Debt Rattle, February 11 2008

Updated 6.10 pm

Ilargi: I just have to post the article below (kudo webjazz) but don't miss the Shiller video below it!!. It is 'eerily precisely' in the vein of something I've been warning about for a long time, it even enhances it. I know I said two weeks ago I'd write an article on it, but there's simply been no time so far. I'll get back to the article tomorrow, but I do want to post it, and reiterate the following:

What I've been saying all that time comes down to this: Small, local, governments will be hit, financially, from three sides at the same time (the article makes it four), and it will (start to) happen this year.

1. Decreasing tax revenues, especially property taxes, will limit financing for project building and maintenance, and lead to large scale job losses for those who work in the field.
   
2. Issuing bonds, the main source of credit to keep day-to-day expenditures flowing, will become much harder, and in many cases downright impossible. The bond insurers can't guarantee bonds anymore, so investors don't know who to trust, and as per point 1, the financial situation of the local government has worsened, making its bonds less attractive.
   
3. Local governments themselves have funds that need to be invested. And 99% of them are invested in the same bonds and securities that they themselves now have a hard time finding buyers for. Think about that ironic paradox for a moment. Most of them have these investments managed by 'professionals', and those have all gone for max profit.
   
   And now we can add another coffin's nail:
   
4. The bonds that have already been issued have become far more expensive to service. That's what it means when Ambac was downgraded from AAA to AA. And these are costs that have to be paid, no matter what.
   

What goes for local governments, goes equally for hospitals, bridge authorities, water treatment and many other "public goods". We will see huge deterioration in road quality, health care facilities and tons of other services we take for granted. There's simply no more money. The system's broken. Governments at all levels will try raising taxes, but it will be from an ever more impoverished population. That will not work.

This goes to show to what extent our society relies on debt. Without it, nothing works. No debt, no money.

Bond Insurance Turns Toxic for Munis as Rates Soar

Bond insurance sold by MBIA Inc., Ambac Financial Group Inc. and Security Capital Assurance Ltd. is backfiring on counties, universities and hospitals across the U.S., more than doubling some borrowing costs. Park Nicollet Health Services in Minneapolis may pay an extra $5 million to $6 million this year, about a quarter of its operating profit, because interest on $375 million in floating- rate debt doubled in the last six weeks, said Chief Financial Officer David Cooke. The rate on $98 million insured by Ambac climbed to 6 percent on Jan. 30 from 3.06 percent on Jan. 2.

"We'll have to reduce our capital expenditure program, which means less equipment, less modernization of facilities," Cooke said in an interview. The hospital paid Ambac to "count on that AAA insurance for 30 years. Now it's going away on us."

Investors are shunning insured bonds after three of the biggest guarantors, owned by Ambac, Security Capital and FGIC Corp., were stripped of at least one AAA credit rating amid losses on debt tied to subprime mortgages. Interest costs on floating-rate bonds sold by more than 100 governments, hospitals and colleges rose as much as 7 percentage points since the beginning of January even as the Federal Reserve lowered its benchmark rate for U.S. borrowing by 1.25 percentage points.

"The market's in a state of turmoil,'' said Bryan Mayhew, chief financial officer for [the Bay Area Toll Authority in Oakland, California], which manages the San Francisco Bay Bridge and six other state-owned toll bridges. Tax-exempt money-market funds can't hold debt rated lower than AA-, and downgrades to insurers are enough in some instances to make the bonds it backs ineligible.

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Robert Shiller not on the Great Depression. Not.

Ilargi: Yale Economics professor Robert Shiller, whose S&P/Case-Shiller House Index is one of the prime barometers for the US economy, tries to reassure the public that we will not dive into another Great Depression, by constantly talking about.. the Great Depression. No, it won’t get that bad, well, the housing bust will be as bad, or actually much worse, since we come from far higher peaks, but we have Bernanke, and he should be able to avoid us going into a next Great Depression, so, no, no way, we won’t go into a Great Depression. That is, unless we make mistakes. We come away from this interview wondering what exactly Shiller is trying to convey. 7.30 min of recommended viewing.

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The Economic State Of The Union -- 2008

As we head into another recession and hear politicians tell us how recession can be avoided with stimulus packages that further expand household and government debt, remember that between 2001 and the end of 2007 each new job created by these same methods cost $1.8 million per job in new debt liabilities.



In just the past seven years, U.S. household debt almost doubled and federal debt soared by near two-thirds, rocketing by a combined $10.5 trillion. The total combined debt of households ($14.4 trillion) and the federal government ($9.2 trillion) is now 168 percent of GDP, far higher even than in the brief spike during World War II. All other levels and ratios of debt also have soared far beyond any past precedent.

Yet, this record-shattering explosion of debt stimulus created the weakest seven-year job growth (4.4 percent) and one of the weakest periods of real GDP growth (18.1 percent) since the Depression: less than 6 million new jobs ($1.8 million of debt per job) and a mere $4 trillion increase in GDP.



This period began with the collapse of Wall Street's stock market bubble from the late 1990s and ends now with the collapse of Wall Street's housing and other debt bubbles. That such massive mortgage and consumer borrowing, tax cuts and war spending produced such remarkably weak real economic results suggests the months and years ahead could be quite difficult

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Ilargi: When the fine G7 folk come with numbers like this, you just know you have to at least double them. After all, they still talk about avoiding a recession. Between the lines, though, they’re sending a message. And it’s not a good one.

The most important thing to come out of the Finance G7 is that there is some kind of pact concerning increased write-offs by financial institutions. It’s safe to assume that it’s the Europeans who have insisted on more clarity, and have made strong threats against US banks, ratings agencies and bond insurers who keep on hiding their numbers.

We’ll know more in about two weeks, when the audited accounts come in. The G7 message is: count on losses much bigger than we’ve seen so far.

Subprime losses could rise to $400bn

Senior global policymakers have raised projections for the size of subprime-related credit losses in a move that implies financial institutions will have to increase write-offs. Speaking after the meeting of Group of Seven finance leaders, Peer Steinbrück, German finance minister, said the G7 now feared that write-offs of losses on securities linked to US subprime mortgages could reach $400bn.

This is sharply higher than the $120bn credit losses that Wall Street banks and other institutions have revealed in recent weeks – and also far bigger than the US Federal Reserve’s estimates for subprime losses last year of $100bn-$150bn.
But G7 finance ministers admitted that it remained unclear where much of this subprime pain would eventually emerge, not least because the path of the credit crunch was still uncertain. Mr Steinbrück and other ministers appealed to financial institutions to provide “prompt and full disclosure’’ of losses, to restore confidence.

“The next 10 days to two weeks will be crucial because we are going to have the first audited accounts [from financial institutions] since the crisis started,” added Mario Draghi, governor of the Bank of Italy and chair of the Financial Stability Forum, a committee of international supervisors and central bankers. Mr Draghi said regulators were ready to force banks to reveal their losses and replenish their equity ratios. He did not rule out the possibility that governments might eventually need to inject capital into banks, although he stressed that market solutions should take precedence. The comments followed a weekend of G7 talks that were dominated by the credit turmoil and the implications of these problems for the global economy.

The finance ministers said they stood braced for individual and collective action to ensure financial stability and avoid recession. They conceded that growth was likely to slow in all their economies, since the world was facing what Hank Paulson, US Treasury secretary, called a “challenging and uncertain environment”, due to tighter credit, a deterioration of the US housing market, higher oil prices and rising inflation. But Mr Paulson said he believed the US stood a good chance of avoiding recession. “I believe that we are going to keep growing. If you are growing, you are not in recession, right?”

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Bad Debt: $100 Billion, $400 Billion, Who's Counting?

These are not good days for the dominant "who could have known?" school of economics. First, they missed the housing bubble. Since it has started to unravel, they have continually understated the size of the fallout. Only now are most economists beginning to acknowledge that the economy is virtually certain to be thrown into a recession from the collapse.

Fortunately, the media do not hold economists responsible for their failures. The NYT gives us yet another example of non-accountability. At the very end of an article warning that the impact of the housing collapse is likely to be substantial, the NYT reports "The German finance minister, Peer Steinbrück, said members agreed that write-offs at banks related to subprime mortgages could reach $400 billion, about four times estimates just a couple of months ago."

Being off by 300 percent might be considered a serious problem in other lines of work, but apparently not for economists. For the record, I expect total losses for the financial sector to approach $1 trillion.

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Housing Futures Continue Rapid Descent

While the homebuilder stocks have recently formed an uptrend on a large pickup in volume, the outlook for the actual real estate market in 2008 has cratered. The CME has housing futures that track the S&P/Case-Shiller Median Home Price indices. Over the last 3 months, investors have been sending the November 2008 contracts much lower.

As shown in the charts and tables below, Los Angeles home prices are now expected to decline 16% from 11/07 to 11/08. The 11/08 contract for Los Angeles has fallen 15% over the last 3 months. The composite index of all 10 cities is expected to fall 10% from 11/07 to 11/08, down 7% over the last 3 months.

There are a few cities not expected to fall too much though. Chicago and New York are expected to fall less than 5% by this November, and the New York 11/08 contract is actually up 2.32% over the last 3 months. Expectations have clearly become very negative for housing this year. We wonder if 11/08 is the capitulation point?

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Refinancing: Only for the privileged few

The good news: mortgage rates are down. The bad news: it's much harder to qualify for a refinanced loan these days. What's more, the borrowers who need to refinance the most - because their adjustable rate mortgages (ARMs) are resetting to higher interest rates - are among those having the most trouble winning approvals.

"I'm turning away about 60% to 75% of the clients who come to me for a refi," said Bob Moulton, president of Americana Mortgage Group on Long Island, N.Y. "Some don't have enough equity and others have bad credit scores." During the boom years, lenders approved most anyone with a pulse. Not so today. Mortgage brokers recognize this and are now being very selective about the clients whose applications they choose to submit to the likes of Wells Fargo or Bank of America.

If an applicant has poor credit, or a home whose value is rapidly deteriorating, they're just not going to bother.
"If the person is Sweet Polly Purebread - good income, good assets, high credit score - there's money out there," said Moulton. "But if not, then it's harder." Interest rates are way down - 5.67% is the going rate for a a 30-year fixed loan this week, according to Freddie Mac. That has generated a spike in refinancing applications.

Total mortgage applications were up 73% last week from a year earlier, according to the Mortgage Bankers Association (MBA), and 69%of those applications were for refis. Last February, when interest rates were about 6.3%, about 46% of applications were for refis. The make-or-break metric for anyone looking to refinance right now is home equity - the difference between what is owed on a house and what the house is worth. But with home prices down, many homeowners have little of that precious commodity left.

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Ilargi: There’s still a vague memory hidden deep in my brain of The Economist as a magazine that was worth reading. But sweet Jesus, guys, I really actually had to check the date on this article. And it is from this year, not February 2006. It would have been from then, though, if the rag still had class. The maggots emanating from Milton Friedman’s carcass find out there was loose lending and moral hazard in mortgages. You think?

Chain of fools

There is a growing consensus that loose credit and too-clever-by-half financial wizardry sowed the seeds of America's still-deepening economic malaise. One practice in particular has been singled out for censure—the bundling of loans into assets that could be sold on to investors. The charge is that by breaking the link between those who vet borrowers and those who bear the cost when they default, securitisation led to the lax lending that both fuelled and felled America's housing market.

Securitisation is not new, and decades of standardisation in areas such as mortgage finance, car loans and credit cards have removed many of its deficiencies. But new research* by Atif Mian and Amir Sufi of the University of Chicago's business school provides hard evidence that securitisation fostered “moral hazard” amongst mortgage originators, which led them to issue loans to uncreditworthy borrowers.

By examining local variations in housing and mortgage data, the authors were able to identify a causal link running from securitisation to increased credit supply, faster house-price growth and rising default rates. Their findings confirm what many suspected: poor screening by mortgage originators intent on selling on loans was a significant factor in the housing boom and bust.

The researchers' first task was to establish that the explosion of mortgage growth during the boom was down to easier access to credit. Using detailed data collected by government agencies in 3,000 zip-code districts, they were able to identify areas of pent-up demand by calculating the share of mortgage applications that had been turned down. They found that districts with the highest level of mortgage rejections in 1996, the benchmark year, were those where subsequently there was a disproportionately large increase in the rate of approved mortgages in the boom years between 2001 and 2005.

Could it have been that the economic prospects improved in these neighbourhoods, explaining the increase in the use of credit? That would suggest that more borrowers were better placed to repay a mortgage. No, the Chicago economists contend: they found that the places where it became easier to obtain a mortgage—what they call the “high latent-demand” zip codes—also saw declining income and employment growth compared with nearby districts.

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Obligatory Nonsense on Inequality at the NYT

Every year or so, the NYT feels obligated to print a piece of nonsense masquerading as economics from W. Michael Cox, the senior Vice-President of the Dallas Federal Reserve Bank. The first item in this series that I recall was a piece that argued that there was great mobility in the United States because those in the bottom quintile at any point in time were likely to move up to higher quintiles, including even the top quintile, in future years.

This looked very impressive until you found our that Cox used all adults in his sample, not just prime age people, as serious economists would do. This means that the law students and medical students, who are likely to be low income this year, are the basis for much of Cox's upward mobility story, since they will have relatively high incomes when they are lawyers and doctors.

This year's nonsense concerns consumption. Cox tells us that there is much less inequality in consumption than income, so therefore we should not really be concerned about inequality. I won't go through all the problems in Cox's analysis (there are many). I will just point out that the data set that he uses, the consumer expenditure survey (CEX) is not very well-suited for this sort of analysis.

The CEX misses a great deal of consumption. This can readily be seen by simply looking at the aggregate statistics. The average after-tax income reported in the survey is $58,101. Average consumption expenditures are $48,398. This implies a savings rate of 16.7 percent. The National Income and Product Accounts data show a savings rate of less than 1 percent. This suggests that the CEX is missing a great deal of consumer expenditures, which makes this sort of analysis very dubious. You may wonder why the NYT would print columns from someone with such a consistent reputation for getting things wrong. I guess that is the price that we pay for having a regular column from Paul Krugman.

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Ilargi: Businesses in Europe and beyond have no idea what’s headed for them.

European manufacturers hope to weather storm

European manufacturing companies remain optimistic that their sales will increase in 2008 and that their business will remain immune from the deepening gloom over the American economy and among US companies. In a pan-European survey of expectations, 56 per cent of European manufacturers expected their sales volumes to rise over the coming year, compared with 12 per cent forecasting a decline.

The positive balance of 44 percentage points indicates an upbeat view of European companies’ abilities to withstand recessionary forces from the US, but is less positive than a year ago. Then, manufacturers who thought sales would rise outnumbered those expecting a fall by 56 points, according to NTC Economics, the consultancy that compiles closely watched monthly purchasing managers’ indices. Across Europe, confidence levels are strongly influenced by the prospects for each domestic economy. In Spain, the positive balance has fallen from 63 to 21 points over the past year, while it declined only marginally in Britain, Germany and the Netherlands.

The results support the European Central Bank’s argument last week that economic fundamentals in continental Europe “remain sound” and could shore up hopes that Europe will escape relatively unscathed from the financial turmoil. Financial markets have priced in cuts this year in ECB interest rates. But unlike the US Federal Reserve, the ECB has so far resisted pressure to slash borrowing costs. Jean-Claude Trichet, its president, stressed in Tokyo at the weekend that the central bank had not considered a cut at its meeting last week.

Manufacturers in the emerging economies of Brazil, Russia, India and China (Bric) are even more optimistic about 2008, with those predicting a rise in output outnumbering those predicting a fall by 64 points. The results provided “firm evidence that companies across both Europe and the Bric region are not expecting to follow the world’s largest economy into recession”, said Andrew Smith, chief economist of KPMG, which sponsors the research.

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US downturn hits Asian garment makers

An expected downturn in US clothing demand is adding to the woes of Asian garment makers already struggling because of rising costs and stronger currencies. In China, which just three years ago was entangled in a trade dispute with the US and the European Union over export quotas, concerns have switched to the spiralling costs that are eroding its competitive advantage.

“Costs are hitting us,” says Henry Tan, chief executive of Luen Thai, a large Hong Kong-based manufacturer with operations in China. “Sales to Europe are not so bad because the euro is strong, but sales to the US are very difficult.”
Chinese manufacturers have been facing double-digit annual wage increases over the past few years. More recently their headache has come from the renminbi’s appreciation, which Beijing has allowed to gather pace this year as it seeks to curb inflation. Manufacturers now “have to compete on brand rather than on volume”, says Chen Wenjiang, president of Haining Grand Double Eagle Garments, a leather-jacket maker based in China’s eastern Zhejiang province.
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Garment makers face a similar challenge in India, where an appreciation of the rupee that started last year has seen an estimated 500,000 jobs – out of a total workforce of 55m – cut in the textiles industry, the country’s second-largest em-ployer after agriculture. Since September Indian exports to the US have slowed by 5-6 per cent. This makes it likely the government will miss its initial $160bn (€110bn, £82bn) export forecast for the fiscal year ending in March, according to G. Bujpal, at the commerce ministry.

The difficulties are also spreading to smaller Asian garment producers such as Cambodia and Bangladesh, which until recently had been riding a textiles boom. Impoverished Cambodia depends heavily on its garment industry, which accounts for 96 per cent of exports and 13 per cent of GDP. And the industry relies heavily on US consumers, the market for about 70 per cent of output. But after growing about 17 per cent in the first half of 2007, Cambodia’s garment exports plummeted 22 per cent per cent in the fourth quarter, in part because of a precipitous 49 per cent drop in exports to the US market in December.

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The ecological economy an essay

Picture a drunk so far gone that he's bent on drinking himself sober. It's much like the behaviour of governments and central banks in Canada and the U.S. in the face of a looming North American recession, suggests Robert Costanza.

In response to an economic downturn caused by excesses of debt run up in pursuit of over-consumption, the banks have slashed interest rates and governments have cut sales taxes and offered tax rebates in hopes that people will spend more on stuff and services and thereby boost the economy back to full-throttle growth. Heaven forbid they should invest it in savings; it would be the ruination of the whole scheme.

"It's crazy, insanity," said Costanza, who is director of the Gund Institute for Ecological Economics at the University of Vermont. "Insanity means doing the same things and expecting a different result."
It would seem not the best of times to be pushing the cause of ecological economics, of which Costanza is a prime mover.

He and his eco-economist cohorts preach against the classic doctrine of the dismal science. It disputes the long-standing assumption that the measure of a nation's economic health and well-being of its society is a steadily growing gross national product. They argue that traditional economic accounting doesn't factor in the cost of resource depletion and environmental damage involved in sustaining a perpetually burgeoning GNP.

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Dutch refuse to sign off on EU accounts

The Netherlands is to refuse to sign off on the European Union’s accounts in an attempt to force national governments to take more responsibility for the European money they spend.

Wouter Bos, Dutch finance minister, is set to be heavily outvoted at a meeting of his peers on Tuesday to pass the 2006 budget of €107bn (£80bn, $155bn), in spite of huge errors found by auditors last year in the four-fifths of money that is spent nationally. Mr Bos, backed by the European Commission and members of the European parliament, aims to press states to provide proof that the money was well spent. The Commission has threatened to suspend billions of euros worth of payments or take legal action if they do not provide such proof.

Mr Bos, who last year became the first finance minister to sign an annual statement that EU agricultural spending had been audited, has said he will vote against discharge of the budget. “An improvement needs to be made in accounting for EU money, and much more work needs to be done by member states,” a Dutch government spokesman told the Financial Times. “This is an issue for member states more than the Commission.”

The court of auditors, the EU’s financial watchdog, has qualified the EU’s accounts for 12 years in a row for lack of controls. It found that 12 per cent of the €32bn regional fund budget was paid out in error in 2006. That was six times the error rate for agricultural subsidies. Though only a fraction of it may have been misused, states were unable to show they had sent it to the right recipient, the auditors said.

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Gold Traders See Through ECB’s ‘Smoke and Mirrors’

European Central Bank chief, Jean “Tricky” Trichet, likes to operate behind a veil of “Smoke and Mirrors” in managing the Euro zone’s monetary policy, which is designed to fool most people, most of the time. Most importantly, “Tricky” Trichet, has fueled the fastest growth in the Euro M3 money supply in history, running at three times the rate of the ECB’s original guidelines, deemed consistent with low inflation.

So it shouldn’t have been a surprise to learn that inflation in the Euro zone hit an all-time high of 3.2% in January, and far above the ECB’s inflation target of 2 percent. Euro zone producer price inflation picked up to an annual 4.3% in December, led by higher food and energy costs. Trichet and his band of propaganda artists have given plenty of lip service to fighting inflation in recent months, but behind the veil of “Smoke and Mirrors”, haven’t lifted a finger to put empty words into action.

“We are ready to act pre-emptively, if longer-term inflation expectations threaten to persistently deviate from our inflation goal,” warned Bundesbank chief Axel Weber in the Jan 25th edition of the German newspaper Boersen-Zeitung. On Jan 24th, Bank of France chief Christian Noyer said, “On European interest rates, our principle objective is price stability, our duty is to defend purchasing power,” he said.

Yet under the leadership of “Tricky” Trichet, the purchasing power of the Euro in “hard money” terms, measured against the price of gold, has collapsed by 90% over the past four years. Speaking to the World Economic Forum in Davos on Jan 24th, “Tricky” Trichet told central bankers that under the capital market system it was natural for risks to emerge, but central bankers’ main job is to solidly anchor inflation expectations. “There is one needle in our compass and it is price stability.”

“What is extremely important is to offer as steady grounds as possible. First, price stability and then solidly anchor inflation expectations. If risks did not materialize you would not be living in a market economy, you would be living in the Soviet Union,” Trichet explained. Yet 2-weeks later, Trichet was shifting his vigilant stance against inflation, and leaving the door ajar for ECB rate cuts in the months ahead.

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Ilargi: Prudent Bear’s overview is exhaustive. Tons of things that you haven’t seen before.

At the Heart of Deepening Monetary Disorder

Unbalanced Global Economy Watch:

February 8 – Bloomberg (Greg Quinn):  “Canada added 46,400 jobs in January, more than four times as many as anticipated… The unemployment rate fell to 5.8% from 6% the previous month, returning to a 33-year low set in October…”

February 5 – Bloomberg (Fergal O’Brien):  “European retail sales fell the most in at least 13 years in December as higher food and energy costs prompted consumers to rein in their Christmas spending.  Retail sales in the euro area declined 2% in December from a year earlier, the biggest drop since at least January 1995…”

February 5 – Bloomberg (Steve Scherer):  “Italy’s inflation rate in January surged to the highest in at least 11 years, driven by rising energy, transportation and food costs.  Consumer prices calculated by European Union standards rose 3.1% from a year earlier…”

February 5 – Bloomberg (Ben Sills):  “Industrial production in Spain, which accounts for a seventh of the economy, posted the biggest contraction in more than five years in December as slower European growth curbed demand for Spanish goods.  Production at factories, farms and mines fell 2.4% from a year earlier after adjusting for the number of days worked…”

February 8 – The Wall Street Journal (Christopher Emsden and Edith Balazs):  “Accelerating inflation is driving interest rates higher in Eastern Europe, even as borrowing costs on the western side of the continent are coming down. The Czech National Bank on Thursday raised its core interest rate by a quarter of a percentage point to 3.75% in an effort to fight inflation, which hovers near six-year highs. The move followed similar rate increases in Poland, Romania and Serbia in recent days, and the dashing of hopes for a rate cut in Hungary, as inflation gallops across the continent. The main drivers of inflation in the east are the same as in the west: rising food and energy prices. Inflation rates are also above central-bank targets in the euro zone and in the United Kingdom…  But along with higher food and energy prices, the economies of the east are also seeing spill-over into so-called second-round effects, such as wage increases to compensate for higher prices. Those second-round effects threaten to keep inflation rates at higher levels in Eastern Europe for a longer period of time…”

February 8 – Bloomberg (Marketa Fiserova and Andrea Dudikova):  “Czech inflation accelerated faster than expected in January to the quickest pace in more than nine years because of government increases in taxes, rent and healthcare fees.  The inflation rate rose to 7.5% from 5.4% in December…”

February 7 – Bloomberg (Ott Ummelas):  “Estonia’s inflation rate rose to a near 10-year high in January, led by an increase in taxes on fuel, alcohol and tobacco, boosting concerns that high consumer prices may help undermine economic growth.  The inflation rate increased to 11%, the most since April 1998, from 9.6% in December…”

February 5 – Bloomberg (Alex Nicholson):  “Russian inflation accelerated in January to its fastest pace in 30 months as oil and gas prices surged, fueling consumer demand.  Consumer prices rose an annual 12.6% in January from 11.9% in the previous month…” 

February 7 – Bloomberg (Alex Nicholson):  “Central Bank Deputy Chairman Alexei Ulyukayev said the Russian economy is showing signs of ‘overheating,’ the Interfax agency reported… High consumer demand and an ‘imbalance’ between wage growth and productivity are ‘symptoms of overheating…’”

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