FedUpUSA

Archive for June 21st, 2010

By Satyajit Das

Central banks cut interest rates, governments provided cheap money giving only the illusion of recovery and a normal functioning economy. But the year of wishful thinking is over.

A Year of Wishful Thinking

The period from March 2009 was the year of wishful thinking. Central banks cut interest rates and governments opened their checkbooks, providing a flood of cheap money that gave the illusion of recovery and a normal functioning economy. By pouring a lot of water into a bucket with a large hole, the world sustained the impression that the receptacle was almost full. As Norman Cousins, an American political journalist, noted: “Hope is independent of the apparatus of logic.”

Governments merely transferred the debt from private sector balance sheets onto public balance sheets. The Global Financial Crisis (GFC) has morphed into a Global Sovereign Crisis (GSC) as sovereign governments now face difficulty in raising money.

Stock markets and asset prices have tumbled. Money markets are exhibiting an anxiety not seen since late 2008/early 2009. The year of wishful thinking has run its course.

Cradle of Debt

If sub-prime was the Patient Zero of the GFC, then Greece, the cradle of Western civilization, was the equivalent of the GSC. As historian Arnold Toynbee observed: “An autopsy of history would show that all great nations commit suicide.”

Greece’s significance is not its economic size (around 0.5% of global GDP (Gross Domestic Product)) but its significant debts. Profligate public spending, a large public sector, generous welfare systems — particularly for public servants — low productivity, an inadequate tax base, rampant corruption, and successive poor governments were responsible for the parlous state of public finances.

Several events focused attention on the problems. Greece needed to borrow around Euro 50 billion in 2010 to refinance maturing debt and fund its budget deficit. There were damaging disclosures that Greece, like many other European countries, had used derivatives to manipulate its debt figures. Greece bungled attempts to mask its increasing difficulties in refinancing maturing debt, including statements about a large purchase by China of its debt which was denied by the supposed buyer.

The revelations focused attention on underlying problems setting off alarm bells. Smelling blood in the water, markets pushed up the cost of Greek debt. The Greek stock market fell sharply by around 30%. Gradually, the ability of the country, as well as Greek banks and companies, to raise money ground to a halt.

Greece was also the “canary in the coal mine”, highlighting similar problems in the PIGS (Portugal, Ireland, Greece, and Spain) as well as some Eastern European countries. These countries alone have around Euro 2 trillion of debt outstanding. Larger countries — the FIBS (France, Italy, Britain, and the States) — also have similar problems of large public debt, unsustainable budget deficits, and (in most cases) unfavorable current account deficits (both in absolute terms and relative to GDP).

Going Nuclear

Will Durant, an American historian, advised that: “One of the lessons of history is that nothing is often a good thing to do and always a clever thing to say.” Initially, European politicians and bureaucrats, who suffer from delusions of adequacy, did nothing, but wouldn’t shut up about it. The oft repeated battle cry was “no default, no bailout, no exit.” Germany remained especially hostile to any financial bailout. Repeated invocations of the no-bailout clause underlying the eurozone drew attention to the risks of Greece’s debt.The major problem was contagion — the consequences if Greece was to unable to raise money from commercial sources. Much of Greece’s debt is owed to investors outside the country, mainly banks and investors in other European countries. If Greece defaulted on this debt, then the resulting losses would have serious consequences for the affected banks and banking systems. Countries, such as Portugal, Spain and Ireland, with similar economic problems would inevitably be scrutinized and targeted.

By February 2010, the need for coordinated action by the eurozone countries and the European Union (EU) was evident. While pledging eternal support, the EU postponed action, waiting for Greece to agree to an austerity program to remedy its finances. The cause of European unity wasn’t served by attacks by George Papandreou, the Greek Prime Minister, that the EU was creating a “psychology of looming collapse” and making Greece “a laboratory animal in the battle between Europe and the markets.”

In April 2010, as the market for Greek debt worsened (the additional interest rate that Greece had to pay reached 8.00% p.a. over that paid by Germany), after considerable prevarication, the EU proposed a highly conditional euro 30 billion rescue package. The Haiku writing, Belgian, Herman Van Rompuy, President of the European Council, hoped “it will reassure all the holders of Greek bonds that the eurozone will never let Greece fail … If there were any danger, the other members of the eurozone would intervene.”

Markets considered the proposal inadequate and unlikely to avoid a Greek default. Increasingly desperate as circumstances began to rapidly spiral out of control, the EU increased the package in early May 2010 to Euro 110 billion, including a Euro 30 billion contribution from the International Monetary Fund (IMF) who would supervise the package and the implementation of the economic “cure.”

About a week later, continued market skepticism and increasing pressure on Portugal, Spain, and Ireland forced the EU to “go nuclear.” After months of slow and tortured discussions, the EU acted with surprising speed announcing a “stabilization fund” to the value of Euro 750 billion to support eurozone countries, including an IMF contribution of (up to) Euro 250 billion. The actions were designed in no particular order to salvage the EU, the euro and over-indebted eurozone participants by stopping contagion and further spread of the crisis.

Nicolas Sarkozy, the French President, turned the eurozone’s sovereign-debt crisis into a personal triumph. The proposal, he let it be known, was 95% French. Le Figaro led the cheerleaders reporting Sarkozy’s comment that “in Greece they call me “the savior.’ “

Struggling for a telling phrase, journalists spoke of financial “shock and awe.” A single word – “panic” — better summed up the actions. Initially, stock markets rose sharply, especially shares of banks exposed to Greece who would benefit from the rescue. The interest rates on Greek, Irish, Italian, Portuguese, and Spanish bonds fell sharply. As the announcement over the weekend caught traders unaware, the rally was driven largely by the covering of short positions.

“Shock and awe” quickly proved more shocking and less awe-inspiring than the EU had hoped. Wiser commentators mused that if Euro 750 billion wasn’t going to do the trick, then what was?

Brussels, We’re Not Receiving You

Details of the “plan” remain sketchy. The entire package conveys the impression that the EU and ECB are hopeful that the announcement will suffice to bring stability to markets and the facilities won’t ever have to be used.

A problem of too much debt was being solved with even more debt. Deeply troubled members of the eurozone were trying to bail out each other. Given that all have significant levels of existing debt, the ability to borrow additional amounts and finance the bailout remains uncertain.

The reality is that Germany, with its large pool of domestic savings, must be the cornerstone of the rescue effort. Predictably, German credit-risk margins have increased while the peripheral countries’ credit margins have fallen. The effect of the stabilization fund is that stronger countries’ balance sheets are being contaminated by the bailout. Like sharing dirty needles, the risk of infection for all has drastically increased.

Karl Dunninger, a trader, writing at www.seekingalpha.com captured the madness:
 

The most-amusing part of this is that nations seriously in debt and without a pot to piss in will be “contributing” some of the money to fund the debt. Spain, for instance, has pledged to do so. Where is Spain going to get the money from? Will they sell bonds at 8% to fund a loan at 5%? That’s a very nice idea… let’s see, we lose 3% on those deals. That ought to help Spain’s fiscal situation, don’t you think?

Solvency Not Liquidity, Stupid

At best, the plan provides temporary liquidity to cover immediate financing needs, repaying maturing debt, and financing deficit. In a striking parallel to the early stages of the GFC, the reality that it’s a “solvency” problem not a “liquidity” problem remains unacknowledged.

Most of the countries in the firing line have unsustainable levels of debt. For example, beyond 2010, Greece needs to re-finance borrowings of around 7%-12% of its GDP (around Euro 16 billion to Euro 28 billion) each year till 2014. There are significant maturing borrowings in 2011 and 2012. In addition, Greece is currently running a budget deficit (currently over 12% but projected to decrease) that must be financed. As noted above, Greece’s total borrowing, currently around Euro 270 billion (113% of GDP), is forecast to increase to around Euro 340 billion (over 150% of GDP) by 2014.

The IMF’s publicly available economic analysis that its plan assumes is that Greece is able to refinance long-term debt by early 2012 and short-term debt even earlier. Given that Greece is expected to have a total debt burden of around 150% of GDP and total interest payment of 7.5% of GDP, the ability to raise funds and the assumed 5% cost of refinancing may be optimistic.

The IMF plan calls for a program of fiscal austerity and major structural reform. This would entail a sharp reduction in the budget deficit to less than 3% of GDP and public debt under 60% of GDP. It’s unlikely that Greece, despite heroic speeches from politicians, will be able to meet these targets.

Temporary emergency funding won’t solve fundamental problems of excessive debt and a weak economy. Government expenditure will need to be slashed and taxes raised to reduce its debt. But the government is too large a part of the economy and the suggested austerity measures will most likely cause a severe recession. In turn, this will drain tax revenues and increase expenditures, making it difficult to reduce the budget deficit and funding needs.

The level of indebtedness may already be too high. Kenneth Rogoff and Carmen Reinhart in their survey of financial crises This Time Is Different argue that sovereign debt above 60-90% of GDP restrains growth. Greece’s interest payment now totals around 5% of GDP and is scheduled to rise over 8% by GDP. Rising interest costs will only worsen this problem.

The cure may not be feasible or won’t help make it easier to meet future debt obligations. Ireland has already implemented austerity measures. The government debt as a percentage of GDP has increased to 64% from 44%. The budget deficit as a percentage of GDP has doubled to 14% from 7%. The nominal GDP of the country has fallen by 18%.

The plan may also make further liquidity problems inevitable. Instead of allowing Greece to raise funds normally, the bailout package is assisting investors to reduce exposure via repayment of maturing debt and the sale of illiquid longer-term securities. The package also risks forcing other vulnerable countries to rely on the stabilization fund.

As Woody Allen once observed: “More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other, to total extinction. Let us pray we have the wisdom to choose correctly.”

Minyanville

Over a third of HAMP participants have exited the program and another batch is coming up. Those leaving the program will likely end up in foreclosure. Moreover, 4 million delinquent borrowers are not even eligible for the program.

Please consider Borrowers exit troubled Obama mortgage program.

The Obama administration’s flagship effort to help people in danger of losing their homes is falling flat.

More than a third of the 1.24 million borrowers who have enrolled in the $75 billion mortgage modification program have dropped out. That’s more than the 27 percent who have managed to have their loan payments reduced to help them keep their homes.

Last month alone, 150,000 borrowers left the program — bringing the total to 436,000 who have exited since it began in March 2009. A major reason so many have fallen out of the program is the Obama administration initially pressured banks to sign up borrowers without insisting first on proof of their income. When banks later moved to collect the information, many troubled homeowners were disqualified or dropped out.

“The majority of these modifications aren’t going to be successful,” said Wayne Yamano, vice president of John Burns Real Estate Consulting, a research firm in Irvine, Calif. “Even after the permanent modification, you’re still looking at a very high debt burden.”

HAMP Performance Report Through May 2010

Here are a couple of charts from the Making Home Affordable Program Servicer Performance Report Through May 2010.

Hamp Trials Started

Permanent Modifications

Waterfall of HAMP-Eligible Borrowers

Not all 60-day delinquent loans are eligible for HAMP. Other characteristics may preclude borrower eligibility. Based on the estimates, of the 5.7 million borrowers who were 60 days delinquent in the 1st quarter of 2010, 1.7 million borrowers are eligible for HAMP. As this represents a point-in-time snapshot of the delinquency population and estimated HAMP eligibility, we expect that more borrowers will become eligible for HAMP from now through 2012.

Only 30% of the 5.7 million borrowers who are 60 days delinquent are eligible for the program. 4 million delinquent borrowers are stuck. Of those eligible for the program, only 346,000 have completed the trial and received a permanent modification.

Many of those receiving a permanent modification will slip back into default and head for foreclosure. Many of those who successfully keep their house would be better off if they lost it.

Looking at HAMP from every angle, it’s safe to say the program was a failure and another huge wave of foreclosures is coming down the road.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com
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Back in February 2009, the U.S. Congress passed an $862 billion “economic stimulus” bill to help the struggling American economy recover from the horrible financial crisis of 2007 and 2008.  Right now, federal agencies are spending this stimulus money at the rate of approximately 196 million dollars an hour, and they will continue to spend it in staggering amounts up until the September 30, 2010 deadline.  Unfortunately, instead of being spent on useful projects that would revitalize U.S. industry and put American workers back to work, much of this money is being flushed directly down the toilet on some of the most wasteful projects imaginable.  The truth is that nobody is better at wasting money than the U.S. government.  In fact, some of the things that the U.S. government has been spending money on are absolutely mind blowing. 

The following are just some of the examples of “stimulus waste” that we have seen over the last 16 months….   

*Florida Atlantic University in Boca Raton, Florida used $15,551 in stimulus money to pay two researchers to study how alcohol affects a mouse’s motor functions.

*The U.S. government handed over a staggering $54 million in “stimulus cash” to Connecticut’s politically-connected Mohegan Indian tribe, which runs one of the highest grossing casinos in the country.

*Syracuse professor of psychology Michael Carey received $219,000 in federal stimulus money for a study that examines the sex patterns of college women. 

*A dinner cruise company in Chicago got nearly $1 million in stimulus funds to combat terrorism.

*$233,000 in stimulus money went to the University of California at San Diego to study why Africans vote.

*The Cactus Bug Project at the University Of Florida was allocated $325,394 in stimulus funds to study the mating decisions of cactus bugs.  According to the project proposal, one of the questions that will be answered by the study is this: ”Whether males with large weapons are more or less attractive to females.”

*One Denver developer received $13 million in tax credits to construct a senior housing complex despite that fact that the same developer is being sued as a slumlord for running rodent-infested apartment buildings in the city of San Francisco.

*Sheltering Arms Senior Services was awarded a contract worth $22.3 million in stimulus money to weatherize homes for poor families in Houston, Texas - but a new report from Texas Watchdog says that the weatherization work was performed so badly that 33 of the 53 homes will need to be completely redone.

*A liberal theater in Minnesota named ”In the Heart of the Beast” (in reference to a well known quote by communist radical Che Guevara) received $100,000 for socially conscious puppet shows.

*California’s inspector general found that $1 million in stimulus funds for a program to give summer jobs to young people was improperly used for overhead expenses such as rent and utility bills.

*Landon Cox, a Duke University assistant professor of computer science, was awarded $498,000 in stimulus money to study Facebook.

There is one question that I would really like an answer to.  Who died and made BP king of the Gulf of Mexico?  In recent weeks, BP has almost seemed more interested in keeping the American people away from the oil spill than in actually cleaning it up.  Journalists are being pushed around and denied access, disaster workers are being intimidated and abused and now BP has even go so far as to hire an army of private mercenaries to enforce their will along the Gulf coast.  Are we suddenly living in occupied Iraq?  How in the world did a foreign oil company get the right to start pointing guns at the American people?  The last time I checked, BP did not own the Gulf of Mexico and did not have the right to tell the American people where they can and cannot go.  The truth is that BP could have avoided all of this by running an open, honest and transparent operation from the start.  They could have welcomed help from all sources, they could have tried to be open with the media, and they could have tried to be fair with the volunteers and rescue workers.  But instead BP has been conducting this whole thing as if we are living in a totalitarian dictatorship and they are the dictators.

Over the last several weeks, members of the mainstream media attempting to cover the oil spill in the Gulf of Mexico have been yelled at, harassed, kicked off public beaches and threatened with arrest.  The Obama administration keeps promising ”to improve media access”, but so far their promises haven’t seemed to make much difference.  In fact, a recent AP report detailed several recent highly disturbing incidents of journalist intimidation….   

The Economic Collapse

The FDIC which technically supports the nation’s banking system is for all practical purposes insolvent.  I’m not sure the magnitude of this problem has sunk into the psyche of the American public.  The FDIC insures accounts at banks that include checking, saving, and CD accounts from a bank failure.  This has occurred with regular frequency since the recession started 29 long months ago.  Some 247 banks have failed since 2008 with a total asset base of $616 billion.  The government has tried to calm the unsettled waters by raising the regular deposit coverage from $100,000 to $250,000 even though the FDIC deposit insurance fund is in the negative.  This seems to have calmed the nerves of people since the days of long lines at IndyMac Bank in California but nothing has really changed at least at the core of the financial system.  To the contrary things have worsened for the banking system.

The list of troubled banks continues to grow:

Source:  Fortune, FDIC

This chart tells us that we should be gearing up for another round of bank failures.  The increase of deposit insurance from $100,000 to $250,000 is largely a charade.  1 out of 3 Americans have absolutely no savings whatsoever.  We have 17 percent unemployed or underemployed and another 20 to 25 percent working in the low paying service sector.  Nearly 50 percent of Americans have nowhere close to $100,000 in liquid assets to insure, so increasing the insurance to $250,000 is merely a public relations move to show strength.

The current amount of assets at troubled banks is over $400 billion but since the FDIC doesn’t list all troubled banks this is much larger:

Source:  FDIC

Now the above survey only goes up to the end of 2009.  Since the start of the year another 82 banks have failed and the FDIC is probably at some undisclosed location somewhere in the United States right now getting ready to close another few banks since Fridays have become synonymous with bank closings.  The list of troubled banks increasing is a reflection of the massive amount of troubled loans.  These loans wouldn’t be in such deep trouble if the economy was healthy and Americans were servicing their loans.  But the middle class isn’t really participating in this shadow recovery.

A recent survey by none other than the FDIC shows that a good portion of Americans don’t even participate in the banking system:

“ A substantial percentage of lower-income households are unbanked. Nearly 20 percent of lower income U.S. households—almost 7 million households earning below $30,000 per year—do not currently have a bank account. Households with earnings below $30,000 account for at least 71 percent of unbanked households.    

Not having enough money to feel they need an account is the most common reason why unbanked households are not participating in the mainstream financial system.”

Do these people care that accounts are insured up to $250,000?  Who are we really protecting here?  You also need to ask how we are going to pay for all these additional bank failures if the deposit insurance fund is already in the negative.  That is where the Federal Reserve and U.S. Treasury step in with more of your taxpayer money.

The Federal Reserve attempts to paint this image as a government agency but they are not.  They serve the purpose to protect the banking system.  Even the Fed website gives us a nice little history on this:

“(Fed history) From December 1912 to December 1913, the Glass-Willis proposal was hotly debated, molded and reshaped.  By December 23, 1913, when President Woodrow Wilson signed the Federal Reserve Act into law, it stood as a classic example of compromise—a decentralized central bank that balanced the competing interests of private banks and populist sentiment.”

There is much more back history to this but suffice it to say that this move helped consolidate the power of banks into a few hands instead of having many more banks competing for your business.  Keep in mind when this past, the public was heavily against it just like the public was against TARP when this crisis rolled around.  Yet the Fed listens to their big banks and protects them at all costs even if it means robbing the public blind (a sort of reverse Robin Hood).  In the end after nearly 100 years of the Federal Reserve, the main purpose is nearly accomplished:

“The top 4 banks of Bank of America, JP Morgan Chase, Wells Fargo, and Citibank make up 55 percent of all banking assets.”

And banking assets across the country are enormous.  The FDIC backs 8,000 banks that carry over $13 trillion in assets.  These big four banks have their hands in over 50 percent of this amount.  Who controls the wealth in this country controls the levers of political power.  The way the system is currently setup we find that the banks have an incredible amount of power.  Actually, it is the biggest banks that have the big power since they are fine with hundreds of little bank failures since that opens up the market for bigger banks to step in and open up shop.  Smaller banks don’t have access to the easy money Federal Reserve window and certainly did not get handouts like many of the biggest banks did.

Foreclosures remain at record levels and this means banks are facing more and more loans that enter into default.  This costs money.  As we have mentioned, the FDIC is insolvent so where is this money coming from?

“(US Banker) Treasury likes it, the Federal Deposit Insurance Corp. likes it, and the banking industry likes it—that is, S. 541, introduced last week by Sen. Chris Dodd (D-Conn.) The bill would permanently increase the FDIC’s ability to borrow from the Treasury for its Deposit Insurance Fund, raising the cap to  $100 billion from $30 billion, the limit set back in 1991. The Depositor Protection Act would also temporarily allow the FDIC to borrow up to $500 billion after consultations with Treasury, the Federal Reserve, and the President.

FDIC chairman Sheila Bair voiced enthusiasm in a letter to Dodd, noting “the FDIC believes it is prudent to adjust the statutory line of credit proportionally to leave no doubt that the FDIC can immediately access the necessary resources to resolve failing banks and provide timely protection to insured depositors.” Passage of the increased borrowing ability “would give the FDIC flexibility to reduce the size of the recent special assessment, while still maintaining assessments at a level that supports the DIF with industry funding.”

And there you have it.  I am certain that the banks are spending large amounts of money creating a way to couch this additional bailout as a helping hand for middle class Americans but in the end if we don’t change the system, the money will flow through the same rivers as of those from the last decade.  With so many bank failures lined up because of horrible commercial real estate and residential loans, we can expect to bailout indirectly failed casinos in Las Vegas and owning shopping malls in random parts of the country.  The FDIC is flashing code red and they are lining up with hat in hand for taxpayer money.  If after 29 months you still haven’t gotten it, this money is likely to funnel up to the top 1 percent in an incredibly unbalanced fashioned.

My Budget360

By Karl Denninger