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Financial Skeptic Bulletin, February 2008

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[Feb 28, 2008] Inflation is Your (Ben's) Friend

Calculated Risk Here is partial excerpt from a great Saturday Night Live piece in the late '70s, with Dan Aykroyd impersonating Jimmy Carter:
Inflation is our friend. For example, consider this: in the year 2000, if current trends continue, the average blue-collar annual wage in this country will be $568,000. Think what this inflated world of the future will mean - most Americans will be millionaires.

Everyone will feel like a bigshot. Wouldn't you like to own a $4,000 suit, and smoke a $75 cigar, drive a $600,000 car? I know I would! But what about people on fixed incomes? They have always been the true victims of inflation. That's why I will present to Congress the "Inflation Maintenance Program", whereby the U.S. Treasury will make up any inflation-caused losses to direct tax rebates to the public in cash.

Then you may say, "Won't that cost a lot of money? Won't that increase the deficit?" Sure it will! But so what? We'll just print more money! We have the papers, we have the mints.

[Feb 23, 2008] Troubling analogies between USSR and USSA (United Subprime States of America).

[Feb 20, 2008] Calculated Risk

"Mankiw's 10 principles of economics, translated for the uninitiated", by Yoram Bauman, www.standupeconomist.com . Presented at the AAAS humor session, February 16, 2007.

[Feb 20, 2008] What they need is a moratorium on price declines

The latest foreclosure moratorium plan, announced earlier today, is all well and good for delaying the inevitable - a major repricing of anything and everything that has to do with real estate and mortgages now that everyone has regained their senses - but it does little to get at the heart of the current problem.<

Paraphrasing Countrywide CEO Angelo Mozilo, if banks and the government really want to fix the current mess, they should get at the heart of the problem - price declines, not foreclosures.<

As the Orange One pointed out some time ago (see Angelo Mozilo is a moron), as long as home prices continue to go down, foreclosures will continue to rise.<

The obvious solution? Stop home prices from declining. By decree.

[Feb 19, 2008] How SubPrime Really Works

This utterly hysterical Powerpoint has been circulating round Wall Street trading desks for a few days now. I embedded it into Google apps and posted it on line -- boom! Instant viral video. Now everyone can enjoy the warped sense of humor that accompanies losing $100s of billions of dollars. (MS Office not required)...

[Feb 18, 2008] Slowing economy scuppers junk-bond funds by John Waggoner

USATODAY.com

You've had a bad week. The new bumper on your car is going to cost $3,000. Your tooth implants will send your dentist to Aruba. Your pen pal in Nigeria didn't transfer $25 million to your bank account.

How could things get worse?

Oh, yeah. You own a junk-bond fund.

[Feb 17, 2008] Physician heal thyself by Julian Delasantellis

Asia Times

In the United States, many prominent economists, including Clinton-era Treasury secretary Laurence Summers, are proclaiming that the US economy desperately needs this assistance. In a January 6 opinion piece in the Financial Times, he laid out his argument as to why the US economy was in desperate need of aid.

Fiscal stimulus is appropriate as insurance because it is the fastest and most reliable way of encouraging short-run economic growth at a time when a serious recession downturn would pressure American families, exacerbate financial strains, raise protectionist pressures and hurt the global economy.
Like a drunk in a bar ordering another round because he's heard that, since a glass of red wine a day has some purported health benefits, it's logical to assume that a whole bottle of 120-proof Scotch must have even more, the Congress heard this wisdom, raised a glass to the fine Dr Summers, toasting, "I'll drink to that".

[Feb 8, 2008] Boom in the Doom - iTulip.com Forums

"monetarists, economists whose ideology revolves around a hatred of wage inflation for the bottom 95% and taxes for the top 5% while never meeting an asset price inflation it didn't like."

[ Feb 1, 2008] CBS Follies Every Breath You Take Lyrics

See also YouTube - Every Breath Bernanke Takes. It's really high qaulity parody... The lead performer's name is Michael O'Rorke. MBA 2006... Poor Helicopter Ben :-). 4:15pm

The Big Picture reported that the WSJ's Marketbeat was just as amused:

Glenn Hubbard: King of Pain

Today's best four minutes of the day: an uproarious parody of the Police's "Every Breath You Take" by students at Columbia Business School, which purports to show the school's dean, Glenn Hubbard -- and, no, that is not Mr. Hubbard, the school confirms, but a look-alike student -- taking Fed Chairman Ben Bernanke to task for monetary policy mistakes (in a fit of jealousy over not getting the position). It's hard to resist the charm of any attempt to poke at the Fed, especially one that includes the couplet "Hope your models break/bet that beard is fake." The real Mr. Hubbard was traveling and could not be reached for comment.

April 26, 2006 [George W. Bush:] "Ben Bernanke is the right man to build on the record that Alan Greenspan has established. I will urge the Senate the act promptly to confirm Ben Bernanke as the fourteenth Chairman of the Federal Reserve."

Every breath you take
Every change of rate
Jobs you don't create
While we still stagflate
I'll be watching you\

Every single day
Bernanke takes my pay
When growth goes away
Inflation will stay
I'll be watching you

Oh can't you see?
The Fed's where I should be
How my poor heart aches
With each of your mistakes

First you move your lips
Hike a few more BPS
When demand then dips
And the yield curve flips
I'll be watching you

Since you came supply's lost without a trace
I dream at night that I punch you in the face
Your interest policies I cannot embrace
I feel so wronged and I long for Greenspan's place
I keep cryin': Benny! Benny! Please...

Oh can't you see?
The Fed Chair should be me
How my poor heart aches
When prices escalate

Every move you make
Every oath you take
Hope your models break
Bet that beard is fake
I'll be watching you

CBS is great
Wouldn't change my fate
But we'll be watching you
We'll be watching you

Stump Speech

The Epicurean Dealmaker

Recent readers of these pages will be aware that I have been engaged in an ongoing dialogue of sorts with several market commentators concerning the vexed and contentious issue of banker pay, especially as it relates to the ongoing crisis in financial markets. While tempers may have flared, I do hope that we can quickly move beyond casting aspersions

ASPERSE, v.t. Maliciously to ascribe to another vicious actions which one has not had the temptation and opportunity to commit.

at each other and mutual backbiting

BACKBITE, v.t. To speak of a man as you find him when he can't find you.

about real or supposed injustices

INJUSTICE, n. A burden which of all those that we load upon others and carry ourselves is lightest in the hands and heaviest upon the back.

alleged by one and sundry to have been committed by our fellow participants in the financial economy. For the stakes are high for all of us, not just commercial and investment bankers, to prevent a more permanent and damaging disruption to the economy and the financial markets by precipitate and ill-conceived action in any one area, including that of compensation to investment banking employees and other financial middlemen.<

While I fear it may be too late to keep this dispute out of the world of

POLITICS, n. A strife of interests masquerading as a contest of principles. The conduct of public affairs for private advantage.

and the interfering hands of that most fearful and meddlesome creature, the

POLITICIAN, n. An eel in the fundamental mud upon which the superstructure of organized society is reared. When we wriggles he mistakes the agitation of his tail for the trembling of the edifice. As compared with the statesman, he suffers the disadvantage of being alive.

I believe I echo the sentiments of many when I say I would prefer a thorough airing of the situation in public to the resolution of our various grievances through

LITIGATION, n. A machine which you go into as a pig and come out of as a sausage.

So, while I remain resolutely convinced that banker pay is far more symptomatic than causal for the bulk of the current problems under which we all suffer, I do wish to

APOLOGIZE, v.i. To lay the foundation for a future offence.

to my various interlocutors for any

INJURY, n. An offense next in degree of enormity to a slight.

I may have caused them with my intemperate language and scathing sarcasm.<

After all, I believe a fine Hegelian conflict of thesis and antithesis to be the most effective way for all of us to discover the

TRUTH, n. An ingenious compound of desirability and appearance. Discovery of truth is the sole purpose of philosophy, which is the most ancient occupation of the human mind and has a fair prospect of existing with increasing activity to the end of time.

about this issue, and I also believe it will help us move past this valley of despond on to a bright and shining

FUTURE, n. That period of time in which our affairs prosper, our friends are true and our happiness is assured.
* * *

I thank you for your attention, Fellow Citizens, and I look forward to your vote in the coming primary election.

February

A pyramid scheme is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a disbelief in financial reality, including the hope of an extremely high rate of return.

A bubble. A bubble relies on suspension of belief and an expectation of large profits, but it is not the same as a Ponzi scheme. A bubble involves ever-rising (and unsustainable) prices in an open market (be that shares of a stock, housing prices, the price of tulip bulbs, or anything else). As long as buyers are willing to pay ever-increasing prices, sellers can get out with a profit. And there doesn't need to be a schemer behind a bubble. (In fact, a bubble can arise without any fraud at all - for example, housing prices in a local market that rise sharply but eventually drop sharply because of overbuilding.) Bubbles are often said to be based on "greater fool" theory.

Wikipedia

Interestingly enough, Americans now understand we have a problem

George W. Bush

"It's sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end,"

Warren Buffet

[Feb 29, 2008] Keeping Down With The Joneses

Less than a year ago it was a struggle to keep up with the Joneses. Now the Joneses are not spending. The new struggle is to keep down with the Joneses. This theme is discussed in Consumers cut back on small pleasures.

Such small luxuries seemed almost necessities in happier economic times. But no more for lots of folks, including those and other USA TODAY readers who described how they've changed their habits.
The murky financial outlook and recession fears are factors. Another driver: fear of being out of step with a cultural mind-set that increasingly says less is more. If your best friend and next-door neighbors are cutting back on little luxuries, shouldn't you be, too?

"For years, we had the opposite. It was all about keeping up with the Joneses. Now, the Joneses are starting to cut back," says Ellie Kay, author of 12 personal finance books.

"There's a sense that prices are rising - and will continue to rise - but wages will not," says Ken Goldstein, economist at The Conference Board. "This is squeezing household budgets whether they're $200 per week or $200,000 per year. Folks are looking closely at anything they don't have to purchase now."

"The new status isn't how much you've got, but your ability to show what you don't spend," says futurist Watts Wacker, who advises businesses on trends.

"This is a seminal moment. It's not a fad that will die out when the economy picks up."
Trends guru Faith Popcorn puts it this way: "It's cooler not to spend."

[Feb 28, 2008] Twenty-Cent Paradigms/Steven Pearlstein Takes on Wall Street

"Greenspan got out before he could be fired"... One thing we could do is not to glamorize Wall Street so much in the press or in movies, and begin to show more appreciation for real entrepreneurs and public servants and scientists and engineers.
February 24, 2008

In his Washington Post column last week, Steven Pearlstein offered a scathing multi-count indictment against Wall Street's purveyors of "financial innovation":

For starters, these innovations have helped to create a cycle of financial booms and busts that have a tendency to spill over into the real economy, contributing to a heightened sense of insecurity.

They have shortened the time horizons of investors and corporate executives, who have responded by under-investing in research and the development of human capital.

They have contributed significantly to massive misallocation of capital to real estate, unproven technologies and unproductive financial manipulation.

They have made it easy and seemingly painless for businesses, households and even countries to take on dangerous levels of debt.

They have given traders a greater ability to secretly manipulate markets.

They have given corporations clever new tools to hide risks, liabilities and losses from investors.

And by giving banks the tools to circumvent reserve requirements and make more loans with less capital, they have enormously increased the leverage in the financial system and with it the risk of a financial meltdown.

But far and away the greatest damage from all this financial wizardry is the obscene levels of compensation it has generated for a select group of Wall Street executives and money managers.

For when you look over the long term, at the good periods and the bad, it is obvious that the pay collected by these masters of the universe has been grossly excessive -- out of line with the personal financial risk they have taken, out of line with their skills relative to the next-best performers and certainly out of line with the returns earned by investors...

It would be bad enough if the consequences of this excessive pay were confined to Wall Street. Unfortunately, it has not worked out that way. For the prospect of earning untold wealth also has attracted an enormous amount of young talent that could have been more productively used in science, engineering, medicine, teaching, public service and businesses that generate genuine long-term value.

Is it not fair to ask whether the United States can remain the world's most prosperous and innovative economy when half of the seniors at the most prestigious colleges and universities now aspire to become "i-bankers" at Goldman Sachs?

So I hope you'll forgive me, dear readers, when I say that the best thing that could happen to our economy is for a dozen high-profile hedge funds to collapse; for investment banking to enter a long, deep freeze; for a major bank to fail; and for the price of a typical Park Avenue duplex to fall by 30 percent. For only then might we finally stop genuflecting before the altar of unregulated financial markets and insist that Wall Street serve the interest of Main Street, rather than the other way around.

So, what is to be done? Some of the implications came up in Pearlstein's "chat" with readers. One is better regulation:

Boston, Mass.: Citigroup, State Street, and myriad other US banks hid billions in contigent SIV liabilities off-balance sheet, often using off-shore tax havens. What does this say about the FED's competence as a regulator? Or do you think it's a matter that the FED is corrupt and turned a willful blind eye to all of these off-balance sheet transactions? Is it time to combine regulators so that there is one sole financial markets regulator? Thanks Steve!

Steven Pearlstein: The Fed is not corrupt but they have been blinded by the mindless regulatory philosophy of the Greenspan era and they do look on the big bans and the holding companies as their charges -- institutions to be protected, part of a financial system that needs to be protected -- so they never utter a bad word about them and try to handle things quietly and without penalty. The result is that they give up the deterrant aspect of regulation, which is to have a ritual hanging every couple of years and scare the bejezzus out of people so they behave better in between the hangings.

The Fed doesn't believe in that. They also don't believe they should substitute their judgment for the markets, which is crazy, because in financial regulation, that is exactly the purpose of regulation. Otherwise, you'd just leave things to markets. It is a form of modesty that they have taken to gross excess. And frankly it is not going to change until someone like Barney Frank finally makes such an example of a Fed chairman of the head of the Fed's banking regulation department that they get fired for being a bad regulator. Greenspan got out before he could be fired, but there are others who should be held accountable so that their unpleasant dismissal will be a lesson that will be remembered by their successors.

(N.B. Barney Frank is Chairman of the House Financial Services Committee). Pearlstein isn't the only one calling for more effective regulation - Martin Feldstein, one of Ronald Reagan's economic advisors (i.e., not a lefty), recently did so. The economic market failures that necessitate regulation are primarily of the "imperfect information" variety - i.e. that when people (or institutions) buy a financial asset they have a limited knowledge of the underlying risks. This problem seems to get worse as the financial assets become more complicated.

Another, more profound, issue that deserves more thought than it gets is the type of behavior that receives approbation in our society:

Potomac, Md.: Steven, thank you for your comment on the status of America's financial system today. As a 24 year-old finance professional looking to apply to business school in the coming years, I hope to shift into a line of work that generates "genuine long-term value." I remember at graduation the air of superiority surrounding my classmates who landed jobs as analysts on Wall Street. For many of us at "elite" Northeast schools, they seem to be the only jobs out there, because everyone is gunning for them. How can the other industries appeal to the talented kids who are so easily swayed by the glamour of I-banking salaries and bonuses?

Steven Pearlstein: That's a simple question that probably doesn't have a simple answer. But one thing we could do is not to glamorize Wall Street so much in the press or in movies, and begin to show more appreciation for real enterpreneurs and public servants and scientists and engineers. I think a lot of this is as much cultural as economic.

The "credit crunch" resulting from some of these "financial innovations" turning out badly is one of the reasons the US economy may be headed into a slump. That is, if there is a recession, we have partly to blame our excessive zeal for "de-regulation," "free markets," and greed (er, "rational self-interest"). The age of Milton Friedman, indeed.

[Feb 28, 2008] LEADER- Dangerous animals in the banking zoo

"An investment bank is more like a zoo, full of bizarre, prideful and sometimes dangerous animals."
Feb 23 2008 | Financial Times

Commercial and retail bankers are like battery hens. You put them in a small cubicle, pressurize them with tough sales targets but provide a decent salary, and they will produce a steady stream of returns. Most are conservative, somewhat harassed souls, who seldom think to bite the hand that feeds them.

An investment bank is more like a zoo, full of bizarre, prideful and sometimes dangerous animals. A zookeeper who pushes them around, or issues orders, is asking to have an arm bitten off. Instead, the job is to keep the animals in their cages, so they do not savage the paying customers, while understanding their individual behavior patterns. What does it mean, for example, when a derivative trader refuses to take a holiday...

[Feb 28, 2008] Contracts, by Dean Baker

The banks are very upset over the possibility that Congress may change the law to allow bankruptcy judges to rewrite the terms of mortgage loans as they can other loans when a person declares bankruptcy. Naturally they are pulling out all the stops in making their case. The Washington Post quotes a Bush administration spokesperson saying that the proposed change "is interfering with contracts."

... ... ...

Clearly, neither the Bush administration nor the banks, both of whom eagerly supported the bankruptcy reform bill, have any principled objection to interfering with contracts. Their objection seems to be based more on whom the interference is favoring. ...

[Feb 28, 2008] Why Washington's rescue cannot end crisis story By Martin Wolf

February 26 2008 | FT.com

Last week's column on the views of New York University's Nouriel Roubini (February 20) evoked sharply contrasting responses: optimists argued he was ludicrously pessimistic; pessimists insisted he was ridiculously optimistic. I am closer to the optimists: the analysis suggested a highly plausible worst case scenario, not the single most likely outcome.

Those who believe even Prof Roubini's scenario too optimistic ignore an inconvenient truth: the financial system is a subsidiary of the state. A creditworthy government can and will mount a rescue. That is both the advantage – and the drawback – of contemporary financial capitalism.

In an introductory chapter to the newest edition of the late Charles Kindleberger's classic work on financial crises, Robert Aliber of the University of Chicago Graduate School of Business argues that "the years since the early 1970s are unprecedented in terms of the volatility in the prices of commodities, currencies, real estate and stocks, and the frequency and severity of financial crises"*. We are seeing in the US the latest such crisis.

All these crises are different. But many have shared common features. They begin with capital inflows from foreigners seduced by tales of an economic El Dorado. This generates low real interest rates and a widening current account deficit. Domestic borrowing and spending surge, particularly investment in property. Asset prices soar, borrowing increases and the capital inflow grows. Finally, the bubble bursts, capital floods out and the banking system, burdened with mountains of bad debt, implodes.

With variations, this story has been repeated time and again. It has been particularly common in emerging economies. But it is also familiar to those who have followed the US economy in the 2000s.

When bubbles burst, asset prices decline, net worth of non-financial borrowers shrinks and both illiquidity and insolvency emerge in the financial system. Credit growth slows, or even goes negative, and spending, particularly on investment, weakens. Most crisis-hit emerging economies experienced huge recessions and a tidal wave of insolvencies. Indonesia's gross domestic product fell more than 13 per cent between 1997 and 1998. Sometimes the fiscal cost has been over 40 per cent of GDP (see chart).

By such standards, the impact on the US will be trivial. At worst, GDP will shrink modestly over several quarters. The ability to adjust monetary and fiscal policy insures this. George Magnus of UBS, known for his "Minsky moment", agrees with Prof Roubini that losses might end up as much as $1,000bn (FT.com, February 25). But it is possible that even this would fall on private investors and sovereign wealth funds.

In any case, the business of banks is to borrow short and lend long. Provided the Federal Reserve sets the cost of short-term money below the return on long-term loans, as it has for much of the past two decades, banks can hardly fail to make money.

If the worst comes to the worst, the government can mount a bail-out similar to the one of the bankrupt savings and loan institutions in the 1980s. The maximum cost would be 7 per cent of GDP. That would raise US public debt to 70 per cent to GDP and would cost the government a mere 0.2 per cent of GDP, in perpetuity. That is a fiscal bagatelle.

Because the US borrows in its own currency, it is free of currency mismatches that made the balance-sheet effects of devaluations devastating for emerging economies. Devaluation offers, instead, a relatively painless way out of a slowdown: an export surge. Between the fourth quarter of 2006 and the fourth quarter of 2007, the improvement in US net exports generated 30 per cent of US growth.

The bottom line, then, is that even if things become as bad as I discussed last week, the US government is able to rescue the financial system and the economy. So what might endanger the US ability to act?

The biggest danger is a loss of US creditworthiness. In the case of the US, that would show up as a surge in inflation expectations. But this has not happened. On the contrary, real and nominal interest rates have declined and implied inflation expectations are below 2.5 per cent a year. An obvious danger would be a decision by foreigners, particularly foreign governments, to dump their enormous dollar holdings. But this would be self-destructive. Like the money-centre banks, the US itself is much "too big to fail".

Yet before readers conclude there is nothing to worry about, after all, they should remember three points.

The first is that the outcome partly depends on how swiftly and energetically the US authorities act. It is still likely that there will be a significant slowdown.

The second is that the global outcome also depends on action in the rest of the world aimed at sustaining domestic demand in response to a US shift in spending relative to income. There is little sign of such action.

The third point is the one raised by Harvard's Dani Rodrik and Arvind Subramanian, of the Peterson Institute for International Economics in Washington DC, (this page, February 26), namely the dysfunctional way capital flows have worked, once again.

I would broaden their point. This is not a crisis of "crony capitalism" in emerging economies, but of sophisticated, rules-governed capitalism in the world's most advanced economy. The instinct of those responsible will be to mount a rescue and pretend nothing happened. That would be a huge error.

Those who do not learn from history are condemned to repeat it. One obvious lesson concerns monetary policy. Central banks must surely pay more attention to asset prices in future. It may be impossible to identify bubbles with confidence in advance. But central bankers will be expected to exercise their judgment, both before and after the fact.

[Feb 27, 2008] Monolines Now witness the destructive power!

February 23, 2008 | Accrued Interest

To get to the bottom of this, let's look at Ambac and MBIA's "problem" bonds. These are the bonds trading at large discounts to their original value, and not just because of generalized weaker liquidity: closed-end second liens, home equity, sub-prime first liens, and ABS CDOs. Here is Ambac's exposure to "problem" bonds: (from Ambac's investment relations site)

And MBIA: That's a total of $116.1 billion. So here are some of the questions that remain to be answered.

As long as these questions linger, the credit market is going to continue to discount brokerage and bank bonds, which are currently at or near all-time wides. In addition, if banks are uncertain about their capital position, their willingness to lend will be compromised. In other words, we need come to some conclusion with the monolines before the economy can start moving forward.

[Feb 27, 2008] How Much Stimulus Dollar Amounts versus Efficacy

Econbrowser

I think that incipient Federal liabilities combined with the rest-of-the-world's disillusionment with dollar assets is going to mean that discretionary expansions in fiscal policy will be ill-advised.

Still, I think a fiscal stimulus of 1 percentage point of GDP to soften the slowdown makes sense -- as long as we get the maximum "bang for the buck" of deficit spending, and the stimulus is not open-ended. In other words, I share Andy Samwick's (and Jim Hamilton's) queasiness about letting the Bush-ian deficit spending/debt building tendencies persist (plenty of documentation here, here and here). In addition, the deficit spending should be aimed at increasing aggregate demand, as opposed to providing a windfall to households and businesses that will only enhance wealth or profits.

Comments

Having returned from Davos dazed and confused let me share the one major takeaway that I simply cannot shake.

The takeaway is the relentless expression of contempt, not veiled, not thinly-veiled, just spat out into the face ... impolite critics, no defenders.

This is something that I have never experienced before, not from this collection of people.

I suspect that what blew it wide open was the Bernanke fiasco last week, coming right at the start of the events.

The entire experience has worn me out and wrung me out

====

Excellent work, but most analysis seem to miss the point. The business tax incentives and tax payer rebate checks are a diversion.

Lets mail the working staff a one time $300 check, while we give $150K and a hall pass to the buyers and banks that got us into the mess.

Where's the beef? The pea is under the pod called the GSE loan limit increase from $417K to $729K.

The more stringent FNMA, FHLMC limits are raised for one year, while the less stringent FHA limits are raised, permanently.

According to California Sen. Barbara Boxer's office:

On the average $650,000 jumbo loan balance, a 30-year fixed rate mortgage, the lower rate (-1%) on the "conforming" GSE jumbo would result in an average $417 per month savings, every month for 30 years!

That's a $150K subsidy which amounts to white collar welfare for rich homeowners and speculators.

Millions of 1, 2, 3 & 5 year interest only & teaser jumbos will be reset this year. Calculations estimate if only 1 million default after a FHA refi, this will result in a $260 billion cost to the taxpayer within 2 years.

There is nothing preventing Countrywide and other lenders from refinancing their delinquent and defaulting "liar loans" with the GSE's under this program.

In effect tax payers will be subsidizing the banks and borrowers with non conforming jumbo loans: California 35%, New York 19.5%, New Jersey 13,5% & DC 21.5%

This stimulus package is despicable, disgusting, a disaster and a disgrace. Should it pass and be signed into law as currently drafted, its constitutional legality needs to be tested.

At a minimum, it is a violation of the GSE charters infringing into the "primary" mortgage markets. I urge you to contact your House & Senate reps to have the loan limit increase provision stricken from the bill.

http://naybob.blogspot.com/2008/01/barney-frank-hr-1852-sb-2338-economic.html

======

I'd also suggest taking a big knife to the bloated military budget and reallocating it to peaceful activities (education, health, energy efficiency) that could generate more jobs, better social outcomes, and contribute to real security in the longer term.

======

Sorry to all to be absent from the debate. The new semester is upon me.

One way to look at my argument is as follows. Stipulate that $150 billion is the size of the package to be implemented. Then, for each dollar, what provisions have the largest multiplier (in the Keynesian sense). So my criticism is not of investment incentives per se consituting 1/3 of the package, but rather that each dollar devoted to accelerated depreciation will lead to small impetus to aggregate demand. If those investment incentives were in the form of investment tax credits, I would be less critical.

So in this sense, kharris has perhaps said it better than I did.

Posted by: Menzie Chinn at January 29, 2008 02:01 PM

[Feb 27, 2008] Crony Capitalism Comes (Returns) to America By Menzie Chinn

February 23, 2008 | Econbrowser

Or, who will be the Keating 5 of the 2000's? Perspectives from those of us who remember the East Asian crises of the 1990's.

From the NYT:

News Analysis

A 'Moral Hazard' for a Housing Bailout: Sorting the Victims From Those Who Volunteered

By EDMUND L. ANDREWS

Published: February 23, 2008

WASHINGTON -- Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for "financial innovation."

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government -- now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at "moderate to high risk" of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

"We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market," the financial institution noted.

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government's $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a "moral hazard," many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington -- read, taxpayers -- could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy.

... ... ...

One paragraph in the article I find quite amusing is this one:

Surprisingly, the normally free-market Bush administration has expressed interest. Treasury officials confirmed that several senior officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr. Taylor said he had also received calls from officials at the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which is part of the Treasury Department.

To me, it is completely unsurprising that the Administration should be willing to bail out financial institutions. They are well connected in the way that the unemployed [1] or the uninsured [2] are not.

However, this is not a rationale for not intervening. As I've said before, "Just say 'no'" is not a viable policy. The key point is to realize that, just like some of the East Asian economies in 1997, we are well past the point about worrying about the impact of current policies on "moral hazard" (see this analysis [pdf]). We needed prudential regulation in the period leading up to the housing boom (sadly, policy makers failed in that respect). That is when contingent liabilities built up (see these posts on "looting" [3], [4]). Now, it is not possible for the government to credibly commit to not intervene, when the financial system's operation is at stake (i.e., as Krugman has said, the horse is out the barn door).

And make no mistake -- the financial system is to some degree already frozen, and there is little prospect for a complete unfreezing of the system without substantial government intervention. From Deutsche Bank Economics/Strategy Weekly (Feb. 22):

...Taking MBS spreads as an example, spreads have now widened beyond the levels reached in the convexity episode of 2003, and is approaching the highs of the LTCM crisis of 1998. We emphasize that it is important for the market not to anticipate the kind of mean reversion that occurred in those previous widening episodes. In 1998, the spread widening wasn't a result of a systemic problem (at least in the principal developed economies), but rather was narrowly addressed with the unwinding of LTCM's positions. Spreads moved back relatively quickly on GSE buying, as GSE’s then were a reasonably large part of the mortgage market at that time, unlike the current moment, when the GSE's have been and are still hampered by regulatory and competitive restrictions, and thus are too small to serve as a stabilizing force.

In this sense, the current crisis is very much like the S&L crisis. And as it looks more and more likely that the government will have to spend billions of dollars bailing out investors, banks, and households, it seems to me that accountability is required. Who in the Administration pushed to prevent regulatory oversight? Who in Congress pushed the interests of the banks?

And we should look very carefully at the proposals that are being pushed by the financial industry, even as we acknowledge that laissez faire is not tenable, and we seek to establish procedures and institutional reforms that will prevent a replay. In particular, thinking about a well-funded, integrated, regulatory system that is insulated from political pressures would be a good place to start.

=====

Comments

I'm ready to sign on to a bank bailout as soon as we slap a 100% tax on all banker incomes above a generous $100,000 a year, more than twice the median income. After all, the bankers were very successful in pushing through bankruptcy reform in 2005 to keep consumers from defaulting. Likewise shouldn't we squeeze the people responsible for this debacle to pay for their own bailout. Why should guys like Charles Prince and Stan O'Neal be able to just walk away with hundreds of millions of taxpayer bailout money?

More seriously, how about public ownership equity in exchange for a bailout. It seems to work for Britain. Why should some guy from Abu Dhabi get an equity stake for his bailout of Citigroup and U.S. citizens get nothing?

Or how about a whopping increase in the corporate tax on financial institutions? Something like 40% of all U.S. company profits in recent years have been in the financial sector. This seems to be a perversion of the economy and maybe we need to discourage its growth.

======

It's amazing how ignorant of history some of the posters on this thread are.

In the 19th century, the banking system was virtually unregulated-- and there were frequent panics, fraud, and so on. The economic damage tended to be short-lived, but that was due to the fact that the economy was largely agricultural and regionally fragmented. As the nation became larger and the scale of banking increased, the consequences of crashes became more serious and longer-lasting.

There are some truly ludicrous proposals in the comments above. One commenter imagines that the solution is to go back to local banks. How does he imagine that large-scale enterprises, running into billions of dollars, could be efficiently funded by small banks? The more likely result is that corporations would get their funding from foreign competitors.

Another poster proposes that we let the banking system collapse, since a new banking system will arise like a phoenix from the ashes "in no time." This was tried in 1930, and after two years and the wreckage of 30% of the economy, the people grew restless at waiting for "no time" to elapse. Even with vigorous intervention, businesses that had closed "in no time" remained shuttered for a decade, and farmers displaced from their land never regained it.

There is something very wrong about an educational system that permits very ignorant people to think they have a right to be both rude and loud.

Posted by: Charles at February 25, 2008 08:41 PM It's early 2008 and AAA rated mortgage backed securities released as recently as last May are already at a 15% default rate. In early 2009, the default rate will be 60% at a minimum.

The Feds need to call in the CEO's of Citi, BoA, WashMutual, Wachovia, Merrill, and the dozen or so others who participated in producing, selling, packaging, rating, this crap. They need to be told in no uncertain terms that they have limited choices:

1. Avoid corporate bankruptcy by minimizing defaults. This can be done by working with borrowers NOW to discount loans and terms to market value. Where default is inevitable, they will need to dispose of property in an orderly and efficient manner to avoid further deterioration of their assets.

2. Any institution that declares bankruptcy or needs a bailout by American taxpayers who have already been bled white by these vulture's greed, incompetence and incomprehensibly poor business judgment will be nationalized. All executives and board members will be immediately fired. All executives and board members for the last 5 years will be required to return salaries and bonuses with interest because it's absolutely clear that, whatever else they were doing, it sure the hell wasn't their job. All land, buildings, contracts, and assets will become the property of the U.S. Treasury. The lawsuits alleging fraud that are beginning to be filed by the poor suckers who were last to hold the worthless securities will be allowed, but only against the individuals who perpetuated the fraud, not against the nationalized company.

If they don't like them beans, then they can work through this mess themselves.

Posted by: CathyG at February 25, 2008 09:36 PM

[Feb 26, 2008] The Anatomy of a Bear Market - Seeking Alpha

An interesting list of false predictions of a financial meltdown from quite respectable and extremely well informed people

... a bear market is only possible if there is a consensus that a financial crisis is significantly worse than ever before. And that is why we are currently in a bear market. A few examples of this psychology:

[current predictions -- remains to be seen how good, bad]

- etc.

This psychological trap will probably always be with us. The most experienced investors and bankers have careers that last about 30 years, a blink in economic history. "It is hardly surprising, therefore, that people are constantly amazed by each new cycle that comes along - and find it difficult to see it in historic proportion," says Kaletsky.

[Feb 26, 2008] Welcome to PrudentBear.com

There is now a positive feedback loop that feeds the crisis..

"Half of U.S. states are projecting budget deficits next fiscal year as the slowing economy curbs tax collections, forcing local governments to spend savings, cut funding for programs, borrow or raise taxes, a report found."
Bloomberg News, January 28, 2008

[Feb 26, 2008] Bernanke, Greenspan at Fault as U.S. Faces Slump, Stiglitz Says By Mark Barton and Ben Sills

Feb. 26 (Bloomberg) -- Joseph Stiglitz, a Nobel-prize winning economist, said successive Federal Reserve chairmen have left the U.S. economy facing a "very significant'' slowdown.

Current Fed chief Ben S. Bernanke was too slow to cut interest rates as the U.S. real-estate market deteriorated, while his predecessor, Alan Greenspan, "actively looked the other way'' as the housing market inflated, Stiglitz said in a Bloomberg Television interview today in London.

The spillover from the biggest U.S. housing slump in 25 years, turmoil in financial markets and higher energy prices are curbing growth in the world's biggest economy. The financial- services industry is curtailing credit and conserving capital.

Greenspan ``is right that this downturn is going to be the worst downturn in a quarter century, but he's largely to blame,'' Stiglitz said. "It's not just that he was asleep at the wheel, he actively looked the other way'' by dismissing the housing-price appreciation as ``froth.''

Following mounting losses on past loans, banks have already taken writedowns of $163 billion since the beginning of 2007. President George W. Bush signed a $168 billion stimulus package that will deliver tax rebates to more than 100 million households.

Bernanke cut Fed interest rates twice last month, including an emergency reduction of 75 basis points between meetings, in a bid to prop up growth as the financial writedowns and the prospect of a further housing decline saw U.S. stocks slump. The S&P 500 index is down 6.6 percent this year.

Too Late

"Clearly they acted too late,'' Stiglitz said. ``The dramatic lowering of the main interest rate by 75 basis points was a panic not a prudent measure.''

The $3 trillion cost of the Iraq war, which diverted the country's resources from investment in economic productivity and sent the budget deficit higher, will continue to hold back growth in the U.S., Stiglitz said.

[Feb 25, 2008] Insurers' Day of Reckoning

"I am afraid that all that is happening is the further leveraging of an already leveraged and highly interdependent financial system."
February 25, 2008 Mish's Global Economic Trend Analysis

Minyan Peter was writing about Insurers' Day of Reckoning earlier today before this news hit. Nothing happened to change the relevance of what he had to say so let's take a look.

A hurricane comes through your town and levels your house. A few weeks later, you receive a letter from your insurance company telling you that unless you buy some of its stock, it won't be able to pay your insurance claim. What do you do?

As far fetched as this question may feel, this is, in principle, what's behind the bailout of the monoline insurance companies. Unless their biggest CDS counterparties step up with more capital, the insurance companies won't be able to make good on their CDS and the banks will be forced to take write-downs.

How this all plays out remains to be seen, but I would suggest that until additional capital comes into the financial services system from organizations other than other financial services companies, I am afraid that all that is happening is the further leveraging of an already leveraged and highly interdependent financial system.

[Feb 25, 2008] Credit Card Reform Is Coming/Payback For A decade Of Greed

"Treat people fairly instead of what you can get away with and this kind of reaction does not happen. For cash strapped banks, such legislation could not come at a worse time. But this is just a start. A reform of bankruptcy reform is bound to happen as well."
February 23, 2008 | Mish's Global Economic Trend Analysis

The pendulum has reversed. This is just the initial stages of reversal. The proposals are what they are and they do not have to make sense. Many won't. However, consumers are fed up and a Congress far more sympathetic to consumers' desires is going to be elected.

And as disgusting as two-cycle billing is, I would not legislate against it. There is a choice. Consumers do not have to choose Discover Card or any other 2-cycle lender.

But when banks purposely mail out statements at the very last minute (which they do), change terms for little reason (which they do), require receipt by noon even when their normal mail delivery is 2:00PM (which they do), and charge absurd overlimit fees instead of disallowing transactions (which they do), this is what happens. I have no sympathy for the banks when legislation over-reaches in the other direction.

Treat people fairly instead of what you can get away with and this kind of reaction does not happen. For cash strapped banks, such legislation could not come at a worse time. But this is just a start. A reform of bankruptcy reform is bound to happen as well.

Credit card and other reforms are coming. Banks better get used to the idea.

[Feb 25, 2008] Nissan's Ghosn U.S. auto market in recession

SEOUL, South Korea -- The head of Nissan Motor Co. said even if the United States is not in recession, its auto industry is.

"We are very lucid on the situation of the industry that there is a recession in the United States, at least in the car market," Chief Executive Carlos Ghosn told reporters, saying automakers face rising costs for iron ore, precious metals, aluminum and other materials.

"These represent risk for the industry," he said.

[Feb 25, 2008] Twenty-Cent Paradigms/Stagflation Redux?

"One reason stagflation is so pernicious is that it puts the Fed in an awkward spot. High inflation requires the Fed to tighten monetary policy (i.e. raise the fed funds rate target), while the proper response to stagnation is to loosen."

The latest inflation report from the BLS has generated some concern about "stagflation," an ugly artifact of the 1970's, making a comeback (can avocado appliances be far behind?). The word is a combination of "stagnation" (i.e. high unemployment and slow growth) and "inflation." We already knew that unemployment has been creeping up (4.9% in January, up from 4.4% last March). And now we learn that over the past 3 months, CPI inflation has been running at a 6.8% annual rate. Partly that reflects oil prices - just as 1970's inflation did - but the "core" CPI (i.e. with food and energy prices removed) has been increasing at a 3.1% annual rate. Ominous portents, but we have some distance to go before things look this bad:

(the red line is the unemployment rate, and the blue is CPI inflation)

One reason stagflation is so pernicious is that it puts the Fed in an awkward spot. High inflation requires the Fed to tighten monetary policy (i.e. raise the fed funds rate target), while the proper response to stagnation is to loosen. At Econbrowser, James Hamilton examines the numbers and the Fed's dilemma.

Paul Krugman believes the appropriate parallel is to early 1990's rather than the late 1970's. He writes:

...I don't believe we're really facing anything comparable to 1970s stagflation. For one thing, we're less dependent on oil: America has more than twice the real G.D.P. it had in 1979, but consumes only slightly more oil. For another, there's no sign of the wage-price spiral that once drove inflation into double digits - in fact, wage growth has been declining even as inflation rises.

What's much more likely is that we'll have an economy like that of the early 1990s, only worse.

The first President Bush presided over the 1990-1991 recession. But his real problem came during the alleged recovery, which was hobbled by financial problems at many banks, which had been badly damaged by the collapse of the late-1980s real estate bubble, and by sluggish consumer spending, held down by high levels of household debt.

As a result, the unemployment rate just kept rising, not reaching its peak of 7.8 percent until June 1992.

If all this sounds familiar, it should. Many economists have pointed out the parallels between the current situation and the early 1990s: another real estate bubble, subprime playing more or less the same role formerly played by bad loans by savings and loan institutions, financial trouble all around.

The difference is that the problems look a lot worse this time: a much bigger bubble, more financial distress, deeper consumer indebtedness - and sky-high oil prices added to the mix...

[Feb 23, 2008] 2007 Spending per Affluent Elite Household

In the original Hackonomics, I buried the detailed spending habits of the of the upper echelon of wealth in America. I suspect you will find this data a bit more unequal than the quintile nonsense we saw from Alm and Cox.

Here is how this group spent their money as follows:

Dollars Spent Category - 2007 Spending per Affluent Elite Household
                    Category           Category
                    Spending           Spending
Summer Spending        *       2007       *      2005    Change 2007/2005
Activity               %      $ Spent     %     $ Spent  $Change %Change
Yacht Rentals        10.60%  $384,000    9.50% $317,000  $67,000  21.14%
Redecorating         44.90%  $129,000   30.90%  137,000  ($8,000) -5.84%
Villa Rentals        15.70%  $106,000   13.80%  $79,000  $27,000  34.18%
Experiential
Excursions           25.80%  $103,000   22.70%  $79,000  $24,000  30.38%
Jewelry/watches      73.70%  $94,000    63.20%  $63,000  $31,000  49.21%
Luxury Cruises       47.50%  $92,000    43.10%  $71,000  $21,000  29.58%
Charitable Giving    97.50%  $82,000    98.40%  $52,000  $30,000  57.69%
Vacation Home
Rentals              12.10%  $82,000    11.80%  $64,000  $18,000  28.13%
Out-of-Home Spa
Services             67.70%  $61,000    48.70%  $49,000  $12,000  24.49%
Summer
Entertaining         93.90%  $56,000    92.40%  $39,000  $17,000  43.59%
Luxury Hotels        95.50%  $48,000    93.40%  $36,000  $12,000  33.33%
Luxury Resorts       84.80%  $41,000    82.60%  $23,000  $18,000  78.26%
At-Home Spa
Services             53.50%  $38,000    47.40%  $26,000  $12,000  46.15%
Apparel/accessories  92.40%  $34,000    86.80%  $16,000  $18,000 112.50%
Audio/visual         51.50%  $31,000    50.70%  $14,000  $17,000 121.43%
Wines and Spirits
for Social
Entertaining         86.90%  $24,000    77.00%  $19,000   $5,000  26.32%
Wines and Spirits
for Personal
Consumption          84.80%  $17,000    74.30%  $11,000   $6,000  54.55%

                                  2007             2005     $Change  %Change
    Total Luxury Summer
    Spending/Household       $622,202.02        $399,187.50 $223,015  55.87%

    *Percentage of those surveyed spending in this category Survey of Households with 
Net Worth $10 Million +

[Feb 22, 2008] Is Time Running Out for Bond Insurers?

Another $75 billion losses at the big banks ?
The decision by the big ratings agencies, Moody's, Standard & Poor's and Fitch is imminent, and at least one of the raters could make an announcement sometime today.
...
[A] downgrade of MBIA and Ambac could pose big problems for the banks that hold bonds they insure. Analyst Meredith Whitney said on CNBC yesterday that the downgrades could cause writedowns of another $75 billion at the big banks.

[Feb 22, 2008] U.S. Stocks Fall, Led by Financials; Fannie Mae, Goldman Drop by Michael Patterson

Bloomberg "People are coming to grips with what is the degree of financial issues,'' David Darst, the New York-based chief investment strategist at Morgan Stanley Global Wealth Management, which oversees $734 billion, said in a Bloomberg Television interview. "We think caution is called for.''

The S&P 500 has lost 1.1 percent this week and is down 9.1 percent in 2008 after a worse-than-forecast manufacturing report yesterday added to evidence that the economy is falling into a recession. The world's largest banks and securities firms have reported about $160 billion of credit losses and asset writedowns since the beginning of 2007 as the collapse in subprime mortgages spreads across debt markets.

"We do not think the stocks fully reflect the severity or duration of the financial headwinds facing the companies,'' he wrote in a research note to clients dated today. There is "more pain than gain.''

[Feb 22, 2008] The Fed's Self-Delusion (Inflation Edition)

Individuals and institutions are capable of considerable self-deception when faced with difficult choices. The Fed's latest signals about what it intends to do about inflation are a classic example.

[Feb 22, 2008] Analyst Meredith Whitney Asks Banks "Where's Waldo ?"

From Mish's blog readers comments: "Whitney is a superstar - a real analyst who actually went with accounting 101 and called bull on Citibank before anyone else. That how she went from CIBC to Oppenheimer on a huge pay raise. What she says means business."

Mish's Global Economic Trend Analysis

I listened to the video (Click Here To Play Video) a half dozen times and offer this transcript by hand. The following may not be perfect but what's presented below should be extremely close. A few sections were not transcribed. Inquiring minds will want to play it.

Maria:
So you predicted the dividend cut, you've been negative on the banks tell us where we stand in this cycle right now. How much more pain is ahead?

Meredith:
Well a lot of people ask where are we in terms of innings or are we half way over. I think we are probably 40% of the way over. And the biggest problem has been this game of finding Waldo.

No one has been forthright about where their losses are actually hidden, where there exposure is. There's still so much risk remaining on bank balance sheets that has yet to be sold and this constrains lending and that's why you have a problem with any type of hiring.

Banks aren't lending so businesses can't grow, manufactures can't invest, and this is a systemic issue because banks are still in denial.

If these assets were truly marked to market banks would be indifferent to whether they hold them or sold them. Obviously they are not indifferent. The fact they are holding it means they have some hope that these assets will recover.

If they had sold these assets 6 months ago they probably would have gotten 50-75% more than they can sell these assets for today. When they do finally come up for sale there is going to be a supply jam that will drive these prices even lower.

That is just one part of banks problem. The other part of the problem is loss curves. Loans they have on balance sheets are accelerating in terms of losses and these banks are under reserved for those loans. So capital issues surround these banks all over the place and a couple of banks are at particular risk.

Image Of Whitney's Financial Calls:
Long – American Express (AXP)
Short – Citigroup (C), Merrill Lynch (MER) , UBS

Maria:
Who is most vulnerable for more losses of dividend cuts?

Meredith:
Believe it or not it's Citigroup. Citi now has earnings problems, they have balance sheet constraints, they have further CDO writedowns, they have exposure to the monolines and they have the single largest concentration of exposure to high LTV [Loan To Value] mortgages.

Citi has over $50 billion in exposure to 90+% LTV mortgages are likely underwater now that housing prices have declined. So they will have the highest severity of losses with respect to those mortgages. I estimate that Citi is anywhere from $6 to $12 billion under reserve because of those exposures. There's no place to hide for Citi.

Maria:
So you think Citigroup will have to cut the dividend again then?

Meredith:
Yes, Citi is capital constrained and they will be further capital constrained when they have to take more writedowns. ...

Historically payout ratios on dividends is under 50%. As Citigroup becomes earnings challenged, its payout ratio of dividends to earnings is 70% and that is imprudent for a board to authorize such payouts particularly when they are going to sovereign nations and borrowing at expensive rates.

Maria:
Will Citi have to raise more capital?

There is not a doubt in my mind that Citigroup will have to raise more capital. Collectively they raised about $20 Billion from sovereign wealth funds and smaller investors. I believe they raised what they could at the time. ...

Citigroup, Merrill, and UBS raised capital that diluted existing shareholders by 20%. That's unheard of. And the fact they are going to have to go back and dilute shareholders even further makes my argument of a payout ratio even stronger.

Maria:
The monolines, Ambac (ABK) and MBIA (MBI) what is your prediction there?

Meredith:
There is no way the rating agencies can possibly know how much capital Ambac and MBIA need because no one understands what the end of the housing market decline is actually going to look like. There's no way they can do it.

Maria:
And as far as things getting worse, how much of this scenario is priced in?

Meredith:
I think that the best case scenario is 15% downside in the financials.
I think that the worst case scenario is 50% downside in the financials.

Maria:
50% downside in the financials, worst case scenario. Meredith, good to have you. Thanks so much.

That was a good interview. But let's discuss bank lending a bit more. Yes, capital impairment is preventing lending.

However, lending is not going to revert back to what it was even if the capital issues are solved. Psychology has changed and it's extremely unlikely to change back for a long time. A secular peak in lending craziness has been reached and the pendulum has far, far to go in the other direction.

The process has just started. More writeoffs are coming from commercial real estate and credit cards. Furthermore there is no reason for businesses to hire or expand given rampant over capacity everywhere. This recession is going to be far deeper and last far longer than anyone thinks.

Mike "Mish" Shedlock

[Feb 20, 2008] Welcome to PrudentBear.com

"Almost half of the U.S. homeowners who in the past two years took out subprime mortgages that now underlie securities would owe more than their property's value if home prices drop an additional 10%."

Bloomberg, February 13, 2008

[Feb 20, 2008] Fed official 2008 economy like 1991 recession - Feb. 19, 2008

Does this mean 4 years of slow growth means or recovery in 2012 ? Is was dissolution of the USSR plus PC revolution (beginning of the dot-com boom, which later turned in bubble) that helped to overcome the headwind, was it ?

The slumping U.S. economy is reminiscent of the aftermath of the 1991 recession, according to the head of the Minneapolis Federal Reserve.

In a speech given Friday morning in Minneapolis, Gary Stern, the regional Fed president, said the current excesses in residential construction, housing market decline, and credit crunch all resemble the "headwinds" environment that prevailed 17 years ago. If that is the case, the economy may be in a slump for some time.

[Feb 20, 2008] Inflation Heats Up in January

No more Fed rate cuts ?

Inflation is showing renewed signs of life, much to the chagrin of financial markets and the Federal Reserve. A report released Feb. 20 showed that the U.S. consumer price index (CPI) rose 0.4% in January, while the core rate, excluding food and fuel, rose 0.3%. Markets expected tamer readings of 0.3% and 0.2%, respectively.

The headline CPI figure posted a 4.3% rate of growth over last year, up from 4.1% seen the month before. The core rate rose to a 2.5% year-over-year pace, from 2.4% seen previously.

[Feb 20, 2008] LBO Deals were Losers for Wall Street

The WSJ Deal Journal has an interesting analysis today: Leveraged Loans: The Hangover Wasn't Worth the Buzz
Investment banks now face around $197 billion in exposure to leveraged loans used to back big buyouts in 2007, adding inestimable stress to their efforts to extricate themselves from the credit crunch. Was it worth it?

Not really, no.

The WSJ's Heidi Moore provides some analysis for several banks. As an example, for Citigroup she writes:
Citigroup ... earned only $856 million in fees from private-equity firms in 2007, even though the bank underwrote leveraged loans totaling $114.3 billion and still holds $43 billion in exposure. Oppenheimer analyst Meredith Whitney estimates Citigroup's leveraged loan write-downs would be about $2.5 billion ...
And this doesn't count the opportunity costs.

[Feb 18, 2008] Signs may tell you economy is picking up, when to act by John Waggoner

This is just third month of the slump and too early to tell who long it will last and how low the stocks will fall. IMHO end of the quarter sucker rally is a possibility but this is not a recovery: the situation is much more serious then it was with dot-com mess for which Greenspan was awarded "Enron Prize for Distinguished Public Service" and it will take longer to dissipate. Maybe Mr. Greenspan deserved that Enron Prize after all.
BTW Sir Alan (aka Maestro Greenspan) really was instrumental in making subprime mess a lot messier then dot com mess. What is really funny is that used copies of his book are holding at the level $15.98. So total depreciation of the book from the moment of publication is 43% (the initial price on Amazon was $35 with 20% discount = $28, I think). While I am surprised that the depreciation is so benign I think it might serve as an estimate for the depreciation of the stock market during this slump ;-)
USATODAY.com

In most cases, the first half of a recession is dreadful for investors. Corporate earnings drop. So does the stock market. But Wall Street looks ahead, and stocks often rally before the economy picks up. If you've been sitting on the sidelines, waiting for the economy to perk up, here are some indicators you should watch:

Typically, small-company stocks rally first at the end of a recession, because they feel the benefit of lower interest rates first, Johnson says. Technology stocks, industrial stocks and basic-materials stocks also fare well after a recession has ended.

Perhaps the most positive economic indicator for stock investors is the economic research bureau's official announcement that a recession has begun. By the time it's made such an announcement, the recession is typically more than halfway through, and stocks have started to rise again.

One major exception was the last recession: Had you bought the S&P 500 in November 2001, you would have lost 15%, thanks to the bursting of the tech bubble.

is a personal finance columnist for USA TODAY. His Investing column appears Fridays. Click here for an index of Investing columns. His e-mail is jwaggoner@usatoday.com.

[Feb 18, 2008] Physician heal thyself by Julian Delasantellis

Asia Times

In the United States, many prominent economists, including Clinton-era Treasury secretary Laurence Summers, are proclaiming that the US economy desperately needs this assistance. In a January 6 opinion piece in the Financial Times, he laid out his argument as to why the US economy was in desperate need of aid.

Fiscal stimulus is appropriate as insurance because it is the fastest and most reliable way of encouraging short-run economic growth at a time when a serious recession downturn would pressure American families, exacerbate financial strains, raise protectionist pressures and hurt the global economy.
Like a drunk in a bar ordering another round because he's heard that, since a glass of red wine a day has some purported health benefits, it's logical to assume that a whole bottle of 120-proof Scotch must have even more, the Congress heard this wisdom, raised a glass to the fine Dr Summers, toasting, "I'll drink to that".

... ... ...

But in the United States, the right to enjoy continuing and uninterrupted high levels of domestic consumption is so sacrosanct that, applied to the private consumption of housing, it forms the core definition of what is called the "American dream." The country can worry about paying for it later - preferably much later.

Hausmann brings up another point that must be obvious in most of the countries of the developing world. When it comes to dealing with economic crises, America's attitude is definitely do as I say, not as I do.

The same voices that supported tough macroeconomic policies to deal with the excesses of spending and borrowing in east Asia, Russia and Latin America are today pushing for a significant relaxation in the US to deal with the so-called subprime crisis. Interest rates should be slashed quickly and $150bn put into taxpayers' pockets by April at the latest, they say.
Following upon the fall of the Soviet Union came a new American attitude as to how developing nations in economic distress should be handled. During the Cold War, these countries were treated gingerly, for the fear was that if these societies were pushed into deep penury they might be tempted to "flip" over to the side of the Communists. With the end of the Communist threat, that fear disappeared, as did the velvet glove. Out came the iron fist.

For about 20 years now, poorer nations in economic distress seeking assistance have had the misfortune to have been subject to what is called the "Washington Consensus."

The core mandate of the Washington Consensus demanded that the supplicant nations severely cut their government social welfare spending in order to generate budget surpluses. Also, the depreciation of these countries' national currencies, and the Washington Consensus demand that the governments stop subsidizing prices of necessities such as imported food and medicine meant that the less fortunate in these societies were subject to substantial hardship in meeting their needs for the daily necessities of life.

Hausmann's quip about the "same voices" advocating the stimulus package for America is a particularly pointed jab at Summers who, as Treasury Secretary, was the hanging judge who sentenced the poor unfortunate nations caught up in the East Asian financial crisis of 1997-98 to the Washington Consensus.

At its core, what is the entire subprime economic meltdown but yet another crisis of American overconsumption, in this case, the overconsumption and resulting misallocation of housing finance capital? The names and the faces may change, but, at its core, the song remains the same. The basic financial mendacity that displayed itself in the loans to the less-developed world in the early 1980's, in the Savings and Loan fiasco in the late 1980's, in the Long Term Credit Management hedge fund collapse in 1998, in the bursting of the dot-com bubble in 2000-01, is now being displayed again in the subprime sector.

Like an obese man not willing to change his lifestyle but still expecting his physician to heal him, unless America shows itself willing to address its real, core underlying problem, its never-ending desire to consume more than it produces, in another 10 years or so the country should expect to be precisely back where it is now.

Fiscal prudence and fiscal discipline may be all well and good for the wogs and gooks carrying the crosses of the Washington Consensus, but as for applying the same dour principles and policy prescriptives to the namesake nation of the Washington Consensus.

Well, American Protestant fundamentalists consider their country to be uniquely blessed and chosen by God, a gleaming city on a hill, a shining light onto all the nations. Good deal, if you never have any intention of paying the light bill.

[Feb 18, 2008] It's too early to be bullish

Really too early -- [NNB Feb 26, 2009]
MSN Money

Lastly, Justin Mamis of The Mamis Letter recently noted that bear markets typically involve three legs: denial, realization and give-up. It's his view that we may have experienced the first leg but that the second one is yet to come. This realization leg occurs when people comprehend why the market is going down and sell stocks in response. As he points out: "A bear market can't end -- never has -- until denial turns into realization. . . . This is a long process, because the light bulb doesn't come on collectively but gradually. Some are quicker to catch on, or less dumb, than others."

As to the give-up leg, Mamis characterizes it as the culminating phase. So, given that we may have seen only the first leg, his eyes and his words are telling him that the process has a long way to go and stocks have a long way to fall

[Feb 18, 2008] Look who's buying now - Nouriel Roubini (7) -

FORTUNE

The debate is no longer about a soft vs. a hard landing, but how hard will the hard landing be. The recession train left the station in December. The recession will be severe because the U.S. consumer - whose spending makes up 70% of our GDP - is shopped-out, saving-less, and debt-burdened.

There is a rising risk of a systemic financial crisis. Avoid risky assets like equities, which could suffer a sudden market crash. You want to buy protection against this by buying options on the CBOE volatility index, known as the VIX, or on the S&P 500.

Be careful with money market funds. Some could have meaningful exposure to securities backed by risky mortgages, or even auto loans or credit card loans, which are also high risk.

Finally, do not buy a home. The housing recession is not near the bottom and prices could fall by another 20% over another year and a half. If you buy now, you'll have a massive capital loss.

[Feb 18, 2008] Look who's buying now - Bob Rodriguez (9)

FORTUNE

CEO, First Pacific Capital and portfolio manager, FPA Capital and New Income Funds

I have 43% in cash. I'm looking to see what other shoes start to fall. The credit crisis is still unfolding, and all we've had are tactical, not strategic solutions. High interest rates didn't cause this credit crisis, so why should interest rate cuts solve it? Congress is hoping the stimulus will help kick start the economy, but single-event tax cuts have been shown to be highly ineffectual.

Several retailers with strong balance sheets have gotten hit pretty hard. Foot Locker (FL) is down in the $10 range, and Jo-Ann Stores (JAS) got down to $9 from about $25. Under normal circumstances, they'd be buys.

But I don't believe we're in a normal environment. I want to see more pain and suffering before I think it's safe to start buying in a big way.

[Feb 18, 2008] Shadows of the CDS Market

"Credit default swaps are going to blow sky high. If 10% of credit default swaps blow up, it would wipe out $4.5 trillion in capital. A mere 1% hit would wipe out $450 billion. We don't know when, but we do know the fuse is lit. " Looks like Ponzi scheme, is not it ? Note the sentiment in comments section: "The U.S. banking system is a traitor to the citizens of the U.S. Let them die." or "The bankers have outsourced the U.S. worker, it is time to outsource the bankers. Viva la Revolucion!"

Mish's Global Economic Trend Analysis

A Credit Default Swap is a bet between two parties on whether or not a company will default on its bonds. A CDS investor is therefore making essentially the bet as the corporate bond investor. The difference being the counterparty is not a company issuing bonds but a third party willing to speculate on the outcome.

... ... ...

Because these contracts are sold and resold among financial institutions, an original buyer may not know that a new, potentially weaker entity has taken over the obligation to pay a claim.

... ... ...

$45 trillion bet on swaps with the entire treasury market is a mere $4 trillion is simply absurd. Compounding the problem is lack of knowledge abut who the guarantors are and lack of liquidity in much of the derivatives market. There's always plenty of liquidity when times are good. However, liquidity is a coward. It runs and hides at the first sign of trouble.

Things are so illiquid now that even the municipal bond market has locked up. Insurance guarantees made by Ambac and MBIA are at the heart of it. See No Underwriter Support For Failed Muni Auctions.

Credit Default Swaps on Ambac and MBIA are trading 7 or more levels below investment grade (deep into junk) and 12-14 levels below the AAA or AA ratings assigned by Moody's, Fitch, and the S&P. Clearly this calls into question the competency of the rating agencies.

Banks and brokerages are unwilling to commit capital and who can blame them?

Credit default swaps are going to blow sky high. If 10% of credit default swaps blow up, it would wipe out $4.5 trillion in capital. A mere 1% hit would wipe out $450 billion. We don't know when, but we do know the fuse is lit.

Comments

===

It's almost as if the person who would pay in the event of a CDS default wrote so much insurance on corporate bonds for a particular company that it might make more economic sense to bail the underlying company out than to let them default on the bonds.

It's kind of the derivative tail wagging the corporate bond dog now. It's as if the fire insurance company's insurance contracts have gotten so large that they might even want to think about starting their own private fire department.

===

Mish: No one knows who the ultimate guarantor of these contracts is. I have stated on many occasions that it just might be "Madame Merriweather's Mudhut Malaysia" or some obscure hedge fund that may not be in business tomorrow.

This is an absolutely perfect example of a "market failure", which renders Libertarian fantasies of the free market laughably juvenile. Much like credit card companies selling off defaults for pennies on the dollar to bottom-feeding collection agencies, this violates what *should* be an absolutely inviolate principle protected by law: contracts must only bind the people who agreed to them in the first place. Party A didn't agree to a damn thing with Party B's "successor in interest", and it is a concept which is a cancer on a free people. I enter into a contract, to a large extent, not only because of the terms but as a judgement of whether I can trust the other party to be faithful to those terms. Removing the right to make that determination, whether it's me and my local bank or two sides of a CDS scheme, is nothing but corporate fascism at work. Whoever has more money has all the power, no matter what supposed "remedies" the other party may have in a court which they may or may not be able to afford.

===

It's almost as if the person who would pay in the event of a CDS default wrote so much insurance on corporate bonds for a particular company that it might make more economic sense to bail the underlying company out than to let them default on the bonds."

Yes, except that it makes even more economic sense for your corporation to collect premiums and put the cash in your pocket through bonuses. Then at the first default shrug your shoulders and let the corporation declare bankruptcy while you walk away with your millions.

Once we had an industrial economy,
then a service economy,
then a financial economy,
and now a corruption and fraud economy.

===

riles666 said: "Does anyone know what the size of the CDS were on Countrywide? Could it be Bank of America looked at their exposure to the swaps and said a buyout would cost them less?"

This has been suggested elsewhere, and may be the case. Counter Party Risk Buyout.

[Feb 17, 2008] Comment is free The debt delusion

There are some very interesting comments for the article. Some of them are reproduced below...
Therein lies a profound contradiction. On one hand, policy must fuel asset bubbles to keep the economy growing. On the other hand, such bubbles inevitably create financial crises when they eventually implode.

This is a contradiction with global implications. Many countries have relied for growth on US consumer spending and investments in outsourcing to supply those consumers. If America's bubble economy is now tapped out, global growth will slow sharply. It is not clear that other countries have the will or capacity to develop alternative engines of growth.

America's economic contradictions are part of a new business cycle that has emerged since 1980. The business cycles of presidents Ronald Reagan, George Bush Sr, Bill Clinton, and George Bush share strong similarities and are different from pre-1980 cycles. The similarities are large trade deficits, manufacturing job loss, asset price inflation, rising debt-to-income ratios, and detachment of wages from productivity growth.

The new cycle rests on financial booms and cheap imports. Financial booms provide collateral that supports debt-financed spending. Borrowing is also supported by an easing of credit standards and new financial products that increase leverage and widen the range of assets that can be borrowed against. Cheap imports ameliorate the effects of wage stagnation.

This structure contrasts with the pre-1980 business cycle, which rested on wage growth tied to productivity growth and full employment. Wage growth, rather than borrowing and financial booms, fuelled demand growth. That encouraged investment spending, which in turn drove productivity gains and output growth.

The differences between the new and old cycle are starkly revealed in attitudes toward the trade deficit. Previously, trade deficits were viewed as a serious problem, being a leakage of demand that undermined employment and output. Since 1980, trade deficits have been dismissed as the outcome of free-market choices. Moreover, the Federal Reserve has viewed trade deficits as a helpful brake on inflation, while politicians now view them as a way to buy off consumers afflicted by wage stagnation.

The new business cycle also embeds a monetary policy that replaces concern with real wages with a focus on asset prices. Whereas pre-1980 monetary policy tacitly aimed at putting a floor under labour markets to preserve employment and wages, it now tacitly puts a floor under asset prices. This is not a matter of the Fed bailing out investors. Rather, the economy has become so vulnerable to declines in asset prices that the Fed is obliged to intervene to prevent them from inflicting broad damage.

All these features have been present in the current economic expansion. Wages have stagnated despite strong productivity growth, while the trade deficit has set new records. Manufacturing has lost 1.8m jobs. Prior to 1980, manufacturing employment increased during every expansion and always exceeded the previous peak level. Between 1980 and 2000, manufacturing employment continued to grow in expansions, but each time it failed to recover the previous peak. This time, manufacturing employment has actually fallen during the expansion, something unprecedented in American history.

The essential role of asset inflation has been especially visible as a result of the housing bubble, which also highlights the role of monetary policy. Despite the massive tax cuts of 2001 and the increase in military and security spending, the US experienced a prolonged jobless recovery. That compelled the Fed to keep interest rates at historic lows for an extended period, and rates were raised only gradually because of fears about the recovery's fragility.

Low interest rates eventually jump-started the expansion through a house price bubble that supported a debt-financed consumer-spending binge and triggered a construction boom. Meanwhile, prolonged low interest rates contributed to a "chase for yield" in the financial sector that resulted in disregard of credit risk.

In this way, the Fed contributed to creating the sub-prime crisis. However, in the Fed's defence, low interest rates were needed to maintain the expansion. In effect, the new cycle locks the Fed into an unstable stance whereby it must prevent asset price declines to avert recession, yet must also promote asset bubbles to sustain expansions.

Comments

THE GREGORY HOUSE APPROACH!

Why can't we find a House with a board and colored pens with a bunch of brains who get hammered putting out ideas to the symptoms:

  1. Symptom One: The American Bubble Economy is in fact tapped out and world economic growth will slow.
  2. Symptom Two: The United States has the largest trade deficit in the history of its existence. Trade inbalance.
  3. Symptom Three: NAFTA & CAFTA along with other Letters have cost, and is costing The United States Million of manufacturing jobs lost and gone.
  4. Symptom Four: Robbing Peter to Pay Paul, using credit cards to pay off debt, creating more debt trying to pay off debt. No way to have savings, driving up household indebtness. Savings are for all practical purposes non-existent.
  5. Symptom Five: The Housing Bubble has bust! House flipping ran prices up on property, created a bubble and the bubble busted, with falling real-estate values.
  6. Symptom Six: The Service Sector Economy has melted down!
  7. Symptom Seven: The Entire Economy is in contraction and not growth. We are well past Stagflation.
  8. Symptom Eight: Surge in government spending across the board caused by the War On Terror, and The Mexican Invasion of The United States breaking the social services systems, of city, county and state placing many into a bankrupt status.
  9. Symptom Nine: Sub-Prime Morgage has melted down!
  10. Symptom Ten: Interests Rates and Inflation were artificially held down by Chinese Surging capital flow into the United States. Each American Citizen owes each Chinese Citizen ($5000) United States Greenback Dollars.
  11. Symptom Eleven: Creative Destruction by the laxity in banking and regulatory standards.
  12. Symptom Twelve: The gap between the have and have not has increased the Bottom (50%) total population earns just (12.8%) of the total national income, were as the top (1%) earn (21%) of the total national income.
  13. Symptom Thirteen: Mort Zuckerman predicts The United States has begun the most serious Economic Downturn, since the "Great Depression" of (1929-1945).

The question is what symptoms have we missed? And, now what do we do to get the patient well?

===

The trade deficit will soon start to decrease, due to inflation in China, the recession, the weak dollar, etc.

For me the biggest problem isn't the borrowing, but what the US has been spending it on. The housing bubble, and the Iraq War, didn't increase productivity.

The US doesn't have to go back to being a vanilla manufacturing economy. The main thing is that they are putting their money to work in some way. They sell a lot of services, and other high-added-value stuff like new technology.

I think they'll always live beyond their means, just because they can, being the dominant economy and dominant currency. But profligate waste may eventually tip them to a point where those descriptions no longer apply. Then they'd be in trouble.

===

Mujokan says about the US:

The main thing is that they are putting their money to work in some way. They sell a lot of services, and other high-added-value stuff like new technology.
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Time to come back to Earth. You are missing the whole point: "they" are only a small group of financial oligarchs that "put their money to work" in the financial sphere of speculation and not the real economy.

Also the concept of High value added stuff" applies to real commodities and goods that a re produced in several stages. It is very difficult to apply it to services.

Finally ,what " new technology "? Teleportation? Mind operated aircraft? Immortality? The "new tech" you have in mind is very old by now, totally incorporated in every economy in the world and mostly manufactures in SE Asia.

===

I am no economist but the link below seems to explain the situation perfectly:

http://mondediplo.com/2008/02/05military

===

Hermine - Yes, Chalmers Johnson has taken over where Seymour Melman left off. You can see a similar article here:

http://www.globalresearch.ca/index.php?context=va&aid=7894

And if you do an author search at this site, there'll be two or three other articles as well.

===

I know very little about economics and perhaps this has been a good thing, it has prevented me becoming indoctrinated.

Last summer I heard an economics prof interviewed on BBC 4 radio news. He said everything was fine. When the BBC starts interviewing experts, ask why.

This bloke has been telling it for some time now:

MIKE WHITNEY
http://www.counterpunch.org/whitney02082008.html

"Right now, many of the country's largest investment banks are holding $500 billion in mortgage-backed securities and other structured investments that are steadily depreciating in value"

Another article here: "Notes from the Foreclosure Front: Baltimore"
http://www.counterpunch.org/debrabander02082008.html

"Baltimore Mayor Sheila Dixon recently announced that the city would sue Wells Fargo, one of the largest national banks and mortgage providers, for targeting African American Baltimoreans with risky subprime mortgages, resulting in a disproportionate number of foreclosures in black neighborhoods."

===

William Engdahl

[Endgame: Unregulated Private Money Creation
What had emerged going into the new millennium after the 1999 repeal of Glass-Steagall was an awesome transformation of American credit markets into what was soon to become the world's greatest unregulated private money creation machine.
[The New Finance was built on an incestuous, interlocking, if informal, cartel of players, all reading from the script written by Alan Greenspan and his friends at J.P. Morgan, Citigroup, Goldman Sachs, and the other major financial houses of New York. Securitization was going to secure a "new" American Century and its financial domination, as its creators clearly believed on the eve of the millennium.
[Key to the revolution in finance in addition to the unabashed backing of the Greenspan Fed, was the complicity of the Executive, Legislative and Judicial branches of the US Government right to the Supreme Court. In addition, to make the game work seamlessly, it required the active complicity of the two leading credit agencies in the world--Moody's and Standard & Poors.]

True, but what's new? Like Palley, no mention of the Third World Debt Crisis coming to a peak in 1983-87. But thats only the Third World, so who cares? That had many more victims. It ended when the Cartagena group of countries threatened to default.

===

This Dr Palley wasn't last in the queue when they were handing out brains. Here's the best description I've ever found of what the Fed and the BoE are up to:

"....relying exclusively on inflation-targeting also risks creating policy moral hazard in asset markets. The underlying cause of the moral hazard is that asset prices may rise considerably during periods of expansion without necessarily inducing inflation and a tightening response from the monetary authority. However, when the expansion comes to an end, asset prices stand exposed. At this stage a significant downward correction of asset prices risks severe negative consequences:

  1. Falling asset prices could freeze markets to the extent that they... make it impossible for debt-burdened assetholders to sell.
  2. By reducing collateral values, they make it harder to get new loans.
  3. They make it harder to estimate the value of new investment projects.
  4. They strike at consumer confidence just when this is crucial to maintaining aggregate demand.

These considerations suggest that the monetary authority will HAVE AN INTEREST IN PREVENTING ASSET PRICES FROM FALLING (my caps). Whereas the monetary authority may pay little explicit heed during the upturn, it steps in to protect values during the downturn."

http://www.thomaspalley.com/docs/articles/macro_policy/asset_price_bubbles.pdf

Essentially what he's saying is that an inflating asset bubble never gets noticed in the inputs to monetary policy, because it doesn't necessarily cause inflation; but once the bubble looks like bursting, the anticipated effects of allowing this to happen force the monetary authority to prop up asset prices.

So monetary authorities are, despite themselves, in the business of moral hazard - of allowing people to get rich off asset-price bubbles, and then saving them from the consequences when the bubble bursts. And this is no sinister conspiracy: it's a consequence of the extremely clunky, primitive market signals used as inputs into monetary policy.

Translate this into UK political economy, and the results are familiar: nothing was done about the housing bubble (for instance) on the way up. But now that it looks like going down, the BoE cuts rates. Moral hazard big time! What has happened is that what looked like just an incidental "feature" of the economy during the good times has taken over the fate of the economy as a whole, so that it's impossible to allow house-prices to tank without wrecking the economy. And people like me who happened to be out of the country for a period of years, and thus haven't bought into the bubble, can just shut up and pay for the gains of those who did.

As a cure, Palley proposes a reserve requirement against asset prices, like the banking reserve requirement against deposits. But I don't quite understand it.

Dr Palley, how about an article explaining your idea of asset-based reserve requirements in language we can understand, maybe going into how it might have prevented the UK property bubble?

(Of course, to the I-wanna-feel-rich/I-have-the-right-to borrow-the-entire-world's-reserves-of-credit brigade, this will seem like Credit Control - Evil! Socialist! Planned Economy! But in the mess we're heading into, that constituency won't be able to shout too loud without fearing a lynching. I hope).

[Feb 16, 2008] Defining the macroeconomic problem - Paul Krugman - Op-Ed Columnist - New York Times Blog

"The result will be a recession or at least something that feels like one." Will bloodbath in debt markets will erase profit growth this year ?

As we debate interest rates, fiscal stimulus and all that, I thought it might be worth backing up to think about what our macroeconomic problem is right now.

Basically, I'd say, the problem is twofold. First, in the mid-00s the U.S. economy got badly unbalanced - too much dependence on housing and housing-inflated consumer spending, too big a trade deficit. This figure shows "deviations" in share of GDP - it's the difference, in percentage points of GDP, between 2007 and average 1980-2000 spending on consumption (C), nonresidential investment (NR), residential investment (R), and net exports (NX). Notice that even with the housing collapse in progress, residential investment was still running a bit high - this year it will surely be well below "normal." But the main thing at this point is high consumption offset by a high trade deficit.


Deviations from the norm

Second, in the process we also got a credit bubble that's now bursting, and threatening to take down spending that wasn't all that high to begin with - like business investment.

What we want, and will eventually get, is a rebalancing: smaller trade deficits, consumer spending more in line with income, more normal housing spending. The trouble is in getting there. At the moment it seems likely that consumption and housing investment will fall faster than net exports can rise - probably with additional downward pressure from at least some types of business investment, especially commercial real estate. The result will be a recession or at least something that feels like one.

The goal of monetary and fiscal policy should be to bridge the gap - to sustain spending until a falling trade deficit comes to the rescue, and to hasten the rise in net exports (remember, in the current context a weak dollar is good.)

What does that say we should be doing that we aren't? I'm working on that.

[Feb 16, 2008] Rising Import Prices, Big News

Stagflation ?

I'm tempted to just lift my blog post from last month, but I'll resist the temptation to be lazy. The basic story is of course the same, there was a sharp jump in import prices again in January. Imports prices overall rose by 1.7 percent, with non-fuel imports rising by 0.7 percent. Import prices are now rising almost everywhere and across the board. Prices of items imported from the EU rose by 1.1 percent last month, from Latin America by 3.6 percent, and from China by 0.8 percent. Prices of goods imported from China have been rising at a 4.4 percent annual rate over the last three months.

This matters because higher import prices will get passed on in higher domestic prices, in other words, inflation is likely to rise. This will make the Fed's choices harder in the months ahead. Efforts to boost the economy with lower interest rates will also feed inflation by lowering the value of the dollar.

It was inevitable that the dollar would eventually fall and put the Fed in this situation -- the huge trade deficits of recent years could not be sustained forever -- but this may be a bad time for this source of inflationary pressure to appear.

[Feb 16, 2008] U.S. Economy: Confidence Drops, Factories Stagnate (Update2) By Bob Willis and Courtney Schlisserman

Another Fed cut on the March 18 meeting ? "Futures contracts on the Chicago Board of Trade show traders see a 38% chance that the Fed will lower the target lending rate by .75% at its next policy meeting on March 18, up from 30% a week ago. The odds of a 50-basis-point cut are 62%. " ` "There's a real question as to what the right policy is...''
Bloomberg.com

The Reuters/University of Michigan index of consumer sentiment fell to 69.6 in February from 78.4 the previous month. The Federal Reserve said manufacturing production was unchanged in January after two months of gains, while a gauge of activity at New York factories contracted this month.

"We're seeing a clear pattern of sudden weakening in both consumer and business confidence, which frankly is the sign of a recession,'' said James O'Sullivan, a senior economist at UBS Securities LLC in Stamford, Connecticut, who had the closest forecast for consumer sentiment in a Bloomberg News survey.

U.S. government bonds rallied after the figures, sending two-year note yields to the lowest level since 2004, while the dollar dropped. The reports reinforced traders' anticipation that the Fed will need to cut interest rates by at least a half- point by the end of the March 18 meeting.

[Feb 15, 2008] Ethics a Non-Issue in America by Charles Hugh Smith

"I am not suggesting criminal charges, though those would be richly deserved by players large and small alike. I am simply suggesting that we as a nation should state that fraud is wrong and should not be rewarded."
February 15, 2008 | Charles Hugh Smith blog

According to author Richard Bitner's website The Mortgage Insider, "Nearly three out of every four subprime mortgages originated by brokers were misleading or fraudulent." (Bitner's book Greed, Fraud & Ignorance: A Subprime Insider's Look at the Mortgage Collapse was recommended here this week.)

... ... ...

As outlined in Bitner's excellent book, fraud and misrepresentation of risk was the game played by everyone from the anxious-to-get-rich-quick borrowers to the anxious-to-make-billions investment banks which packaged the risk under the phony guise of low-risk AAA ratings issued by a handful of powerful fraudsters, a.k.a. the ratings agencies.

Yet pundits and politicos are falling all over themselves in a frenzy to "save" the players large and small from any consequences of their fraud.

... ... ...

I am not suggesting criminal charges, though those would be richly deserved by players large and small alike. I am simply suggesting that we as a nation should state that fraud is wrong and should not be rewarded. The market will deal out the consequences if we just don't intervene.

I want to reiterate a point made earlier this week in Greed, Fraud and Duplicity: How the Housing/Lending Bubble Inflated, which is fraud can be quantified by the dollar amount but the ethical lapse/moral bankruptcy is the same regardless of the fraud's dollar cost.

Thus, the person with no assets and modest income cheated on their subprime loan application. The Wall Street investment banker had the opportunity to cheat on a much larger scale--purposefully packaging high-risk debt into CDOs willfully misrepresented as "low-risk" AAA instruments--but the truth is, each player cheated and lied to gain wealth or credit which they would not have gained had the truth been told. In this way each player, rich and poor, are equivalently morally bankrupt.

[Feb 15, 2007] Banks advised to walk away from buyouts by Paul Murphy

Is this an official end of M&A boom (aka Paulson rally) ? How stocks which were mostly supported by M&A boom will react ? "Could it be that the Great Private Equity Cash Robbery of 2007, in which previously healthy companies either "cleared" their balance sheets of cash-to use the euphemism employed by Steve Odlund, the Chief Cash Clearer at Office Depot - by buying back their own stock at bull-market peaks or faced the prospect of having it cleared for them by the Private Equity Cash Robbers?"
Feb 15, 2007 | FT

Banks are being advised by their lawyers that it would be cheaper to walk away from big buy-out deals than incur further losses on their funding commitments, increasing the chances that more high-profile private equity transactions will collapse.The advice contrasts with conventional wisdom that banks would risk serious damage to their reputations if they were to drop out of deals.

[Feb 15, 2007] A Crisis of Faith by PAUL KRUGMAN

"...ultimately, it's more than a subprime crisis; indeed, it's more than a housing crisis. It's a crisis of faith." Does this mean that 401K investors are in the soup and S&P500 eventually falling to 1100 level or below ?
February 15, 2008 | New York Times

Troubles that began a little over a year ago in an obscure corner of the financial system, BBB-minus subprime-mortgage-backed securities, have spread to corporate bonds, auto loans, credit cards and now - the latest casualty - student loans.

Indeed, this week the state of Michigan suspended a major student-loan program because of the sudden collapse of another $300 billion market you've never heard of, the market for auction-rate securities.

Why has a crisis that began with loans to a limited group of home buyers ended up disrupting so much of the financial system? Because, ultimately, it's more than a subprime crisis; indeed, it's more than a housing crisis. It's a crisis of faith.

I know that sounds dramatic. But, let me talk about what just happened to auction-rate securities.

Like many of the financial innovations that are now being called into question, auction-rate securities are complicated deals that seemed to offer something for nothing.

[Feb 14, 2007] No One Runs Faster Than a Scared Banker!

Bankers are petrified. Feb can drop money from helicopters but it's like giving another drink to alcoholic... Problems are not connected with luck of liquidity but with the luck of solvency. Feb can do little about it. At the same time debt to cash ratio
www.paperdinero.com

Howard Davidowitz of Davidowitz & Associates joins the CNBC to discuss the current state of retail and in particular the results seen during the 2007 holiday season. Davidowitz sees a "colossal disaster" shaping up with the consumer adding that "we are out of money, the Fed can't save us, the worst is yet to come, no one can help out, the consumer has negative savings, the consumer is underwater, they owe money like crazy, we now have five trillion dollars in negative wealth effect from housing, it's getting worse every day, we have a credit crisis that is getting worse, it's going to squeeze the consumer, they can't buy, they got no money."

Originally aired on: 2/7/2008 on CNBC

[Feb 14, 2007] The Credit Crunch Is Now Only Beginning

www.paperdinero.com

David Goldman, senior portfolio strategist at Asteri Capital joins Bloomberg to discuss the latest events and his outlook on the economy. Goldman suggests that the real "credit crunch" is only now just beginning and sees a shortage of bank capital, a grinding shut of the door of credit availability to business and consumers, falling home prices, lower employment and recession.

Originally aired on: 2/12/2008 on Bloomberg

[Feb 14, 2007] Global Structural Breakdown!

An excellent segment with the incredible Louise Yamada, managing director of LYA, to discuss the latest technicals surrounding the apparent structural breakdown of the S&P 500. Yamada demonstrates that the latest bear market decline of the S&P 500 looks very similar to the bear market period following the collapse of the dot-com bubble. Yamada states that there are structural sell signals in the S&P 500 and in ALL OTHER global markets and she suggests to investors that it would be best to get out of the market. For more coverage on the Structural Breakdown read the Twin Peaks periodic series.

[Feb 14, 2007] Not Your Father's Expansion - Or Recession

"We are in the early to middle stages of asset price deflation and credit limitation."
Economic Dreams - Economic Nightmares
Max Wolff offers up a reasoned explanation of why we aren't going to get out of our mess easily, or soon. Soundbite: "Our recent economic performance was the offspring of financial innovation, low interest rates, massive consumer borrowing and asset price inflation. All is running in reverse now. The mechanics of the boom have become the engine of the bust." More:
Credit Crunch and Asset Deflation Recession, Max Fraad Wolff, Huffington Times, Feb. 12: … I believe that our post 2001 economic boom was uniquely and imprudently based on consumer credit and asset inflation. Equities rebounded and performed well- particularly outside the US -- since 2003. American home prices surged. All of this was based on consumer credit. Employment and personal earnings growth was weak across the last few years. Thus, it would not be shocking to see less profound earnings and employment downturn as recession begins. If you boom on house price inflation and consumer credit, you bust when they bust. They are busting now.

How bad is the housing scene? There was a 53% increase in the value of American homes as assets from 2002-2007. The price of all homes increased from $14 trillion to $21 trillion [PDF]. These are paper gains that rise and fall. Now they are falling and likely will decline by at least 15%, or over $3 trillion, before the end of 2009. Across the same period there was a 73% or $4.4 trillion increase in home mortgage debt. [PDF] This isn't going away. In fact, thanks to teaser intro rates and balloon options mortgages, it will rise. Consumer credit borrowing increased by $492 billion or 25%. We borrowed so much and so fast against our inflating homes that the average American went from owning 56% of their home in 2002 to owning 50% in 2007 [PDF]. As prices fall and debt levels remain the same, this percentage will fall further. Very soon the Average American family will own less than the half the value of their home!

From 2002-2007 there was a 55% -- $16 trillion -- increase in financial asset prices, from $29trillion to $45 trillion. [PDF] The prices of financial assets tend to be sensitive to corporate profits and credit conditions. Over the last 4-5 years corporate profits have risen sharply and are at 77 year highs as a percentage of national income. Corporate profit performance has been the mirror image of employee compensation. It has outperformed averages and surged to all time highs. Low interest rates and financial innovation allowed greater profitability and opportunity to corporations, particular those engaged in the booming credit and housing markets. Our recent economic performance was the offspring of financial innovation, low interest rates, massive consumer borrowing and asset price inflation. All is running in reverse now. The mechanics of the boom have become the engine of the bust.

This was not your father's expansion. It was not based on excellent overall economic growth. It was not based on salary and wage growth. There was only a 31%, $2.4 trillion, in disposable income over the last 6 years. Consumer debt increased by $2.4 trillion more than disposable personal income from 2002-2007. Housing and financial price inflation ran at many times the rate of income growth. Debt growth fueled consumer borrowing. A financial asset and housing boom based on easy money and financial innovation created a national economy dependent on assets and home price increases and further credit access. We are now faced with declining housing prices, falling asset prices and squeamish lenders fearful of overly indebted consumers. This is why I believe we are already in a recession or near recession. The near term future will be defined by significant economic weakness.

We don't see particular weakness in jobs and earnings because the recent recovery 2003-2007 was spectacularly weak in terms of job and income growth. The average wage and salary annual percentage gain across 55 years of expansions ran at about 3.8%. Our recent expansion has seen only 1.9% growth in wages and salaries. This is half the average annual wage and salary growth. That is how we reached the dubious low water mark for wages and salaries as a percentage of national income in 2006. In 2006 only 51.6% of national income went to wages and salaries, this is the lowest percentage since 1929 when data collection began. [PDF] We will have to wait to see weakness in the already limping areas of employment and earnings. I don't see how this bodes well for the near term future or acts to dispute our recessionary trajectory?

We are in the early to middle stages of asset price deflation and credit limitation. This is where we found growth and it will be where we find pain in the coming year. More important than the general forecast is the specific policy lesson that our inorganic and unusual recovery offers. It is unsafe, inequitable and fragile to build and base economic performance on asset price inflation and debt. This economic arrangement produces redistribution of wealth from debtors to creditors and creates a very delicate and poorly shared expansion. Sadly, the weakness that comes from the end of the boom falls heavily on the shoulders of those who gained little from the expansion. It must be with this in mind that we make policy and rebuild.

[Feb 14, 2007] Fund Times Veteran Vanguard Bond Skipper to Retire Financial News By Miriam Sjoblom

Yahoo! Finance

This year will mark the end of an era for a two Vanguard bond funds and a balanced fund. Vanguard announced today that manager Earl McEvoy will retire from Wellington Management, subadvisor to the funds, on June 30, capping a distinguished career with the Boston-based firm that spanned three decades. McEvoy has led the efforts on Vanguard High-Yield Corporate (NASDAQ:VWEHX - News) for more than 20 years and Vanguard Long-Term Investment-Grade (NASDAQ:VWESX - News) for more than a decade. His tenure running the bond portion of Vanguard Wellesley Income (NASDAQ:VWINX - News) spans a quarter of a century, and his departure coincides with the previously announced departure of the fund's seasoned stock-picker, Jack Ryan.

McEvoy will undoubtedly be missed--shareholders have long benefited from his knowledge and discipline--but we are confident that the funds will remain in capable hands. John Keogh, who has worked with McEvoy on Wellesley Income for the past three years and managed Vanguard Wellington's (NASDAQ:VWELX - News) bond portfolio for nearly as long, will take over McEvoy's duties at this conservative-allocation fund. Mike Hong, who has been with Wellington for a decade as a credit researcher and, in the past several years, a portfolio manager working closely with McEvoy, will take over High-Yield Corporate. Finally, Lucius T. Hill, a 25-year bond industry veteran who spent the last 15 years at Wellington, will fill the void at Long-Term Investment-Grade.

We're confident that Wellington will handle these transitions smoothly, as they have in the past, and we don't expect the strategies at any of these well-run funds to change.

[Feb 14, 2008] Greenspan Says U.S. Is `On the Edge' of Recession (Update1)

Bloomberg.com

"I think we are clearly on the edge,'' Greenspan told a group of energy-industry executives today at the Cambridge Energy Research Associates' 27th annual CERAWeek conference in Houston. Still, he said, "American business was in such extra-good shape before this problem hit. Otherwise we would be talking about how long and how deep. We are not there yet.''

"While we are at stall speed in the U.S. at the moment, we haven't yet seen the discontinuity that characterizes recession,'' Greenspan said during a question-and-answer session. The lack of available credit "hasn't been a major problem yet for American business,'' he added.

During a Jan. 24 speech in Vancouver, the former chairman said he's worried that an "inevitable'' global recession will create a backlash that forces countries to retreat from worldwide markets. He put the probability of a U.S. recession at "50 percent or more, but we're not there yet.''

[Feb 14, 2008] Bloomberg Ridicules Washington On Economy by WCBSTV NY - snip:

Mayor Michael Bloomberg has unleashed another flurry of jabs on Washington, ridiculing the federal government's rebate checks as being "like giving a drink to an alcoholic" on Thursday, and said the presidential candidates are looking for easy solutions to complex economic problems...

[Feb 14, 2008] Bond Insurer Shockwaves Expand

Before, the muni exposures were considered to be a non-problem. (Accrued Interest reminded us that even though in theory muni bond insurance is a scam, in practice it is valuable to municipalities for whom getting a rating is more costly than buying credit enhancement, and to muni buyers who are often very dependent on ratings in their purchase process). Now they have emerged as a huge issue, and one that vastly complicates the already difficult task of trying to keep the monoline garbage barge afloat.And in case you think the risk to Wall Street is exaggerated, consider this bit of uplifting news from the Financial Times. The bond insurers insisted the credit default swaps they wrote were so stellar that they did not need to post collateral, unlike most other counterparties. The resulting problem is two-fold. First, Wall Street firms entered into what were called negative basis trades in which (in grossly simplified terms) the use of a monoline CDS enabled them to accelerate all the profit over the life of a trade into the current accounting period. A failure of the insurance means the profit will have to be reversed. Second and worse, many players hedged their CDS positions with other CDS. Thus, a failure of a counterparty means supposedly hedged positions are unhedged or only partially hedged, which can lead to losses, unwinding of CDS, and further counterparty failures. The CDS market is over $45 trillion in face value of outstandings, Problems in even a small percentage of swaps would have serious consequences.

[Feb 13, 2008 ] Bankers: The New Socialists (Real Estate Bailout Edition)

February 13, 2008

We've often observed that the reason to keep the banking industry (and Wall Street, now that some firms are too big to fail) on a short leash is that it plays with the public's money: gains go to employees and shareholders but losses are socialized.We now see a bald-faced example of that problem in the latest machinations in Washington, as reported in the Wall Street Journal, "Worried Bankers Seek to Shift Risk to Uncle Sam." There are plans afoot to dump subprime risk on our collective shoulders, courtesy various proposals to guarantee subprime refinanciings.In fairness, as outlined in the Journal, one scheme involves getting the government on the hook, via expanding the mandate of the FHA to include refinancing delinquent borrowers. Note that this turns the previous operation of the FHA on its head. The big reason that the FHA lost market share to subprime lenders was that its lending standards were conservative and required borrowers to undergo screening (horrors!). The second one. of letting servicers write down mortgage balances in line with current market value of the home is oddly similar to the bankruptcy law changes that heretofore the industry has fought tooth and nail (those revisions would have given judges the same power over residential mortgages that they have over commercial: to reduce the secured borrowing to the level of the security, i.e., the value of the real estate, and also modify payment terms). Note that the article focused on the first plan, as will this post. The second one is not bad in concept (remember, no solution is good here; we are talking about less bad among lousy choices), except it leaves the investors as the sole bagholders for lapses that operated all along the securitization chain (it was far more equitable when banks owned the loans they booked, but then again, they could and did make mods without a lot of drama).No one seems to be learning the lesson playing out before our very eyes from the bond insurers: guarantees can become very costly when entered into casually. The promises of various government sponsored enterprises, such as Fannie Mae and Freddie Mac, live in a dubious never-never land, where they are nominally private enterprises but everyone expects that if things got ugly and their mortgage guarantees were to look questionable, the GSEs would be supported by the Federal government.James Hamilton, at the Fed's Jackson Hole conference, pointed out that Freddie and Fannie were undercapitalized and overextended; this was before their ceilings were raised to include jumbo mortgages. Now we are gong to add even worse credits to the burgeoning pile of government guaranteed paper. When I was much younger, I took a business school course taught by Henry Cabot Lodge, Jr. He said that he could remember the day in 1968 when he realized that there were limits on what the US could do, that it could not simultaneously combat poverty, fight a ground war in Asia, and send a man to the moon. It's 40 years later, and most of Washington seems unable to accept what Lodge saw back then, that America is no longer so powerful and economically dominant that it can have whatever it wants. And the comparison to the monolines is not idle. Moody's has already warned that the US is at risk of losing its AAA rating within a decade if it does not rein in spending (aside: we noted that the report had an unduly political spin, arguing for curbing healthcare and Social Security costs. As Paul Krugman, Dean Baker, and others have pointed out, Social Security is not a problem; if one want to be conservative, eliminating the ceiling on FICA would solve the problem. The big problem with Medicare is not demographic, but spiraling health care costs; health care reform with teeth would end that pressure). The more the Federal government makes itself the remedy to all ills, the more it will become incapable of solving any problem.What is particularly disturbing about this latest salvage operation is that it involves no penalty to the firms that created this mess. Of course, that's one of the beauties of the originate and distribute model: there are so many parties in the food chain that it is hard to parse out culpability.But consider one successful model of dealing with a financial crisis, one classified Carmen Reinhart and Kenneth Rogoff designated as one of the "big five" deep and nasty post WWII financial crises, that of Norway. Barry Ritholtz summarized the program:

• Private solutions were explored before the government intervened.
• Share capital was written down to zero before committing public funds.
• The government acted swiftly to limit contagion, but did not provide a blanket guarantee.
• Liquidity support was given to illiquid, but solvent institutions.
• The government did not use an asset management company.

Notice two critical elements lacking in any of the current thinking: taking out public shareholders completely before providing government support and providing only narrow support. The perps take the pain and do not have the opportunity to enjoy any upside from public rescue efforts. And no broad scale guarnatees were made. The FHA proposal on the table, while it may not be mplemented, comes close to that sort of action.Consider: if the parties coming hat in hand to DC for a rescue had to write down all their equity to get help (or even merely all the equity in the directly related operations) I suspect you'd see an outburst of creativity. As Samuel Johnson once said, the prospect of being hanged at dawn wonderfully focuses the mind.But the discussion above assumes that refinancings will work, that upside-down homeowners will embrace these programs (note that the alternative program, the principal charge-off, requires investors to take the hit). But refinancings may not work, that is, they may not get the anticipated level of participation, and even among those that do participate, it may not improve outcomes much. Mark Thoma featured a post by Richard Green, "Is Everything we 'Know about Subprime Wrong?" that in turn summarized a presentation by Paul Willen of the Boston Fed:
(1) Falling house prices lead to defaults more than defaults lead to falling house prices. In the early
part of the decade, when delinquencies reached record levels, default rates remained extremely low, because house prices were rising(2) Interest rate resets have little if anything to do with the large number of defaults we are observing. For the vast majority of subprime loans, defaults or refinances happen before resets take place. It is moreover the case that the size of the resets is smaller than most of us think, because the initial teaser rates are pretty high.(3) While ARMs have higher default rates than FRMs, putting ARM borrowers into FRMs will not necessarily reduce defaults. In the first place, as people move out of ARMs into FRMs, the denominator in the default proportion ratio will decline for ARMs, while increasing for FRMs, meaning that if the number defaults stay constant, the default share in ARMs will still rise.

Note that Willens is not the first to suggest that declining housing prices may be a bigger culprit in defaults than payment stress.So these moves may effectively rearranging the deck chairs on the Titanic, at considerable taxpayer risk.From the Wall Street Journal:
The banking industry, struggling to contain the fallout from the mortgage debacle, is urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.One proposal, advanced by officials at Credit Suisse Group, would expand the scope of loans guaranteed by the Federal Housing Administration. The proposal would let the FHA guarantee mortgage refinancings by some delinquent borrowers....The risk: If delinquent borrowers default on their refinanced loans, the federal government would have to absorb the loss...Another plan gathering support seeks to make it easier for banks to write off part of the unpaid balance on loans that exceed a property's value, people familiar with the matter said. If that happens, homeowners would owe less, and they might be able to refinance their loans and avoid foreclosure.Several lenders are already considering the move, known as a "principal charge off," but are hesitant to move forward. Loan servicers -- the companies that collect monthly mortgage payments -- worry that if they take big write-offs, they might be sued by investors who hold mortgage-backed securities. However, if the industry came forward with a standard backed by the Treasury Department, the legal concerns would likely fade.....The Credit Suisse plan would open the way for nearly 600,000 subprime borrowers, many of whom are delinquent on their mortgages, to refinance into loans backed by the FHA. Some 1.3 million borrowers were either seriously delinquent or in foreclosure at the end of the third quarter, the most recent numbers available from the Mortgage Bankers Association.....In a 20-page summary handed out to lawmakers, policy makers and regulators, Credit Suisse said the plan would make $89 billion in subprime loans eligible for refinancing. Credit Suisse spokeswoman Victoria Harmon said bank officials have "shared our ideas and technical advice on FHA" and received "constructive" responses from the government.Officials from J.P. Morgan Chase & Co. are pulling together their own proposal to expand the number of homeowners who could refinance into FHA-backed loans...Senior Treasury Department officials have been wary of proposals that could expose taxpayers to losses and bail out lenders, but they have been willing to entertain most ideas. Some congressional Republicans are becoming worried that as more bad news and data are released about the housing market, some proposals could expose taxpayers to severe losses."I would share the concern and nervousness about going in that direction," said Rep. Scott Garrett (R., N.J.), a member of the House Financial Services Committee.Sen. Charles Schumer (D., N.Y.) earlier this week urged the lending industry to move toward a standard of partially writing down the principal of "under water" loans, where the borrower owes more than his or her home is worth.Separately, Sen. Schumer called the Credit Suisse plan "an interesting idea, which we are looking at pretty seriously." However, Credit Suisse hasn't won the endorsement of the American Securitization Forum, an influential group of investors.

"The Only Way to Keep the Economy Going Over The Long Run is to Increase the Wages of the Bottom Two-Thirds of Americans"

Robert Reich:

Totally Spent, by Robert Reich, Commentary, NY Times: We're sliding into recession, or worse, and Washington is turning to the normal remedies for economic downturns. But the normal remedies are not likely to work this time, because this isn't a normal downturn.

The problem lies deeper. It is the culmination of three decades during which American consumers have spent beyond their means. That era is now coming to an end. Consumers have run out of ways to keep the spending binge going. ...

The underlying problem has been building for decades. America's median hourly wage is barely higher than it was 35 years ago, adjusted for inflation. The income of a man in his 30s is now 12 percent below that of a man his age three decades ago. Most of what's been earned in America since then has gone to the richest 5 percent.

Yet the rich devote a smaller percentage of their earnings to buying things than the rest of us... They already have most of what they want. Instead of buying, and thus stimulating the American economy, the rich are more likely to invest their earnings wherever around the world they can get the highest return.

The problem has been masked for years as middle- and lower-income Americans found ways to live beyond their paychecks. But now they have run out of ways.

The first way was to send more women into paid work. Most women streamed into the work force in the 1970s less because new professional opportunities opened up to them than because they had to prop up family incomes. ... But there's a limit...

So Americans turned to a second way of spending beyond their hourly wages. They worked more hours. The typical American now works more each year than he or she did three decades ago. Americans became veritable workaholics, putting in 350 more hours a year than the average European, more even than the notoriously industrious Japanese.

But there's also a limit to how many hours Americans can put into work, so Americans turned to a third way of spending beyond their wages. They began to borrow. With housing prices rising briskly through the 1990s and even faster from 2002 to 2006, they turned their homes into piggy banks... But this third strategy also had a built-in limit. With the bursting of the housing bubble, the piggy banks are closing.

The binge seems to be over. We're finally reaping the whirlwind of widening inequality and ever more concentrated wealth.

The only way to keep the economy going over the long run is to increase the wages of the bottom two-thirds of Americans. The answer is not to protect jobs through trade protection. ... Most routine jobs are being automated anyway.

A larger earned-income tax credit, financed by a higher marginal income tax on top earners, is required. The tax credit functions like a reverse income tax. Enlarging it would mean giving workers at the bottom a bigger wage supplement, as well as phasing it out at a higher wage. ... We also need stronger unions, especially in the local service sector that's sheltered from global competition. ...

Over the longer term, inequality can be reversed only through better schools for children in lower- and moderate-income communities. This will require, at the least, good preschools, fewer students per classroom and better pay for teachers in such schools, in order to attract the teaching talent these students need.

These measures are necessary to give Americans enough buying power to keep the American economy going. They are also needed to overcome widening inequality, and thereby keep America in one piece.

The idea that the rich need to spend lavishly to prevent a recession is an old one, see for example the debate over the corn laws and the possibility/impossibility of gluts between Malthus and Ricardo. Later classical economists argued economy-wide gluts were impossible because the interest rate would move to equate saving and investment and, since all saving is converted into investment and investment is part of aggregate demand, there could be no loss of demand from saving (and hence no gluts: supply creates its own demand). Keynes, of course, had something to say about all this, and it's partly a difference in the propensity to consume at the margin (the mpc) that is behind the argument above. But it's easy to anticipate objections to the idea that transfers from rich to poor are needed to maintain a healthy, growing economy, or objections based upon the notion that transfers from rich to poor would harm economic growth.

But here's how I see it. Expanding the EITC is a good idea in any case, so none of that really matters.

[Feb 13, 2008] WSJ: Homes Remain "Wildly Overvalued"

From Brett Arends at the WSJ: Homes in Bubble Regions Remain Wildly Overvalued
... the really bad news is that, even after a year of misery and falling prices, homes ... remain wildly overvalued compared to average personal incomes.There is a strong long-term correlation between the two figures. And in many regions, house prices would still have to fall a very long way to get back into line.How far?Try around a third in Florida and Arizona -- and closer to 40% in California.
Price to income isn't a perfect tool, but it does provide a gross estimate of how far house prices are still above "normal". This points out the mistake many homebuyers made during the boom - they only looked at the monthly payment, and not the price. With low teaser rates, optional negative amortizing payments, and other mortgage innovations, it was easy for a homebuyer to get into a home at 13 or 14 times income.Imagine a home purchased at 13 times income, with a 10% down payment. Say the homeowner switches to a 30 year fixed rate loan with a 6% interest rate. Just the P&I (principal and interest) would equal 84% of the homebuyers gross income!This is called being "house poor". (Owning a home, but not exactly enjoying life).

[Feb 13, 2008] Nationwide, Layoffs are Coming in Large Numbers.

Corporate executives are poised to start making substantial cutbacks in their staffing, according to a new forecast by employment consulting and legal firm Career Protection.In fact, the firm is predicting a 37 percent increase in layoffs this year compared with last year, based on a survey of more than 1,300 corporate executives and senior-level officials that was conducted earlier this month.The layoff forecast is the worst in the past five years, according to Career Protection officials. They also indicated that the firm has already been "inundated" with inquiries from employees at a number of companies that announced layoffs earlier this month, including Bear Stearns (BSC), Chrysler, Citigroup (C), Ford (F), Covidien (COV), General Motors (GM), IndyMac (IMB) and Sprint Nextel (S).

[Feb 13, 2008] Stocks May Decline for Six Months; Biggest Bears in U.S., U.K. By Michael Tsang and Adam Haigh

Bloomberg

The world's biggest stock markets will fall for the next six months as economic growth slows, and investors are the most pessimistic in the U.S. and the U.K., a survey of Bloomberg users showed.

The Standard & Poor's 500 Index, the FTSE 100 Index, France's CAC 40 Index, the German DAX Index, Italy's S&P/MIB Index, the Swiss Market Index and Japan's Nikkei 225 Stock Average will decline, according to the Bloomberg Professional Global Confidence Survey. Only investors in Hong Kong predicted gains. The survey measured the confidence of 5,148 Bloomberg users from New York to London to Paris to Tokyo.

... ... ...

Economists at New York-based Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. predict the U.S. economy is either already shrinking or will contract this year. The International Monetary Fund cut its forecast for global growth last month to 4.1 percent, the slowest since 2003 and below the 4.4 percent pace projected in October.

Companies in the S&P 500, the benchmark for American equities, reported a 20 percent decline in fourth-quarter profit so far, the biggest drop since the last U.S. recession in 2001, data compiled by Bloomberg show. Cisco Systems Inc. Chief Executive Officer John Chambers said this week the sales slump at the San Jose, California-based company may last five quarters.

... ... ...

The S&P 500 fell 8.1 percent so far this year and suffered the biggest January tumble since 1990. In Europe, stocks dropped even more, as investors braced for slower corporate profits.

[Feb 13, 2008] A Chrysler-Scale Bailout Of Those Monolines - Forbes.com

... ... ...

Time is of the essence, since Ackman, whose Pershing Square fund is massively short on MBIA, is baldly and boldly stirring the pot by exposing the frailties of the system to the regulators, and so to the unsuspecting and confused public.

Ackman claims in his letter that the insurers have "several hundred billion dollars of counter-party exposure to financial institutions around the world, of which $125 billion is for subprime related [collateralized debt obligation] structures"--effectively radioactive and impossible to value investments that have tumbled us into crisis.

Moreover, Ackman reveals for the first time the startling revelation that these insurers are leveraged 100-to-1, just like Long-Term Capital Management, a hedge fund that went under in 1998. But due to the absence of any requirements for full disclosure, it was impossible for the public to know this until now. Ackman also points out that these bond insurers have purposely understated the amount of losses reported to the U.S. Securities and Exchange Commission. This is inexcusable in 21st-century finance, Ackman believes.

Moreover, Ackman has provided a rationale for continued shorting of the monolines while he tells us that Ambac's actual losses from collateralized debt obligations (CDOs) are more than six times management's estimates from the insurer.

An earlier Ackman shot across the bow, aimed at the New York State Insurance Department's superintendent, alerted regulators to other liabilities in "non-taxpayer-supported municipal obligations, including hospitals and other health care exposures; project finance, including tax-exempt housing; toll roads; and other infrastructure guarantees."

Ackman stuck the knife into all parties concerned by charging that "these losses have been hidden ... due to inadequate disclosure."

Croesus isn't overly fond of clichés, but the monolines are the proverbial can of worms. I don't expect few humans outside the murky world of finance to comprehend all the angles and reverberations of this terrible mess. But mess it is--and the longer it isn't resolved, the more terrible could be the consequences.

Hedge fund operator Ackman may know better than anyone else but New York State Insurance Superintendent Eric Dinallo just how rotten the state of Denmark is today. But Ackman has his own selfish self-interest, which is to squeeze every penny he can out of his short position while posing as a world-class savant.

And he's damned right to oppose the insurers taking money out of their reserves to pay dividends to the holding companies so they in turn can pay their shareholders--not Ackman--cash dividends. Ackman is right to warn that "by permitting regular dividends to the holding companies, you [the insurance superintendent] risk undermining your capital raising efforts."

Ackman must be persona non grata at the banks and the rating agencies, perhaps the regulators as well. Still, he has done his homework and is in the process of embarrassing the financial system for its foolishness.

His letter to the Fed and to other central bankers and politicians called for:

  1. The disclosure by banks of their CDO exposures. Imagine, we're almost a year into this crisis and still there has not been full disclosure. Croesus loves transparency too, so it's about time.
  2. Banks should be required to hold capital against their CDO exposures.
  3. Independent directors should be appointed to bond insurance subsidiary boards. Imagine that "substantially all directors of these insurance subsidiaries are executives of the holding companies." Another governance mudhole exposed.

You want to know fear itself? The monolines apparently have guaranteed $1.5 trillion worth of variable-rate munis that might have to be liquidated should credit ratings be lowered. It's like Waiting for Godot, a frightening play whose tone is anxiety-provoking, to say the least. Ackman calls any downgrading of $1.5 trillion in muni bonds the potential linchpin of a systemic risk.

The rot is overwhelming. Who can deal with it? The Fed and Treasury should see this is no time to let the free market deal with a crisis. Yes, there's need for a cleanup of the mess. But first the bailout. Are you listening, Mr. Bernanke and Mr. Paulson? Get going.

Forbes.com - Comments

Posted by jonesridge | 02/11/08 11:57 AM EST

Greed is the cause, the fix is punishment. Start with locking in the interest rate on these homes at 6% for the life of the original mortgage, then find the bottom dwellers who sold the sub prime mortgages, take away the commissions they took when they sold them to the banks, take away the commissions the bank got for bundling them and reselling to the Big Greed who only buy them as they expect the poor homeowners interest rate to go thru the roof in 6 months or a year. That leaves the Billion dollar funds having to live with only 6% interest. The Feds can use the RICO act like they are using on illegal immigrant businesses that are seized. Nah, won't happen, with this administration, the Fat Cats will come out with more Government money to contribute to politics.

[Feb 13, 2008] Mish's Global Economic Trend Analysis Project Lifeline A Lifeline For Who

Dangers Of Debt CounselingI found an interesting site tonight called Dangers Of Debt Counseling.
Here are a couple of tips. That first tip above is really pertinent. Many non-profit companies offering "free help" are directly sponsored by those with a vested interest to keep you in debt and keep you paying on that debt.

[Feb 13, 2008] Wall Street Shareholders Suffer Losses Partners Never Imagined by By Christine Harper ;

Bloomberg Less than a decade after Wall Street's last major partnership went public, stockholders are paying the price for bankrolling the industry's expanding risk appetite.Four of the five biggest U.S. securities firms lost about $83 billion of market value last year, almost 90 percent of their net income since 1999, data compiled by Bloomberg show. That cut the annual average return for Morgan Stanley, Merrill Lynch & Co., Lehman Brothers Holdings Inc. and Bear Stearns Cos. during those nine years to 9.7 percent from 16.8 percent.The private partnerships that once dominated Wall Street guarded their capital, used less leverage and limited their risk to trading blocks of stock for clients and shares of companies in mergers, said Roy Smith, a finance professor at New York University's Stern School of Business and a former partner at Goldman Sachs Group Inc. Since raising money from the public, many of the biggest firms have abandoned that caution."If you're betting with other peoples' money, you're more willing to take risk than if it's your own,'' said Anson Beard, 71, who retired from Morgan Stanley in 1994 after 17 years at the New York-based company, where he ran the equities division and helped with the initial public offering in 1986. "You think differently if you're paid in cash and not in ownership. It's heads you win, tails you don't lose.''... ... ... "There are no partners of Merrill Lynch, there are employees,'' said Peter Solomon, a former Lehman executive who's now chairman of New York-based investment bank Peter J. Solomon Co. "So they don't share in the losses and gains the way they should, they are able to shed those on to shareholders.''..."The partners at Lehman Brothers and the partners at Goldman Sachs and the partners at Morgan Stanley didn't take risk that was disproportionate to their resources, and when they did, they paid the consequences so they tried not to,'' Solomon said. These days, "shareholders and the customers are the people who are financing these guys. They're financing casino operators.''

[Feb 12, 2008] The Big Picture

Bill Gross, in the FT, asks some rather intriguing questions late last week:

"How could Ambac (ABK), through the magic of its triple-A rating, with equity capital of less than $5bn, insure the debt of the state of California, the world's sixth-largest economy? How could an investor in California's municipal bonds be comforted by a company that during a potential liquidity crisis might find the capital markets closed to it, versus the nation's largest state with its obvious ongoing taxing authority?"- Bill Gross

The alchemy identified by Gross: Wrapping high risk paper in a high risk derivative / insurance contract does not eliminate any of the risk, nor does it make high risk paper investment grade.

This is slowly being realized for what it actually is: Massive fraud on a widespread structural basis.

[Feb 11, 2008] Consumers, Credit, and Complications

Safe Haven

The news just keeps getting worse. We are now told that we are nowhere close to the end of the writedowns by banks all over the world. Goldman Sachs now estimates that the total loss in the mortgage security world will total $400 billion (this includes more than just subprime mortgages), up from an estimated $200 billion only a few quarters ago. And that is if home prices only fall about 20% on average.

And that probably assumes normal default patterns. The Wall Street Journal noted today that Fitch has warned of an additional $139 billion in mortgage-related losses from individuals who are simply walking away from mortgages where the homes have lost value. They are doing this in advance of foreclosure proceedings. Fitch expects that losses will be 26% of the value on subprime loans made in 2007.

[Feb 11, 2008] Safe Haven Capital Ratios Are Under More and More Pressure

Litigation over subprime mortgages is coming...
I was recently sent a link to a conference that will be held in New York next month. It is basically for people who are interested in litigation over the subprime and credit mess.

Look at some of the topics:

"Look inside the mortgage industry, its underwriting, risk analysis procedures and loan approval technology...

Get up-to-date on who is suing whom and the status of the recent wave of securities complaints ...

Learn the key elements necessary for proving or disproving fraud and negligent misrepresentation ...

Find out what to look for when it comes to disclosures, disclaimers and limitations on standing ...

Learn the role played by rating agencies, insurers and the feds ...

Acquire the skills necessary to successfully prosecute or defend mortgage-backed securities suits."

This is going to take years to sort through.

I wrote in late 2006 that the housing and subprime crisis was going to result in massive litigation. The lawyers will be looking at every deep pocket to see what they can get for their clients who lost money. I can guarantee you the rating agencies are in the crosshairs of hordes of attorneys from around the world. (If you are interested in the conference you can go to http://www.lexisnexis.com/conferences/.)

[Feb 11, 2008] Rebates Could Stave Off Long Recession Financial News - Yahoo! Finance

Global Insight, a private forecasting firm in Lexington, Mass., changed its forecast this past week to project a mild recession in 2008. It predicted the gross domestic product would decline at an annual rate of 0.4 percent from January through March and then at a 0.5 percent rate over the next three months. By one rule of thumb, the economy is in a recession when the GDP declines for six months in a row.

... ... ...

Brian Bethune, a Global Insight economist, said the new forecast projects the economy will rebound in the summer and grow at a 3.4 percent rate as the rebate checks give a jolt to consumer spending. As that impact wears off, growth will slow to a still healthy 2.7 percent rate over the final three months of the year, he said.

Other economists see a similar pattern -- and benefit from the rebates.

"This is going to provide a very important and measurable boost to the economy in the second half of this year. It won't forestall a recession, but it will ensure that the downturn is short and mild," said Mark Zandi, chief economist at Moody's Economy.com.

Zandi said he expected this downturn to be similar to the 2001 recession, which lasted eight months.

The unemployment rate rose by 2.5 percentage points back then. Zandi said it will rise by less than 2 percentage points during this period of weakness, going from a low last year of 4.4 percent to a peak of about 6 percent.

The expectation of a short and mild recession is also based on the view that the Federal Reserve will keep cutting interest rates in the month ahead. The Fed aggressively began lowering rates in January.

... ... ...

Economists said they cannot rule out the chance of a double-dip recession, where the GDP rebounds briefly in response to the rescue plan, only to fall into negative territory again.

"We are not out of the woods yet and the risks remain very high because of the widespread problems in the financial sector," Zandi said.

[Feb 10, 2008] Is Japan Starting to Suffer a Subprime-Induced Credit Crunch

International mutual funds might be hit hard...
naked capitalism

It turns out that the intra-Asia trade that was supposed to immunise the region against a slump is a disguised supply-chain ending up in the US market. American shoppers still make 30 per cent of global demand, just as it did a decade ago. Nothing has really changed.

[Feb 10, 2008] Regulations and regulators

naked capitalism

...the fundamental conflict of interest that created this mess, that the ratings agencies are paid by issuers, when their ratings are for the use of investors. Taking that one on is too hard for an SEC ideologically opposed to meaningful intervention, no matter how patent the need for it is.

Contrast this attitude with the tough words from an EU regulator, as quoted in Reuters:

European Union Internal Market Commissioner, Charlie McCreevy, warned on Wednesday that if credit ratings agencies did not correct the lack of distinctive ratings for structured finance products, he would take action."If the proposals are not forthcoming in coming months, I would not hesitate to move forward to have it addressed with regulatory action," McCreevy told the Society of Business Economists in London...."I am not going to be prescriptive today but I will say this: strong independent professional oversight of the credit professionals within the rating agencies...and of the operation of the ratings function is absolutely essential if market and regulator confidence is to be restored with respect to the effective management of the conflict of interest inherent in the rating agencies' business models," McCreevy told the audience in London.
Now consider the harebrained statements from the SEC, via Bloomberg:
The U.S. Securities and Exchange Commission may propose new rules for credit-rating companies to help evaluate securities following investor losses related to subprime mortgages, the agency's chairman said.The rules would increase disclosure about "past ratings'' to help determine whether rankings successfully predicted the risk of default, SEC Chairman Christopher Cox said at a securities conference in Washington today. The regulations may also address the differences between ratings on structured debt and rankings for corporate and municipal bonds.Investors could then use the enhanced disclosure to "punish chronically poor and unreliable ratings,'' Cox told reporters after his speech. "The rules that we may consider would provide information to the markets in a way that facilitates'' comparisons, he said.
Punish chronically poor and unreliable ratings? What in God's name is that supposed to mean? The market already disagrees plenty with published ratings. Has Cox ever looked at the AAA ABX index? And all of this patently obvious repudiation by the market of rating agency grades has had zero effect on their behavior. Even the specter of monoline credit default swaps of MBIA and Ambac priced at distressed levels still has not embarrassed them into making downgrades. Why? They are paid by the issuers! What investors and the market thinks has zero effect on their bottom line. If months of horrific press won't induce them to clean up their act (the reforms proposed by S&P are similarly cosmetic), a mere tabulation of past performance certainly won't.

[Feb 10, 2008] Angry Bear/ Growth Under High Tax v. Low Tax Regimes

Cactus caught Lawrence Kudlow spouting his free lunch supply-side stupidity again earlier this week...

Kudlow is touting the real GOP agenda – tax the working poor but don't tax the rich. He fails to explain why such Nibor Dooh policies foster more long-term growth. Instead he implies that some serious research paper by Art Laffer has proven this case somehow. Funny – he failed to tell us the title of this paper or which academic journal chose to publish Laffer's laugher. Kudlow confuses the Keynesian recovery that was to inevitably follow the collapse of aggregate demand in 1982 with long-term growth. One can also note that the 1950's recessions with the same frequency of the 1970's. To clarify matters, we've done two things. Show real GDP growth for each year of the second half of last century (1951 to 2000). While the period from 1951 to 1980 did have its share or low or negative real GDP growth, it also had some periods of very rapid GDP growth. The next two years had only two recessions but the Reagan recession leading to the largest unemployment rate since the Great Depression.

[Feb 10, 2008] Angry Bear Recession Indicators

The NBER committee that officially determines the dates for recessions has a few favorite, or key indicators that it gives much more weight. One of the indicators is real manufacturing and trade sales. Not many people pay much attention to it because it does not have its own press release and wall street traders do not bet on it. It is an old Business Conditions Digest (BCD) that use to be published by the Bureau of Economic Analysis. But when they quit doing the BCD and the leading indicator the Conference Board took over responsibility of publishing this series because it is a component of the coincident index. But as the following chart it has a very good record of signaling recession turning points..

But something strange has been happening to this index over the last few months of 2007. It has been improving and actually implies that growth may be accelerating, not slowing. One probable reason for the recent strength is that it includes exports, where growth is very strong. But if you think the NBER is on the verge of declaring that we are entering a recession this indicator suggest otherwise.

[Feb 9, 2008] 5 Historical Economic Crises and the U.S by Barry Ritholtz

"Given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one."

February 9, 2008 | Big Picture

You see, Reinhart and Rogoff draw parallels between the current U.S. financial woes and five previous financial crises. All five of these were "associated with major declines in economic performance over an extended period:"

- Japan (1992)
- Spain (1977)
- Norway (1987)
- Finland (1991)
- Sweden (1991)

Of course, none of these are identical to the present 2008 USA, economically, culturally, or politically. However, when one takes a closer look, some of the major parallels are a cause for concern.

The Chronicle of Higher Education did just that. In reviewing the Reinhart and Rogoff paper, they focused on the parallels to the Japan crisis.

Like Japan et al., the United States has seen:

The authors' conclusion:

"Given the severity of most crisis indicators in the run-up to its 2007 financial crisis, the United States should consider itself quite fortunate if its downturn ends up being a relatively short and mild one."

[Feb 9, 2008] A Long Story by Paul Krugman

"And if past experience is any guide, the troubles will persist for a long time - say, into the middle of 2010."

February 8, 2008 | NYT

And if past experience is any guide, the troubles will persist for a long time - say, into the middle of 2010.

The problems now facing the U.S. economy look a lot like the problems that caused the last two recessions - but this time in combination.

On one side, the bursting of the housing bubble is playing the role that the bursting of the dot-com bubble played in 2001. On the other, the subprime crisis is creating a credit crunch reminiscent of the crunch after the savings-and-loan crisis of the late 1980s, which led to recession in 1990.

... ... ...

And some highly respected economists are issuing dire warnings. There has been a lot of buzz about a new paper by Carmen Reinhart and Kenneth Rogoff that compares the United States in recent years to other advanced countries that have experienced financial crises. They find that the U.S. profile resembles that of the "big five crises," a list that includes, for example, Sweden's 1991 crisis, which caused the unemployment rate to soar from 2 percent to 9 percent over a two-year period.

Maybe we'll be lucky, and that won't happen. But what can be done to limit the damage?

[Feb 9, 2008] Calculated Risk Is the Current Financial Crisis So Different

"For the five most catastrophic cases (which include episodes in Finland, Japan, Norway, Spain and Sweden), the drop in annual output growth from peak to trough is over 5 percent, and growth remained well below pre-crisis trend even after three years. These more catastrophic cases, of course, mark the boundary that policymakers particularly want to avoid."

Carmen Reinhart and Kenneth Rogoff, January 14, 2008

Yesterday Professor Krugman referenced a new paper by Carmen Reinhart and Kenneth Rogoff: Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison

...Barry Rithopded some commentary.

[Feb 9, 2008] Remarks by John C. Dugan Comptroller of the Currency January 31, 2008

Over a third of the nation's community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.

[Feb 9, 2008] G-7 Says Global Growth May Weaken, Market Turmoil to Persist By John Fraher and Theophilos Argitis

Feb. 10 (Bloomberg)

"Downside risks still persist, which include further deterioration of the U.S. residential housing markets'' and tighter credit conditions, G-7 finance ministers and central bankers said in a statement in Tokyo yesterday. U.S. Treasury Secretary Henry Paulson said "we should expect continued volatility'' in markets as risk is repriced. "

"The problems are going right through all parts of the financial markets and there's not much the G-7 can do about this,'' said Gilles Moec, an economist at Bank of America Corp. in London. "There's a danger that the downturn will become a self-fulfilling prophecy.''

Risks remain "that further shocks may lead to a prolonged recurrence of the acute liquidity pressures experienced last year,'' Bank of Italy Governor Mario Draghi said. "It is likely we face a prolonged adjustment, which could be difficult.''

[Feb 8, 2008] Belt-Tightening Among Wealthy Shoppers Could Choke Other Households"

February 8, 2008 | Associated Press

Lower-income workers are dependent on their business and tips.

It's hard to feel sorry for well-heeled shoppers whose idea of tough economic times is passing on $1,000 Burberry raincoats or that $300 limo ride while the working poor skimp on vegetables and take the bus.

But economists say that recent signs of cutting back by the affluent could hurt the economy and deliver even more pain to lower-income workers, who are dependent on their business and fat tips.

... ... ...

Cutbacks by the wealthy have a ripple effect across all consumer spending, said Michael P. Niemira, chief economist at the International Council of Shopping Centers. That's because American households in the top 20 percent by income – those making at least $150,000 a year – account for about 40 percent of overall consumer spending, which makes up two-thirds of economic activity.

Niemira expects the retail sector, whose growth was fueled in part by strong gains at luxury chains, will struggle to eke out a 1 percentage sales increase in stores opened at least a year during the next few months. That's below the 2.1 percent average for 2007 and 3.7 percent for 2006.

Just look at the cutbacks by Dali Wiederhoft, a 52-year-old marketing executive from Reno, Nev., made skittish by a volatile stock market, a 20 percent decline in her home value and recession fears.

Over the past three months Wiederhoft pared her spending on clothes to $500 per month from about $3,000; that means no more Jimmy Choo shoes and David Yurman jewelry. Her cutbacks also included canceling the services of a cleaning woman and a lawn care company. She also plans to trade in her BMW for a Ford when her lease expires in about a month.

"This is a time to have cash, not to spend. So, I'm cutting wherever I can," she said.

Such reined-in spending seems to be the end of a winning streak for luxury retailers that once appeared immune to the economic slowdown. Tiffany & Co.and Williams-Sonoma Inc. both reduced their earnings outlooks and Burberry PLC said it may miss its 2008 profit forecast. Coach Inc. reported a 1.1 percent decline in same-store sales at its North American stores for the second quarter ended Dec. 29, 2007 and Compagnie Financire Richemont SA, the Swiss parent of Cartier and Baume & Mercier, reported a slowdown in holiday sales growth.

Soaring home values had made upper-middle class shoppers feel wealthy in recent years, causing them to trade up to $500 Coach handbags and $1,000 espresso makers, but a housing slump has wiped away their paper wealth. The woes are creeping into even the high-end luxury sector, as affluent shoppers are rattled by the turbulence in the financial markets.

American Express Co., whose customers are generally affluent, said it expects slower spending and more missed payments on credit cards throughout 2008.

The economy needs affluent shoppers to spend with enthusiasm. According to the government's latest survey of consumer expenditures, the top 20 percent of households spend about $94,000 annually, almost five times the bottom 20 percent and more per year than the bottom sixty percent combined.

Then there's also the multiplier effect. When shoppers splurge on $1,000 dinners and $300 limousine rides, that means fatter tips for the waiter and the driver. Sales clerks at upscale stores, who typically earn sales commissions, also depend on spending sprees of mink coats and jewelry. But the trickling down is starting to dry up, threatening to hurt a broad base of low-paid workers like Warren, the limo driver.

Classy Ride Limousine Service, which caters to clients with an average household income of $200,000, has suffered a 10 percent sales dip this January vs. the same month last year, according to general manager Jason Lattier. The 13-year-old business started seeing a slowdown last November when sales dropped 15 percent vs. the same month the year before. That 15 percent decrease was the worst monthly drop in about four years, he said.

[Feb 8, 2008] "Credit Crisis: Where Was The SEC?" by Liz Moyer

And where was Fed with this wonderful Maestro at the helm ?

Forbes'

Six years after the lessons of Enron and a decade after Long-Term Capital collapsed, regulators still can't seem to blunt the damage complex securities can have on financial markets. Why?

It's a fair question. Investment banks, mortgage brokers and ratings agencies are all being blamed for the subprime mortgage bubble and its sudden and stunning demise. But little has been said about the watchdogs at the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority, the regulators who oversee the activities of the banks. They have the power to stop fraud in the business of selling the complex credit derivatives, and they have jurisdiction over whether the complex securities sold by the banks met suitability requirements for the investors who bought them. Yet time and again, they've failed to do so.

Most notably, the SEC has the power to monitor whether the investment banks had adequate capital relative to their trading positions and balance sheets and the proper risk management systems to prevent catastrophic losses. More than $100 billion in write-downs later, several banks are scrounging for capital, and it's clear those risk management procedures weren't functioning very well, if at all.

One of the problems is the lack of clear information, outside the banks and trading floors, about the credit derivatives market. Collateralized debt obligations (CDO) and other structured finance products trade over-the-counter rather than on an exchange, at least in the United States. Many of them trade infrequently, meaning price information is limited.

Washington and Wall Street have been hesitant to clamp down on the over-the-counter market, the source of much profit-making. Last year, as the subprime market began its collapse, the President's Working Group, which includes the Treasury Department, the Federal Reserve, the SEC and the Commodities Futures Trading Commission, recommended against tighter oversight of the over-the-counter market, in the context of vetoing tighter regulation of hedge funds, saying the industry can self-police.

A counterparty risk group led by former New York Fed President Gerald Corrigan has also recommended industry "best practices" in lieu of tighter regulation of the derivatives trading market.

Leaving it up to Wall Street hasn't proven very effective, however. "The decision by the President's Working Group to recommend no detailed regulation of the over-the-counter market was wrong," says David Ruder, a former SEC chairman and now law professor at Northwestern University.

Regulators are taking a hard look at how banks structured, priced and sold mortgage-laden securities, but by the estimate of some it's too little and too late. "I don't think all the king's horses and all the king's men will put this together again," says Gary Aguirre, a former SEC lawyer.

There were warning signs.

In the summer of 2006, Jeff Kronthal, a senior executive in Merrill Lynch's structured products group, was fired after reportedly balking at then-Chief Executive Stanley O'Neal's demands that the firm get more aggressive in its risk-taking with mortgage securities. Kronthal was hired back by new Chief Executive John Thain in December to advise on the firm's risk management.

He wasn't the only one to sound alarms about the housing bubble and the explosion of the credit derivatives market. "Many credible people were public about their dissatisfaction with the mortgage loan market," says Janet Tavakoli, a structured finance expert with her own Chicago consulting firm.

She blames the ratings agencies for flawed ratings methodologies. The Fed and the SEC, among other regulators, are just packs of economists and lawyers. "I do not expect lawyers to be rigorous in their analysis."

Regulators saw warning signs as early as 2005, but failed to pursue them. Bear Stearns, in its first quarter 2005 financial disclosure, said it faced the threat of a civil enforcement action in connection with its pricing, valuation and analysis of $63 billion worth of CDOs. In the same filing, Bear Stearns said it was contacted by the New York State attorney general, then Eliot Spitzer, about $16 billion worth of CDOs it sold to an unnamed client.

The inquiries were brought up again in the August quarterly regulatory report and in the year-end 2005 filing, when Bear Stearns said it was "continuing to respond to subpoenas and other requests for information from regulatory and law enforcement officials."

But that's the last time Bear Stearns brought it up, suggesting the matter had been sidelined or dropped. Aguirre says it sounds fishy. "I find it troubling," he says.

Aguirre has his own beef with the SEC. He was fired in 2005 after aggressively pursuing an insider trading case against Pequot Capital, the powerful New York hedge fund. Aguirre, who says he was fired after trying to interview current Morgan Stanley Chief Executive John Mack in the matter, says the agency is too close to the industry it covers to be effective as a watch dog. A spokesman for the SEC wouldn't comment for this story.

Others say it's just a matter of things spiraling out of control more quickly than anyone could imagine. "It's very late in the nt color="#FF0000">On Friday, Massachusetts securities regulators filed a civil fraud suit against Merrill Lynch over $14 million worth of collateralized debt obligations it sold to the town of Springfield. The state claims the CDOs were unsuitable and sold without the town's consent. (Merrill has acknowledged the latter and paid the town back in full for the investment, which is now practically worthless.)

Earlier last week, the Federal Bureau of Investigation disclosed it had opened criminal fraud probes into 14 companies over their mortgage securitization activities, which includes everything from originating loans to buying them, packaging them and selling them to investors. The FBI didn't identify the companies.

Connecticut and New York attorneys general have also opened investigations into how Wall Street structured and sold mortgage-laden securities.

Goldman Sachs, Morgan Stanley and Bear Stearns have disclosed in their recent regulatory filings that they have been questioned by multiple regulators about their activities involving subprime mortgage securities. In November, Merrill Lynch said the SEC had initiated an inquiry into its subprime mortgage portfolio. All the banks have said they are cooperating. Maybe they should shore up their risk management while they're at it.

[Feb 08, 2008] The Big Picture/Newsflash: Trading is Very Addictive

February 07, 2008 | The Big Picture

in Psychology/Sentiment | Trading

Not that this is news to anyone who trades, but:

"A small group of scientists, including some psychologists, say they are starting to discover what many Wall Street professionals have long suspected - that people are hard-wired for money. The human brain, these researchers say, responds to high-stakes trading just as it does to the lure of sex. And the riskier the trades get, the more the brain craves them.

French prosecutors have likened Mr. Kerviel's trades to a drug habit. That is no surprise to Brian Knutson, a professor of psychology and neuroscience at Stanford University and a pioneer in neurofinance, an emerging field that combines psychology, neuroscience and economics, to examine how the brain makes decisions."

As someone who started on a trading desk, I can tell you from personal experience it is absolutely true. And my transition from trading to research reminded me the period of time when I gave up speedballing heroin and cocaine years ago -- the longing, that sense of emptiness, that yearning for the sweet, sweet high . . . hmmmmm.

Where was I?

Oh, yes, trading addictions.

In all seriousness, there is a definite adrenal rush to trading, and the highs and lows not all that different from what gamblers experience. The difference is casino gambling is nearly entirely random, whereas markets have some degree of non-random behavior, thanks to mean reversion and human behavior. Then there are the advantages of compounding.

The full article is worth a read . . .

[Feb 08, 2008] Mish's Global Economic Trend Analysis- Bubble Economy Endgame

=== === ===

I've been wondering for weeks when one of the pundit class would say something about Boomers cashing out their houses for retirement purposes - and that not working out so well in light of current events. You guys can be counted on, as always.

=== === ===

As an old farmer, maybe you will see this as I see it: The contraction of the number of farms and the aging of farmers created a system of farmers using their farms as retirement funds, selling off the pieces to suburban developers. Easy loan money created Monsterbellum Suburbia, where everyone was borrowing on the Perception of Perpetual Growth.

Meanwhile, the real source of distributed sustainable income, the small farm and the working villages, were turned into megafarms dependent upon cheap oil to grow cheap food to be processed by cheap oil and transported to the (now larger) Monsteropoli Borrowing on the HOPE that some imaginary middle class will suddenly pop into existence is the plan of the Fed, while forgetting that the middle is now non-existent, and the classes now consist of those who work, and those who don't. The missing middle isn't a class, but middle geography and mid-production.

[Feb 08, 2008] [Greed & Fear] On the end of securitization and the looming sell-off

FT Alphaville

It's the 10th anniversary of the onset of the Asian crisis this week and the world has turned almost full circle, says CLSA's Christopher Wood in his latest Greed & Fear client newsletter. In his usual neat way of putting things, Wood notes that a decade ago, "Asia was collapsing and America kept growing". Now the consensus is almost the reverse: "namely that the US economy has a bit of a problem in its housing market, but the world economy will be fine because of the growth coming out of Asia".

The real issue, though, is that "nonsensical leveraged games played by the debt floggers in the world of fixed income again threaten a systemic crisis".

He's not always right but Wood is right often enough to take his warnings on board. In this case, anybody in the field of securitization should take note. The present global credit bubble will end in a financial crisis which will be deflationary in nature and will have its epicenters in New York and London, he says. "The upshot of the crisis will be an aggressive return to regulation of matters related to credit including, quite possibly, the outlawing of securitization."

The question, however, is whether the current rumblings of distress in the market for collateralized debt obligations are the trigger for the full-scale financial crisis, which Wood assumes "will one day be inevitable". G&F is not yet convinced about this but there is certainly the potential that they could be. "Investors who dismiss this prospect out of hand delude themselves".

The last has not been heard of CDOs, and the wholesale downgrading of these structured credits "will occur before the end of the year", he predicts. "This will more than justify the spread widening that has already taken place. The simple reason is that the US housing market will continue to weaken.

The longer the US housing downturn goes on, the harder it will become to conceal that the edifice of debt collateralized by mortgages is not worth what its holders claim it to be, Wood says. This is also why the Federal Reserve will be cutting interest rates before the end of the year, he adds.

The "flawed business model of securitization run amok", meanwhile, has also been applied to two other areas that are not yet perceived as problems, "but which inevitably will become problems": The two areas are the leveraged loans driving the LBO mania, and securitized non-recourse financing of commercial real estate.

The growing focus on the problems in the mortgage-related area means that shorting mortgage-related paper or related CDOs is not as good a trade as it was a few months ago or even a few weeks ago. The best credits to short now are those funding the LBOs and the commercial real estate precisely because the market is not really focusing yet on the obvious risks.

In Asia, a full-scale credit blowup would "probably cause a decline of at least one third in the MSCI Asia ex-Japan index with higher-beta markets declining by more," notes Wood . "This is because leveraged investors would have to sell profitable investments to cover losses elsewhere. Still, this would simply be collateral damage from a crisis that did not originate in Asia."

Such a selloff in Asia would be a massive buying opportunity since the region is in a long-term bull market. It would also probably serve as a positive catalyst for Asia to pursue a more domestic-demand-driven growth model in line with the Billion Boomers theme.

Well, it certainly couldn't hurt to take note.

[Feb 7, 2007] Ackermann Says Bond Insurers Threaten Debt `Tsunami' (Update1)

Feb. 7 (Bloomberg)

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

"It could be a tsunami-like event comparable to subprime,'' Ackermann said in a Bloomberg Television interview in Frankfurt today. Deutsche Bank, Germany's biggest bank, is "well positioned'' on its risk from bond insurers, he said.

[Feb 7, 2007] The Bubble Bursts

Our economy is in serious trouble," writes Eric Janszen in the cover story for the February Harper's. "Both the production-consumption sector and the FIRE [finance, insurance and real estate] sector know that a debt-inflation Armageddon is nigh, and both are praying for a timely miracle, a new bubble to keep the economy from slipping into a depression." (Harpers)

[Feb 7, 2007] FT.com- US public finances feel the pinch

The economic downturn in the US is starting to hit government revenues, the head of the Congressional Budget Office has told the Financial Times.

In an interview, Peter Orszag, the CBO director, said the slowdown "is showing up in revenue". Tax receipts were softer "across revenue as a whole" but "the slowing is most marked in corporate tax receipts".

[Feb 7, 2007] Is Overindebtedness Pushing Us Into a Deflationary Spriral - Seeking Alpha

"In the fourth quarter of 2007, new foreclosures averaged 2,939 a day, double the pace of a year earlier. In the 1930s, lenders were seizing homes at an average rate of 3,000 a day, adjusted for today's housing stock size," according to RealtyTrac Inc.

Merrill Lynch's economist David Rosenberg sees "potential for another 25% to 30% downside over the next two years" in home prices on top of the already 9% drop. A 35% drop from the peak median home price of $230,000 essentially reprises it to $151,000 in 2010. Many homeowners at risk have no money down in their home. To a degree then, the financial burden will not fall on the homeowners losing their homes, but back on the financial institutions and loan originators involved in this whole credit creation/lending process.

Financial institutions' real debt burdens are beginning to soar amidst a current debt deflation crisis created by escalating foreclosures and falling home prices. To mitigate the burden of this growing crisis, there is anecdotal evidence banks are beginning to liquidate these unwanted assets at firesale prices. Deutsche Bank and other banks have been slashing prices on repossessed homes to get rid of them. In a recent transaction mentioned on Business Week's Hot Property blog, Deutsche Bank sold a house in Woodbridge, Va. in December for $150,000, less than half its last sale price of $315,000 in the spring of 2005.

[Feb 7, 2007] Papers Show Wachovia Knew of Thefts - New York Times

Last spring, Wachovia bank was accused in a lawsuit of allowing fraudulent telemarketers to use the bank's accounts to steal millions of dollars from unsuspecting victims. When asked about the suit, bank executives said they had been unaware of the thefts.But newly released documents from that lawsuit now show that Wachovia had long known about allegations of fraud and that the bank, in fact, solicited business from companies it knew had been accused of telemarketing crimes.

... ... ...

Lawyers pursuing the lawsuit against Wachovia, which was filed in a Pennsylvania federal court on behalf of a woman named Mary Faloney and other apparent victims, have asked a judge to declare the case a class action, which could expand it to as many as 500,000 plaintiffs.The lawsuit alleges that Wachovia accepted fraudulent, unsigned checks that withdrew funds from the accounts of victims, often elderly. Wachovia forwarded those checks to other banks that were unaware of the frauds, which in turn sent money to the swindlers.A judge is expected to rule on the class action request by this summer. Wachovia, in court filings, has denied the suit's allegations. The company declined to comment on the pending litigation.... ... ... The Pennsylvania suit against Wachovia alleges that the bank's involvement with telemarketing thefts dates to October 2003, when Wachovia was warned by another bank that a Wachovia client named AmeriNet had tried to process more than $100,000 in improper withdrawals.AmeriNet was a "payment processor," a company that creates unsigned checks on behalf of telemarketers to withdraw funds automatically from customer accounts. Such checks, once widely used by businesses collecting monthly fees, are legal if customers approve the transactions.However, a Wachovia executive wrote to colleagues, evidence suggested AmeriNet was creating unapproved checks."Keep in mind historically, telemarketing is an easy way to money launder and commit fraud. To knowingly bank a customer who is perpetrating fraud places the bank at great exposure," wrote that executive, Tim Brady, according to documents that are part of the lawsuit.Mr. Brady, who did not return phone calls, recommended closing the AmeriNet account in 2003, according to that e-mail message. But Wachovia continued working with the company until 2005, when AmeriNet paid $50,000 to settle complaints filed by the attorneys general of five states. Wachovia was not named in those complaints.In late 2003, a Wachovia executive announced to colleagues via e-mail that her unit, because of AmeriNet, had seen "an increase in our annual revenue projection."Wachovia declined to comment on those e-mail messages, citing pending litigation.Wachovia also worked with other payment processors, according to court documents. In 2004, Wachovia held a lunch for the owner of a payment processor that the bank knew had drawn thousands of previous complaints."It is important that our relationship is firm and in good standing" with the owner of that company, Your Money Access, wrote the Wachovia executive, Ms. Pera, to colleagues. Your Money Access was sued last year by the Federal Trade Commission and seven states on suspicion of helping to steal up to $69 million.There were other internal warnings, as well.In 2005, a Wachovia fraud investigator wrote to colleagues that 79 percent of the checks submitted by one Wachovia client, Suntasia, had been returned in August because of unauthorized withdrawals and other problems. Regulators say return rates in excess of 2.5 percent is evidence of potential fraud."I have good reason to believe that all of the deposited items are unauthorized drafts," wrote the fraud investigator, Bill McCann in a 2005 e-mail message.But Wachovia continued doing business with Suntasia until last year, when the company was shut down by a court order, according to the lawsuit.Wachovia declined to comment on Mr. McCann's e-mail. Mr. McCann declined to return calls.Moreover, executives at other banks, including Bank of America, Wells Fargo, Citizens Bank, the Social Security Administration and the Justice Department Federal Credit Union also warned Wachovia multiple times that its accounts were being used for fraud, according to the lawsuit against the bank.In 2006, an executive at Citizens Bank wrote via e-mail that thieves were routing unauthorized checks through Wachovia that stole from Citizens account holders."We have spoken to many of our customers who have been victimized by this scam," wrote the Citizens executive, according to court documents. "We would appreciate it if you would shut down accounts of any customers of yours that may be engaging in improper activity."But Wachovia kept that account open until it was frozen by a federal court a few weeks later, as part of a government lawsuit against the client.A Wachovia spokeswoman said that in every case where a bank complained, an investigation was opened and that some accounts were closed.But court records show that many of those accounts stayed open for years after the complaints were received.Last June, after Wachovia's involvement with telemarketing thefts was reported by The Times, Congressional lawmakers, including Representative Edward J. Markey, Democrat of Massachusetts and senior member of the House Energy and Commerce Committee, asked five regulatory agencies to answer questions regarding the unsigned checking system that fraud artists used. Senator Tom Harkin, Democrat of Iowa, also asked the Senate Banking Committee to investigate the issue.Many of those agencies responded by saying they lacked jurisdiction. "Clearly, more needs to be done to prevent fraud in this area," Mr. Markey said in a statement. A spokeswoman for Mr. Harkin said lawmakers were considering hearings.Other regulators say the banks are to blame."These types of crimes only are possible because banks tolerate them," said the United States attorney in Philadelphia, Patrick L. Meehan, who prosecuted a payment processor accused of using Wachovia accounts to steal more than $100 million."Who knows how many other crimes like this are occurring every day without anyone realizing it?" Mr. Meehan said.

[Feb 6, 2008] naked capitalism Martin Wolf Can We Corral the Financiers

One statistic in the article is particularly noteworthy. The profits of financial firms grew from under 5% of after tax profits in 1982 to nearly 41% in 2007 while their share of corporate value added grew from 8% to 16%. Translation: financiers have managed to suck fees out of the economy well in excess of their utility. And Wolf does not mention some of the unhealthy side effects of the finance cart leading the economy horse, namely, the short-term earnings fixation that has badly distorted corporate behavior, encouraging underinvestment and excessive cost-cutting.

... ... ...

The big question, indeed, is whether lessons must be embedded in regulation. Optimistic opponents of regulation argue that the banks have learnt their lesson and will behave more responsibly in future. Pessimistic opponents fear that legislators might create a Sarbanes- Oxley squared. The Act passed by the US Congress in 2002, after Enron and other scandals, was bad enough, they say. The banks might now suffer something worse."Dream on" is my reply to the optimists. To the pessimists, I respond: yes, the danger of over-regulation is real, but so is that of doing nothing at all.Two points shine out about the financial system over the past three decades: its ability to generate crises, and the mismatch between public risk and private reward.

... ... ...

As William White of the Bank for International Settlement has noted, banks almost always get into trouble together.* The most recent cycle of mad lending, followed by panic and revulsion, is a paradigmatic example.One response would be to raise capital requirements counter-cyclically, in response to the growth of credit, as Profs Goodhart and Persaud suggested. They also suggest a variable maximum loan-to-value ratio for mortgages. Mr White adds the need for tighter monetary policy.These are all reasonable ideas. Yet, as Mr White also notes, the strength of the pressures against taking "away the punchbowl just as the party gets going", in former Fed governor William McChesney's famous phrase, is formidable. In addition to bureaucratic inertia, such action is subject both to unavoidable uncertainty about the dangers of current trends and to resistance from private interests. Furthermore, regulators are in constant danger of losing sight of the systemic wood for the institutional trees. I would add to all this the simple fact that freedom of US monetary policy is constrained by the monetary and exchange-rate policies of others, notably of China.

... ... ...

A financial sector that generates vast rewards for insiders and repeated crises for hundreds of millions of innocent bystanders is, I would argue, politically unacceptable in the long run. Those who want market-led globalization to prosper will recognize that this is its Achilles heel. Effective action must be taken now, before a still bigger global crisis arrives.

Comments

No changes in regulation will do anything. I have seen 31 years of "regulatory reform" in the CPA profession. All failed. My answer: repeal the Federal Reserve Act and let banks fail. Starting with Citibank. Financiers compensation is absurd compared with what people earn in the "real" economy. What does Lloyd Blankfein at Goldman Sachs (GS), a firm which sends "alumni" into the public sector, do to earn a $68 million bonus? Have former GS guy, Hank Paulson, shill for him? This is crazy. Discussing regulatory "reform" is a waste of time. You are correct, the privatization of profit and the socialization of loss is a problem. However, it is the Fed that largely makes this possible. h US Treasury bills and bonds disappear, never to be seen again.

The US debtor economy is in a bleak place. And saving more is the only way out. Monetary policy is no longer an effective tool. It may even be a damaging one:

With the US now the world's largest external debtor nation, monetary policy in the US is increasingly constrained by international financial markets. The (to my mind) reckless interest rate cuts by the Fed risk spooking domestic and international holders of US dollar-denominated securities who have many alternative investment opportunities, both low risk sovereign debt instruments and higher-risk/higher-return investments in non-US equities, including those issued by emerging markets. The risk of a sharp sell-off of US dollar -denominated securities and an associated increase in long-term US dollar interest rates could easily turn the US slowdown into a recession, even a prolonged one. A US recession that would be mild with 10-year US Treasury bonds yielding 3.6 percent could become deep with 10-year US Treasury bonds at 6.6 percent.

For the past couple of decades, the US consumer has been saved from the consequences of his under-saving by wallet-expanding painless capital gains. Unfortunately these capital gains were to a significant extent bubble-born and these bubbles have imploded one after the other. After the tech bubble and bust and the housing boom and bust, I cannot see another asset bubble coming along in time to rescue the improvident US consumer.

[Feb 5, 2008] Economist's View

"It may be an abandonment of free-market principles, but no one has ever accused the Street of putting principle above profit." Standard & Poor's estimated banks had around $125bn of such CDO hedges with monolines in place.

Obviously, this is bad news for the insurers ... but it's also very dangerous for credit markets as a whole. This is because of a peculiar feature of bond insurance: insurers' credit ratings get automatically applied to any bond they insure. M.B.I.A. and Ambac have enjoyed the highest rating possible, AAA. As a result, any bond they insured, no matter how junky, became an AAA security... The problem is that this process works in reverse, too. If the insurers lose their AAA ratings ... then the bonds they've insured will lose their ratings ... which will leave investors holding billions upon billions in assets worth a lot less than they thought. That's why so many people on Wall Street are pushing for a bailout for the insurers. It may be an abandonment of free-market principles, but no one has ever accused the Street of putting principle above profit. ... [...full article...]

[Feb 5, 2008] MIT commercial property price index posts second straight quarterly decline, MIT News

The next domino to fall ?

The value of U.S. commercial real estate owned by big pension funds fell another 5 percent in the fourth quarter of 2007, according to an index produced by the MIT Center for Real Estate.

Greg Mankiw's Blog P(recession now)=0.355

Is recession a possibility for a nation which spending a billion a week on Iraq war ? Did Fed used up a large chunk of their ammunition before real action started ? Is GDP in current circumstances an economic measure interesting only to completely brainwashed economists ? What is the correlation between GDP and nation prosperity? to what extent it masks phenomenon that Krugman described as "Americans make a living selling each other houses, paid for with money borrowed from the Chinese." ?
Employment Numbers as Recession Indicators. The abstract:
This paper investigates the value of employment data as real-time recession indicators. Among popular monthly labor measures, the unemployment rate is the most useful as an indicator of recession, whereas two top measures of employment growth–payroll jobs and civilian emploopulation ratio, also provide little or no value in anticipating a recession. The best pre-recession employment indicator is actually weekly claims for unemployment insurance (UI). The paper reviews a new technique for predicting recessions, and develops an employment recession probability index. The index indicates a 35.5 percent chance that the U.S. economy is in recession, sharply up from 10 percent last month.

Stiglitz: On the Fallen Standing of the US High Finance

What qualifications do you need to work in the article from Mark Thoma) is a report from Davos by Nobel Prize winner Joseph Stiglitz on the considerable skepticism abroad toward US financial and business practice, particularly our faith in deregulation. It is a telling indicator of how rapidly the world is changing, yet many in the US are still in denial.From Stiglitz:
Not surprisingly, the atmosphere at this year's World Economic Forum was grim. Those who think that globalization, technology, and the market economy will solve the world's problems seemed subdued. Most chastened of all were the bankers. Against the backdrop of the sub-prime crisis, the disasters at many financial institutions, and the weakening of the stock market, these "masters of the universe" seemed less omniscient than they did a short while ago.And it was not just the bankers who were in the Davos doghouse this year, but also their regulators – the central bankers.Anyone who goes to international conferences is used to hearing Americans lecture everyone else about transparency. There was still some of that at Davos. I heard the usual suspects – including a former treasury secretary who had been particularly vociferous in such admonishments during the East Asia crisis -– bang on about the need for transparency at sovereign wealth funds (though not at American or European hedge funds).But this time, developing countries could not resist commenting on the hypocrisy of it all. There was even a touch of schadenfreude in the air about the problems the United States is having right now –- though it was moderated, of course, by worries about the downturn's impact on their own economies.Had America really told others to bring in American banks to teach them about how to run their business? Had America really boasted about its superior risk management systems, going so far as to develop a new regulatory system (called Basle II)? Basle II is dead –- at least until memories of the current disaster fade.

Bankers – and the rating agencies – believed in financial alchemy. They thought that financial innovations could somehow turn bad mortgages into good securities, meriting AAA ratings. But one lesson of modern finance theory is that, in well functioning financial markets, repackaging risks should not make much difference.

If we know the price of cream and the price of skim milk, we can figure out the price of milk with 1% cream, 2% cream, or 4% cream. There might be some money in repackaging, but not the billions that banks made by slicing and dicing sub-prime mortgages into packages whose value was much greater than their contents.

It seemed too good to be true -– and it was.

Worse, banks failed to understand the first principle of risk management: diversification only works when risks are not correlated, and macro-shocks (such as those that affect housing prices or borrowers' ability to repay) affect the probability of default for all mortgages.

I argued at Davos that central bankers also got it wrong by misjudging the threat of a downturn and failing to provide sufficient regulation. They waited too long to take action. Because it normally takes a year or more for the full effects of monetary policy to be felt, central banks need to act preemptively, not reactively.

Worse, the US Federal Reserve and its previous chairman, Alan Greenspan, may have helped create the problem, encouraging households to take on risky variable-rate mortgages by reassuring those who worried about a housing bubble that there was at most a little "froth" in the market.

Normally, a Davos audience would rally to the support of the central bankers. This time, a vote at the end of the session supported my view by a margin of three to one. Even the plea of one of central banker that "no one could have predicted the problems" moved few in the audience -– perhaps because several people sitting there had, like me, explicitly warned about the impending problem in previous years.

The only thing we got wrong was how bad banks' lending practices were, how non-transparent banks really were, and how inadequate their risk management systems were.

It was interesting to see the different cultural attitudes to the crisis on display. In Japan, the CEO of a major bank would have apologized to his employees and his country, and would have refused his pension and bonus so that those who suffered as a result of corporate failures could share the money. He would have resigned.

In America, the only questions are whether a board will force a CEO to leave and, if so, how big his severance package will be. When I asked one CEO whether there was any discussion of returning their bonuses, the response was not just no, but an aggressive defense of the bonus system.

This is the third US crisis in the past 20 years, after the Savings & Loan crisis of 1989 and the Enron/WorldCom crisis in 2002.

Deregulation has not worked. Unfettered markets may produce big bonuses for CEOs, but they do not lead, as if by an invisible hand, to societal well-being. Until we achieve a better balance between markets and government, the world will continue to pay a high price.

[Feb 4, 2008] Would Marx say rising tide today lifts all boats -- Shanghai Daily by Brad DeLong

From comments at Economist's View "The currency is the foundation of a nation state. Those that control the currency's movement control the nation. When looking for answers of who holds power, follow the money. " Bankers – and the rating agencies – believed in financial alchemy and "greed is good" approach. Society will pay the price.

Wolf recently excoriated the world's big banks as an industry with an extraordinary "talent for privatizing gains and socializing losses ... (and) get(ting) ... self-righteously angry when public officials ... fail to come at once to their rescue when they get into (well-deserved) trouble ... (T)he conflicts of interest created by large financial institutions are far harder to manage than in any other industry."

For Wolf, the solution is to require that such bankers receive their pay in installments over the decade after which they have done their work. But Wolf's solution is not enough, for the problem is not confined to high finance.

The problem is a broader failure of market competition to give rise to alternative providers and underbid the fortunes demanded for their work by our current generation of mercantile princes.

[Feb 4, 2008] Federal spending mythology, by Paul Krugman

One thing I've written about a number of times, but becomes especially worth emphasizing now that John McCain is the presumptive Republican nominee, is the myth of runaway federal spending under the Bush administration. McCain has said on a number of occasions that he doesn't know much about economics - although, straight-talker that he is, he has also denied having ever said such a thing. But one thing he thinks he knows is that the Bush administration has been spending like a drunken sailor. Has it?

Consider the actual record of spending. Never mind dollar figures, which grow because of inflation, population growth, and other normal factors. A better guide is spending as a percentage of GDP. And this has increased, from 18.5% in fiscal 2001 to 20% in fiscal 2007.

But where did that increase come from? Three words: defense, Medicare, Medicaid. That's the whole story. Defense up from 3 to 4% of GDP; Medicare and Medicaid up from 3.4% to 4.6%, partially offset by increased payments for Part B and stuff. Aside from that, there's been no major movement.

Behind these increases are the obvious things: the war McCain wants to fight for the next century, the general issue of excess cost growth in health care, and the prescription drug benefit.

So the next time Mr. McCain or anyone else promises to rein in runaway spending, they should be asked which of these things they intend to reverse. Are they talking about pulling out of Iraq? Denying seniors the latest medical treatments? Canceling the drug benefit? If not, what are they talking about?

Comments

robertdfeinman says...

I'll say it again, using percentage numbers is a false measure.

Better to compare spending against other similar societies. By this measure militarism is completely out of whack. US military spending is as much as the rest of the world put together. Does the US have 50% of the world population or 50% of the economic activity?

Is GDP a meaningful denominator given the bubbles caused by overvaluing of financial assets and other intangibles?

Does that "defense" line include all aspects of militarism, or only those explicitly called defense? Does it include the current wars which are funded by special, supplemental, appropriations? Does it include hidden costs buried in other departments? Does it include payments on the national debt caused by prior military adventures? Does it include payments to veterans and other benefits?

I also dislike seeing Medicare/Medicaid and Social Security called "federal spending". These programs are government administered. The money is raised explicitly to fund these activities. If it weren't for LBJ trying to disguise the true cost of the Vietnam war then they would never have been added to the budget.

Militarism is 50% of the discretionary federal budget. How does that compare with other industrialized nations? What do they have instead that we are lacking because we have drained all this money from other activities?

If Krugman's point is that Bush hasn't been much worse than several prior presidents then that's true, but so what. If you get run over by a car does it matter if it was the front wheel that killed you or the rear one which followed?

The forces in this country are beyond rational control. The majority party can make changes around the edges but is unwilling, or unable to alter the basic direction.

Chalmers Johnson calls it the military/industrial/congressional complex and it's about to take us over a cliff. What destroyed the USSR? Well there may be lots of causes, but one that stands out is the unwillingness of the nomenklatura to see the reality staring them in the face - the society was economically hollow.

[Feb 3, 2008] Shiller- Historic Housing Bust, Possible Severe Recession

Shiller said that home declines will last another year at least. This is a historic housing bust comparable to the same during Great depression. Every cycle is different and before Great Depression prices were rising more modestly (17-20%) and they dropped 30%. He does not think that we are going into Great Depression. If we are going into recession fear of the inflation can go to the back burner as recession is a powerful anti-inflationary mechanism. Homeowners already lost approximately 2 trillions, so household balance sheets are in bad sheets. This is ongoing this an unfolding problem with more foreclosures down the road. if this recession is not handled properly it can be a very serious recession. confidence matters, but people get scary story without any savings. Hopefully Bernanke will not make same mistakes as he an expert on Great Depression. We are seeing consumer confidence falling and that's a serious problem. This country has serious earning quality problem.

[Feb 3, 2008] Jobs Contract as 2007 Job Growth Revised Away

ADP data are usually more correct...

Nonfarm payrolls fell by an estimated 17,000 in January, the Labor Department said. This is the first decline since August 2003. The decline in payrolls was much weaker than the 85,000 increase that had been expected by Wall Street economists surveyed by MarketWatch.The labor market has clearly deteriorated. Job growth has averaged 41,000 over the past three months, compared with an average of 109,000 in the first quarter of 2007. The report contradicts the January employment survey released on Wednesday by ADP that estimated that 130,000 private sector jobs were created in January.

[Feb 2, 2008] Small Law Firm's Big Role in Bundling Mortgages - New York Times

New York state prosecutors are investigating whether Wall Street banks withheld crucial information from investors about the risks posed by subprime loans. McKee Nelson has not been subpoenaed in the investigation or accused of any wrongdoing.

But as investors' losses mount, companies across the financial services industry are coming under scrutiny. Bankers, auditors and lawyers are bracing for a wave of lawsuits. One law firm, Cadwalader Wickersham & Taft, is already fighting a $70 million malpractice suit over its mortgage securities work.

[Feb 1, 2008] Wall Street Journal

Merrill Lynch & Co. has bought back, from Springfield, Mass., complex debt securities that rapidly collapsed in value during the credit crisis.
..

[Feb 1, 2008] More than 20 years in the making

"what happens in sub-prime stays in sub-prime" phase of this mess. And that might include Fed. Billionaire investor George Soros said central banks have 'lost control' of financial markets.

January 25 – Financial Times (Henny Sender): "So far, most of the rout in the debt markets has been linked to the US subprime mortgage debacle. Increasingly, however, many hedge funds are betting there is far worse to come for the corporate debt market as well. Hedge fund managers and the trading desks of some of the savviest firms on Wall Street are expecting a severe downturn in the corporate debt market… A number of trades have been made on the assumption that, when things go wrong, corporate creditors will receive far less than 100 cents on the dollar, and the more junior their debt, the less they will get back."

Cuomo Using Martin Act to Pursue Subprime Securities Fraud

Sellers of financial snake oil at Bear Stearns, Deutsche Bank, Morgan Stanley, Lehman, and Merrill might needs alcohol or sleeping pills or both to sleep at night. Not thet many will go to jail...

From the Wall Street Journal:

The New York attorney general's office, pursuing an investigation into whether Wall Street firms improperly packaged and sold mortgage securities, is latching onto a powerful regulatory tool: the 1921 Martin Act.The state law, considered one of the most potent legal tools in the nation, spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud. As a result, the act has become an influential hammer in recent years for New York state prosecutors in cracking down on securities manipulation, improper allocation of initial public offerings of stock and misleading stock research on Wall Street....... ... ... With data provided by Clayton, Mr. Cuomo's office is seeking to gather more information on how Wall Street firms purchased home loans that had been singled out as "exception loans" -- that is, loans that didn't meet the originator's lending standards. Data from Clayton, for instance, indicates that in 2005 and 2006, years in which the mortgage-securitization business was going full throttle, some investment banks acting as underwriters were purchasing large numbers of loans that had been flagged as having exceptions, these people said.



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