggested.  The new fiat German currency would immediately appreciate while the euro depreciates, but their banks would still have loans in euro which would cause them significant losses.  Pettis thinks the losses would be less and more orderly than a deficit country leaving the euro.  Either way the surplus country leaving the euro would take a big hit and it is a waste of time trying to avoid it and it is better to face it and deal with it and "as any good Minskyite would tell you, that means we have to pay special attention to the balance sheet dynamics."  Pettis also believes this would set up a two entity Europe of Germany and its associated countries and France and its associated countries.

With respect to the Swiss franc, Pettis believes the Swiss National Bank has decided to become very serious about currency wars.  Switzerland is enduring a large inflow of foreign currency and appreciation of the franc with significant negative impact on Swiss exports.  "The world is seriously deficient in demand compared to capacity and every country is going to try (has already tried) to capture as large a share of that demand as it can. This means every country is going to try aggressively to export capital or limit capital imports."

"But of course it doesn’t work that way. If capital-exporting countries want to increase capital exports in order to acquire a bigger share of global demand, and capital-importing countries want to limit or reverse capital imports, something has to give way. This is basically what we mean by trade and currency wars."

Switzerland has chosen to slow or eliminate foreign capital inflow by capping the rise of the franc.  Pettis believes it cannot work and there will be massive speculative inflows in the Swiss franc on the expectation the inflows will cause the Swiss National Bank to revalue.  In a few months the SNB will have to take even more forceful measures.  When countries continue to desperately export capital to each other while continually crying foul at attempts to import capital, currency wars will roll on as he explain in his recent Foreign Policy article. 

This also means we should not get too excited about news London may become an offshore trading center for the Chinese RNB currency.  Every time the suggestion is made that the renminbi will become more international, excitement sweeps the world, although nothing ever really happens.  One only has to look at the developing currency wars and understand everyone wants to export capital and no one wants to import it so why would China want its currency to evolve into a reserve currency by trading internationally.

There has also been speculation that a country like Nigeria would want to diversify reserves and hold renminbi, but Pettis thinks this is only a speculative idea based on the renminbi price being heavily subsidized by the PBoC and, therefore, only likely to appreciate.  China is unlikely to allow any but the financially small countries to attempt this and does not want to see it at all, since "The PBoC is required to buy up all the dollars offered in exchange for RMB in order to keep the value of the currency where it is, and any increased foreign demand for RMB bonds automatically means that the PBoC must take the other side of the trade. Its reserves will have to increase by exactly the amount of dollars that Nigeria (or any other foreigner) uses to buy the RMB. And the faster China’s reserves rise, the greater than domestic monetary mayhem and the greater the losses the PBoC will ultimately take on the negative carry and the revaluation of the RMB."  The short version of his discussion of this in his mid-May newsletter was "...that once you exclude intercompany transactions, nearly all the trade activities denominated in RMB consist of Chinese imports, and almost none of it consists of Chinese exports. Why is this important? Because Chinese imports denominated in RMB result in long RMB positions in Hong Kong, whereas exports result in short RMB positions."  Once the speculative demand dries up, there is little real demand for RNB transactions and the off shore RNB market would be very small.

Speculative demand will begin to dry up when the perceptions on the total amount of debt on the Chinese national balance sheet begin to improve.  However, debt levels continue to rise and rise very rapidly.  Most analysts have downplayed the resulting credit impact of China's spectacular growth.  Such an analysis implies China has an infinite debt capacity, which Pettis finds impossible.  What concerns Pettis now is that as analysts have caught on to this, the "horror" stories have begun to multiply out of control about "...cash flow squeezes among SOEs and the smaller banks, about unrecorded guarantees and lending by SOEs, about highly pro-cyclical lending by banks, about a huge variety of dubious transactions in the informal banking sector, with non-transparent links to the banking sector, and so on and so on. Everyone nowadays seems to have horror stories.  For this reason, Pettis advises we remain skeptical.  We should not scare ourselves into overreacting.  Pettis does not see China reaching its "... debt capacity until one of three things has happened:

1. Depositors flee the banking system because of uncertainty about repayment prospects. I think this is unlikely to happen unless inflation rises sharply and, because of the highly adverse cash flow impact of high nominal rates, the PBoC is unable to raise deposit rates sufficiently.

2. Household transfers are too high. Debt servicing costs should be met out of the increased economic activity generated by the debt. If they aren’t, the balance one way or another must result in a transfer of wealth from one sector of the economy – usually the household sector. As these transfers rise, the ability of that sector to generate growth becomes smaller and smaller. At some point the transfers are too large to be managed, and investment growth must stop. Of course if the government begins to privatize assets and uses the proceeds to clean up the banks and repay loans, this problem need not happen.

3. The private sector becomes so worried about the possibility of financial instability and rising of financial distress costs that they disinvest faster than the government can invest."
   Another way to extend debt capacity limits, according to Pettis, would be similar to Brazil in the mid 1970's when it was "saved" by massive petro-dollar recycling and a subsequent lending boom switching domestic debt to external debt, which allowed Brazil to keep investing and growing until the 1982 crisis and a lost decade.  In principle, China could do this, but it is unlikely to become a net foreign borrower as it would also have to reverse its huge current account surplus into a current account deficit.  He thinks there would institutional impediments preventing this from happening.
   
   
   Everyone knows by now that Chinese inflation is down to 6.2% in August, but he finds these numbers to be so much within expectation that he has nothing to add.  Inflation appears to have peaked, but the numbers require another month or two of observation and Pettis believes the PBoC also believes this.  There is also growing concern among economically literate policymakers about rising debt and weak consumption, because these are basically the same problem.  He expects to see comments back and forth on inflation, but a number of policymakers are reluctant to support more expansionary credit growth as a credit contraction is politically very unlikely.
   Pettis remains concerned that the Chinese consumption imbalance remains a fundamental problem despite Yukon Huang writing in the Wall Street Journal that consumption is in fact far higher than official government figures and takes issue with Huang's interpretation of the studies cited, because one study actually shows 2/3rds of hidden income accruing to the top 10% wealthiest and almost all to the top 50% and, since the wealthy a much smaller share of income than the poor, it would suggest the consumption imbalance is actually much larger.  Pettis also finds the reported size of the imbalance by Huang to be astonishing.  Just because the NBS data is awfully wrong, this would not increase China's invulnerability from crisis.  In the end, all the possible arguments against the dismissal of the fundamental consumption imbalance problem need not be made, because the balance of payments tell us it is extraordinarily low.  "... China doesn’t have either a current account deficit or a balance of zero. It has instead one of the highest current account surpluses ever recorded. This can only happen if the savings rate exceeds by a huge margin the investment rate – which, remember, was itself by 2008 the highest we had ever seen, and which has soared even further in the past few years
   
   
   "By definition, then, China’s savings rate must be extraordinarily high to allow it both a huge investment rate and a huge current account surplus. Since savings is simply the difference between total production and total consumption, China must also have an extraordinarily low level of consumption in order for the balance of payments to balance. I would argue that it almost certainly does."

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On the Supremacy of The Irrational: Pushing Greece to the Brink of Implosion

While Europeans saw the decision of the eurozone Finance Ministers to back away from a funding plan for Greece and demand an affirmative Greek vote and a further austerity program as a smart political move, other parts of the world saw it as yet another internecine failure to comprehend what is going on in Greece and the conditions of the Greek people.  Europeans refuse to consider that it is the euro which has driven Greece to its present state and believe Greece would enjoy no confidence from the international market if it defaulted whether within the euro or by adopting its own fiat currency.  Nor do they understand that a default within the euro would be a disorderly default, while a planned (is there enough time?) default with a fiat currency could be orderly.  The question of confidence is in how long the euro will continue destroying its current account balance deficit members with its refusal to adopt proper fiscal transfer mechanisms consistent with an economically efficient monetary union.

The essential and fundamental differences between a fiat currency and the euro have confused many commentators and economists, because they do not recognize the euro's failure to provide a fiscal transfer process creates a denial of national fiscal policy and how continued political demands for more and more austerity is destructive of aggregate demand creating a perceived lack of political will which engenders a growing lack of international confidence in the ability of the euro to serve the people of the eurozone.

While John Dizard dismisses Greek protests as just "striking civil servants" who will have no impact on Greek politics and incorrectly assumes that periodic monthly large withdrawals from Greek banks are runs on the banks and a banking crisis when there are no lines of clamoring depositors demanding their money.  He assumes a default is coming and that it will be within the euro and it will cause Greek banks to fail, because they own Greek debt, as do many individuals, pension funds, and foreign banks.  Wealthy Greeks, beginning for a period in 2010, have and are periodically moving money out of Greece, as well as other assets such as yachts, to avoid taxes and ordinary Greeks have started this year to withdraw deposits in order to maintain living conditions, i.e., they are devouring their savings, as we have written in this recent post.  This is consistent with a currency crisis, which is a lack of confidence, rather than a banking crisis.  The Greek protestors are a diverse group of union members. unemployed, pensioners, and small business people, who despair over the loss of sovereignty, threats to democracy and human freedom from eurozone proponents who demand political unity at any cost which cannot fix the euro, and living conditions which are spiraling down.  They have had enough of austerity and politicians who cannot serve the best interests of the people.

In order to protect the euro, Greece, Ireland, and now Portugal have been forced into austerity and bailout designed to defend core European banks.  Ireland was conned into accepting indentured servitude for its citizens.  Portugal has been duped into accepting austerity which the ECB demanded and which the Portugese may find unpalatable more quickly than desired.  Greece has been pushed and pushed to the brink of enslavement as the eurozone demands absolute fiscal control of Greece as core Europe continues to hide the capitalization needs of its large and smaller banks.  At what point will a people not fight back?

If Greece were to default, why would they not do so in an orderly process which includes withdrawal from the euro and redenomination of its debt in its own fiat currency, devalued in relation to the euro, which would protect its banks and citizens?  It would not be easy, but, if it were thoroughly planned, the substantive economic damage would be primarily contained to eurozone banks and foreign holders of private debt which would still be income producing.  This is not a scenario which I relish, nor one I have advocated, but the eurozone seems committed to implosion as long as it defends the euro as a currency without a fiscal transfer process and demands austerity and human misery of its less economically powerful members even if it means the destruction of sovereign rights to protect its citizenry and democracy.  I would much rather see eurobonds, a fiscal transfer mechanism, and coordinated investment from the European Investment Bank, as Rob Parenteau and Jan Kregel have written and/or tranche transfers, as Yanis Varoufakis has proposed, although I wonder if tranche transfers by themselves might just delay the end game.  Unfortunately, we do not live in reasonable times.  The Irrational rules.  Are we doomed to relive the currency crisis of 1931 Germany which was caused by a lack of political will and deficit reduction economic policies, which created an international lack of confidence in Germany's ability, despite a trade surplus, to pay international debts in a currency fixed to the gold standard?


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Is the Euro Steeped in Self-Deception and Suicidal Delusion?

After only one day, the Euro Deal of the recent EU Summit began to wilt under the bright heat of the flood lights of rational scrutiny.  On Day 2, we saw a repetition of how the German Constitution is a fundamental stumbling block to a politically united eurozone fiscal union with additional pleadings which could force Bundestag approval of EFSF bond purchases (not the bond purchase program but the actual individual purchases themselves).

We also saw on Day 2 the Erste Group bank of Austria suddenly writedown its CDS portfolio by 1.49 billion euro creating a a 750 million euro shortfall just two weeks after projecting a profit and reducing its 2010 profit 12%.  It reduced its CDS portfolio to 300 million euro yesterday from 5.2 billion euro as of the end of September.  It also announced it was cancelling its repayment of 1.2 billion euro in State aid, while proclaiming it had no intention of requesting new State aid as it would cover the loss with a 35% (only) return of executive bonuses and the use of retained earnings over the next three quarters.  It should be noted that the Erste Group had substantial exposure to Eastern Europe as do Greek bank Subsidiaries in Eastern Europe.

Worse, not only is Sarkozy seeking China's investment in EFSF bonds or the SPV to be created (Van Rompuy is on record from earlier in the year favoring consideration of Chinese investment), but Klaus Regling, the executive director of the EFSF, was not only already talking with the Chinese but even suggesting that EFSF debt could be issued in Yuan.  It is economically incompetent for a sovereign nation with its own fiat currency to issue debt denominated in a foreign currency.  For a monetary union with no fiscal transfer mechanism to issue debt in a foreign currency (Yuan), when its member nations are under credit attack for debt already denominated in a foreign currency (euro), is beyond incompetent; it is economically suicidal.

The surplus countries of the eurozone have the money to invest in the deficit countries; there is no need for foreign investment in eurozone debt which will cause the euro to be sold and dollars purchased by the eurozone countries which will strengthen the euro and make eurozone exports more expensive.  The surplus eurozone countries, in order to economically correct trade imbalances within the eurozone, should be using the current account surplus funds to invest in the infrastructure and manufacturing of the deficit countries. The Euro Deal of this past week has not increased the equity stake of member nations; it only has the member nations providing insurance guarantees. 

The one size fits all approach of the eurozone just does not work.  The deficit countries cannot export and privatize their way into surplus under austerity.  The current account surpluses needed to drive down the existing high private sector leverage and public sector deficit in the deficit countries is too massive (even in Ireland) to be obtained from export growth and the privatization of public assets.

Yet, the mantra of convergence, competitiveness and austerity remain as the key mistakes enshrined as European Monetary Union holy grails carry forwarded from the EMU 1991 currency crisis.  Convergence never happened.  Kantoos Economics, a German economics blog, has had two recent posts which exemplify the group think mindset of the European Monetary Union. One was on competitiveness in which a post by Kash Monsori is used in an attempt to show how misunderstood the European concept of "competitiveness" is and that imposed austerity in the deficit countries is not a self fulfilling economic disaster. The second post on Kantoos Economics is on the "necessary" rigidity of currency unions and internal devaluation as the only method of adjustment for trade imbalances with a currency union.  If Kantoos Economics wants to take on a non-European on competitiveness, then Kantoos would be well advised to take on Rebecca Wilder who has shown the "competitiveness" concept as promulgated in the eurozone is a chimera in which all countries must be like Germany in which the concept has become to mean the efficiency of the economy as a whole involving "...strong macro-prudential policy, infrastructure, efficiency and income gains, savings, etc."  In fact, the concept of competitiveness more generally describes and reflects data from a variety of factors such as education, infrastructures, institutions, technological development, health, macroeconomic environment, market efficiency, labor efficiency, and innovation to name a few.  It is always best when theory adapts to the reality of data rather than morph data to fit a phantasmagorical theory.

When one looks at worker statistics, the Greek worker works longer hours for less money than workers in other EU countries.  However, most Greek workers are involved in agriculture and the worker productivity has a smaller euro value.  For productivity to improve, there needs to be technological improvement within Greece.  In fact if you look at the northern and southern eurozone countries, there is no evidence of profligacy and laziness.  What you will see is, the creation of the euro lead t a massive flow of capital from the northern countries to the southern countries, because it was profitable for the northern countries.  Marshall Auerback and Rob Parenteau have provided a concise and strong economic criticism of the Greek myth of profligacy and the ultimate self-destructive nature of austerity not only on the deficit countries but also on the surplus eurozone countries.  They paint a convincing picture of the need for a more coordinated mutually beneficial growth option involving direct investment by the surplus countries in the infrastructure, technological development, and manufacturing of the deficit countries.

The Australian economist, Bill Mitchell, who has been a long time critic of the euro, sees the Euro Deal as one which solves nothing, continues all of the same problems, intensifies the anti-democratic policies of the eurozone, and increases the pressure on the surplus countries to suffer the same fate as the deficit countries.

What does this leave us with?  Desperation, human suffering, failed nations, a breeding ground for authoritarian regimes, economic collapse?  Or does it leave us with an existential epiphany of NO HOPE and the recognition of a common humanity and purpose that digs down and comes up with the political will to get things done for the best interests of the many and a respect for individual freedom which promotes unbiased, empirical analysis of economic data, the needs of aggregate demand, and recognizes the economic growth power of full employment?

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Ireland's Bad Bank

Ireland has received praise for its draconian austerity program and  the creation of the National Asset Management Agency, a "bad bank" formed to purchase toxic assets from Irish banks.  The EU, the IMF, and Moody's have all praised the formation of this bad bank, but is it a good "bad bank" or a bad " bad bank"?

The Baseline Scenario did a good analysis of the Irish financial crisis:  "Ireland’s difficulties arose because of a massive property boom financed by cheap credit from Irish banks.  Irelands’ three main banks built up 2.5 times the GDP in loans and investments by 2008; these are big banks (relative to the economy) that pushed the frontier in terms of reckless lending.  The banks got the upside and then came the global crash in fall 2008: property prices fell over 50%, construction and development stopped, and people started defaulting on loans.  Today roughly 1/3 of the loans on the balance sheets of banks are non-performing or “under surveillance”; that’s an astonishing 80 percent of GDP, in terms of potentially bad debts."

Much to the original consternation of the EU, Ireland responded by guaranteeing all liabilities of Irish banks, rather than a capped amount like other EU members, and injected capital into the banks purchasing 25% of the Allied Irish Bank and 16% of the Bank of Ireland while nationalizing the Anglo Irish Bank, whose CEO had hidden 122 billion euro in loans and has just been recently arrested for fraud.  In the last two years, approximately 40 billion euro in loans in the eleven Irish banks and building societies have been written down.
Now they are planning to buy toxic assets from the banks and give them government bonds; in essence, the government will be issuing 1/3 of GDP in government debt for these distressed assets.

Rather than forcing the creditors of these banks to share the burden, a strong lobby of real estate developers, bond investors, and politicians linked to the developers and bankers prevailed in pushing a "corporate socialist" solution in which the profits were privatized and the losses shoved on the public by making the taxpayers responsible rather than have the creditors pay for their risk taking.  A bad bank formed for the public good would have restructured those debts and the creditors would have taken the hit.

On March 30th, the National Asset Management Agency said it would be taking on $22 billion in loans at an average 47% discount amounting to a 32 billion euro writedown for the banks: 3.29 billion euro from Allied Irish Bank at a 43% haircut, 1.93 billion euro from the bank of Ireland at a 35% haircut, 10 billion euro from the already nationalized Anglo Irish Bank, and smaller amounts from the Irish Nationwide Building Society and the EBS Building Society.  Eventually, NAMA will buy 81 million euro of loans in four tranches of which this first tranche contains 5.5 billion euro of investment property loans, 1.3 billion euro in land, and 800 million euro in hotels.  It will also require the banks to have 8% in private core equity capital, which has caused considerable confusion as to how much each bank will have to raise.  It also means the government will own 70% of Allied Irish Bank and 40% of the Bank of Ireland, but actual ownership statistics are hard to reconcile with respect to ownership statistics before and after discounts and capital levels.

The future tranches may show significantly higher discounts as more land rather than investment gets moved.

The debt burden of this bailout of creditors will force the debt/GDP burden of Ireland to over 100% by the end of 2011.  All of the harsh austerity deficit cuts are still going to leave a 2010 deficit of 12.5%.  While these discounts constitute a restructuring, the use of government debt to finance the purchases rather than shares in NAMA places the burden on the public which faces continue long-term unemployment.  On the other hand, NAMA and the Irish government recognized the necessity to strip the toxic purchases out in parallel from all of the banks and building societies at the same time rather than in a cascading chaos of individual institutions as is so prominently discussed in the United States.

In April, the Allied Irish Bank sold assets for 4.6 billion euro to raise capital and the Anglo Irish Bank raised 2.25 billion euro in two bonds covered by the government guarantee.

A good "bad bank" places the burden on the creditors where is belongs in a capitalist society.  A bad "bad bank" places the burden of future losses on the shoulders of common taxpayers.

Ireland is an excellent case study, but it is not a good example.  Its parallel action in toxic asset purchases is highly commendable and it appears they have actually got, with EU insistence, some value with the discounts in the first tranche.  The use of full government guarantee of all liabilities and government bonds to purchase the toxic assets shoves the losses off to the public and away from the risk takers who caused the problems.



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Ireland's Indentured Servitude

The people of Ireland have been impressed into a life of indentured servitude by the financial engineers of the IMF and EU to pay the debts of bankers (723 billion euro of guarantees) which were not their debts and to docilely accept their role as servile cash cows to be milked and milked to insure European banks will not suffer and the financial elite can become more wealthy.  The forced bailout of Ireland was not about Ireland's debt, it was about the Irish banks senior bond holders -- other European banks with Germany (and the German government may not know the extent) and the United Kingdom the most exposed.  Yet, countries harboring these financial predators have been reluctant to share the burden with Ireland after the ECB, in 2008, convinced the Irish government that it had to save the Irish banks at all costs and with no direct economic help.  In coercing the Irish government to make private bank debt public debt, the ECB and European (and global) financial interests turned a country with manageable debt and a current account trade surplus (except with the Untied Kingdom) into a ticking time bomb, but the bomb was not in Ireland; it is in Europe and the banks of Europe and it is still ticking.

The problem of the Irish banks was a combination of no proper risk management by the banks, a lack of regulation and politicians looking the other way, an intransigence of some eurozone members to consider a fiscal mechanism, and an inflow of foreign money, particularly from other European banks, as a result of the exchange rates established for the euro between the eurozone countries, creating a housing and construction bubble with the help of developers.  When the bubble burst, the Irish government was cajoled into saving the banks and compounding the problem with a poorly formed "bad" bad bank rather than letting the banks fail and be restructured.  Instead, they were encouraged to endow a capitalism without losses. Yet, as Iceland demonstrated, any sovereign country with its own currency has the power to protect its people and remain free.  Iceland banks saw many European investors, individual and corporate, chasing higher interest rates depositing money.  When the financial crisis of 2008 hit, liquidity froze up globally and eventually over a two week period the Icelandic banks had increasing difficulty in obtaining interbank and overnight liquidity loans.  Faced with the failure of the banks, the government of Iceland chose to let them fail, nationalized the remaining assets and devalued the krona some 80% against the euro.  The people of Iceland rejected an imposed Icesave program to indemnify foreign investors.  The only real aid was an IMF loan partially subsidized by other Scandinavian countries which Iceland has never fully drawn upon and which should be paid by 2012.  In fact, Iceland emerged from recession in Q3 of this year.  But Ireland is not Iceland, because Ireland does not have its own currency; if it were to default, it would have to leave the euro and adopt its own currency, perhaps by converting debt into legal tender during a transition period.

An IMF/EU bailout is another loss of sovereignty. The ticking time bomb ticked louder as the government discovered more toxic debt and capital needs than estimated by auditors in the the banks, as the cost of debt and swaps kept going up, as the banks liquidity problems grew with the growing lack of international confidence, as international corporate depositors withdrew money, as the Irish government poured more and more money into the banks while the ECB bought Irish bonds here and there, as subordinated bond holders were forced to share the losses and the senior bond holder's guarantees were questioned, and as other eurozone nations repeatedly voiced intentions to not help or to hinder help until Ireland had only bailout or eventual default as choices.  In continuation of Ireland's political establishment's predilection towards being the good euro partner, the challenges of default and an Icelandic type of resurrection were churlishly ignored.  Besides, pressure was building for the world to discover the real risks of all European banks.

At least the head of the Irish Central Bank tried to send a veiled message to the ECB and European banks when he said there would be no more money for the Irish banks and they were all for sale to foreigners.  He was letting them know they had a responsibility in this and they had the most to lose.

Rather than paying attention to the cost to the Irish people, international attention was focused on preserving special indemnity for the senior bond holders and the lack of international confidence exhibited in rising debt and swaps costs at any hint of bond holders sharing the burden of losses of investment.  At the same time the Irish 4 year deficit reduction budget, containing a 15 billion euro austerity program, necessary to facilitate the IMF/EU bailout of 85 billion euro, of which 35 billion would be for the Irish banks and 17.5 billion would have to be contributed from Irish pension funds, and based on an unlikely economic growth of 2.5% to 2.75% was proposed to cut child welfare, minimum wage, increase taxes including the VAT affecting families the most but not the corporate tax (a source of revenue as it encouraged foreign corporations to incorporate in Ireland), have pension funds load up on government bonds, and change pension rates and ages.  What type of world prefers to raid public pensions to protect private senior bond holders from sharing in the losses of their investments?   Ireland has even been required to post collateral for the ESFS loan. Political opposition and public discontent appears to be growing despite the budget approval. The augmented austerity package as well as current austerity program were seen as obvious drags on economic growth, which may only be .9% next year as a result of these measures, and Irish standard of living.  Despite serious rumors of bank restructuring or burden sharing by senior bond holders, there was nothing in the budget or bailout which implies any change for the banks or senior bond holders.  While eurozone countries were concerned about Irish debt and the costs of a bailout, the Irish public and the world were puzzling over the different interest rates being reported for the IMF portion, the overall bailout (5.8%), and the EFSF contribution, which must be a higher rate than the total bailout rate since the IMF rate was lower than the bailout rate.  Amid all of the planning, the very essential piece of the ESFS was being ignored, because it is not only unfunded, but as the ticking bomb ticks louder through the euro countries its funding is more precarious without the establishment of a euro bond.

The question became is Ireland solvent or is it not.  Ireland had the money to continue through at least the first half of 2011 without help.  The real problem was the suicidal guarantee of private Irish bank debt.  To me, the whole question of solvency was actually the fear it might be economically wise and beneficial for Ireland to default by restructuring debt and the banks and the risks of the European banks would be naked with potential liabilities of 2245 billion euro, if the EMU will not form a fiscal mechanism or fiscal stabilization emergency program.   Without national fiscal space, the future rollover risk of debt and perception of risk premium vulnerability not only crippled Ireland, but is a risk vulnerability of any euro nation as the eurozone has no means of absorbing asymmetric region-specific shocks.

The sad state of affairs is Ireland is not being saved because the Irish need help, but because the eurozone, in its failure to structure a fiscal mechanism and refusal to deal with the national imbalances of not having a fiscal union, has placed European banks in a position in which they are vulnerable and dependent on the international faith and confidence in the euro to support the eurozone countries.  The financial contagion of "Ireland" cannot be stopped unless the eurozone imbalances are addressed by the establishment of a fiscal mechanism consistent with a union of sovereign nations in which sovereign debt is not really sovereign.  Ireland's problem is a fiscal problem and it is a fiscal problem that grew from the private sector not the public sector.  As such it is a clear refutation of the German perspective of the euro and the eurozone.  As this euro currency crisis spreads from weak link to weak link with continued reluctant and late intervention by the eurozone and ECB, the keystone moment will be Spain and Italy, as one of the four largest EU economies, will be the death knell.  Attempts to ignore the inevitable, without fiscal action by the eurozone as a whole, by throwing blame around and putting eurozone countries in opposing camps is courting euro death.  Despite attempts to mask the debate as about beggar nation debt, the number of German banks and  European banks (there are two active lists in this link for German banks on left column and lower on the left European banks) exposed to Ireland demonstrate the interwoven systemic danger of European banking encouraged by government guarantees of debt to engage in riskier investing within a union which does not have the authority to act as a union of sovereign nations.  All it takes to turn the euro crisis around is the establishment of a fiscal mechanism, stronger bank regulation, and the commitment of the eurozone countries to a one for all and all for one loyalty.  Unfortunately, the ESFS without a euro bond is not a fiscal mechanism and the national politics of many eurozone countries are not as self sacrificing as Ireland.

The bomb is ticking and even German bonds have seen three recent auction failures.  All for one and one for all or global financial chaos.





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Denial and the Pan-European Debt Crisis

As if the euro Trojan Horse was not being prominently offered, the European Union today issued a statement offering solidarity with Greek austerity measures but with no commitment to a solution to the pan-European debt crisis which is unfolding.  And the European and US stock markets went whistling along as if no solution was the shadow of a solution.  Hope driven stock markets which ignore reality are very unhealthy signals. 

In fact, the solidarity but no commitment statement implied that if there is any assistance to Greece it will not be in any form which acknowledges the euro as a multi-national currency which inhibits its euro nations from exercising a complete sovereign fiscal policy within their nations and the failure to provide the ECB with the economic tools, available to any national central bank with its own currency, to respond to the economic conditions of individual euro nations.  The design failures of the euro and the ill-conceived economic restrictions imposed by the Stability and Growth Pact were destined to yield a financial crisis.

German sentiment continues to be very divided, because it has enjoyed a positive euro exchange rate in comparison to other countries, such as Greece, Spain, and Portugal.  The Frankfurter Aligemeine today editorialized that Germany should return to the deutschmark and denies any European Union responsibility for the economic stability of its members.  This is a position which denies the reality of German banks exposure to the euro nations with significant leverage problems:  "German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan."

It is estimated that two-thirds to 77% of Greek debt is held outside of Greece: France with $75 billion, Switzerland with $64 billion, and Germany with $43.2 billion.  The contagion has already affected Greek banks ability to roll over repo debt. On the European banking scene, the exposure risks also include those of the Baltic states who have their own currencies, but the currencies are pegged to the euro.

It appears if any patchwork assistance is provided to Greece, it may well require a further surrender of national sovereignty rather than creating a European bond as I and others, such as Marc Chandler, have suggested.  Brussels is proceeding down the road of political compromise rather than seizing the problem by its causes and solidifying a core Eurozone with a currency and an ECB that acknowledges the exchange rate competitiveness gaps, the need for a European bond, the need of individual member nations to exercise sovereign fiscal policies,  and the need of an ECB with the economic tools to assist individual member nations and coordinate within the European Union.  At the present time we have a 20 billion euro liquidity problem, but the Eurozone will need to finance approximately 1.6 trillion euro of debt in 2010.  Ineffectual political compromise will engender a pan-European debt crisis which would ripple across Europe and around the world.


In discussing Greece, which has a relatively small economy, Spain, which has a much larger economy, is often mentioned as a possible next focus of the pan-European debt crisis, but Italy and Ireland are right up there with Spain with significant public and private bank debt.  They all have excess leverage and are suffering from public fiscal problems which have been facilitated by a negative euro exchange rate and inhibited by the Stability and Growth Pact.  Which will be next?  Greece could just be the training exercise as the derivatives traders hone their skills to wind the deficit hawks up and harvest larger CDS trading profits.

The rest of the world should not be waiting.  The UK had a failed bond auction in March of 2009 and has recently stated it may need to inject more cash into its economy.  Germany had a failed bond auction in January.  The 30 year United States treasury auction with its high yield and 24% direct buyers is considered by many as a weak failed auction today.

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Greece, Spain, and the Euro Trojan Horse

We have written and commented on Greece and Spain as well as Iceland, Italy, Ireland, and Portugal.  This week saw a rash of sovereign debt credit default swap speculation driving the costs of CDS for Greece, Spain, and Portugal higher as well as other countries, including the United States.  The speculation is another example of the need for derivatives regulation and a transparent trading and recording market.  The fear of sovereign debt default by a European Union Euro currency nation is a wasted exercise, unless you are profiting from the same type of unregulated speculation which helped bring Bear Stearns and Lehman down and drove Merrill Lynch and Morgan Stanley into larger, more systemically dangerous relationships.

The problems in Greece and Spain are vastly different, but both are derived from the Euro.  Greece and Spain both suffer from a competitiveness gap in that their Euro exchange rate is overvalued while surplus exporting countries, like Germany, have an undervalued exchange rate.  Greece has tourism, shipping, agriculture, and banking, with an aggressive exposure to emerging Eastern Europe, as economic engines combined with an aging demographic population and falling birth rate.  The immediately prior Greek government also soured relations with the EU by supplying economic information which was not correct leaving the current Greek government with testy EU demands.  Given the lack of industrial economic growth and exports, Greece has less immediate but longer term problems.

Spain has more immediate problems.  The Euro caused negative interest rates in Spain from 2002 to 2006, which caused massive economic overheating during which Spain became the largest issuer of covered bonds in Europe driven by the mortgage market. These Cedulas are secured by mortgage loans on domestic properties issued by any Spanish bank or savings institution.  In some instances, they are participation securitizations in which the holder is entitled to only a percentage participation.  Under Spanish law, unlike the Phandbriefe in Germany, Spain undertook the largest departure from the German bond model and it is less demonstrable that investors could lay hands on the assets in the event of issuing institution insolvency.  When the current global financial crisis caused lending to cease in Spain in August of 2008, it was as if the whole financial system had seized up.  The question has become to what extent the government may have to act if the individual issuing institutions do not have the ability to make these covered bonds good in the future.  This would be a serious European problem, because, in over 200 years no Phandbriefe has ever defaulted. The financial seizure in the financial sector and the bursting of the mortgage asset bubble has created significant unemployment. Nationally, unemployment is in excess of 19% and youth unemployment (16+) is 44.5%.  The unemployment situation places a much more immediate pressure on the Spanish problem.

If Spain or Greece had their own currency, they would have more ability to apply fiscal and monetary policies to stimulate their economies and create employment. The speculative attack on their ability to issue bonds at reasonable yields is an unwarranted attack on their sovereignty, because the actual target of the attack is the Euro and is fueled by EU rules which require member nations to have only 3% debt to GDP without respect to the Euro competitiveness gap or internal national economic conditions.  Both countries should be increasing public spending to target economic growth and job creation, but they are being forced by the EU to reduce their budget deficits.  These enforced budget austerity programs are both reducing public sector wages.  This will fuel deflation.  Prior to the global financial crisis, Spain had a surplus.  The 2010 deficit estimate is 9.8% of GDP. 7.5% in 2011, 5.3% in 2012 with an austerity program which will cut $70.1 billion.  Despite the high unemployment, the people of Spain have not yet realized the fate to which the EU is consigning them.

In Greece, it is another story.  General strikes are already planned for February 10 and 24.  It is estimated that the EU enforced austerity program will accelerate the decline in Greek GDP from <1.7%>; to <7%>;.  Greek unemployment, presently 8.3%, will increase by another 300,000 as a direct result.  Does the EU really want to promote social disturbances in Greece and have them spread to Spain and then to Portugal, with its politically divided government?  Greece is raising its fuel tax.  Lower public spending, higher taxes, lower wages, and increasing unemployment are not the economic drivers the EU should be forcing on these countries.  Greece needs more budgetary control given the historical level of corruption which means spending should be efficiently targeted to spur economic growth and jobs.  Despite those deficit hawks who would drive countries into depression, public debt is not the same as private debt and it is private debt fueled by unregulated derivatives speculation which has caused this global financial crisis.  To turn our focus away from needed financial regulatory reform to an an unwarranted sovereign debt default fear which has been promoted by derivatives speculators is intolerable.  Are we to allow the derivatives speculators to become the new terrorist overlords?

There has been much gratuitous talk of bailing out Greece and how the EU will not bail out any member nation.  In fact, the legal authority exists for the EU to bail out a member nation, but it is not necessary.  All that is required is that the EU provide loans which will target economic growth and jobs and revise its monetary policies to more appropriately take into consideration the competitiveness gap of the Euro exchange and the actual internal economic conditions of each member country.  To force a debt to GDP rule down a countries throat when it needs to increase public spending is asking for economic turmoil.  To the extent, that some countries budget deficits have been inefficiently expanded by corruption or incompetence is an issue which needs to be addressed by targeted, efficient public spending.  The problem with the EU providing loans is the surplus EU countries, like Germany , who benefit from the Euro competitiveness gap, are not going to want to share in the risk.

Yet, there are European rumors that large French and German banks have significant exposure to Greek debt. Greek banks have used Greek debt as collateral on loans from (repos)  the ECB, but the ECB, at the end of 2010, will no longer accept collateral with less than an A credit rating, which Greek bonds no longer have.  Currently, there is every expectation that market pressures will continue and, perhaps, grow.  All of this makes it all the more important for the EU and ECB to quickly formulate a loan plan for targeted spending in Greece and Spain, as well as any other Euro competitiveness gap country with similar problems, such as Portugal and Italy.

Much has been made of the IMF providing money to Greece as the preferred process and the IMF has indicated it would be willing to work with Greece, but Greece has not approached the IMF.  In as much as these problems in Greece and Spain have been at least partially caused by the Euro, I do not see the EU wanting the IMF to help Greece.  Additionally, the EU and the ECB need to face up to the need of the Euro to be responsive to the economic conditions of the member nations and the need to address the Euro competitiveness gap.  The EU has studied the possibility of issuing EU bonds since at least 2000 and this current situation is just the reason the EU and ECB should quickly develop an EU bond program and begin issuing EU bonds.

If EU member nations using the Euro are not able to apply fiscal and monetary policy, because they no longer have a national currency, then the EU and the ECB need to develop the monetary policy tools to allow their member nations to apply appropriate fiscal policies to best serve their citizens.

The possibility of default is speculative hoopla and deficit hawk destructiveness.  While deficits need to be controlled,  targeted public spending grows an economy and the withdrawal of public spending constricts an economy.  At the present time, Greece and Spain need targeted spending and financial regulatory reform.  Default is not a plausible option given the domino effect.

Note:  I am aware that the EU currency is spelled euro and not capitalized, but I have chosen to capitalize it to emphasize that it is a currency of 16 nations and, as such, it faces the problems a global currency would have to resolve.


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Douglas L. Campbell on "Breaking Badly: The Currency Union Effect on Trade"

Douglas Campbell has written a very interesting paper on the effects currency unions have on trade in which the analysis of the data comes to different conclusions than current economic literature.  He explains the paper in his blog post and his concerns that the paper will never be published, because he is going up against big names in the profession.  Basically, his paper tests whether omitted variables in past studies affect the analysis of a large data set.  He looks at each major currency union including the eurozone and appropriate control groups and finds according to the papers abstract: "As several European countries debate entering, or exiting, the Euro, a key policy question is how much currency

Economy & Market Week Ended 12/18/2010

In this commentary we look at the tax cut (again, we had a detailed in analysis in our prior commentary) and possible challenges for Social Security, the continuing problems of unemployment and deleveraging, whether growing income inequality precedes financial crises, the Fed, inflation, the failure of HAMP, the foreclosure mess and other bank issues, attempts to skirt around financial reform, some possible concerns in Canada, the continuing problems of the eurozone and what some people want to do about them, Ireland, the problems in Spain, Germany's troublesome positions and reasoning, China's importance, and market conditions (warnings?) as well as U.S. and international data.

Inflation (CPI) in the United States for the month of November came in at 1.14% (1.17% in October).  If the 1990's calculation was used it would be approximately 4.3%; if the 1980's calculation was used it would be approximately 8.8%.  From October to November it rose 0.04% but December may show a larger increase as December 2009 was <.18%> and may also be affected by QE2.

As we have mentioned, the new tax cut bill does nothing for those who have been unemployed for longer than 99 weeks and they will slide off into uncounted anonymous limbo.  Here are the unemployment figures by state.  Illinois has 9.6% unemployment.

The deleveraging process has been a subject of interest for some time and I have often commented on it.  The sad fact is that the develeraging process by consumers is being driven by debt default just as I have written in the past that business deleveraging is fueled by write-offs of bad loans and asset values.

1.6 million Americans have put off retirement to continue working as the result of falling asset prices.

The cut in the payroll tax is being seen by some Republicans as a means to change Social Security, which has been a concern to many economists as the result of the President's Deficit Commission Report, despite it not receiving the necessary 14 votes to be recommended to Congress.  It is interesting to note that one of the 11 votes for the Deficit Commission Report was Illinois Senator Dick Durbin who said "It is just a step forward in the debate."  Considering how close Dick is to President Obama and the rumors we mentioned last week that the President's State of the Union speech may contain a call for Social Security reform.  This is the wrong focus.  The focus should be on Medicare fraud and escalating health care costs which were not addressed in the very limited and poorly designed PPACA health care bill (another example of political compromise and poor economics which ignored the models of universal health care provided through private insurance companies at significantly lower cost in France, Switzerland, and the Netherlands).  In the past, we have covered two economic discussions on making social security and taxes more equitable by either extending payroll taxes to all income without limits or through income taxes on all income earned or unearned.  However, the political agenda appears to be to cut taxes to benefit the wealthy and to cut programs the wealthy do not need or use under the pretext of deficit reduction. 

We have written on numerous occasions about the economic necessity to stimulate the economy with targeted spending which creates jobs now in order to grow the economy out of this disinflationary, slow growth, and high unemployment long term economic condition.  The original stimulus was too little, too slow, the failure to reform the financial system which precipitated the financial crisis is setting up the next financial crisis, and the tax cut bill stimulus is meaningless, if not welfare for the wealthy.  Nothing is well served by increasing economic inequality within a republican democracy; it diminishes and eventually destroys the middle class and the middle class is essential in any sustainable democracy.  We have written about studies showing growing inequality since the 1960's and now studies are showing economic inequality may be either one of the causes or an indicator of impending economic crises, because there was significant growth in economic inequality prior to both the Great Depression and this most recent financial crisis.

There is a lot of hype about possible municipal bond defaults in the near future.  Much of this is overblown, but there are some towns, cities, and counties under significant stress as the result of insufficient stimulus from the Federal government and, in some instances, mismanagement and/or corruption on the local level.  There has been a lot of political talk that some states should be forced into bankruptcy as a means of cutting retirement, health care, and social welfare programs.  While municipalities and counties can declare bankruptcy under the Bankruptcy Code, there is no provision allowing a state to declare bankruptcy.  With the failure to extend Build America Bonds, there will be more pressure and less liquidity in the municipal bond market, but that does not deter quality investing.

The attempts to banish facts from the economic and political debate extended to the Financial Crisis Inquiry Commission in which a partisan vote resulted in a minority report which banishes the use of any terms which might cast blame for the Financial Crisis on banks and Wall Street choosing to ignore the unpunished financial fraud which caused the financial crisis and, in fact, to show solidarity with those political leaders who would have government serve the bankers.  It is unfortunate when facts are inconvenient.

The Federal Reserve Open Market Committee released its December meeting statement in which it reaffirmed the interest rate of zero to 25 bps for an extended period, reinvesting principal payments of securities held, and will begin a $600 billion purchase at $75 billion per month of longer term Treasuries.  The sole vote against the monetary policy action was Mr. Hoenig again, who remains concerned about increased risks of future economic and financial imbalances increasing long term inflation expectations over time.  While there is some encouraging data, the Fed has still not addressed the demand needed to bring unemployment down and long term interest rates will rise as this slow recovery progresses, but one should not expect the Fed to change direction any time soon.

The Federal Reserve provided approximately $140 billion more in loans to foreign banks during the financial crisis than it disclosed publicly earlier this month.  The Fed may be trying to make changes to the rescission and disclosure provisions of the Truth in Lending Act as the pressures build, as the result of the mortgage and foreclosure mess/fraud, on the banks and their servicers to potentially make good on deceptive mortgages and, in fact, the banks are pushing the Fed to do just exactly that.

As many economic and financial commentators have been writing, the HAMP foreclosure prevention and modification program has been failing, if not an outright failure, as the result of banks dragging their feet in the application process (some real horror stories out there), of people whose applications were pending being foreclosed on anyway, and of the government not sufficiently pushing and regulating the process.  People are dropping out of the program faster than are they are joining.  The Congressional Oversight Panel has issued a pretty nasty report on the Treasury program.  Bank of America is being sued by Nevada and Arizona, because the bank proceeded on foreclosures while applications were pending in violation of a 2009 agreement with Arizona.

PricewaterhouseCoopers, LLP has issued two audit reports for two different banks which support contradictory positions in which MBIA is asserting a large asset in the form of refund demands on Bank of America, while Bank of America has not made any reserve provisions to pay the contractual claims of $2.2 billion.  This is obviously an example of auditor's reliance upon management to determine value.  This deferral to management, when no readily determinable value exists, is a serious and fundamental audit problem from which no professional good will result.

The Dodd-Frank Bill mandated that derivatives will be traded through regulated clearinghouses, but the bankers who control at least two of the risk committees of the two largest clearinghouses are determined to keep transactions through banks and defeating proposals which improved and make more transparent the way derivatives are traded.

Despite consumer protection laws, the banks are desperate for profits and, with the additional protection of the 2005 bankruptcy reform, they are seeking out and actively marketing to risky credit card customers to whom they charge higher fees and interest rates until they hit the wall.  The Federal Reserve has the power to stop this if they wanted to do so.

The Ohio Attorney General Richard Cordray has been named to head up the enforcement division of the Consumer Financial Protection Bureau, which will not make the banks happy.

The Bulls minus Bears sentiment index is again approaching +40 (as of December 12).  The last time it broke above +40 was October 2007 when the market proceeded to crash. Another reason to be cautious right now is that no one else is; the VIX is approaching levels (as of December 13) of high complacency and, as the VIX goes below 17, investors are leaving more of their portfolios exposed to risk.

The ratio of household debt to disposable income in Canada in Q3 was 1.48 which exceeds the United States ratio of 1.47 and caused Canadian central bankers and finance officials to publicly voice concerns that the growing debt level could threaten recovery.  The Bank of Canada sees the vulnerabilities of households as high and the debt levels unprecedented.

The Canadian dollar dropped for the second week as investor's turned to U.S. government debt as safety against the potential problems of the eurozone.

The Governor of the Bank of Canada, Mark Carney, indicated that the current European difficulties are not over and the pattern of global economic growth is changing.  Canada should adapt to a world were their will be inflation in emerging markets and disinflation in developed markets.

The eurozone core is more complicated and problem laden than many wish to recognize with political instability in Belgium and Italy, issued debt which has to be periodically rolled over (from which France is not immune), and the German bund has been caught in the sell-off of U.S. Treasuries.  All of these factors show the liquidity risks going forward and how vulnerable the eurozone is to any market shock or perceived weakness.

On December 14th, the Spanish 10 year debt yield exploded.  Spain and its banks will have to refinance 265 billion euro ($345 billion) in 2011 and Moody's has indicated Spanish banks may actually have $177 billion euro losses on their books, which caused the Spanish Finance Minister, Salgado, to defend the solvency of the Spanish banking system.  On Thursday, bond auction yields rose even higher from between 80 to 140 bps from prior auctions for the same maturities.  On Friday, the Bank of Spain reported that bad loan ratios for Spanish banks were at a 15 year high.  Of importance is the fact that Spanish debt is largely held in European hands and the eurozone crisis has seen an unwinding of the euro carry trade and the funding positions of the Swiss franc, which has seen significant increase in value despite the Swiss Central Bank intervening on numerous occasions to keep its value down.

Trichet, ECB President, said the European nations should extend and broaden the bailout fund.  He also reiterated his adherence to deficit reduction while maintaining the European nations should share a larger burden in tackling the fiscal crisis.  Some ECB officials were indicating the ECB may need more capital while Trichet refused to comment.  However, an analysis of ECB assets (covered and government bonds and potential problem assets) shows the ECB had almost exhausted its 2009 capital funding.  Eurozone central banks have lost 5 billlion euro on the ECB's government bond purchases.  By the 16th, it was announced the ECB would almost double its capital base by 5 billion euro ($6.6 billion) to protect it from losses as it continues to buy government bonds.

Ireland's Dail approved the bailout which includes more support for Irish banks.  The United Kingdom will earn 440 million pounds on its 7.5 year 3.25 million pound loan to Ireland at 5/9% for the first eight tranches.
While the European Union is supplying the bulk of the bailout to Ireland, the EU Commission, in its Autumn forecasts, is not very supportive of the economic possibilities of Ireland obtaining its GDP and budget goals.  The Bank of England entered into a foreign exchange swap agreement with the European Central Bank to provide up to 10 billion pounds ($15.5 billion) for euro which would be made available to the Central Bank of Ireland which could provide Irish banks with pounds and UK banks, with their exposure to Irish banks, with euro.  With the deteriorating conditions in Ireland, the Lloyds Banking Group will have a 2010 impairment charge with respect to Irish loans of 4.3 billion pounds, which is approximately a 54% increase during 2010.

Prior to the Thursday Euro Summit, Germany's Merkel was trying to stake out a more moderate nine point plan, but still maintaining a resolute position on deficit reduction, on the need to work together with more harmony and asserting that Germany was not trying to dictate to anyone.  Germany has begun to recognize the international concern that it needs to address the choices Germany has within the eurozone which revolve around more European integration, a realistic appraisal of financial aid to eurozone members to maintain economic growth or fiscal balance, and how to address the rollover, reduction, and /or restructuring of debt.  Despite Germany's reiteration that the euro must be defended, many economists still insist the structure of the euro is directly responsible for the economic problems in the peripheral countries.  Internally, political opposition has surfaced in Germany on Merkel's prior hard line policies against the euro bond concept and fiscal integration with a firm opinion piece by two former German ministers on the necessity of Germany to lead the fight for integration despite the costs to Germany.  This has "coincided" with Merkel's attempt to protect German interests while moderating her positions to be more accommodating, within fiscal policy boundaries, towards common European interests.

At the European Summit, EU leaders committed to establishing a permanent debt-crisis mechanism by 2013, which has two problems: one, it is too late and two, it remains incorrectly focused on debt and not economic stability and growth.  Germany nixed any current addition to bail out funding or providing economic aid to Portugal and Spain, reinforcing market skepticism about eurozone support of the euro.  Luxembourg Prime Minister Juncker wanted more flexible use of the emergency funds, but Germany was unwilling to speculate on more flexible uses at this time.   The yet to be created European Stability Mechanism will replace the European Financial Stability Facility (EFSF) and will only be able to grant loans on strict conditions to member nations in distress with private sector bond holders sharing the burden.

Germany continues to oppose the creation of a common euro bond based on the fear that Germany, who has prospered the most from the creation of the euro, will have to bear the highest burden of any "joint and several" guarantee and is contradictory of a fiscal/debt policy perspective for which each nation is on its own as if a monetary union did not exist.  The Italian Finance Minister, Tremonti, and the Luxembourg Prime Minister, Juncker, have jointly been pushing a euro bond to eventually replace national debt.  This is something Germany can never endorse.  I have long held that a euro bond is necessary, but I have always envisioned it as separate from national debt and perhaps funding programs for economic growth at the European Investment Bank (although this would require a change in the way they do business), economic stability programs through a stability mechanism, and purchasing and lending programs of the ECB.  This seems beyond the current framing of the discussion.  Gavyn Davies, who has a better understanding of sectoral balances and a balance sheet economy, is arguing that the failure to address the need for a euro bond will result in the break up of the eurozone.  He has discussed two euro bond possibilities other than "joint and several" with one being a proportional guarantee based on GDP, which Germany is likely to oppose as it has the largest GDP and its yields would be higher than the bund, and a second being the creation of blue and red debt with blue debt jointly guaranteed by all eurozone members and red debt remaining national debt.  He proposes the necessity to create a default trigger and a ratio of blue debt to red debt for each nation, creating the refinancing of current debt at lower rates improving liquidity and the creation of a bond restructuring plan, and providing the means for all new debt issued during financial crisis situations to be blue debt.  While this would broaden the discussion, it still keeps the focus erroneously on fiscal/debt policy rather than economic stability and growth.

The need for structural reforms from member nation to member nation is pointless without an integrated economic stability mechanism which acknowledges that a lack of fiat national money deprives a nation of fiscal policy consistent with its national economic growth and stability needs.  Munchau has proposed a mini fiscal union which appears, at best, to be a temporary compromise, because a true fiscal union or mechanism must deal with economic instability directly.  He would shift all regulation of banks to the EU.  Why not by laws passed and enforced by the EU and regulated by the ECB?  He would address asymmetric shocks with EU six month unemployment insurance.  He would attempt symmetry by taxing current account balance surpluses and deficits equally to finance a bail out fund.  The use of a six month EU unemployment insurance to counteract asymmetric shocks is not a realistically sufficient or broad enough economic stabilizer model.  The focus on current account balances, while a significant indicator of the current dysfunction of the euro structure, is the wrong focus for creating symmetry as a fiscal mechanism which responds to member nation economic growth and structural stability needs could make the current account balances irrelevant between an integrated eurozone.  How such a mechanism would be funded besides a euro bond is the question. 

Bill Mitchell has been an ardent opponent of the euro and long maintained the euro nations would be better off economically if they were to withdraw from the eurozone and have their own fiat money and monetary policy powers.  While withdrawing from the eurozone is probably an extreme position and could possibly generate a global economic shock, his argument that the fiscal fallacy of the eurozone leaders has led to a loss of economic perspective is compelling.  The fiscal myth has become ingrained to the degree that economic theory and thought has been limited to only one "politically correct" thought process.  "The relevant question is never asked – what is the role of fiscal policy and how can governments use this unique capacity (when they are fully sovereign) to improve the lives and outcomes of the citizens. That sort of debate is circumvented by the logic of the fiscal councils and the rules it is charged with enforcing directly or via moral suasion. It results in the sort of austerity madness that we are now seeing."  The idea that nations are financially constrained and that government surpluses are government savings is self-destructive.  The role of the gold standard in worsening the Great Depression is well documented.  The present day attempt to re-institute a pseudo gold standard through the euro is creating the same currency crisis conditions.

The current eurozone policies and compromises are too obviously temporary to assuage the market which judges on decisive actions or lack thereof in pricing swaps and yields.  This continued austerity destroys economic growth and increases the risk of a double dip recession globally.

United Kingdom owned banks worldwide reported an increase in consolidated foreign claims of $176 billion in Q3 to a total of $3971.5 billion.

United Kingdom unemployment rose unexpectedly by 35,000 to 2,502,000 or 7.9%.  This sudden increase was mainly the result of public sector employment layoffs as the result of austerity.  The government projects 330,000 government jobs will be lost in the next four years.

The IMF complimented Greece on its reforms and austerity progress and granted it another payment of $3.3 billion (2.5 billion euro).  Greece's GDP is continuing to contract more than expected (which quite bluntly is no surprise) and bond yields remain high.  Greek GDP is expected to decline 4.25% in 2010 and 3% in 2011.

China has continued to expand its influence in the EU investments and purchases of government debt primarily in Greece, Spain, Italy, Portugal, and Italy.  This is also allowing China to invest their stockpile reserves of euro.  Given the austerity policies of the eurozone, member nations are seeking Chinese investment and purchases of debt.  Germany has indicated it will support China being recognized by the EU as a market economy within five years, which would make it difficult for the EU to levy anti-dumping duties on Chinese products.

Slovakia's Speaker of the Parliament said Slovakia should be ready to leave the eurozone if the credit crisis continues to spread.  It is the most recent member with Estonia to be the 17th member on January 1st.  The Slovak government stomped on this idea as impractical, but some Slovak economists are arguing that it would be better sooner than later, despite the temporary investment disruption, as it would have a less important impact on the eurozone.

On the 13th, the Financial Times speculated why China, in the face of rising inflation, is pursuing an anything but rate hikes strategy.  November CPI was 5.1% up from the prior month's 4.4% and well above the 3% target.  With last weekend's economic conference, Chinese leaders are making a very public display of intent to control inflation with bank reserve requirements, lending restraints, and the need to head off asset bubbles.  At the same time, China wants to give the market more sway over rates within the next five years to further China as a global financial center.

Not only has China recognized the importance of a healthy Europe, but Europe is beginning to recognize the importance of China on European recovery and the risk of an emerging Asia slowing down with a hard landing on the European economy, especially Germany, as well as globally.

John Hussman in his weekly commentary dated Monday the 13th listed five conditions which capture basic over valued, over bought, over bullish, rising yields and then lists ten historical periods corresponding to those conditions with December 2010 being the last one.  He is hard defensive and suffering for it.  He provides a mathematical explanation of why, when one uses per share dividend growth rate to calculate estimates of long term expected equity returns, you should not double count by adding repurchases to dividends as if they were a separate cash flow.  He estimates the expected ten year total return of the S&P 500 to be about 3.7% annually.  He agrees with Grantham that high quality large caps will most likely present the best prospects for total returns  in the coming years.  It should be noted that in the past year, and continuing, small caps have presented the best total returns.  In response to the sharp spike in Treasury yields, he changed the duration of the Total Return Fund to just under 1 year from 2.5 years.

Doug Short graphs and details the Treasury yields have increased since the November 3rd Fed FOMC meeting announcing the details of QE2 and its longer term Treasury purchases.

Market: There were 6 bank failures for a total of 157; the unofficial problem bank list is 920.

                        DOW/Volume                                     NASDAQ/Volume
Mon:            18.24/up 5.7%                                        <12.63>/down 1.4%
Tue               47.98/down 0.4%                                       2.81/down 0.8%
Wed            <19.07>/up 16.5%                                   <10.50>/up 2.2%
Thu:                41.78/down 9.8%                                    20.09/down 8.2%

Fri:                  <7.34>/up 80.0%                                      5.66/up 41.2%

Total                    81.59                                                    5.43

Mon: Oil was up 82 cents to $88.61; Dollar weaker; rally fizzled.

Tue: Oil was down 33 cents to 88.28; Dollar stronger but weaker against the pound; lagging market volume; retail sales up but Best Buy is big disappointment; no surprises in the Fed statement; 10 year Treasury up 16 bps to 3.4% - highest since May breaching technical support.

Wed: Oil was up 34 cents to 88.62; Dollar stronger; bond yields rising as spread between 2 year and 30 year Treasuries reached a record 395 bps; oil supplies were down 9.9 million barrels (8 year largest drop), gas supplies were up 800,000, and distillate supplies were up 1.1 million.

Thu: Oil was down 92 cents to 87.70; Dollar weaker; credit card companies down in lower volume market with thin traded stocks up; Treasuries start back up; weekly jobless claims were down 3000 to 420,000, 4 week moving average was down 5250 to 422,750, and continuing claims were up 22,000 to 4,135,000.

Fri: Oil was up 32 cents to 88.02; Dollar stronger but weaker against the yen; quadruple options and futures expiration day; new 2010 yearly high for the NASDAQ and S&P 500 with little movement in price.

United States: 10 year Treasury yields (3.36%) at 6 month high as they tumbled in the Asian markets.

A Virginia Federal judge invalidated parts of the PPACA (healthcare) which required individual participation without choice but did not rule on other parts; this will be appealed.

U.S. business inventory for October was up 0.7% to $1.42 trillion -- highest since February 2009 but less than the expected 1% (up 1.3% in September).

Retail sales were up 0.8% in November  --- expected up 0.6%; ex-auto it was up 1.2%; October was revised up to 1.7% from 1.2%.

PPI (Producer Price Index) -- wholesale prices -- was up 0.8% in November -- more than expected as the result of energy prices; core prices were up 0.3% which was more than the expected 0.2%.

Best Buy Q3 profit was down 4.4% citing weaker demand for tv and entertainment systems.

A Hartford study found 38.8% of Americans 45 years of age or older will rely on Social security as the primary source of retirement income; this is up from 26.7% in 2006.  27.1% will work for as long as they are healthy.  37.2% are unsure if they will ever be able to retire.

Industrial production was up 0.4% in November (down 0.2% October) to 93.9; capacity utilization was up to 75.2.

New York Fed Empire State Manufacturing Survey for December showed general business conditions were up 22 to 10.6 (it was down 27 in November indicating contraction);  prices paid were up 6 to 28.4; employment was down 13 to <3.4>; new orders were up 27 to 2.6.

Bank of America credit card loss rate was down to 9.92% from 10.15%; delinquency was down to 5.47% from 5.6%.  J.P. Morgan charge offs were up to 7.16% from 7.0%; delinquencies were down to 3/68% from 3.81%.  CapOne delinquencies were down to 4.26% from 4.45%; charge offs were up to 7.56% from 7.26%.

FDIC is proposing bank holding companies maintain the same capital levels as their federally insured banks.

Moody's said it may move closer to cutting U.S. rating if the Republican compromise tax package (which was subsequently passed) is passed.

CoreLogic house prices for October were down 3.93% vs year ago -- third month down.

U.S. housing starts for November were up 3.9%.

Philly Fed Manufacturing Survey for December business activity was up to 24.3 from 22.5, which is a five year high (expected down to 17.5); prices paid  were up to 51.2 from 34.0; prices received were up to 10.7 from <2.1>; new orders were up to 14.6 from 10.4; inventory was down to <5.9> from <2.0>.

Oracle EPS was up 33% to 51 cents per share; revenue was up 47% to $8.6 billion.

U.S. current account deficit was up 3.3% in Q3 to $127.2 billion.

30 year mortgage rate was up 22 bps to 4.83%.

Global mergers and acquisitions were up approximately 20% in 2010 to $2.25 trillion with emerging markets involved in 17% of the deals and the energy sector was involved in 40% of the deals.

ECRI Weekly Leading Indicators (WLI) was <0.1> from last week's <1.4>.

Unemployment was up in 21 states, down in 15, and steady in 14.

International:  The Chinese selective reserve requirement of 19% for the six largest banks was extended 3 months.

BIS (Bank of International Settlements) and the EIB (European Investment Bank) both said Germany's call for bond holder haircuts in bank bonds intensified the euro crisis.  The ECB may as for more capital from the eurozone nations; it bought 2.667 billion euro ($3.5 billion) in government debt last week.

Canadian industrial capacity utilization was up 1.2% Q3 to 78.1, which is a two year high; output of manufactured goods was up 0.6%.

The Japanese Prime Minister is proposing a 5% corporate tax cut (currently at 40%).

UK November inflation was 3.3% (CPI) with the expectation it will reach 3.5% in early 2011; core inflation was stable at 2.7%.

China will raise export duties on rare earths in 2011 to curb shipments.  It will target 4% inflation rate for 2011 (up from 3% target) and 8% growth (economists expects 9%).

China attracted $91.7 billion in foreign direct investment in the first 11 months of 2010, which is up 18% from the same period in 2009.

Moody's cut Spain's debt rating to Aa1 citing mounting debt and funding needs as well as worries the central government will not be able to control local authorities in achieving structural improvement.

S&P may cut Belgium's credit rating in 6 months if political impasse is not resolved (very little progress is being made).

Germany said it would give the ECB more capital if it was needed to combat the "debt" crisis.

ECB will almost double its capital base effective 12.29 by 5 billion euro to 10.76 billion euro.
Sweden raised its interest rates 25 bps to 1.25% and boosted its economic growth forecast this year and next.  It sees continuing rate hikes coming.

UK retail sales in November were up 0.3% (October was revised to up 0.7%) on food, toys, and jewelry.

Ireland's GDP Q3 was up 0.5% (down 1% in Q2) with exports up 3.6%; GDP vs year ago was down 0.5%.

Moody's slashed Ireland's credit rating 5 notches to Baa1 from Aa2.  Last week Fitch lowered it 3 notches to BBB+.

RIM sales were up 40%.

Eurozone PMI (Markit Purchasing Manager's Index survey) was down 1.7 in December to 53.7 for services and up 1.5 to 56.8 for manufacturing.  Eurozone trade surplus was up to $6.92 billion in October; up 7.7% from September.

Spanish Prime Minister Zapatero said he was determined to raise the retirement age to 67 from 65 to slash the deficit despite opposition of labor unions.

Moody's palced 6 Greek banks on review for possible downgrade: National Bank of Greece, EFG Eurobank Ergasias, Alpha Bank, Piraeus Bank, Agricultural Bank of Greece, and Attica Bank.

China's CPI was up to 5.1% in November vs year ago.

Swiss National Bank held interest rates at zero to 0.75% on concerns the European crisis could derail economic recovery.

Bank of Montreal will acquire Marshall & Isley for $4.16 billion.

The IMF said Ireland might grow 0.9% in 2011.


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