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Bumsen Sie die Erbsenzähler!

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The perspective on the Greek crisis, fed to most Americans by way of the megabank-controlled, mainstream news media, has been based on criticism of a “leftist” or “socialist” Greek government.  The magic words, leftist and socialist are intended to portray the Greeks as the bad guys in the picture, whereas those characterized as the “good guys” – die Erbsenzähler (led by German Finance Minister Wolfgang Schäuble) are portrayed as patiently leading the petulant Greeks toward the path of financial responsibility.

schaeuble-dijsselbloem

Nothing could be further from the truth.  For starters, Alexis Tsipras of the Syriza party was not elected Prime Minister of Greece until January 26, 2015.  His predecessor, Antonis Samaras was a member of the New Democracy party.

Many bloggers and financial writers have been criticizing the European Central Bank’s handling of the Greek financial crisis since 2010.  Edward Harrison has written extensively on the subject at his Credit Writedowns blog.  On June 29, Mr. Harrison provided a history on the crisis:

First, let’s remember that back in 2010, most of the creditors to Greece were in the private sector, many of them banks in other Eurozone countries. At that time, the fragility of the European and global economy, and of the European banking system was much greater than it is now. And this caused Europe to panic. What’s more is the EU was able to corral the IMF into joining the EU in bailing Greece out, even though doing so broke its own rules and disregarded the analysis of its own economists. This was the original mistake and the whole chain of events since then has been a futile attempt to justify that original decision.

*   *   *

The most obvious answer is the weak banks. The now deceased former German Central Bank Head Karl Otto Pöhl said at the time that it was all about rescuing weak German and French banks – and rich Greeks too. This is most definitely true. For example, back in 2012, the FT’s James Mackintosh quoted JPMorgan which reckons only 15 billion euros of 410 billion in ‘bailout’ funds actually went to the Greek economy. The rest went to creditors of the Greek government.

The ongoing intransigence of the troubled nation’s troika of creditors (European Central Bank, the International Monetary Fund and the European Union) has drawn harsh criticism from a wide assortment of astute individuals.  From here in the States, Mike Shedlock (a/k/a “Mish”) has been a frequent – yet well-reasoned and balanced – critic of the Eurogroup’s stance.  Here is what Mish had to say on July 10:

German chancellor Angela Merkel has stated many times recently that Greeks got generous terms on its alleged bailout.

Merkel is either a blatant liar or dumb as a rock. I believe the former. It is the bailed out banks in Germany and France that got generous terms.

To save French and German banks of €60 billion or so in losses on Greek bonds they never should have purchased in the first place, eurozone taxpayers are now on the hook for at least €326 billion.

Draghi’s famous “whatever it takes” speech should have been suffixed with “to save the banks”.

Greek and eurozone taxpayers got the shaft and remain at risk.

On July 12, Mish shared his reaction to “THE Final Offer Before Grexit”, as presented by the Eurogroup:

The wording of this document makes it clear Germany wants to push Greece out of the eurozone.

Please review the final sentence of the proposal. Here it is again: “In case no agreement could be reached, Greece should be offered swift negotiations on a time-out from the euro area, with possible debt restructuring.”

If Greece turns down the offer, it gets “swift” negotiations on a “temporary time out“, including the possibility of restructuring.

In contrast Greece has no chance of restructuring if it accepts all of the above demands.

Tsipras would be a fool to accept this proposal.

As I have said all along, Greece’s best chance is to default, not pay back a cent, and initiate the reforms it needs to grow over the long haul.

Greece does not need the euro. No country does.

Economist Steve Keen did a wonderful job debunking all of the falsehoods, which have been relied upon to justify the imposition of an absurd austerity regimen on Greece.  Dr. Keen also pointed out why the troika – rather than the Greek government – would be at fault in the event of a Grexit.  Here is his July 6 BBC interview.

The Eurocrats are pressing their luck too far.  If this stupidity persists, we should expect some awful consequences.



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EU-phoria Fades

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The most recent “light at the end of the tunnel” for the European sovereign debt crisis was seen on Friday June 29.  At a summit in Brussels, leaders of the European Union member nations agreed upon yet another “plan for a plan” to recapitalize failing banks – particularly in Spain.  The Summit Statement, which briefly summarized the terms of the plan, explained that an agreement was reached to establish a supervisory entity which would oversee the European banking system and to allow recapitalization of troubled banks without adding to sovereign debt.  By owning shares in the ailing banks, the European Stability Mechanism would no longer have a senior creditor status, in order to prevent investors from being scared away from buying sovereign bonds.

The bond markets were relieved to know that once again, taxpayers would be paying for the losses sustained by bondholders.  The reaction was immediate.  Spanish and Italian bond yields dropped faster than William Shatner’s pants when he passed through airport securitySpain’s ten-year bond yield dropped to 6.51 percent on June 29 from the previous day’s closing level of 6.87 percent.  Italy’s ten-year bond yield sank to 5.79 percent from the previous closing level of 6.24 percent.

Global stock indices went parabolic after the news from Brussels on June 29.  Nevertheless, many commentators expressed their skepticism about the latest plan.  Economist John Hussman of the Hussman Funds discussed the shortcomings of the proposal in his Weekly Market Comment:

The upshot here is that Spain’s banks are undercapitalized and insolvent, but rather than take them over and appropriately restructure them in a way that requires bondholders to take losses instead of the public, Spain hopes to tap European bailout funds so that it can provide capital directly to its banks through the European Stability Mechanism (ESM), and put all of Europe’s citizens on the hook for the losses.Spainhas been trying to get bailout funds without actually having the government borrow the money, because adding new debt to its books would drive the country further toward sovereign default.  Moreover, institutions like the ESM, the ECB, and the IMF generally enjoy senior status on their loans, so that citizens and taxpayers are protected.  Spain’s existing bondholders have objected to this, since a bailout for the banks would make their Spanish debt subordinate to the ESM.

As a side note, the statement suggests that Ireland, which already bailed its banks out the old-fashioned way, will demand whatever deal Spain gets.

So the hope is that Europe will agree to establish a single bank supervisor for all of Europe’s banks.  After that, the ESM – Europe’s bailout fund – would have the “possibility” to provide capital directly to banks.  Of course, since we’re talking about capital – the first buffer against losses – the bailout funds could not simply be lent to the banks, since debt is not capital.  Instead, it would have to be provided by directly purchasing stock (though one can imagine the Orwellian possibility of the ESM lending to bank A to buy shares of bank B, and lending to bank B to buy shares of bank A).  On the question of whether this is a good idea, as opposed to the alternative of properly restructuring banks, ask Spain how the purchase of Bankia stock has been working out for Spanish citizens (Bankia’s bondholders should at least send a thank-you note).  In any event, if this plan for a plan actually goes through, the bailout funds – provided largely by German citizens – would not only lose senior status to Spain’s government debt; the funds would be subordinate even to the unsecured debt held by the bondholders of Spanish banks, since equity is the first thing you wipe out when a bank is insolvent.

It will be interesting to see how long it takes for the German people to figure this out.

The criticism expressed by Charles Hugh Smith is particularly relevant because it addresses the latest move by the European Central Bank to lower its benchmark interest rate by 25 basis points (0.25%) to a record low of 0.75 percent.  Smith’s essay, entitled “Sorry Bucko Europe Is Still in a Death Spiral” consisted of sixteen phases of the death spiral dynamic.  Here are the final seven:

10. Transferring bad debt to central banks does not mean interest will not accrue: interest on the debt still must be paid out of future income, impairing that income.

11. Lowering interest rates does not create collateral where none exists.

12. Lowering interest rates only stretches out the death spiral, it does not halt or reverse it.

13. Centralizing banking and oversight does not create collateral where none exists.

14. Europe will remain in a financial death spiral until the bad debt is renounced/written off and assets are liquidated on the open market.

15. Anything other than this is theater.  Pushing the endgame out a few months is not a solution, nor will it magically create collateral or generate sustainable “growth.”

16. The Martian Central Bank could sell bonds to replace bad debt in Europe, but as long as the MCB collects interest on the debt, then nothing has changed.

The Martians would be extremely bent when they discovered there is no real collateral for their 10 trillion-quatloo loan portfolio in Europe.

Of course, Mr. Smith is forgetting that the Martians could call upon those generous taxpayers from planet Zobion for a bailout   .   .   .


 

Get Ready for the Next Financial Crisis

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It was almost one year ago when Bloomberg News reported on these remarks by Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group:

“There is definitely going to be another financial crisis around the corner because we haven’t solved any of the things that caused the previous crisis,” Mobius said at the Foreign Correspondents’ Club of Japan inTokyotoday in response to a question about price swings. “Are the derivatives regulated?  No.  Are you still getting growth in derivatives?  Yes.”

I have frequently complained about the failed attempt at financial reform, known as the Dodd-Frank Act.  Two years ago, I wrote a piece entitled, “Financial Reform Bill Exposed As Hoax” wherein I expressed my outrage that the financial reform effort had become a charade.  The final product resulting from all of the grandstanding and backroom deals – the Dodd–Frank Act – had become nothing more than a hoax on the American public.  My essay included the reactions of five commentators, who were similarly dismayed.  I concluded the posting with this remark:

The bill that is supposed to save us from another financial crisis does nothing to accomplish that objective.  Once this 2,000-page farce is signed into law, watch for the reactions.  It will be interesting to sort out the clear-thinkers from the Kool-Aid drinkers.

During the past few days, there has been a chorus of commentary calling for a renewed effort toward financial reform.  We have seen a torrent of reports on the misadventures of The London Whale at JP Morgan Chase, whose outrageous derivatives wager has cost the firm uncounted billions.  By the time this deal is unwound, the originally-reported loss of $2 billion will likely be dwarfed.

Former Secretary of Labor, Robert Reich, has made a hobby of writing blog postings about “what President Obama needs to do”.  Of course, President Obama never follows Professor Reich’s recommendations, which might explain why Mitt Romney has been overtaking Obama in the opinion polls.  On May 16, Professor Reich was downright critical of the President, comparing him to the dog in a short story by Sir Arthur Conan Doyle involving Sherlock Holmes, Silver Blaze.  The President’s feeble remarks about JPMorgan’s latest derivatives fiasco overlooked the responsibility of Jamie Dimon – obviously annoying Professor Reich, who shared this reaction:

Not a word about Jamie Dimon’s tireless campaign to eviscerate the Dodd-Frank financial reform bill; his loud and repeated charge that the Street’s near meltdown in 2008 didn’t warrant more financial regulation; his leadership of Wall Street’s brazen lobbying campaign to delay the Volcker Rule under Dodd-Frank, which is still delayed; and his efforts to make that rule meaningless by widening a loophole allowing banks to use commercial deposits to “hedge” (that is, make offsetting bets) their derivative trades.

Nor any mention Dimon’s outrageous flaunting of Dodd-Frank and of the Volcker Rule by setting up a special division in the bank to make huge (and hugely profitable, when the bets paid off) derivative trades disguised as hedges.

Nor Dimon’s dual role as both chairman and CEO of JPMorgan (frowned on my experts in corporate governance) for which he collected a whopping $23 million this year, and $23 million in 2010 and 2011 in addition to a $17 million bonus.

Even if Obama didn’t want to criticize Dimon, at the very least he could have used the occasion to come out squarely in favor of tougher financial regulation.  It’s the perfect time for him to call for resurrecting the Glass-Steagall Act, of which the Volcker Rule – with its giant loophole for hedges – is a pale and inadequate substitute.

And for breaking up the biggest banks and setting a cap on their size, as the Dallas branch of the Federal Reserve recommended several weeks ago.

This was Professor Reich’s second consecutive reference within a week to The Dallas Fed’s Annual Report, which featured an essay by Harvey Rosenblum, the head of the Dallas Fed’s Research Department and the former president of the National Association for Business Economics.  Rosenblum’s essay provided an historical analysis of the events leading up to the 2008 financial crisis and the regulatory efforts which resulted from that catastrophe – particularly the Dodd-Frank Act.  Beyond that, Rosenblum emphasized why those “too-big-to-fail” (TBTF) banks have actually grown since the enactment of Dodd-Frank:

The TBTF survivors of the financial crisis look a lot like they did in 2008.  They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power.  They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation.  Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their advantage.

Last year, former Kansas City Fed-head, Thomas Hoenig discussed the problems created by the TBTFs, which he characterized as “systemically important financial institutions” – or “SIFIs”:

…  I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism.  They are inherently destabilizing to global markets and detrimental to world growth.  So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril.

Although the huge derivatives loss by JPMorgan Chase has motivated a number of commentators to issue warnings about the risk of another financial crisis, there had been plenty of admonitions emphasizing the risks of the next financial meltdown, which were published long before the London Whale was beached.  Back in January, G. Timothy Haight wrote an inspiring piece for the pro-Republican Orange County Register, criticizing the failure of our government to address the systemic risk which brought about the catastrophe of 2008:

In response to widespread criticism associated with the financial collapse, Congress has enacted a number of reforms aimed at curbing abuses at financial institutions.  Legislation, such as the Dodd-Frank and Consumer Protection Act, was trumpeted as ensuring that another financial meltdown would be avoided.  Such reactionary regulation was certain to pacify U.S. taxpayers.

Unfortunately, legislation enacted does not solve the fundamental problem.  It simply provides cover for those who were asleep at the wheel, while ignoring the underlying cause of the crisis.

More than three years after the calamity, have we solved the dilemma we found ourselves in late 2008?  Can we rest assured that a future bailout will not occur?  Are financial institutions no longer “too big to fail?”

Regrettably, the answer, in each case, is a resounding no.

Last month, Michael T. Snyder of The Economic Collapse blog wrote an essay for the Seeking Alpha website, enumerating the 22 Red Flags Indicating Serious Doom Is Coming for Global Financial Markets.  Of particular interest was red flag #22:

The 9 largest U.S. banks have a total of 228.72 trillion dollars of exposure to derivatives.  That is approximately 3 times the size of the entire global economy.  It is a financial bubble so immense in size that it is nearly impossible to fully comprehend how large it is.

The multi-billion dollar derivatives loss by JPMorgan Chase demonstrates that the sham “financial reform” cannot prevent another financial crisis.  The banks assume that there will be more taxpayer-funded bailouts available, when the inevitable train wreck occurs.  The Federal Reserve will be expected to provide another round of quantitative easing to keep everyone happy.  As a result, nothing will be done to strengthen financial reform as a result of this episode.  The megabanks were able to survive the storm of indignation in the wake of the 2008 crisis and they will be able ride-out the current wave of public outrage.

As Election Day approaches, Team Obama is afraid that the voters will wake up to the fact that the administration itself  is to blame for sabotaging financial reform.  They are hoping that the public won’t be reminded that two years ago, Simon Johnson (former chief economist of the IMF) wrote an essay entitled, “Creating the Next Crisis” in which he provided this warning:

On the critical dimension of excessive bank size and what it implies for systemic risk, there was a concerted effort by Senators Ted Kaufman and Sherrod Brown to impose a size cap on the largest banks – very much in accordance with the spirit of the original “Volcker Rule” proposed in January 2010 by Obama himself.

In an almost unbelievable volte face, for reasons that remain somewhat mysterious, Obama’s administration itself shot down this approach.  “If enacted, Brown-Kaufman would have broken up the six biggest banks inAmerica,” a senior Treasury official said.  “If we’d been for it, it probably would have happened.  But we weren’t, so it didn’t.”

Whether the world economy grows now at 4% or 5% matters, but it does not much affect our medium-term prospects. The US financial sector received an unconditional bailout – and is not now facing any kind of meaningful re-regulation.  We are setting ourselves up, without question, for another boom based on excessive and reckless risk-taking at the heart of the world’s financial system.  This can end only one way:  badly.

The public can forget a good deal of information in two years.  They need to be reminded about those early reactions to the Obama administration’s subversion of financial reform.  At her Naked Capitalism website, Yves Smith served up some negative opinions concerning the bill, along with her own cutting commentary in June of 2010:

I want the word “reform” back.  Between health care “reform” and financial services “reform,” Obama, his operatives, and media cheerleaders are trying to depict both initiatives as being far more salutary and far-reaching than they are.  This abuse of language is yet another case of the Obama Administration using branding to cover up substantive shortcomings.  In the short run it might fool quite a few people, just as BP’s efforts to position itself as an environmentally responsible company did.

*   *   *

So what does the bill accomplish?  It inconveniences banks around the margin while failing to reduce the odds of a recurrence of a major financial crisis.

On May 17, Noam Scheiber explained why the White House is ”sweating” the JPMorgan controversy:

In particular, the transaction appears to have been a type of proprietary trade – which is to say, a trade that a bank undertakes to make money for itself, not its clients.  And these trades were supposed to have been outlawed by the “Volcker Rule” provision of Obama’s financial reform law, at least at federally-backed banks like JP Morgan.  The administration is naturally worried that, having touted the law as an end to the financial shenanigans that brought us the 2008 crisis, it will look feckless instead.

*   *   *

But it turns out that there’s an additional twist here.  The concern for the White House isn’t just that the law could look weak, making it a less than compelling selling point for Obama’s re-election campaign.  It’s that the administration could be blamed for the weakness.  It’s one thing if you fought for a tough law and didn’t entirely succeed.  It’s quite another thing if it starts to look like you undermined the law behind the scenes.  In that case, the administration could look duplicitous, not merely ineffectual.  And that’s the narrative you see the administration trying to preempt   .   .   .

When the next financial crisis begins, be sure to credit President Obama as the Facilitator-In-Chief.


 

Too Important To Ignore

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On March 21, the Federal Reserve Bank of Dallas released a fantastic document:  its 2011 Annual Report, featuring an essay entitled, “Choosing the Road to Prosperity – Why We Must End Too Big to Fail – Now”.  The essay was written by Harvey Rosenblum, the head of the Dallas Fed’s Research Department and the former president of the National Association for Business Economics.  Rosenblum’s essay provided an historical analysis of the events leading up to the 2008 financial crisis and the regulatory efforts which resulted from that catastrophe – particularly the Dodd-Frank Act.

While reading Harvey Rosenblum’s essay, I was constantly reminded of the creepy “JOBS Act” which is on its way to President Obama’s desk.  Simon Johnson (former chief economist for the International Monetary Fund) recently explained why the JOBS Act poses the same threat as the deregulatory measures which helped cause the financial crisis:

With the so-called JOBS bill, on which the Senate is due to vote Tuesday, Congress is about to make the same kind of mistake again – this time abandoning much of the 1930s-era securities legislation that both served investors well and helped make the US one of the best places in the world to raise capital.  We find ourselves again on a bipartisan route to disaster.

*   *   *

The idea behind the JOBS bill is that our existing securities laws – requiring a great deal of disclosure – are significantly holding back the economy.

The bill, HR3606, received bipartisan support in the House (only 23  Democrats voted against).  The bill’s title is JumpStart Our Business Startup Act, a clever slogan – but also a complete misrepresentation.

The bill’s proponents point out that Initial Public Offerings (IPOs) of stock are way down.  That is true – but that is also exactly what you should expect when the economy teeters on the brink of an economic depression and then struggles to recover because households’ still have a great deal of debt.

*   *   *

Professor John Coates hit the nail on the head:

“While the various proposals being considered have been characterized as promoting jobs and economic growth by reducing regulatory burdens and costs, it is better to understand them as changing, in similar ways, the balance that existing securities laws and regulations have struck between the transaction costs of raising capital, on the one hand, and the combined costs of fraud risk and asymmetric and unverifiable information, on the other hand.” (See p.3 of this December 2011 testimony.)

In other words, you will be ripped off more.  Knowing this, any smart investor will want to be better compensated for investing in a particular firm – this raises, not lowers, the cost of capital.  The effect on job creation is likely to be negative, not positive.

Simon Johnson’s last paragraph reminded me of a passage from Harvey Rosenblum’s Dallas Fed essay, wherein he was discussing why the economic recovery from the financial crisis has been so sluggish:

Similarly, the contributions to recovery from securities markets and asset prices and wealth have been weaker than expected.  A prime reason is that burned investors demand higher-than-normal compensation for investing in private-sector projects. They remain uncertain about whether the financial system has been fixed and whether an economic recovery is sustainable.

To repeat what Simon Johnson said, combined with the above-quoted paragraph:  the demand by “burned investors” for “higher-than-normal compensation for investing in private-sector projects” raises, not lowers, the cost of capital.  How quickly we forget the lessons of the financial crisis!

The Dallas Fed’s Annual Report began with an introductory letter from its president, Richard W. Fisher.  Fisher noted that while “memory fades with the passage of time” it is important to recall the position in which the “too-big-to fail” banks placed our economy, thus leading Congress to pass into law the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank).  Although Harvey Rosenblum’s essay was primarily focused on the Dodd-Frank Act’s efforts to address the systemic risk posed by the existence of those “too-big-to-fail” (TBTF) banks, other measures from Dodd-Frank were mentioned.  More important is the fact that the TBTFs have actually grown since the enactment of Dodd-Frank.  Beyond that, Rosenblum emphasized why this has happened:

The TBTF survivors of the financial crisis look a lot like they did in 2008.  They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power.  They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation.  Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their advantage.

The ability of the financial sector “to resist the pressures of federal regulation” also happens to be the primary reason for the perverse effort toward de-regulation, known as the JOBS Act.  At the Seeking Alpha website, Felix Salmon reflected on the venality which is driving this bill through the legislative process:

There’s no good reason at all for this:  it’s basically a way for unpopular incumbent lawmakers who voted for Dodd-Frank to try to weasel their way back into the big banks’ good graces and thereby open a campaign-finance spigot they desperately need.

I don’t fully understand the political dynamics here.  A bill which was essentially drafted by a small group of bankers and financiers has managed to get itself widespread bipartisan support, even as it rolls back decades of investor protections.  That wouldn’t have been possible a couple of years ago, and I’m unclear (about) what has changed.  But one thing is coming through loud and clear:  anybody looking to Congress to be helpful in the fight to have effective regulation of financial institutions, is going to be very disappointed.  Much more likely is that Congress will be actively unhelpful, and will do whatever the financial industry wants in terms of hobbling regulators and deregulating as much activity as it possibly can.  Dodd-Frank, it seems, was a brief aberration.  Now, we’re back to business as usual, and a captured Congress.

The next financial crisis can’t be too far down the road   .   .   .


Niall Ferguson Softens His Austerity Stance

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I have previously criticized Niall Ferguson as one of the gurus for those creatures described by Barry Ritholtz as “deficit chicken hawks”.  The deficit chicken hawks have been preaching the gospel of economic austerity as an excuse for roadblocking any form of stimulus (fiscal or monetary) to rehabilitate the American economy.  Ferguson has now backed away from the position he held two years ago – that the United States has been carrying too much debt

Henry Blodget of The Business Insider justified his trip to Davos, Switzerland last week by conducting an important interview with Niall Ferguson at the annual meeting of the World Economic Forum.  For the first time, Ferguson conceded that he had been wrong with his previous criticism about the level of America’s sovereign debt load, although he denied ever having been a proponent of “instant austerity” (which is currently advocated by many American politicians).  While discussing the extent of the sovereign debt crisis in Europe, Ferguson re-directed his focus on the United States:

I think we are going to get some defaults one way or the other.  The U.S. is a different story.  First of all I think the debt to GDP ratio can go quite a lot higher before there’s any upward pressure on interest rates.  I think the more I’ve thought about it the more I’ve realized that there are good analogies for super powers having super debts.  You’re in a special position as a super power.  You get, especially, you know, as the issuer of the international reserve currency, you get a lot of leeway.  The U.S. could conceivably grow its way out of the debt.  It could do a mixture of growth and inflation.  It’s not going to default.  It may default on liabilities in Social Security and Medicare, in fact it almost certainly will.  But I think holders of Treasuries can feel a lot more comfortable than anyone who’s holding European bonds right now.

BLODGET: That is a shockingly optimistic view of the United States from you.  Are you conceding to Paul Krugman that over the near-term we shouldn’t worry so much?

FERGUSONI think the issue here got a little confused, because Krugman wanted to portray me as a proponent of instant austerity, which I never was.  My argument was that over ten years you have to have some credible plan to get back to fiscal balance because at some point you lose your credibility because on the present path, Congressional Budget Office figures make it clear, with every year the share of Federal tax revenues going to interest payments rises, there is a point after which it’s no longer credible.  But I didn’t think that point was going to be this year or next year.  I think the trend of nominal rates in the crisis has been the trend that he forecasted.  And you know, I have to concede that. I think the reason that I was off on that was that I hadn’t actually thought hard enough about my own work.  In the “Cash Nexus,” which I published in 2001, I actually made the argument that very large debts are sustainable, if your borrowing costs are low. And super powers – Britain was in this position in the 19th century – can carry a heck of a lot of debt before investors get nervous.  So there really isn’t that risk premium issue. There isn’t that powerful inflation risk to worry about.  My considered and changed view is that the U.S. can carry a higher debt to GDP ratio than I think I had in mind 2 or 3 years ago.  And higher indeed that my colleague and good friend, Ken Rogoff implies, or indeed states, in the “This Time Is Different” book.  I think what we therefore see is that the U.S. has leeway to carry on running deficits and allowing the debt to pile up for quite a few years before we get into the kind of scenario we’ve seen in Europe, where suddenly the markets lose faith.  It’s in that sense a safe haven more than I maybe thought before.

*   *   *

There are various forces in [the United States’] favor. It’s socially not Japan.  It’s demographically not Japan. And I sense also that the Fed is very determined not to be the Bank of Japan. Ben Bernanke’s most recent comments and actions tell you that they are going to do whatever they can to avoid the deflation or zero inflation story.

Niall Ferguson deserves credit for admitting (to the extent that he did so) that he had been wrong.  Unfortunately, most commentators and politicians lack the courage to make such a concession.

Meanwhile, Paul Krugman has been dancing on the grave of the late David Broder of The Washington Post, for having been such a fawning sycophant of British Prime Minister David Cameron and Jean-Claude Trichet (former president of the European Central Bank) who advocated the oxymoronic “expansionary austerity” as a “confidence-inspiring” policy:

Such invocations of the confidence fairy were never plausible; researchers at the International Monetary Fund and elsewhere quickly debunked the supposed evidence that spending cuts create jobs.  Yet influential people on both sides of the Atlantic heaped praise on the prophets of austerity, Mr. Cameron in particular, because the doctrine of expansionary austerity dovetailed with their ideological agendas.

Thus in October 2010 David Broder, who virtually embodied conventional wisdom, praised Mr. Cameron for his boldness, and in particular for “brushing aside the warnings of economists that the sudden, severe medicine could cut short Britain’s economic recovery and throw the nation back into recession.”  He then called on President Obama to “do a Cameron” and pursue “a radical rollback of the welfare state now.”

Strange to say, however, those warnings from economists proved all too accurate.  And we’re quite fortunate that Mr. Obama did not, in fact, do a Cameron.

Nevertheless, you can be sure that many prominent American politicians will ignore the evidence, as well as Niall Ferguson’s course correction, and continue to preach the gospel of immediate economic austerity – at least until the time comes to vote on one of their own pet (pork) projects.

American voters continue to place an increasing premium on authenticity when evaluating political candidates.  It would be nice if this trend would motivate voters to reject the “deficit chicken haws” for the hypocrisy they exhibit and the ignorance which motivates their policy decisions.


 

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Recession Watch

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A recession relapse is the last thing Team Obama wants to see during this election year.  The President’s State of the Union address featured plenty of “happy talk” about how the economy is improving.  Nevertheless, more than a few wise people have expressed their concerns that we might be headed back into another period of at least six months of economic contraction.

Last fall, the Economic Cycle Research Institute (ECRI) predicted that the United States would fall back into recession.  More recently, the ECRI’s weekly leading index has been showing small increments of improvement, although not enough to dispel the possibility of a relapse.  Take a look at the chart which accompanied the January 27 article by Mark Gongloff of The Wall Street Journal.  Here are some of Mr. Gongloff’s observations:

The index itself actually ticked down a bit, to 122.8 from 123.3 the week before, but that’s still among the highest readings since this summer.

*   *   *

That’s still not great, still in negative territory where it has been since the late summer.  But it is the best growth rate since September 2.

Whatever that means.  It’s hard to say this index is telling us whether a recession is coming or not, because the ECRI’s recession call is based on top-secret longer leading indexes.

Economist John Hussman of the Hussman Funds has been in full agreement with the ECRI’s recession call since it was first published.  In his most recent Weekly Market Comment, Dr. Hussman discussed the impact of an increasingly probable recession on deteriorating stock market conditions:

Once again, we now have a set of market conditions that is associated almost exclusively with steeply negative outcomes.  In this case, we’re observing an “exhaustion” syndrome that has typically been followed by market losses on the order of 25% over the following 6-7 month period (not a typo).  Worse, this is coupled with evidence from leading economic measures that continue to be associated with a very high risk of oncoming recession in the U.S. – despite a modest firming in various lagging and coincident economic indicators, at still-tepid levels.  Compound this with unresolved credit strains and an effectively insolvent banking system in Europe, and we face a likely outcome aptly described as a Goat Rodeo.

My concern is that an improbably large number of things will have to go right in order to avoid a major decline in stock market value in the months ahead.

Another fund manager expressing similar concern is bond guru Jeffrey Gundlach of DoubleLine Capital. Daniel Fisher of Forbes recently interviewed Gundlach, who explained that he is more afraid of recession than of higher interest rates.

Many commentators have discussed a new, global recession, sparked by a recession across Europe.  Mike Shedlock (a/k/a Mish), recently emphasized that “without a doubt Europe is already in recession.”  It is feared that the recession in Europe – where America exports most of its products – could cause another recession in the United States, as a result of decreased demand for the products we manufacture.  The January 24 World Economic Outlook Update issued by the IMF offered this insight:

The euro area economy is now expected to go into a mild recession in 2012 – consistent with what was presented as a downside scenario in the January 2011 WEO Update.

*   *   *

For the United States, the growth impact of such spillovers is broadly offset by stronger underlying domestic demand dynamics in 2012.  Nonetheless, activity slows from the pace reached during the second half of 2011, as higher risk aversion tightens financial conditions and fiscal policy turns more contractionary.

On January 28, Steve Odland of Forbes suggested that the Great Recession, which began in the fourth quarter of 2007, never really ended.  Odland emphasized that the continuing drag of the housing market, the lack of liquidity for small businesses to create jobs, despite trillions of dollars in cash on the sidelines, has resulted in an “invisible recovery”.

Jennifer Smith of The Wall Street Journal explained how this situation has played out at law firms:

Conditions at law firms have stabilized since 2009, when the legal industry shed 41,900 positions, according to the Labor Department.  Cuts were more moderate last year, with some 2,700 positions eliminated, and recruiters report more opportunities for experienced midlevel associates.

But many elite firms have shrunk their ranks of entry-level lawyers by as much as half from 2008, when market turmoil was at its peak.

Regardless of whether the economic recovery may have been “invisible”, economist Nouriel Roubini (a/k/a Dr. Doom) has consistently described the recovery as “U-shaped” rather than the usual “V-shaped” graph pattern we have seen depicting previous recessions.  Today Online reported on a discussion Dr. Roubini held concerning this matter at the World Economic Forum’s meeting in Davos:

Slow growth in advanced economies will likely lead to “a U-shaped recovery rather than a typical V”, and could last up to 10 years if there is too much debt in the public and private sector, he said.

At a panel discussion yesterday, Dr Roubini also said Greece will probably leave Europe’s single currency within 12 months and could soon be followed by Portugal.

“The euro zone is a slow-motion train wreck,” he said.  “Not only Greece, other countries as well are insolvent.”

In a December 8 interview conducted by Tom Keene on Bloomberg Television’s “Surveillance Midday”, Lakshman Achuthan, chief operations officer of the Economic Cycle Research Institute, explained his position:

“The downturn we have now is very different than the downturn in 2010, which did not persist.  This one is persisting.”

*  *  *

“If there’s no recession in Q4 or in the first half I’d say of 2012, then we’re wrong.  …   You’re not going to know whether or not we’re wrong until a year from now.”

I’m afraid that we might know the answer before then.


 

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Keeping The Megabank Controversy On Republican Radar

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It was almost a year ago when Lou Dolinar of the National Review encouraged Republicans to focus on the controversy surrounding the megabanks:

“Too Big to Fail” is an issue that Republicans shouldn’t duck in 2012.  President Obama is in bed with these guys.  I don’t know if breaking up the TBTFs is the solution, but Republicans need to shame the president and put daylight between themselves and the crony capitalists responsible for the financial meltdown.  They could start by promising not to stock Treasury and other major economic posts with these, if you pardon the phase, malefactors of great wealth.

One would expect that those too-big-to-fail banks would be low-hanging fruit for the acolytes in the Church of Ayn Rand.  After all, Simon Johnson, former Chief Economist for the International Monetary Fund (IMF), has not been the only authority to characterize the megabanks as intolerable parasites, infesting and infecting our free-market economy:

Too Big To Fail banks benefit from an unfair, nontransparent, and dangerous subsidy scheme.  This isn’t a market.  It’s a government-backed distortion of historic proportions.  And it should be eliminated.

Last summer, former Kansas City Fed-head, Thomas Hoenig discussed the problems created by what he called, “systemically important financial institutions” – or “SIFIs”:

… I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism.  They are inherently destabilizing to global markets and detrimental to world growth.  So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril.

So why aren’t the Republican Presidential candidates squawking up a storm about this subject during their debates?  Mike Konczal lamented the GOP’s failure to embrace a party-wide assault on the notion that banks could continue to fatten themselves to the extent that they pose a systemic risk:

When it comes to “ending Too Big To Fail” it actually punts on the conservative policy debates, which is a shame.  There’s a reference to “Explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy” but it is sort of late in the game for this level of vagueness on what we mean by “unwinding.”  That unwinding part is a major part of the debate.  Especially if you say that you want to repeal Dodd-Frank and put into place a system for taking down large financial firms – well, “unwinding” the biggest financial firms is what a big chunk of Dodd-Frank does.

Nevertheless, there have been occasions when we would hear a solitary Republican voice in the wilderness.  Back in November,  Jonathan Easley of The Hill discussed the views of Richard Shelby (Ala.), the ranking Republican on the Senate Banking Committee:

“Dr. Volcker asked the other question – if they’re too big to fail, are they too big to exist?” Shelby said Wednesday on MSNBC’s “Morning Joe.”  “And that’s a good question.  And some of them obviously are, and some of them – if they don’t get their house in order – they might not exist.  They’re going to have to sell off parts to survive.”

*   *   *

“But the question I think we’ve got to ask – are we better off with the bigger banks than we were?  The [answer] is no.”

This past weekend, Timothy Haight wrote an inspiring piece for the pro-Republican Orange County Register, criticizing the failure of our government to address the systemic risk resulting from the “too big to fail” status of the megabanks:

The concentration of assets in a few institutions is greater today than at the height of the 2008 meltdown.  Taxpayers continue to be at risk as large financial institutions have forgotten the results of their earlier bets.  Legislation may have aided members of Congress during this election cycle, but it has done little to ward off the next crisis.

While I am a champion for free-market capitalism, I believe that, in some instances, proactive regulation is a necessity.  Financial institutions should be heavily regulated due to the basic fact that rewards are afforded to the financial institutions, while the taxpayers are saddled with the risk.  The moral hazard is alive and well.

So far, there has been only one Republican Presidential candidate to speak out against the ongoing TBTF status of a privileged few banks – Jon Huntsman.  It was nice to see that the Fox News website had published an opinion piece by the candidate – entitled, “Wall Street’s Big Banks Are the Real Threat to Our Economy”.  Huntsman described what has happened to those institutions since the days of the TARP bailouts:

Taxpayers were promised those bailouts would be a one-time, emergency measure.  Yet today, we can already see the outlines of the next financial crisis and bailouts.

The six largest financial institutions are significantly bigger than they were in 2008, having been encouraged to snap up Bear Stearns and other competitors at bargain prices.

These banks now have assets worth over 66% of gross domestic product – at least $9.4 trillion – up from 20% of GDP in the 1990s.

*   *   *

The Obama and Romney plan simply appears to be to cross our fingers and hope no Too-Big-To-Fail banks fail on their watch – a stunning lack of leadership on such a critical economic issue.

As president, I will break up the big banks, end future taxpayer bailouts, and restore capitalist principles – competition and creative destruction – to our financial sector.

As of this writing, Jon Huntsman has been the only Presidential candidate – including Obama – to discuss a proposal for ending the TBTF situation.  Huntsman has tactfully cast Mitt Romney in the role of the “Wall Street status quo” candidate with himself appearing as the populist.  Not even Ron Paul – with all of his “anti-bank” bluster, has dared approach the TBTF issue (probably because the solution would involve touching his own “third rail”:  regulation).  Simon Johnson had some fun discussing how Ron Paul was bold enough to write an anti-Federal Reserve book – End the Fed – yet too timid to tackle the megabanks:

There is much that is thoughtful in Mr. Paul’s book, including statements like this (p. 18):

“Just so that we are clear: the modern system of money and banking is not a free-market system.  It is a system that is half socialized – propped up by the government – and one that could never be sustained as it is in a clean market environment.”

*   *   *

There is nothing on Mr. Paul’s campaign website about breaking the size and power of the big banks that now predominate (http://www.ronpaul2012.com/the-issues/end-the-fed/).  End the Fed is also frustratingly evasive on this issue.

Mr. Paul should address this issue head-on, for example by confronting the very specific and credible proposals made by Jon Huntsman – who would force the biggest banks to break themselves up.  The only way to restore the market is to compel the most powerful players to become smaller.

Ending the Fed – even if that were possible or desirable – would not end the problem of Too Big To Fail banks.  There are still many ways in which they could be saved.

The only way to credibly threaten not to bail them out is to insist that even the largest bank is not big enough to bring down the financial system.

It’s time for those “fair weather free-marketers” in the Republican Party to show the courage and the conviction demonstrated by Jon Huntsman.  Although Rick Santorum claims to be the only candidate with true leadership qualities, his avoidance of this issue will ultimately place him in the rear – where he belongs.


 

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More Favorable Reviews For Huntsman

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In my last posting, I focused on how Jon Huntsman has been the only Presidential candidate to present responsible ideas for regulating the financial industry (Obama included).  Since that time, I have read a number of similarly favorable reactions from respected authorities and commentators who reviewed Huntsman’s proposals .

Simon Johnson is the former Chief Economist for the International Monetary Fund (IMF) from 2007-2008.  He is currently the Ronald A. Kurtz Professor of Entrepreneurship at the MIT Sloan School of Management.  At his Baseline Scenario blog, Professor Johnson posted the following comments in reaction to Jon Huntsman’s policy page on financial reform and Huntsman’s October 19 opinion piece for The Wall Street Journal:

More bailouts and the reinforcement of moral hazard – protecting bankers and other creditors against the downside of their mistakes – is the last thing that the world’s financial system needs.   Yet this is also the main idea of the Obama administration.  Treasury Secretary Tim Geithner told the Fiscal Times this week that European leaders “are going to have to move more quickly to put in place a strong firewall to help protect countries that are undertaking reforms,” meaning more bailouts.  And this week we learned more about the underhand and undemocratic ways in which the Federal Reserve saved big banks last time around.  (You should read Ron Suskind’s book, Confidence Men: Wall Street, Washington, and the Education of a President, to understand Mr. Geithner’s philosophy of unconditional bailouts; remember that he was president of the New York Fed before become treasury secretary.)

Is there really no alternative to pouring good money after bad?

In a policy statement released this week, Governor Jon Huntsman articulates a coherent alternative approach to the financial sector, which begins with a diagnosis of our current problem:  Too Big To Fail banks,

“To protect taxpayers from future bailouts and stabilize America’s economic foundation, Jon Huntsman will end too-big-to-fail. Today we can already begin to see the outlines of the next financial crisis and bailouts. More than three years after the crisis and the accompanying bailouts, the six largest U.S. financial institutions are significantly bigger than they were before the crisis, having been encouraged by regulators to snap up Bear Stearns and other competitors at bargain prices”

Mr. Geithner feared the collapse of big banks in 2008-09 – but his policies have made them bigger.  This makes no sense.  Every opportunity should be taken to make the megabanks smaller and there are plenty of tools available, including hard size caps and a punitive tax on excessive size and leverage (with any proceeds from this tax being used to reduce the tax burden on the nonfinancial sector, which will otherwise be crushed by the big banks’ continued dangerous behavior).

The goal is simple, as Mr. Huntsman said in his recent Wall Street Journal opinion piece: make the banks small enough and simple enough to fail, “Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail.  There is no reason why banks cannot live with the same reality.”

The quoted passage from Huntsman’s Wall Street Journal essay went on to say this:

These banks now have assets worth over 66% of gross domestic product—at least $9.4 trillion, up from 20% of GDP in the 1990s.  There is no evidence that institutions of this size add sufficient value to offset the systemic risk they pose.

The major banks’ too-big-to-fail status gives them a comparative advantage in borrowing over their competitors thanks to the federal bailout backstop.

Far be it from President Obama to make such an observation.

Huntsman’s policy page on financial reform included a discussion of repealing the Dodd-Frank law:

More specifically, real reform means repealing the 2010 Dodd-Frank law, which perpetuates too-big-to-fail and imposes costly and mostly useless regulations on innocent smaller banks without addressing the root causes of the crisis or anticipating future crises.  But the overregulation cannot be addressed without ending the bailout subsidies, so that is where reform must begin.

Beyond that, Huntsman’s Wall Street Journal piece gave us a chance to watch the candidate step in shit:

Once too-big-to-fail is fixed, we could then more easily repeal the law’s unguided regulatory missiles, such as the Consumer Financial Protection Bureau.  American banks provide advice and access to capital to the entrepreneurs and small business owners who have always been our economic center of gravity.  We need a banking sector that is able to serve that critical role again.

American banks also do a lot to screw their “personal banking” customers (the “little people”) and sleazy “payday loan”-type operations earn windfall profits exploiting those workers whose incomes aren’t enough for them to make it from paycheck-to-paycheck.  The American economy is 70 percent consumer-driven.  American consumers have always been “our economic center of gravity” and the CFPB was designed to protect them.  Huntsman would do well to jettison his anti-CFPB agenda if he wants to become President.

Mike Konczal of the Roosevelt Institute, exhibited a similarly “hot and cold” reaction to Huntsman’s proposals for financial reform.  What follows is a passage from a recent posting at his Rortybomb blog, entitled “Huntsman Wants to Repeal Dodd-Frank so he can Pass Title VII of Dodd-Frank”:

So we need to get serious about derivatives regulation by bringing transparency to the over-the-counter derivatives market, with serious collateral requirements.  This was turned into law as the Wall Street Transparency and Accountability Act of 2010, or Title VII of Dodd-Frank.

So we need to eliminate Dodd-Frank in order to pass Dodd-Frank’s resolution authority and derivative regulations – two of the biggest parts of the bill – but call it something else.

You can argue that Dodd-Frank’s derivative rules have too many loopholes with too much of the market exempted from the process and too much power staying with the largest banks.  But those are arguments that Dodd-Frank doesn’t go far enough, where Huntsman’s critique of Dodd-Frank is that it goes way too far.

Huntsman should be required to explain the issues here – is he against Dodd-Frank before being for it?  Is his Too Big To Fail policy and derivatives policy the same as Dodd-Frank, and if not how do they differ?  It isn’t clear from the materials he has provided so far how the policies would be different, and if it is a problem with the regulations in practice how he would get stronger ones through Congress.

I do applaud this from Huntsman:

RESTORING RULE OF LAW

President Huntsman’s administration will direct the Department of Justice to take the lead in investigating and brokering an agreement to resolve the widespread legal abuses such as the robo-signing scandal that unfolded in the aftermath of the housing bubble.  This is a basic question of rule of law; in this country no one is above the law. There are also serious issues involving potential violations of the securities laws, particularly with regard to fair and accurate disclosure of the underlying loan contracts and property titles in mortgage-backed securities that were sold.  If investors’ rights were abused, this needs to be addressed fully.  We need a comprehensive settlement that puts all these issues behind us, but any such settlement must include full redress of all legal violations.

*   *   *

And I will note that the dog-whistles hidden inside the proposal are towards strong reforms (things like derivatives reform “will also allow end-users to negotiate better terms with Wall Street and in turn lower trading costs” – implicitly arguing that the dealer banks have too much market power and it is the role of the government to create a fair playing field).  Someone knows what they are doing.  His part on bringing down the GSEs doesn’t mention the hobbyhorse of the Right that the CRA and the GSEs caused the crisis, which is refreshing to see.

If Republican voters are smart, they will vote for Jon Huntsman in their state primary elections.  As I said last time:  If Jon Huntsman wins the Republican nomination, there will be a serious possibility that the Democrats could lose control of the White House.


 

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European Sovereign Debt Crisis Gets Scary

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The simplest explanation of the European sovereign debt crisis came from Joe Weisenthal at the Business Insider website.  He compared the yield on the 5-year bond for Sweden with that of Finland, illustrated by charts, which tracked those yields for the past year:

Basically they look identical all through the year up until November and then BAM.  Finnish yields are exploding higher, right as Swedish yields are blasting lower.

The only obvious difference between the two:   Finland is part of the Eurozone, meaning it can’t print its own money. Sweden has no such risk.

While everyone’s attention was focused on the inability of Greece to pay the skyrocketing interest rates on its bonds, Italy snuck up on us.  The Italian debt crisis has become so huge that many commentators are voicing concern that “sovereign debt contagion” across the Eurozone is spreading faster than we could ever imagine.  The Los Angeles Times is now reporting that Moody’s Investors Service is ready to hit the panic button:

Throwing more logs on the Eurozone fire, Moody’s Investors Service said early Monday that the continent’s debt crisis now is “threatening the credit standing of all European sovereigns.”

That’s a not-so-subtle warning that even Moody’s top-rung Aaa ratings of countries including Germany, France, Austria and the Netherlands could be in jeopardy.

Meanwhile, every pundit seems to have a different opinion about how the crisis will unfold and what should be done about it.  The latest buzz concerns a widely-published rumor that the IMF is preparing a 600 billion euro ($794 billion) loan for Italy.  The problem with that scenario is that most of those billions would have to come from the United States – meaning that Congress would have to approve it.  Don’t count on it.  Former hedge fund manager, Bruce Krasting provided a good explanation of the Italian crisis and its consequences:

I think the Italian story is make or break.  Either this gets fixed or Italy defaults in less than six months.  The default option is not really an option that policy makers would consider.  If Italy can’t make it, then there will be a very big crashing sound.  It would end up taking out most of the global lenders, a fair number of countries would follow into Italy’s vortex.  In my opinion a default by Italy is certain to bring a global depression; one that would take many years to crawl out of.  The policy makers are aware of this too.

So I say something is brewing.  And yes, if there is a plan in the works it must involve the IMF.  And yes, it’s going to be big.

Please do not read this and conclude that some headline is coming that will make us all feel happy again.  I think headlines are coming.  But those headlines are likely to scare the crap out of the markets once the implications are understood.

In the real world of global finance the reality is that any country that is forced to accept an IMF bailout is also blocked from issuing debt in the public markets.  IMF (or other supranational debt) is ALWAYS senior to other indebtedness of the country. That’s just the way it works.  When Italy borrows money from the IMF it automatically subordinates the existing creditors. Lenders hate this.  They will vote with their feet and take a pass at Italian new debt issuance for a long time to come.  Once the process starts, it will not end.  There will be a snow ball of other creditors.  That’s exactly what happened in the 80’s when Mexico failed; within a year two dozen other countries were forced to their debt knees.  (I had a front row seat.)

I don’t see a way out of this box.  The liquidity crisis in Italy is scaring us to death, the solution will almost certainly kill us.

Forcing taxpayers to indemnify banks which made risky bets on European sovereign debt is popular with K Street lobbyists and their Congressional puppets.  This has led most people to assume that we will be handed the bill.  Fortunately, there are some smart people around, who are devising better ways to get “out of this box”.  Economist John Hussman of the Hussman Funds, proposed this idea to facilitate significant writedowns on Greek bonds while helping banks cope the impact of accepting 25 percent of the face value of those bonds, rather than the hoped-for 50 percent:

Given the extremely high leverage ratios of European banks, it appears doubtful that it will be possible to obtain adequate capital through new share issuance, as they would essentially have to duplicate the existing float.  For that reason, I suspect that before this is all over, much of the European banking system will be nationalized, much of the existing debt of the European banking system will be restructured, and those banks will gradually be recapitalized, post-restructuring and at much smaller leverage ratios, through new IPOs to the market.  That’s how to properly manage a restructuring – you keep what is essential to the economy, but you don’t reward the existing stock and bondholders – it’s essentially what we did with General Motors.  That outcome is not something to be feared (unless you’re a bank stockholder or bondholder), but is actually something that we should hope for if the global economy is to be unchained from the bad debts that were enabled by financial institutions that took on imponderably high levels of leverage.

Notably, credit default swaps are blowing out even in the U.S., despite leverage ratios that are substantially lower (in the 10-12 range, versus 30-40 in Europe).  As of last week, CDS spreads on U.S. financials were approaching and in some cases exceeding 2009 levels.  Bank stocks are also plumbing their 2009 depths, but with a striking degree of calm about it, and a definite tendency for scorching rallies on short-covering and “buy-the-dip” sentiment.  There is a strong mood on Wall Street that we should take these developments in stride.  I’m not convinced.  Our own measures remain defensive about the prospective return/risk tradeoff in the stock market.

The impact this crisis will have on the stock market explains why mainstream news media coverage has consistently understated the magnitude of the situation.  It will be interesting to observe how the “happy talk” gets amped-up as the situation deteriorates.


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The Monster Is Eating Itself

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Back on February 10, 2009 – before President Obama had completed his first month in office – two students at the Yale Law School, Jeffrey Tebbs and Ady Barkan, wrote an article which began with the point that the financial crisis was caused by the recklessness and greed of Wall Street executives.  Tebbs and Barkan proposed a “windfall bonus tax” on those corporate welfare queens of Wall Street, at the very moment when budget-restrained states began instituting their own economic austerity measures so that The Monster could be fed:

Last week, Connecticut Gov. M. Jodi Rell proposed a state budget that slashes crucial public services, including deep cuts to health care for kids and pregnant women, higher education and consumer protection.  She says that the cuts are necessary to close our state’s budget shortfall, but she’s apparently unwilling to increase taxes on Connecticut’s millionaires.

That is to say, while your hard-earned tax dollars are funding Christmas bonuses for Wall Street’s jet-set, Connecticut’s government will be cutting the programs and services that are crucial to your health and safety and to the vitality of our communities.

Since that time, “reverse Robin Hood” economic policies, such as the measures proposed by Governor Rell, have become painfully widespread.  As an aside:  Despite the fact that Governor Rell announced on November 9, 2009 that she would not seek re-election, the conservative Cato Institute determined that Rell was the only Republican Governor worthy of a failing grade on the Institute’s 2010 Fiscal Policy Report Card.

The entity I refer to as “The Monster” has been on a feeding frenzy since the financial crisis began.  Other commentators have their own names for this beast.  Michael Collins of The Economic Populist calls it “The Money Party”:

The Money Party is a very small group of enterprises and individuals who control almost all of the money and power in the United States.  They use their money and power to make more money and gain more power.  It’s not about Republicans versus Democrats.  The Money Party is an equal opportunity employer.  It has no permanent friends or enemies, just permanent interests.  Democrats are as welcome as Republicans to this party.  It’s all good when you’re on the take and the take is legal.  Economic Populist

*   *   *

The party is also short on compassion or even the most elementary forms of common decency.  It’s OK to see millions of people evicted, jobless, without health care, etc., as long as short term profits are maintained for those CEO bonuses and other enrichment for a tiny minority.  It’s perfectly acceptable for this to go on despite available solutions.  If you don’t look, it’s not there should be their motto.

Beyond that, The Monster’s insensitivity has increased to the point where it has actually become too numb to realize that the tender morsel it is feasting on happens to be its own foot.  Until last year, The Monster had nearly everyone convinced that America would enjoy a “jobless recovery”, despite the fact that the American economy is 70 percent consumer-driven.  Well, the “jobless recovery” never happened and the new “magic formula” for economic growth is deficit reduction.  As I discussed in my last posting, Bill Gross of PIMCO recently highlighted the flaws in that rationale:

Solutions from policymakers on the right or left, however, seem focused almost exclusively on rectifying or reducing our budget deficit as a panacea. While Democrats favor tax increases and mild adjustments to entitlements, Republicans pound the table for trillions of dollars of spending cuts and an axing of Obamacare.  Both, however, somewhat mystifyingly, believe that balancing the budget will magically produce 20 million jobs over the next 10 years.

Simon Johnson, who formerly served as Chief Economist at the International Monetary Fund, conducted a serious analysis of whether such “fiscal contraction” could actually achieve the intended goal of expanding the economy.  The fact that the process has such an oxymoronic name as “expansionary fiscal contraction” should serve as a tip-off that it won’t work:

The general presumption is that fiscal contraction – cutting spending and/or raising taxes – will immediately slow the economy relative to the growth path it would have had otherwise.

*   *   *

There are four conditions under which fiscal contractions can be expansionary.  But none of these conditions are likely to apply in the United States today.

*   *   *

The available evidence, including international experience, suggests it is very unlikely that the United States could experience an “expansionary fiscal contraction” as a result of short-term cuts in discretionary domestic federal government spending.

Economist Stephanie Kelton explained that the best way to lower the federal budget deficit is to reduce unemployment:

The bottom line is this:  As long as unemployment remains high, the deficit will remain high.  So instead of continuing to put the deficit first, it’s time get to work on a plan to increase employment.

Here’s the formula:  Spending creates income.  Income creates sales.  Sales create jobs.

If you think you can cut the deficit without destroying jobs, dream on.

Dr. Kelton has identified the problem:  Deficit reduction schemes which disregard the impact on employment.  Nevertheless, The Monster is determined to press ahead with a “deficits first” agenda, regardless of the consequences.  The Monster will have its way because its army of lobbyists has President Obama under control.  As a result, we can expect increased unemployment, a diminished tax base, less consumer spending, less demand, decreased corporate income, lower GDP and more deficits.  The Monster’s gluttony has placed it on a course of self-destruction.  Perhaps that might be a good thing – if only it wouldn’t cause too much pain for the rest of us.


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