Bluffton, South Carolina. "Varn & Platt Canning Co. 10-year-old Jimmie. Been shucking 3 years. 6 pots a day, and a 11-year-old boy who shucks 7 pots. Also several members of an interesting family named Sherrica. Seven of them are in this factory. The father, mother, four girls shuck and pack. Older brother steams. 10 year old boy goes to school. Been in the oyster business 5 years. Father worked for 25 years in the Pennsylvania Coal Mine, and the oldest brother there. They said they liked the oysters business better because the family makes more"
Stoneleigh: It is time to undertake the yearly review and update of our primer guide, with a view to making it easier for our readers to see the entirety of our TAE worldview in one place. Primers are continuously added in order to flesh out the biggest possible big picture. This will continue as we move over to our new site later this year. These essays are not tied to the events of a specific day, week or month, but are the ones that take a step back and look at the world through a wide angle lens.
We have covered a wide variety of topics in the three and a half years of our existence. The point is to tackle complexity and make it comprehensible, rather than assuming away the context as most analyses do. All the strands of our century of challenges are interwoven, with each affecting the others. It is vital to understand those interactions, as well as to understand each separate topic and their relative timelines. Different factors will act as primary drivers at different times.
We retain our primary focus on Ponzi finance and the nature of markets, since the consequences of a major bubble implosion will have the greatest impact in the shortest time. Exploring those consequences, both within and beyond the financial realm is of immediate importance, given the scale of the impacts and how quickly they can manifest as a contraction picks up momentum to the downside.
As always, we cover energy as the master resource, and this year the major focus of new energy primers has been the catastrophe at Fukushima. We have also begun to cover the natural gas situation in North America in some detail, returning to the familiar theme of Ponzi dynamics.
The Resurgence of Risk, which appeared at The Oil Drum Canada in August 2007 provides the background to how we came to be in our present predicament. It is by far the longest of the primers, and its purpose is to explain in some depth the nature of our credit bubble, the role of 'financial innovation', the distinction between currency inflation and credit hyper-expansion and the mechanism by which value disappears as a bubble deflates.
For further explanation of the ponzi nature of bubbles, the spectrum of ponzi dynamics underlying many economic phenomena and the implications of this for where we are headed, see From the Top of the Great Pyramid.
This ties in with an earlier piece from The Oil Drum Canada, Entropy and Empire, detailing the progression of hegemonic power from empire to empire, as each rises, over-reaches, falls and passes the mantle on to its successor.
The picture in terms of real politik (ie the way the world really works behind the scenes) is further developed in
- Economics and the Nature of Political Crisis,
- Corruption, Culpability and Short-Termism,
- Hornswoggled Absquatulation,
- A Future Discounted,
- The Worth of the Earth,
- Beyond the Trust Horizon,
- The Lord of More,
- Trickles, Floods and the Escalating Consequences of Debt,
- The View From the Bottom of the Pyramid and
- The Last of the Affluent, the Carefree and the Innocent.
When bubbles reach their maximum extent, they invariably deflate. Our explanation as to why this is inevitable can be found in Inflation Deflated, followed by, The Unbearable Mightiness of Deflation, a rebuttal to inflationist Gary North, and Debunking Gonzalo Lira and Hyperinflation.
The Nature of Markets:
We dispute classical economic theory and the received wisdom as to the nature of markets. Markets are not objective, mechanical and rational as the Efficient Market Hypothesis would have you believe. Our explanation of markets as human phenomena grounded in destabilizing positive feedback can be found in Markets and the Lemming Factor, A Glimpse Into the Stubborn Psychology of Fish and The Future Belongs to the Adaptable (with kudos to Robert Prechter, who has been developing the hugely important theory of socionomics for many years). Historical perspective with regard to bubbles and financial crisis is provided in The Infinite Elasticity of Credit, and a view of finance and ecology as analogous systems structure can be found in Fractal Adaptive Cycles in Natural and Human Systems.
We have a number of articles on specific aspects of our current crisis. Our view of real estate can be found in Welcome to the Gingerbread Hotel and Bubble Case Studies: Ireland and Canada. Employment is covered in War in the Labour Markets and An Unstable Tower of Breaking Promises.
The Special Relativity of Currencies and Dollar-Denominated Debt Deflation address our view of currency inter-relationships and the value of currency relative to available goods and services.
Our take on the future for gold can be found in A Golden Double-Edged Sword, and our view of -global- trade is covered in The Rise and Fall of Trade.
Oil and Gas:
Our view of the intersection between peak oil and finance can be found in Energy, Finance and Hegemonic Power and Oil, Credit and the Velocity of Money Revisited. The notion of shale gas as a game-changer and a clean source of energy is challenged in Get Ready for the North American Gas Shock and Fracking Our Future. Ponzi dynamics feature once again.
Renewables and Electricity:
The prospects for renewable power are encapsulated in Renewable Power? Not in Your Lifetime, A Green Energy Revolution? and The Receding Horizons of Renewable Energy.
Nuclear power, in the aftermath of the Fukushima catastrophe, is covered in a series of articles written in the two months following the earthquake: How Black is the Japanese Nuclear Swan?, The Fukushima Fallout Files, Fukushima: Review of an INES class 7 Accident, Fukushima: Fallacies, Fallout, Fundamentals and Fear and Welcome to the Atomic Village.
Departing from finance and energy, our contribution to the health debate, which is relevant to future food supply and storage, can be found in Our Daily Bread, or Not, As the Case May Be.
Summary and Lifeboat Prescriptione:
A point-form summary of our views for the future is available in 40 Ways to Lose Your Future, and our prescription for facing hard times is presented in How to Build a Lifeboat.
This is our attempt to convey what we as individuals can hope to do about it for ourselves, our families and friends. We cannot avoid living through a Greater Depression, but we can take action, and, being forewarned, we can hopefully avoid many pitfalls. We can attempt to avoid becoming part of the herd that is determined to throw itself off a cliff.
The big picture is of crucial importance as we have reached, and passed, the pinnacle of a golden age. We are moving into an era of uncertainty and upheaval such as none of us have hitherto experienced but all of us must try to navigate successfully. We at The Automatic Earth will continue to provide what assistance we can with that process. The TAE world tour continues, recently in the US, currently in Europe and in Australia after Christmas.
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The moral decay of our society is as bad at the top as the bottom
by Peter Oborne - Telegraph
David Cameron, Ed Miliband and the entire British political class came together yesterday to denounce the rioters. They were of course right to say that the actions of these looters, arsonists and muggers were abhorrent and criminal, and that the police should be given more support. But there was also something very phony and hypocritical about all the shock and outrage expressed in parliament. MPs spoke about the week’s dreadful events as if they were nothing to do with them.
I cannot accept that this is the case. Indeed, I believe that the criminality in our streets cannot be dissociated from the moral disintegration in the highest ranks of modern British society. The last two decades have seen a terrifying decline in standards among the British governing elite. It has become acceptable for our politicians to lie and to cheat. An almost universal culture of selfishness and greed has grown up.
\It is not just the feral youth of Tottenham who have forgotten they have duties as well as rights. So have the feral rich of Chelsea and Kensington. A few years ago, my wife and I went to a dinner party in a large house in west London. A security guard prowled along the street outside, and there was much talk of the "north-south divide", which I took literally for a while until I realised that my hosts were facetiously referring to the difference between those who lived north and south of Kensington High Street.
Most of the people in this very expensive street were every bit as deracinated and cut off from the rest of Britain as the young, unemployed men and women who have caused such terrible damage over the last few days. For them, the repellent Financial Times magazine How to Spend It is a bible. I’d guess that few of them bother to pay British tax if they can avoid it, and that fewer still feel the sense of obligation to society that only a few decades ago came naturally to the wealthy and better off.
Yet we celebrate people who live empty lives like this. A few weeks ago, I noticed an item in a newspaper saying that the business tycoon Sir Richard Branson was thinking of moving his headquarters to Switzerland. This move was represented as a potential blow to the Chancellor of the Exchequer, George Osborne, because it meant less tax revenue.
I couldn’t help thinking that in a sane and decent world such a move would be a blow to Sir Richard, not the Chancellor. People would note that a prominent and wealthy businessman was avoiding British tax and think less of him. Instead, he has a knighthood and is widely feted. The same is true of the brilliant retailer Sir Philip Green. Sir Philip’s businesses could never survive but for Britain’s famous social and political stability, our transport system to shift his goods and our schools to educate his workers.
Yet Sir Philip, who a few years ago sent an extraordinary £1 billion dividend offshore, seems to have little intention of paying for much of this. Why does nobody get angry or hold him culpable? I know that he employs expensive tax lawyers and that everything he does is legal, but he surely faces ethical and moral questions just as much as does a young thug who breaks into one of Sir Philip’s shops and steals from it?
Our politicians – standing sanctimoniously on their hind legs in the Commons yesterday – are just as bad. They have shown themselves prepared to ignore common decency and, in some cases, to break the law. David Cameron is happy to have some of the worst offenders in his Cabinet. Take the example of Francis Maude, who is charged with tackling public sector waste – which trade unions say is a euphemism for waging war on low?paid workers. Yet Mr Maude made tens of thousands of pounds by breaching the spirit, though not the law, surrounding MPs’ allowances.
A great deal has been made over the past few days of the greed of the rioters for consumer goods, not least by Rotherham MP Denis MacShane who accurately remarked, "What the looters wanted was for a few minutes to enter the world of Sloane Street consumption." This from a man who notoriously claimed £5,900 for eight laptops. Of course, as an MP he obtained these laptops legally through his expenses.
Yesterday, the veteran Labour MP Gerald Kaufman asked the Prime Minister to consider how these rioters can be "reclaimed" by society. Yes, this is indeed the same Gerald Kaufman who submitted a claim for three months’ expenses totalling £14,301.60, which included £8,865 for a Bang & Olufsen television. Or take the Salford MP Hazel Blears, who has been loudly calling for draconian action against the looters. I find it very hard to make any kind of ethical distinction between Blears’s expense cheating and tax avoidance, and the straight robbery carried out by the looters.
The Prime Minister showed no sign that he understood that something stank about yesterday’s Commons debate. He spoke of morality, but only as something which applies to the very poor: "We will restore a stronger sense of morality and responsibility – in every town, in every street and in every estate." He appeared not to grasp that this should apply to the rich and powerful as well.
The tragic truth is that Mr Cameron is himself guilty of failing this test. It is scarcely six weeks since he jauntily turned up at the News International summer party, even though the media group was at the time subject to not one but two police investigations. Even more notoriously, he awarded a senior Downing Street job to the former News of the World editor Andy Coulson, even though he knew at the time that Coulson had resigned after criminal acts were committed under his editorship.
The Prime Minister excused his wretched judgment by proclaiming that "everybody deserves a second chance". It was very telling yesterday that he did not talk of second chances as he pledged exemplary punishment for the rioters and looters.
These double standards from Downing Street are symptomatic of widespread double standards at the very top of our society. It should be stressed that most people (including, I know, Telegraph readers) continue to believe in honesty, decency, hard work, and putting back into society at least as much as they take out.
But there are those who do not. Certainly, the so-called feral youth seem oblivious to decency and morality. But so are the venal rich and powerful – too many of our bankers, footballers, wealthy businessmen and politicians.
Of course, most of them are smart and wealthy enough to make sure that they obey the law. That cannot be said of the sad young men and women, without hope or aspiration, who have caused such mayhem and chaos over the past few days. But the rioters have this defence: they are just following the example set by senior and respected figures in society. Let’s bear in mind that many of the youths in our inner cities have never been trained in decent values. All they have ever known is barbarism. Our politicians and bankers, in sharp contrast, tend to have been to good schools and universities and to have been given every opportunity in life.
Something has gone horribly wrong in Britain. If we are ever to confront the problems which have been exposed in the past week, it is essential to bear in mind that they do not only exist in inner-city housing estates.
The culture of greed and impunity we are witnessing on our TV screens stretches right up into corporate boardrooms and the Cabinet. It embraces the police and large parts of our media. It is not just its damaged youth, but Britain itself that needs a moral reformation.
Most Americans don't have $1,000 saved for emergency
A majority, or 64 percent, of Americans don't have enough cash on hand to handle a $1,000 emergency expense, according to a survey by the National Foundation for Credit Counseling, or NFCC, released on Wednesday.
Only 36 percent said they would tap a rainy day funds for an emergency. The rest of the 2,700 people polled said that they would have to go to other extremes to cover an unexpected expense, such as borrowing money or taking out a cash advance on a credit card.
"It's alarming," said Gail Cunningham, a spokeswoman for the Washington, D.C.-based non-profit. "For consumers who live paycheck to paycheck -- having spent tomorrow's money -- an unplanned expense can truly put them in financial distress," she noted.
That's the case for Allyson Curtis, 35. "I think about it every day," she said. Curtis was unemployed for only three months last year, but in that time she accumulated $5,000 in credit card debt that she's now struggling to pay down. In the case of an emergency, Curtis said she would likely postpone other payments and pile on additional debt.
She is already putting off $450 in dental work and a car inspection due to a crack in her windshield, which will cost $300 to replace, she said.
Many respondents, 17 percent, said they would borrow money from friends or family. Another 17 percent said they would neglect other financial obligations -- like a credit card bill or mortgage payment -- in order to free up some funds.
Alternatively, 12 percent of the respondents said they would have to sell or pawn some assets to come up with $1,000 and 9 percent said they would need to take out a loan. Another 9 percent said they would get a cash advance from a credit card, according to the NFCC.
Cunningham finds that particularly troubling. Neglecting other debt obligations -- or worse piling on more debt -- "really exacerbates the problem," she said.
An earlier study by the same organization found that 30 percent of Americans have $0 in non-retirement savings. A separate study by the National Bureau of Economic Research found that 50 percent of Americans would struggle to come up with $2,000 in a pinch.
Reflections On "Correction 2" - This Summer It's Different
by Daniel Alpert - Westwood Capital
I feel more emboldened than ever (probably a good sign I should be rethinking my premise) to reiterate my general contextual theory that the developed world is experiencing the dual deflationary forces of a "supply shock" from the emerging markets, combined with a debt overhang remaining from the bubble period.
During the credit bubble the developed world (with the U.S. leading the way) attempted to neuter the supply shock with borrowed funds from our "suppliers." Thus we plugged the yawning gap between domestic production and consumption.
Europe did fundamentally the same thing, except that borrowing was state sponsored and enabled by the fiscal and monetary disconnect inherent in the Maastricht Treaty. Europeans used their borrowing to fund their social welfare system and to offset (as in Greece) corrupt tax regimes. No matter, the underlying issue was the same, they were producing far less than they consumed - with the exception of Germany, which in exchange for an undervalued currency elected to close its eyes to the subsidies its banks we providing to others in the zone.
Net, net - Euro Zone-wide - the effect is the same as it is stateside. But instead of order of relative debt burdens (high to low) being households/government/financial institutions/businesses (except small businesses, which are much like households) as it is in the U.S., the order in Europe is government/financial institutions/households/businesses.
Japan, of course did it differently still - looking back on their two decades of debt deflation, sacrificing corporate, financial institution and government balance sheets, while households were left to slowly dis-save over time.
Debt deflation is debt deflation, wherever the debt resides. Growth suffers either way. Adding the excess supply and productive capacity of the 3.5 billion people in the emerging markets overwhelmed aggregate global demand even before the developed world over-leveraged itself.
So, the next question to ask relative to the market events of July and August is: Why are things breaking down again now?
The answer is not as elusive as it may seem to some market participants.
Effectively we have "maxed-out" again - been "cut off" to use another metaphor. For a while, the developed world continued to pump itself up with additional liquidity, initially (and in Europe still) in the form of transferring private and sub-sovereign risk to government and central bank balance sheets. Shortly thereafter, the developed world engaged in large scale (but poorly spent) stimulus to attempt to stabilize plummeting demand. Finally, we have resorted to supply-side moves - zero interest rate policy, quantitative easing and tax breaks (either new or continued).
But here we are again. The aggregate debt burden in the U.S. and Europe has been shifted about in what can only be deemed a shell game - but it has not been significantly reduced and may have even risen last quarter.
Now the markets have wisely concluded that it is politically unlikely that we will see any fiscal stimulus - to the contrary we are confronted with 1937-like calls for, and actions towards, fiscal austerity.
Finally, the wiser policy makers in the central banking dodge have realized that additional monetary stimulus is futile at best, and counterproductive at worst. Increasing the supply of capital or liquidity to a globe that is awash in excess supply of capital and the means to use it, is like throwing lighter fuel on sputtering barbecue grill. You get a raging flare of commodity and financial asset inflation, and then the fire dies again - because the charcoal is not arranged properly in order to grow the heat: the temporary inflation kills demand rather than enhancing it.
Ben, Barack, Tim, Claude, Angela and Nick, have not been tending the grill well, I am afraid. And there is no question that the fire is dying during the cocktail hour.
Not that their intentions were bad, mind you. Trying to reflate the economy and employing the wealth effect of rising markets to spur demand is – from a text book perspective – the right thing to do to combat a shortage of demand and disinflation in general. But if the secular, structural environment is inhospitable to such moves, re-employment and middle class deleveraging do not follow – both of which are the necessary prerequisites for economic growth and the raising of sufficient revenues to deleverage governments.
The problem, of course, is that there are no options left that seem viable within the political environment we now inhabit. Members of congress from the heartland and representatives of the burghers of Germany and Holland have reached, perhaps foolishly, the breaking point on both fiscal spending and central bank bloat - simultaneously.
We have long been unable - despite valiant efforts to make our currency unattractive (ZIRP, QE, etc.) - to devalue the dollar in order to re-inflate the economy. Our trading partners simply won't let us in an environment of excess supply - everyone can't devalue at once – and the curse of being the world’s reserve currency is that the dollar is also the flight currency in times of weakness. Protectionist measures - once again being grasped at by otherwise well-intentioned but desperate minds - are more frightening to the market than almost any other solution.
The markets have merely awakened to this fact as the previous measures have expired or been removed, the economies of the U.S. and Western Europe having reacted accordingly.
I have written at length on what to do about the situation in the U.S. - in short, QE3...bad; modest deflation in nominal wages, prices an asset values...needed; an ambitious public infrastructure rebuilding and re-employment program at modest wages...good; household and financial institution debt restructuring and hits to creditors...simply unavoidable.
But we can talk about all that after Labor Day. The markets, probably not incorrectly, have concluded that all of the above are not yet on the agenda of anyone with the power to implement and shepherd economic restructuring. And that just means that the second and final items on the foregoing list off needed solutions will merely happen in a less controlled way. Needless to say - the markets don't like that anymore than the hit to equity capital that will inevitably result from pursuing the necessary systemic repairs.
We can, of course, merely try to wait for the expansion of demand in the emerging nations. The events of recent weeks are what that waiting looks like. And it would be a very, very long wait--
EU Heading for Eurobond Clash
by James G. Neuger - Bloomberg
European ratification of a reinforced crisis-management fund will act as a prelude to an even more divisive debate: whether to put more money into the pool and use it to borrow on behalf of all 17 euro states. The question of "eurobonds" or "fiscal union" -- toxic language in northern countries like Germany -- will force itself onto the agenda once the retooled rescue fund is in place as soon as next month.
The trigger will be a European Commission feasibility study of jointly sold eurobonds, seen by a growing number of economists as the only way of guaranteeing to the markets that countries such as Italy won’t go bust. Unprecedented bailouts by governments and the European Central Bank have so far failed to stamp out the crisis that is menacing the region’s core members.
"No single currency has ever survived without some form of debt mutualization," said Simon Tilford, chief economist at the London-based Centre for European Reform, a research institute focused on European integration. "There’s an increasing recognition that that is the only way of stabilizing the euro zone." The European debt crisis that began in Greece in late 2009 has triggered 365 billion euros ($521 billion) in emergency bailout loans, exposed cracks in the euro’s architecture and rattled markets around the world. The fallout may overcome the unwillingness of euro leaders to forge a U.S.-style fiscal union and give up control over national budgets.
'Reverse the Dynamic'
"Only Germany can reverse the dynamic of a European decay," billionaire investor George Soros wrote in today’s Handelsblatt, the Dusseldorf-based newspaper. "Germany and other countries with a AAA rating have to approve some sort of euro-bond regime. Otherwise, the euro will implode."
For now, the focus is on country-by-country approval of the July 21 decision to empower the 440 billion-euro European Financial Stability Facility to buy bonds in the secondary market, grant precautionary credits and recapitalize banks. A raucous parliamentary exchange is shaping up in Germany, already dragged by the debt crisis into an unforeseen role as the euro zone’s guarantor after assenting to the EFSF in 2010.
German Chancellor Angela Merkel and French President Nicolas Sarkozy, who meet in Paris on Aug. 16, have an end-of- September ratification target to enable the EFSF to relieve the ECB of the bond-purchasing job. Along with September’s planned enactment of laws to strengthen Europe’s deficit-limitation rules and monitor economic imbalances, the EFSF upgrade will touch off a fracas Merkel has sought to avoid.
"Iron Chancellor Opposes Eurobonds," German newspaper Die Welt headlined last December when Merkel blunted earlier talk of the idea. Eurobonds are "taboo, damaging, undesired," Norbert Barthle, budget-policy spokesman for her Christian Democratic bloc in parliament, told Bloomberg News on Aug. 5.
While the opposition Greens Party agrees that the EFSF package should be passed as quickly as possible, "we don’t think it’s sufficient," co-leader Juergin Trittin said on ZDF television today. "In Europe, we need to stop individual states from refinancing themselves with bonds: We need European bonds," Trittin said. "That’s the only way to finally stop the speculation against the crisis states and these endless pictures of Merkel and Sarkozy going from summit to summit."
Polls suggest the Greens and their Social Democratic allies, who also back eurobonds, would defeat Merkel’s coalition if elections were held now.
Acting on a July request by the European Parliament, the Brussels-based commission will before year-end issue a report on how the pooling of borrowing could reinforce a monetary union that markets view as no stronger than its weakest link. Greece is the most expensive country in the world to insure against default.
The commissioner drafting the proposals, Olli Rehn of Finland, is already promoting them in a way that appeals to the fiscally tight countries in the euro area’s north. The study will examine whether eurobonds "could contribute to fiscal discipline and increase liquidity in the bond markets in Europe so that the countries enjoying highest credit rating standards would not see their borrowing costs higher," Rehn said on Aug. 5.
Germany, which authored the rules that failed to prevent Europe’s debt explosion, fears that mutual borrowing would drive up its financing costs, historically the euro area’s lowest and the benchmark for the region.
A switch to shared borrowing would push up German funding costs by 1.22 percentage points -- German 10-year yields are about 2.3 percent -- adding 25 billion euros a year to Germany’s interest bill, Kai Carstensen of the Ifo Institute in Munich told the Frankfurter Allgemeine Zeitung on July 19. "In terms of a eurobond, if it goes well then fine, but there is a real possibility that it won’t and the Germans will have to pay for it," Charles Goodhart, a former Bank of England policy maker and professor at the London School of Economics, said in a telephone interview. "It is essentially a transfer union in disguise."
Two broad options are under consideration in Brussels, according to EU officials: building out the EFSF and its successor as of mid-2013, the European Stability Mechanism, into a Europe-wide borrowing agent; or issuing joint bonds.
'Stabilize the System'
A jumbo fund that acts like a bank would be less controversial, since the EFSF already exists and is run by a former German Finance Ministry official, Klaus Regling. It would need close to 2 trillion euros to chase speculators away from Italy and Spain, Royal Bank of Scotland Group Plc estimates. "What we need is a sort of European monetary fund that can go in and stabilize the system with the backing of the central bank," Thomas Mayer, chief economist at Deutsche Bank AG, told Bloomberg Television.
The best-known joint-issuance proposal is the so-called blue-red model, drafted by researchers at the Brussels-based Bruegel institute. It foresees the 17 euro users selling common bonds to cover debt up to 60 percent of each country’s gross domestic product, the level deemed "sustainable" by the euro’s founding treaty. Greece’s debt last year was 143 percent of GDP, compared to Italy’s 119 percent and Germany’s 83 percent.
That tranche of "blue" bonds would carry a common interest rate. Debt over the treaty limit would be financed by "red" bonds, sold by each country on its own at penalty rates that provide an incentive to keep deficits down.
Blue bonds would form a 5.6 trillion-euro market, dwarfing today’s national pools, according to the authors of the May 2010 proposal, Jacques Delpla and Jakob von Weizsaecker. By turning the euro market into the world’s second largest after U.S. Treasuries, the liquidity boost would quash the Germans’ cost concerns by saving each country 30 basis points per bond, the authors wrote.
Under a variant mooted by economists Paul De Grauwe and Wim Moesen in 2009, the interest coupon on a common bond would be computed as the weighted average of yields paid by each national borrower. Germany and Greece would pay the same rate differential as before, banishing the risk of the rich subsidizing the weak, De Grauwe and Moesen wrote. The advantage for Greece would lie in guaranteed market access, they said.
"There is no way you can help the weaker parties without hurting the strongest parties," Gary Jenkins, head of fixed- income credit research at Evolution Securities in London, said on Bloomberg Television. "But unfortunately for them, they’re in a union. So they’re either in it, or they’re not. And they either have to have some kind of transfer of money, some kind of guarantee system or the whole thing’s going to fall apart."
Weaker euro states could lose local banks
by Harry Wilson - Telegraph
Weaker eurozone members face the prospect of being left with no domestic banks in future as market resistance to funding lenders in peripheral countries grows.
Equity analysts at Standard & Poor's, the credit rating agency, said that the problem with the European banking system is that it is "not aligned to the single currency area" and that larger banks with operations across the region were likely to replace smaller single country-focused lenders.
"We envisage that banks operating on a more EU-wide basis, alongside an ECB with appropriate powers, would be an important part of a sustainable euro project," said Tony Silverman, a financial analyst at S&P. "This may mean peripheral countries should not necessarily expect to have their own domestic banks," he added.
Mr Silverman points out that about 50pc of eurozone deposits lent through the European Central Bank and the interbank market are to banks that have loans in excess of their deposits, adding there is a "conspicuous" absence of banks that are net lenders to the market. "We would question whether this is sustainable and indeed to what extent such funding can meaningfully be regarded as temporary," said Mr Silverman.
Banks in countries such as Greece, Portugal and Ireland have become dependent on ECB funds to remain in business and loans originally seen as short-term have become an integral part of their funding.
The eurozone crisis has put a focus on these issues and there are now doubts as to whether many of these lenders remain viable as independent entities in the longer term. "Eurozone countries have as much right to their own banks as Northumberland," said Mr Silverman.
Ireland is undertaking a drastic reform of its banks and is in the process of merging four of its largest lenders to create two new – what is hoped will be more solid – banks able to eventually be returned to the private sector having been nationalised. In Spain too, the authorities have pushed the country's regional savings banks – known as cajas – to merge to create larger banks.
However, Mr Silverman's analysis suggests that even these larger institutions will remain unsustainable in the long-term due to their domestic focus. Figures for May show that ECB borrowing by Spanish banks increased for the first time in nine months, pointing to an increased funding risk among the smaller savings banks.
In France there are also concerns that the funding markets are becoming increasingly wary about the country's banks.
David Faber, Chris Whalen and Euro Banks
by Bruce Krasting, My Take On Financial Events
I think a lot of Chris Whalen over at Institutional Risk Analytics, so I tuned in CNBC to listen to him this morning. At one point the discussion turned to Europe and Chris made it clear:
There are growing funding issues at some European banks
David Faber jumped out of his chair and challenged Whalen. He implied that Chris was making things up and spreading rumors. I was a bit surprised. It was if Faber was defending the Euro banks.
Faber is an ass. He doesn’t read newspapers either. Two recent headlines:
My understanding from talking to Europe again the morning is that there is a constant drain of dollar funding from highly rated core European banks. I’m absolutely confirming what Whalen has separately heard.
Behind the problems are US money market funds. They have been reducing their exposure to the big “safe” Euro banks. This process has been ongoing for some time. It's not news at all.
This chart from Fitch shows where the exposures were at the end of June. Note that there is not much outstanding for Spain and Italy, but you can be sure that even those numbers are much lower today. Germany is relatively small; the reason is they don’t pay much for deposit money. But look who is a total of 15% of all US money funds.France.
A US money fund that is either facing redemptions (they are) or who just wanted to reduce Euro bank exposure there is only one place to go; France. And that is what is happening. I have no idea of the volume of this unwind; my instincts tell me it is pretty large. It accelerated today.
It’s only Wednesday. There is a lot of time to worry about this before Friday. Normally big developments in Europe have happened over a weekend. That may not be case this time around. The markets may force the global finance leaders to move more quickly to (try to) stabilize things.
The mechanism is already in place. The US dollar swap agreements can be used at any time. A trillion of liquidity could be provided very quickly. It would require that the central banks of Europe on-lend the liquidity to the commercial banks. That would solve the solvency issue. It would be the equivalent of a Euro TARP. A semi-nationalization of the banks.
I wrote yesterday that I was dumfounded by Bernanke’s decision to extend ZIRP for two years. This unprecedented step has huge risks attached to it. Bernanke is well aware of that. Why did he risk it all? He must have known that there was soon to be a very big sucking noise from Europe. One that would require the USA to lend Europe some very big bucks.
I have some sense of what is going on in the background. Chris Whalen has a much better idea than I. But the big shots at the major banks know exactly what is going on the funding markets. After all, they ARE the funding markets. I can assure you that central bankers and treasury officials are all talking as well.
So if your wondering why stocks are tanking and bonds are soaring it’s because the news on this is already out. It’s just not in print. A thanks to Chris Whalen for putting this so squarely on the table.
The era of incredible shrinking banks
by Frank Partnoy - FT
How many people does it take to operate a modern bank and how much should such a bank’s shares be worth? The one-two punch of recently announced lay-offs and stock price declines suggests that the answer to both questions is a lot smaller than you might think.
The numbers are staggering. As of midday on Wednesday, shares of Barclays and Credit Suisse, which announced lay-offs last week, are down more than 20 per cent for the month. Shares of HSBC, which will be making 30,000 redundancies – a 10th of its workforce – are down 17 per cent. Shares of Lloyds, which is cutting 15,000 jobs, are down nearly that much.
Other financial institutions, including Goldman Sachs and UBS, have announced job cuts and suffered double-digit share price declines. And then there are Bank of America and Citigroup, the two banks facing the most intense pressure from investors this week; together they employ more than half a million people. For now.
Typically, job cuts are good for shareholders because they reduce labour costs and improve efficiency. But these lay-offs have set off a labour-capital death spiral: they are bad for employees but are proving even worse for shareholders, and the declines in the share prices of banks are putting yet more pressure on employees and will probably lead to more lay-offs. And so on, and so on.
Bank analysts cite several reasons for share price declines, including litigation exposure, declining investor and consumer confidence and a faltering economy. But one overarching factor, which also explains the increase in lay-offs, is the declining importance of banks.
Banks are supposed to play only a limited function in the economy. Historically they just match lenders and borrowers. Most banking activity – lending, underwriting, mergers, sales, trading and wealth management – revolves around the allocation of capital. But over time, banks have expanded into riskier and more complex activities, including structured finance, derivatives trading and regulatory arbitrage, which can allocate capital in distorted ways. But even distorted capital allocation is still capital allocation; for better and worse, that is essentially what banks do.
In the future, improved technology will reduce the number of human beings needed to allocate capital, as it has done in other service industries. People will also play a smaller role in dealmaking and trading, just as they do when we board a plane or shop for clothes. HSBC is downsizing so dramatically because its leaders look at technology companies and see their bank as a dinosaur that must shed weight or become extinct.
Contrast the employment numbers for banks and technology firms. HSBC and Google obviously differ in substance but both companies are focused on innovation and service, and also have roughly similar market capitalisations. The striking difference is that Google generates these numbers with fewer than 30,000 employees – not even as many people as HSBC is laying off.
Facebook and its peers also play an allocative function, just as banks do, except they help people move content instead of capital. Social network firms and banks both allocate information; in one case it is personal data and in the other it is money. As with Google, though, the employment numbers differ starkly. Facebook’s equity is worth more than that of most banks, yet it has just 2,000 employees.
Imagine the following thought experiment. If all of the world’s major banks had failed during 2007-08, and regulators had permitted Apple, Facebook, Google and Microsoft to take over the economy’s capital allocation function, how would employment numbers have changed? Surely any neo-bank would hire smart lenders, traders, analysts and advisers, the people who have the strongest relationships with, and knowledge of, the institutions that demand or supply capital. But would they have hired all of them? Half? How many people would a new bank really need? Hedge funds take on traditional bank functions with a fraction of the employees.
When my new law students arrive for classes later this month, I will begin with one question: for whose benefit should companies be run? Most for-profit companies are run for the benefit of shareholders. But banks have been run more for the benefit of employees. In the future, banks will face pressure from both groups. They will occupy a smaller place in the economy and they will be less profitable. In a decade, there will be fewer professionals working on Wall Street than there are today. As banks revert to their more limited historical role in capital allocation, they will face hard choices about who to favour: shareholders or employees?
The recent turmoil among banks illustrates a deep irony: although banks are supposed to be exemplars of capitalism, during the previous two decades, bank employees have consistently won the labour-capital battle. As banks expanded, employees extracted most of the gains, like professional athletes demanding their teams’ profits and leaving owners with paltry returns, or even losses. Sports owners will suffer such indignities in exchange for glamour value. But owning a bank isn’t very much fun and future owners are going to play fewer games with smaller teams.
Wild Trading Is Little Help for Banks
by Aaron Lucchetti - Wall Street Journal
The dog days of August have turned hectic in the financial markets. But a spell of wild stock trading won't be enough to quiet the profit questions dogging Wall Street's biggest firms.
The recent stock-market carnage has been marked by a pronounced surge in trading activity. More than 16 billion shares changed hands daily on all U.S. markets as stocks gyrated Friday, Monday and Tuesday. That puts those three days among the 10 busiest stock-trading days ever, according to New York Stock Exchange parent NYSE Euronext. Thursday didn't make the busiest-ever list but registered a still-substantial 13 billion shares.
A run of frenzied trading sounds like a rare bit of good news for big brokerage firms such as Goldman Sachs Group Inc. and Morgan Stanley. Shares in both firms are trading near two-year lows, after a run of softening profits, and are fetching less than book value, a measure of a firm's net worth.
Yet even a sustained run of heavy trading volume alone isn't likely to make up for the setbacks they have suffered lately. While bond trading has picked up in recent weeks, new deals have slowed, putting pressure on a business that was a big driver of Wall Street profits during the 2009-2010 recovery. Bond and commodity trading revenue at nine big U.S. and European banks dropped 37% in the second quarter from the first quarter, according to Nomura Securities.
What's more, a stock-trading surge likely won't generate enough commission revenue for banks and securities firms to overcome the losses they are expected to take this quarter from holding stock inventories whose value has fallen with the recent market rout. "It's a tough environment," says Nomura analyst Glenn Schorr. "Derisking is derisking, and that means people do less" after the initial storm clears.
Part of the reason that heavy activity likely won't save the day is that action sometimes doesn't predict trading profits as well as other indicators. Mr. Schorr points to the direction of the 10-year Treasury yield and the number of bond deals being sold on Wall Street.
On those metrics, the third quarter could be tough. Mr. Schorr noted that while bond trading may improve from the second quarter, the worst environment for bond trading desks tends to be times like now, when both Treasury yields and debt underwriting levels fall. Falling Treasury yields aren't bad on their face, but often correspond with a worsening economy, which is bad for bank profits as their lending spreads narrow.
In the third quarter so far, Treasury yields are plummeting, with the 10-year Treasury note recently yielding 2.34%, down from 3.18% on June 30. Debt underwriting is on a pace to fall from both the second quarter of this year and the third quarter of 2010, according to research firm Dealogic.
Another factor pointing toward a weak quarter: volatility. Roger Freeman, an analyst with Barclays Capital, says that banks' vast trading desks perform better when a key market volatility index known as the VIX stays below 30 on the Chicago Board Options Exchange. That is because banks can more easily and profitably hedge their stock inventories when blue-chips aren't diving and surging frantically.
Last month, while Congress worked to reach a debt-agreement with President Barack Obama, the so-called fear gauge rose from the teens into the 20s, then spiked into the 30s and 40s when a last-minute agreement failed to prevent a debt-downgrade by ratings firm Standard & Poor's.
Adding to the banks' pain, a sharp stock-market correction usually ails other parts of Wall Street, from the prime brokerage business that serves hedge funds to the brokerage forces serving wealthy individuals and bankers trying to get nervous companies to raise money or buy competitors.
Announced merger volume this month is down about 20% from the pace set during the first part of August of last year, while stock underwriting volume is down 28% so far this quarter, Dealogic says. Bond underwriting, excluding Treasurys, is being hit the hardest, falling 36% during the quarter from last year's pace, according to Dealogic.
Wall Street could have been hit harder had it not been for efforts to reduce its risk in recent years. Goldman Sachs, Bank of America Corp., Morgan Stanley and others have closed or announced plans to spin off trading desks designed to make profitable bets for the bank, rather than serve clients.
In part, that is why revenue and earnings estimates haven't been slashed yet by analysts following the banks. Analysts' estimates of Goldman Sachs's third-quarter per-share profit has fallen more than 20% since June 30, according to FactSet Research, in part because Goldman released disappointing second quarter earnings in July. Earnings estimates have fallen less sharply at Morgan Stanley, Citigroup Inc. and Deutsche Bank.
One beneficiary of the market mayhem: financial exchange companies, whose stocks have held up better than bank stocks. While exchanges may suffer later if there's an activity hangover after the decline, they get the immediate benefit of higher volume now without holding the inventories plaguing banks.
On Wednesday, Sandler O'Neill analyst Richard Repetto released a report saying that exchanges such as Nasdaq OMX Group Inc. and NYSE Euronext could see better earnings than expected in the third quarter, due to "surging" volumes in both stocks and derivatives contracts such as stock-index futures.
Mr. Repetto voiced caution, however, about online brokers such as TD Ameritrade Holding Corp. It benefits from heavy trading activity: This week, TD Ameritrade's CEO said the company had the busiest day in its history, processing more than 900,000 trades. But the company stands to be hurt by continued low interest rates, since it means there's less money to be earned by investing clients' balances, Mr. Repetto said.
Trading volumes hit record levels
by Telis Demos - FT
Trading in equities and derivatives has hit record levels this week as investors traded frantically in response to a tumult of factors such as the US Federal Reserve’s decision to stick with near-zero interest rates until 2013, fears over the US’s credit rating and the eurozone debt crisis.
Trading in currencies and gold, seen by many investors as a "safe haven" alternative to dollars, have spiked as central banks in the US, Europe and Japan have intervened to attempt to pump liquidity into currency, equity and sovereign debt markets. "A lot of the selling is being driven by uncertainty," said John Schlitz, head US market technician at Instinet. "It’s panic versus greed, and panic generates higher volume than greed.
CME Group, the world’s largest futures market, reported an all-time volume record on Tuesday, beating the last peak of activity hit during the "flash crash" last year in the US, when markets gyrated wildly.
On the CME, there were 25.7m contracts traded across all asset classes, with individual market records being hit in gold and Australian dollars. "With all this volatility and uncertainty, people might be nervous about making big, long-term bets on stocks. The leverage built in to derivatives contracts allows investors to benefit from smaller, shorter-term trades," said Justin Schack, managing director at Rosenblatt Securities.
Equity markets are also seeing levels of trading not witnessed since the height of the financial crisis. Tuesday’s US equity market volume of 16.9bn shares was the fifth highest on record, surpassed only by trading in the fall of 2008 and around the May 6 "flash crash". "It hasn’t been the huge spikes that we’ve seen in other situations, like on May 6. It’s been much more orderly but heightened activity throughout the day," said Joe Mecane, executive vice-president at NYSE Euronext.
The value of share trades done on the London Stock Exchange more than doubled on Tuesday to £10.8bn, from £5.3bn on August 2. On Wednesday morning at the market open, the New York Stock Exchange saw an all-time message traffic record of 121,257 messages per second in one 30-second period, which includes orders placed, cancelled, executed and routed.
The US options markets, where the CBOE Volatility Index, or the "Vix", trades, also set a daily record for the third session in a row, with 41.5m contracts traded on Monday. That compares to a peak of 27.7m contracts during September 2008, when Lehman Brothers collapsed.
Nicole Sherrod, managing director at online retail brokerage TD Ameritrade – which reported a record 900,000 trades on Monday – said that retail traders were particularly concerned with the US debt downgrade. They have also been unusually active in options trading, with covered calls seeing spikes in activity. Such contracts allow traders to generate income from long-term holdings. "Near-zero rates are forcing people to find alternative ways to generate income," she said.
Institutional traders have swarmed back into the equities market after mostly sitting on the sidelines during the past two years. Trading volumes at Liquidnet, a marketplace for blocks of shares available only to large funds, spiked last week to its highest since September 2008, a jump of 50 per cent versus last year.
"The only way to make money in this market is to be highly selective based on fundamentals, and that’s institutional trading," said Joe Mazzella, global head of trading at Knight Capital Group.
High-Frequency Firms Triple Trades in Rout
by Nina Mehta - Bloomberg
The stock market’s fastest electronic firms boosted trading threefold during the rout that erased $2.2 trillion from U.S. equity values, stepping up strategies that profit from volatility, according to one of their biggest brokers.
The increase from Aug. 1 to Aug. 10 over their 2011 average surpassed the 80 percent rise in U.S. equity volume, showing that high-frequency traders made up more of the market during the plunge, Gary Wedbush, executive vice president and head of capital markets at Wedbush Securities, said in a telephone interview. Wedbush is the largest broker supplying bids and offers on the Nasdaq Stock Market, according to exchange data.
"We’re seeing a tremendous amount of high-frequency trading," said Wedbush, whose company is one of the biggest execution and clearing brokers catering to high-speed firms. "Their business is a trading business, and volatility creates far more opportunities. Some of their algorithms and automated systems are trading two, three or five times as many shares as they would have in a more normalized volatility environment."
The role of high-frequency firms in periods of market swings has come under scrutiny since the May 6, 2010, crash that briefly erased $862 billion from U.S. share values. In contrast to their behavior this month, the traders and other professional investors were said to have withdrawn bids as the 2010 selloff worsened, according to a Sept. 30 report from the Securities and Exchange Commission and Commodity Futures Trading Commission.
Equity volume from Aug. 4 through Aug. 10 was a record for any five-day period, according to data compiled by Bloomberg and Credit Suisse Group AG. The daily average of 15.97 billion shares beat the previous record of 15.94 billion from Sept. 15 through Sept. 19, 2008. Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15.
Wedbush, which has about 1,000 employees including about 400 in Los Angeles, has been the largest provider of bids to buy and offers to sell shares on Nasdaq every month this year, according to data from Nasdaq OMX Group Inc. The next-largest was Morgan Stanley in New York.
Daily volume averaged 7.5 billion shares in the first half of 2011 when the Chicago Board Options Exchange Volatility Index, or VIX, was 18.04. It rose 80 percent to 13.6 billion shares from Aug. 1 through Aug. 10 while the VIX climbed to 32.69 and the S&P 500 slid 13 percent. The VIX measures the cost of using options as insurance against declines in the Standard & Poor’s 500 Index.
High-frequency trading is a technique that relies on the rapid and automated placement of orders, many of which are immediately updated or canceled, as part of strategies such as market making and statistical arbitrage and tactics based on momentum. It accounted for about 53 percent of trading earlier this year, down from 61 percent in 2009, according to Tabb Group LLC, a New York-based financial industry research firm. In 2006 it was 26 percent of the market, Tabb said.
Wedbush estimated the firms have made up 75 percent of American equity volume in August. They have boosted trading in shares of Apple Inc., Google Inc., Bank of America Corp. and Goldman Sachs Group Inc. since early July after reducing business the first half of 2011, Wedbush said. The traders are active in the SPDR S&P 500 ETF Trust, iShares Russell 2000 Index Fund and other exchange-traded funds, he said.
U.S. prosecutors have joined a regulatory investigation into whether some high-speed traders are manipulating markets by posting and immediately canceling waves of rapid-fire orders, two officials said in April. Justice Department investigators are working with the SEC to review practices "that are potentially manipulative," according to Marc Berger, chief of the Securities and Commodities Task Force at the U.S. Attorney’s Office for the Southern District of New York.
Algorithms, or strategies that execute bigger orders by breaking them into smaller pieces and sending them to different exchanges, also use high-frequency techniques. Mutual, pension and hedge funds employ algorithms built by brokers or vendors to automate some of their trading instead of manually placing orders in markets or turning to humans to buy or sell blocks. Wedbush said professionals who add bids and offers on exchanges make trading more efficient and reduce the cost to investors of buying and selling shares.
"The bulk of high frequency traders are adding liquidity to the marketplace," Wedbush said. "Automated traders employ a myriad of strategies that seek to profit from a stock’s short- term volatility, but the mass of HFT is adding liquidity by being on both sides of the market or doing creation/redemption arbitrage for ETFs."
Authorized brokers can buy the stocks in an index and swap them for shares in an ETF based on the benchmark, or sell ETF units and get shares of its companies. That reduces price differences between an ETF and the index on which it’s based. High-frequency firms generally focus on the most active securities, with about 80 percent of their trading limited to the 20 percent that are the most popular, Wedbush said.
Futures on the S&P 500 climbed 0.3 percent at 6:11 a.m. in New York today after the gauge surged 4.6 percent to 1,172.64 yesterday. The index had plunged as much as 18 percent from its 2011 high and traded at 12.3 times reported earnings on Aug. 10, the lowest valuation since March 2009, according to data compiled by Bloomberg. Dow Jones Industrial Average futures rose 28 points, or 0.3 percent, to 11,112 today.
63% of Volume
Tim Quast, founder of ModernNetworks IR LLC, a Denver-based consulting firm that advises Cisco Systems Inc., Accenture Plc and other companies about market structure and trading, estimates that high-frequency firms are handling about 63 percent of U.S. equities volume, up from about 61 percent in July and down from last year’s 70 percent.
Surges and rapid declines in the S&P 500 are being driven by institutional investors turning over baskets of stocks and investment banks hedging positions in response to actions by central banks in Japan, Switzerland, Europe and the U.S., Quast said. Institutional investments generally focus on correlation between products and asset classes whereas speculative trading is driven by divergence from historical price relationships among stocks, indexes, currencies and other gauges, he said.
"Institutions are engaged in massive efforts to transfer risk across multiple asset classes because of fluctuations in the yen, franc, euro and U.S. dollar," Quast said. His firm saw shifts in institutional money increase beginning on Aug. 4. "This is causing volume and volatility to increase, which in turn attracts volatility traders," he said.
The S&P 500 has moved in an average range of 2.65 percentage points between intraday highs and lows in the past month, the biggest gyrations since the 20-minute crash on May 6, 2010. That pushed the VIX up 50 percent to 48 on Aug. 8, the biggest surge since February 2007, then down 27 percent the next day for the second-largest drop in its 21-year history.
"You can look at a VIX chart and that’s almost perfectly correlated to high-frequency trading volumes," said Wedbush, who returned early from a family vacation in Lake Arrowhead, California, to monitor trading at the firm as volatility rose.
Other senior executives cut short their holidays, Wedbush said. Employees in the company’s technology and operations department, who normally get to the office at 3 a.m. Los Angeles time, have worked extra hours each day to run reports and deal with trade breaks that must be reconciled. The only problems Wedbush has seen is delays in reports about trades settling at the end of the day.
The brokerage is conducting the same type of risk and technology monitoring it does every day although it’s been "heightened," Wedbush said. The investment bank also buys and sells shares for institutional customers like mutual funds and engages in proprietary trading. He added that one reason the securities industry has functioned smoothly even as volume surged is increased automation.
"There’s been a tremendous amount of investment by broker- dealers and exchanges in the last three years," he said. "Because of cost-saving efforts and the commission environment being squeezed, people have had to automate their systems. Automation brings less chance for human errors and it’s paid off in this time of high risk, volume and volatility."
French Economy Stalls
by William Horobin and Nathalie Boschat - Wall Street Journal
Data released Friday showed the French economy failed to grow in the second quarter from the first as consumers sharply cut spending, complicating government plans to reduce its deficit as financial markets question its prized triple-A credit rating.
Gross domestic product in the euro zone's second-largest economy was flat in the second quarter after a 0.9% expansion in the first quarter from the end of 2010, national statistics agency Insee said. The figure dashed expectations of a 0.3% expansion, fueling concerns the government may not have the breathing space to meet its deficit targets.
French consumer spending, the traditional growth driver of the domestic economy, had held up during the recession in 2009. Consumer spending was supported through the economic downturn by a government-funded car-scrapping scheme, which was completely phased out at the end of 2010.
The stalled GDP growth follows an exceptional 0.9% surge in the first quarter, which was boosted by businesses increasing their stocks. Such activity failed to contribute to growth in the second quarter. The slowdown is another blow to France at the end of a week when markets have been plunged into turmoil, partly due to investors questioning France's triple-A rating after the U.S. was downgraded last week by Standard & Poor's Corp. There have also been swirling concerns about the health of the large French banks.
Wild swings in bank shares prompted France's stock market regulator, along with those in Belgium, Italy and Spain, to slap restrictions on short selling of financial shares effective Friday. If the French economy fails to expand at the 2% pace the government is expecting for this year, the official target of bringing the deficit down to 5.7% of GDP from 7.1% last year could be compromised. The government insists it will meet its deficit targets come what may, meaning it may need to embark on further spending cuts if growth disappoints.
French Finance Minister Francois Baroin sought to cast the growth outlook in a positive light. "For this year we are in line." he said on French radio, adding the parameters the government is working on for its 2012 budget are unchanged. The French government expects an acceleration of growth in 2012 to 2.25% from 2% in 2011. Insee said if the French economy fails to grow in the third and fourth quarters, the economy would still grow 1.4% in 2011.
France has already come under pressure from the International Monetary Fund to craft contingency measures to ensure it meets its targets. At the end of July, the fund said France cannot risk missing its medium-term fiscal targets given the need to keep borrowing costs low by securing its triple-A rating.
Focus of eurozone crisis turns to France
by Peggy Hollinger and Richard Milne - FT
Nicolas Sarkozy, the French president, gave his finance and budget ministers a week to devise new measures to cut France's budget deficit as shares in the country’s banks plummeted in the latest bout of financial markets turmoil.
Mr Sarkozy summoned his key ministers back from holiday for an emergency meeting as concern mounted over prospects for growth and the country’s ability to meet its debt targets. In a bid to reassure nervous markets, Mr Sarkozy said these "pledges will be kept whatever the evolution of the economic situation".
The meeting came as rumours circulated about French banks and the possibility of a French credit rating downgrade, with Société Générale plunging by as much as 23 per cent. It closed down 15 per cent, after it denied rumours over its financial stability, while Crédit Agricole was off 12 per cent and BNP Paribas down 9 per cent.
Other European banks slumped too, with Italy’s Intesa Sanpaolo down 14 per cent. SocGen’s shares have fallen by third this month and by 45 per cent since the start of the year.
All three main rating agencies have reiterated that France’s triple A credit rating is stable, but several investors and analysts have said it could be next in line following the downgrade of the US from triple A to double A plus last Friday. "Clearly the market is moving on to who is next in the triple A downgrades and the next one is France," said Adrian Cattley, European equity strategist at Citi.
But Didier Duret, chief investment officer at ABN Amro Private Banking, said: "They need to put their public finances in order but it is a very short-term problem. You really don’t have the same political configuration as in the US, which is a big positive." He called the sell-off brutal and unjustified but warned it could become "a self-fulfilling prophecy".
One senior government official suggested the persistent rumours about a downgrade of French debt and the stability of the French banking sector were being fuelled by speculators. "There are people who have their own reasons for throwing rumours around about France," he said. A final decision on the scale of new spending cuts to be included in the budget for 2012 will be taken at a meeting between Mr Sarkozy and François Fillon, prime minister, on August 24.
Wednesday’s meeting was aimed at reassuring markets after credit default swaps – a form of investor protection that pay out in case of a default – reached a fresh record for France of 176 basis points. Italy and Belgium also hit record CDS levels despite continued European Central Bank purchases of Italian and Spanish debt.
The unexpected summons to senior ministers may have helped to fuel concerns over the stability of the French rating and the banking sector, though officials denied that it was anything more than a working meeting. "It may have added oil to the fire," admitted one government official.
Stock markets globally plunged on the dour outlook for growth. The CAC-40 closed down 5.5 per cent and Germany’s Dax-30 fell 5.2 per cent. In lunchtime trading in New York, the S&P 500 fell 3 per cent, erasing much of the previous day’s gains.
US and German benchmark 10-year bond yields fell sharply to close at all-time lows as investors sought havens. The UK’s 10-year Gilts yields fell to a record low of 2.48 per cent, after the biggest one-day fall in 18 months of 24bp. French yields were also down at 3.07 per cent but the premium it pays to borrow over Berlin remained close to euro-era highs.
Nervousness in Paris is growing over the prospects for economic growth next year, amid a sharper than expected contraction in industrial production in June. Unicredit warned on Wednesday that its forecast for 0.2 per cent growth could be at risk. The official second quarter figures will be published on Friday.
Société Générale Rises as a Global Worry
by Louise Story And Liz Alderman - New York Times
It’s a bank that hasn’t been much on Wall Street’s radar since the days of the A.I.G. bailout. But Société Générale, France’s third-biggest bank, has been stirring financial markets once again on concerns about its big holdings of the debt of shaky European neighbors like Greece.
Although its shares closed slightly up on Friday, Société Générale’s stock has fallen more than 40 percent since mid-July and helped pull European bank stocks down earlier in the week. That volatility is a big reason that France on Thursday night imposed a temporary 15-day ban on short-selling — negative bets — against financial and insurance company stocks.
Why does Société Générale matter? Jitters about the bank’s stability reverberate in New York and around the world because, among other things, Société Générale is one of the biggest global players in equity derivatives — financial instruments meant to protect investors against price plunges in stocks. It does business regularly with the likes of Goldman Sachs, JPMorgan Chase and Deutsche Bank.
"They have significant outstanding derivative exposures, which makes them systemically important," said Kian Abouhossein, an analyst covering European banks for JPMorgan Chase. "They are important to the financial system, not just in the U.S. or Europe, but globally." What’s more, Société Générale has something of a history. It achieved notoriety during the last financial crisis when a rogue trader for the bank, Jérôme Kerviel, lost his employer 4.9 billion euros, or $6.7 billion.
Société Générale may be even better remembered for its disastrous entanglement of derivatives contracts with the giant insurer American International Group. The A.I.G. contracts protected Société Générale from its large stake in troubled American mortgage securities — but only after the United States government bailed out A.I.G. in 2008 and agreed to pay companies like Société Générale 100 cents on the dollar. When Société Générale was eventually revealed to be one of the largest recipients of the A.I.G. bailout funds, some critics questioned why a French bank was allowed to cart home $11.9 billion in American government money.
The French government now, as it did back then, is playing a big role in trying to calm markets and protect Société Générale. Investors’ main fear is that the company’s exposure to Greece — it even owns the majority of a Greek bank — and other troubled European countries might cause a panic that drives away its trading partners and disrupts the derivatives market.
Some investors even worry that Société Générale’s holdings of French government bonds might become a problem if ratings agencies downgrade France’s sovereign debt. So far, though, the ratings agencies have been nearly as loud in their denials that they plan such a downgrade as the French government and Société Générale’s executives have been vociferous in insisting that the bank is on solid footing.
In any case, the rumor-driven run on Société Générale is already costing the company money. It has been forced to pay significantly more than some of its sturdier European banking peers to borrow, according to several market participants.
Analysts point out that Société Générale has a strong balance sheet, but they say that panic in the markets can undermine even strong financials. Mr. Abouhossein, for one, says he thinks the market fear is overblown — as is the risk to Société Générale, even if it were forced to take write-downs on the debt of other troubled euro countries, like Italy and Spain. "French banks can always borrow money from the European Central Bank," he said.
In fact, many European banks were doing just that this week. On Wednesday, commercial banks’ requests for short-term loans from the central bank spiked to a three-month high.
Société Générale officials have spent much of the week arguing that the market’s fears were unfounded. On Thursday, the bank’s chief executive, Frédéric Oudéa, described rumors that Société Générale was having trouble raising money as "fantasy."
And in fact, on Thursday Société Générale was able to raise $2 billion in overnight money — although it reportedly paid higher interest than a more stable European bank like Barclays or Rabobank would have had to. The bank is also still lending out money in the overnight market, which is typically interpreted as a sign of strength.
Société Générale’s direct exposure to Greece is not nearly as large as the exposure it had to the American housing market going into the panic of 2008. Nonetheless, it has been unnerving investors with write-downs like the 268 million euro charge on its Greek holdings the bank announced early this month.
Just as many other large European institutions did, Société Générale bought into sovereign debt at a time when those purchases looked mostly risk-free. It amassed about 18.2 billion euros of exposure to Portugal, Ireland, Italy, Greece and Spain — almost as large as the bank’s 19.2 billion euros in holdings of French debt, according to the European Banking Authority. The sovereign debt of most of those other countries has recently been downgraded, hitting the bank’s portfolio.
But analysts say Société Générale, like other European banks, can count on the support of regulators. In the recent agreement for the latest Greek bailout, Société Générale was among the banks that agreed to forgive about one-fifth of the value of the country’s debt. As part of that deal, a pan-European fund is supposed to make money available to help banks that may need assistance covering their losses on Greece — although each of the 17 euro zone nations’ governments must still vote on whether to finance the bailout fund.
Société Générale, in other words, may be as solid — or not — as the euro union itself. "I don’t think the euro is in danger," Mr. Oudéa, Société Générale’s chief executive, said Thursday. "The governments are very attached to the single currency and lucid about the efforts that must be made."
France feels the economic force of the credit ratings agencies
by Tom Bawden - Guardian
As the French prepare their own austerity package the focus on the ratings agencies' role in the recession becomes more acute
It was the week in which the focus of the financial crisis switched from the streets of New York and Washington to the boulevards of Paris. After roughing up the Dow Jones and Barack Obama, it was the turn of French stocks to be pummeled and for Nicolas Sarkozy to scurry back from holiday to defend his country's honour.
However, in both cases, the bogeyman was the same – the ratings agencies, whose actual downgrade of the US sparked market mayhem and whose rumoured placing of the hex on France brought the chaos back to Europe amid massive selling of shares, especially in the French banks SocGen, BNP Paribas and Crédit Agricole.
Friday's news that the French economy flatlined in the second quarter means there will be no respite from rumours that France could be the next country to follow America and be stripped of its coveted AAA-rating. Although the finance minister, François Baroin, said the figures were "not a surprise", consumer spending in France dipped alarmingly last month and the government may now have to find even deeper budget cuts to meet its deficit reduction targets.
France banned short-selling of its banks on Thursday in an attempt to calm the markets. But, however much it would like to, it cannot ban the rating agencies whose power over the fate of nations has become a key factor in the debt crisis drama.
"After last week's downgrade of US bonds by Standard and Poor's (S&P), Paddy Power are now taking bets on which will be the next country to be downgraded from its AAA rating by the agency," the bookmaker announced on Thursday, taking bets on this eventuality for the first time in its history and illustrating the extent to which the ratings agencies have been thrust into the mainstream.
For example, David T Beers, the S&P boss who took the decision, was given a Wikipedia page for his trouble – moving one of the world's lowest profile, but most powerful financial players, into the spotlight for the first time.
Tracing their roots back to the 1860s when they analysed the risks associated with lending to and investing in America's rapidly growing railroad system, the ratings agencies enjoyed life in the shadows for at least their first century. During that time they morphed into hugely powerful organisations, analysing and rating debts attached to everything from companies and governments to bonds and packages of mortgages, just as consumer credit agencies assign individuals a score based on their financial history.
Although confidence in the agencies has been dented by criticism that they failed to spot the US sub-prime mortgage crisis, their ratings are still taken as gospel by much of the investment community, with banks, pension funds and treasuries governed largely by their grading system. As such, their ratings can ripple across the global economy all the way down to influencing mortgage rates, credit cards and car loans, which are priced, in part, against sovereign debt. Not to mention their influence on general investor confidence and the stock markets.
The ratings process is intensive, as armies of analysts pore over their subjects' accounts and phone their contacts in the government, media, academia, banking and industry, digging for any information that affects their credit risk in a procedure that is part egg-headed economist and part gumshoe.
The top credit rating is AAA, essentially implying zero risk to the lender, which the US lost this month and which the UK has managed, so far, to retain. Although each agency uses different codes to represent the slide down the ratings scale, the principle is the same – the lower the rating, the greater the risk and the more interest is likely to be demanded by the borrower to compensate for the increased chance they will not be repaid.
Each of the "big three" agencies of S&P, Moody's and Fitch, divide their scale into two categories: known as investment grade, which is relatively safe, and non-investment grade, or "junk" status which is not. Portugal, Greece and Ireland have all been downgraded to junk status as the European sovereign debt crisis has escalated. There are a total of 10 ratings agencies, such as Rapid Ratings, but the big three are by far the most influential.
The first time the ratings agencies drew any real criticism was in 2001, when some questioned why it was that the big-three agencies had been rating Enron as investment grade just four days before the meltdown of the US energy trading firm. In 2007, they came in for condemnation for their part in the financial crisis, as critics accused them of failing to identify the risks attached to sub-prime mortgages.
An investigation by the US Securities and Exchange Commission (SEC) and the New York attorney general focused on whether the agencies are compromised by earning fees from the banks that issue the debt they rate. The report savaged the industry and contained dozens of internal emails that suggested they had betrayed investors' trust. "Let's hope we are all wealthy and retired by the time this house of cards falters," one unnamed S&P analyst wrote. In another, an S&P employee wrote: "It could be structured by cows and we would rate it."
Earlier this summer, the agencies endured further criticism, this time from European politicians who complained that their various downgrades and comments about the region's debt problems were exacerbating the problem.
But while bankers and politicians realised the importance of the agencies – and attempted to challenge their dominance, in one case calling for some of their comments on the latest Greek debt rescue package to be ignored – the general public remained, by and large, in the dark about their activities and their significance.
All that changed on 5 August, when S&P took an until recently unthinkable step and stripped America of its AAA rating. This psychologically damaging development will go down as a milestone in the decline of US global economic dominance, and it fuelled the panic that has driven down stock markets around the world. Although the other two of the big-three ratings agencies have kept their gold-plated ratings on US debt for now, both are watching the situation closely, while a downgrade of this nature from even one of the agencies is an historic event.
The spotlight is now firmly on the ratings agencies, with the US government attempting to rubbish S&P's analysis and President Obama's insistence that America will always be a AAA nation. Politicians are particularly angry because the trillions of dollars the US government has spent attempting to stimulate the economy – and the decreasing taxes and increasing benefit bills resulting from the recession – are largely responsible for driving the country's debt levels to the point at which S&P deemed a downgrade necessary.
In other words, opponents of the ratings agencies believe the US government is being punished for bailing the economy out of a problem for which they hold the big three partly responsible, because of their failure to highlight the dangers of the toxic sub-prime mortgages that triggered the recession. As Paul Krugman, the Nobel prizewinning economist, said in the New York Times last week: "It's hard to think of anyone less qualified to pass judgment on America than the ratings agencies. The people who rated sub-prime-backed securities are now declaring that they are the judges of fiscal policy? Really?".
That the ratings agencies failed to spot the difficulties embedded in swathes of toxic debt early enough is beyond doubt. But they are hardly alone in an investment industry that turned a blind eye on a mass scale and failed to ask the right questions. Likewise, they are not alone in identifying that the US is in well over its head debt-wise, whether the Obama administration likes it or not.
Some critics have pointed out that there is potential for conflict of interest when agencies rate non-government debt issuers because they are paid by those they judge – a topic high on the agenda of US lawmakers looking to improve the ratings process. There is no such incentive for sovereign ratings which are provided free of charge to the country.
Now that the US has lost its AAA rating, issues such as how ratings agencies make their money have been catapulted from obscurity into potential topics for dinner-table discussion. While they are on the subject, they may also discuss placing a bet on which of the 18 remaining AAA-rated countries will be next to lose its gold plating.
And so the scene is set for a Wikipedia entry for David T Beers, who we learn is a "mustachioed, chain-smoking head of sovereign credit ratings for S&P". Future entries could have a major bearing on how the debt drama ends.
4 European Nations to Curtail Short-Selling
by Louise Story and Stephen Castle - New York Times
A European market regulator announced on Thursday night that short-selling of financial stocks in several countries would be temporarily banned in an effort to stop the tailspin in the markets.
The European Securities and Markets Authority, a body that coordinates the European Union‘s market policies, said in a statement that these negative bets on stocks would be curtailed effective on Friday in France, Belgium, Italy and Spain. They are already banned in Greece and Turkey.
"Today some authorities have decided to impose or extend existing short-selling bans in their respective countries," the authority said. "They have done so either to restrict the benefits that can be achieved from spreading false rumours or to achieve a regulatory level playing field, given the close inter-linkage between some E.U. markets." The statement said details for each country will be posted on their individual financial regulators’ Web sites.
European financial regulators have been discussing a continentwide a ban over the last few days amid fears from governments in places like France that these negative bets on stocks were driving a panic. In short-sales, a trader sells borrowed shares in hopes that they will decline in value before he has to buy them back to close out his loan. The difference in price is his profit, or loss.
But some countries, like Britain, came out publicly against a short-sale ban. Critics say short-selling encourages speculation and pushes stock prices down, sometimes feeding on itself in a panicked market, while advocates say it keeps the market honest and maintains liquidity.
The increasing number of European governments banning short-selling puts United States regulators in a tricky position. Investors with negative views on bank stocks who are forced to close their negative bets in Europe might shift them to American banks. On Thursday, stocks in the United States continued their see-saw ride, surging 4 percent, buoyed by hopeful data on initial jobless claims.
Market participants in the United States were critical of the announcement in Europe. "It is a crisis of confidence and when you do something like this, it shows a lack of confidence, which is exactly the opposite of what you want to say to the markets," said Robert Sloan, managing partner of S3 Partners, a firm that helps hedge funds manage their relationships with their brokers.
Back in 2008, European and United States officials coordinated temporary bans on shorting financial stocks. The bans in Europe are drawing to the list of comparisons that commentators are making between the current market unrest and the financial crisis of 2008. Back then, governments around the world, including Britain and the United States, banned short-selling on financial stocks temporarily. The ban was meant to prevent bank stocks from falling further, but in time, stocks fell anyway.
Hedge funds, in particular, were hurt by the ban because it interfered with trading strategies that pair negative bets with positive ones. The ban on short-selling in 2008 has been widely criticized and blamed for driving investors out of the market altogether, further hurting stock prices.
It is impossible to know whether the panic would have been worse without the ban, which protected companies like Goldman Sachs and Morgan Stanley, but general studies of short-selling have found that bans on that activity can lead to more volatility in the market and lower trading volume, according to Andrew W. Lo, a professor at the Massachusetts Institute of Technology.
Mr. Lo said banning short-selling also removed important information about what investors think about the financial health of companies, and suggested that the bans served mainly political purposes. "It’s a bit like suggesting we take heart patients in the emergency room off of the heart monitor because you don’t want to make doctors and nurses anxious about the patient," he said.
Details were still emerging about each country’s policy. In France, the market watchdog banned short-selling or increasing short-selling positions, effective immediately, for 15 days on 11 financial institutions. They are: April Group, Axa, BNP Paribas, CIC, CNP Assurances, Crédit Agricole, Euler Hermès, Natixis, Paris Ré, Scor, and Société Générale.
Shares in the banks have slumped sharply, sometimes on market rumors. Société Générale’s shares plunged as much as 23 percent Wednesday before closing down 14 percent, on what the chief executive, Patrick Oudea, called "fantasy rumors." Its shares recovered slightly on Thursday, gaining 3.7 percent.
The European authority does not have the authority to impose a policy on short-selling but it can make recommendations and coordinate cooperation among the European Union’s 27 governments. The European Parliament is considering legislation to give the authority additional powers.
Some investors are already anticipating that such a ban may occur, Mr. Sloan of S3 Partners said. He said that for the past two months many investors had been getting out of their short positions, in part out of fear that such a ban might be introduced. He also said if there were more short-sellers in the market now, the markets might be falling less than they are. That is because as markets fall, short-sellers often close their positions to cash in profits and in doing so, they have to purchase shares to cash out.
The markets could use these sorts of buyers now, said Mr. Sloan, who wrote a book after the 2008 crisis called "Don’t Blame the Shorts: Why Short Sellers Are Always Blamed for Market Crashes and How History Is Repeating Itself."
Arturo Bris, a professor of finance at the IMD business school in Lausanne, Switzerland, studied financial stock prices in 2008 before and after a short-selling policy was put in place. On Wednesday, Mr. Bris said that he did not think such a ban in Europe would help in the long run. "If there is a ban in the European markets in the next couple weeks it would stop the blood, but it’s not going to solve the problem," Mr. Bris said. "It would just delay the problem."
Even with the European countries’ bans on short-sales of some stocks, investors who have negative opinions on companies may still find ways to bet against them in the derivatives market, if those sorts of trades remain allowed.
Short selling ban boosts bank shares
A partial ban on short selling in the eurozone boosted European bank shares on Friday but led to confusion among market participants unclear about how the rules would be applied.
France, Italy, Spain and Belgium on Thursday introduced a ban on the short selling of financial stocks for 15 days in response to sharp share price falls this week, but they failed to convince other regulators to go along with a European Union-wide prohibition.
The bans on the controversial practice where investors aim to profit from price falls took effect on Friday morning. But other main markets, including the US and the UK, have said they have no plans to follow suit.
However, differences were emerging on Friday between the four countries that have introduced the latest ban. All four countries have applied the restrictions to various stocks, but the French and Belgium rule changes do not appear to cover derivatives that are included in the Spanish ban. Regulators said they had put the ban in place in an effort to "restrict the benefits that can be achieved by spreading false rumours".
Jean-Pierre Jouyet, head of the AMF, the French securities regulator, said on Thursday night: "They wanted to test French resistance. This is our response, as always very determined, and it will be so for all those who want to put us to the test."
Bank shares across Europe rose on Friday, with Belgium’s Dexia rising to the top of the leaderboard. UniCredit of Italy and Crédit Agricole of France also rose after a week that had seen heavy selling of the region’s lenders. Société Générale, one of Europe’s most heavily sold stocks this week, rose 0.1 per cent on Friday.
But banks in countries not covered by the ban were also higher. Barclays and Royal Bank of Scotland of the UK rose, while Deutsche Bank, Germany’s largest lender by market capitalisation, and Commerzbank were also higher.
However, the experience of 2008, the last time short selling was banned in Europe in the wake of the collapse of Lehman Brothers, shows bans only have a short-term impact and fundamentals reassert themselves in the longer term. "We think that although short sellers are active in the market there has been selling also due to uncertainty on fiscal and monetary policy issues that are yet to be resolved which results in natural selling of asset classes," said Atif Latif at Guardian Stockbrokers.
Lee Hardman at Bank of Tokyo Mitsubishi UFJ said: "With deteriorating investor confidence in eurozone debt likely to continue driving reduced investor confidence in the ability of European banks to withstand the fall out from the eurozone debt crisis we doubt that downward pressure on European financials will now dissipate."
Academics who have studied the 2008 bans said the latest restrictions could backfire. "It is the worst thing to do right now. This would signal to the market there may be something fundamentally bad that is happening," said Abraham Lioui, a professor at the Edhec business school in France.
There was also confusion on Friday at London-based trading platforms like Chi-X Europe and BATS Europe unclear on how the rules applied to them. These alternative trading platforms offer trading in pan-European stocks, including the banks of all four countries that imposed the ban, but are regulated by the Financial Services Authority.
Legal experts at the companies on Friday were in urgent conversations with the FSA over whether their customers were affected by the ban given that that the UK has not introduced the ban.
The introduction of the ban represents a partial victory for the new European Union market regulator, Esma, which has sought to avoid a repeat of the uncoordinated actions that swept around the world after the collapse of Lehman. Greece and Turkey had already imposed restrictions on short selling earlier this week
Germany’s market regulator BaFin said on Friday it had not seen any signs of abuse to warrant taking further action against short selling and Dutch regulator AFM said it had decided against introducing a ban after consulting other European regulators.
Italy, EMU and the Evil Eye
by Ambrose Evans-Pritchard - Telegraph
For those in Euroland convinced that Anglo-Saxon hedge funds and speculators are responsible for the sorry state of the Italian bond market (seemingly the view of EMU’s entire governing class), here is a nugget from a Swiss blue chip investment house.
Dieter Wemmer, CFO of Zurich Financial Services, said his group had slashed its holdings of Italian government bonds by €2bn since June 30, cutting its exposure to €6bn. It also had €5bn of Spanish debt and €18bn of Greek debt.
Much of the capital flight from Italy is crossing into Switzerland, so the Swiss have a good insight into the behaviour of the Italian financial elites.They know what Italy’s insiders are doing.
The ZFS announcement follows a revelation by Deutsche Bank that it had cut its exposure to Italy from €8bn to €1bn by hedging (ie, buying insurance) through the CDS market. These are not hedge funds. They are real money accounts, and they give us a glimpse into what is happening.
Italy has a primary budget surplus, the best fiscal profile of the G7, and low private debt. So why do Swiss investors want to pull out? Why are other countries with their own sovereign currencies and central banks able to borrow at barely over 2pc for ten years despite awful public finances, while Italy had to pay 6pc until the ECB intervened this week, and still has to pay 5pc now?
I hate to keep repeating an elementary point but currency unions switch exchange rate risk into default risk. Italy’s current travails are a direct result of — and function of — EMU membership. The deeper issue is that Italy is 20pc over-valued within EMU and is now trapped in very low growth and a stubborn current account deficit. This is a slow rot. It is directly linked to EMU membership.
Italy could have used the decade and half since Euroland’s currencies were locked together after Maastricht to free up labour markets and carry out the `micro’ reforms needed to make EMU viable. It did not do so. It is very late in the day now.
Yes, before Euroland readers all scream "what about the mess in Britain?", let me repeat for the millionth time that I don’t write about Britain. The rest of the Daily Telegraph is giving blanket coverage to the current stew of riots, knife attacks, and anarchy in British cities.
Britain is of course in a terrible mess, but Gilt yields nevertheless fell below 2.5pc this morning. The UK is very lucky that it still has the sovereign instruments to mitigate the fiscal disaster left by Gordon Brown.
Italy has the ECB, and behind it stands Germany. Whether Germany will continue to stand behind the Project as the cost rises is the great unknown. That angst is what is really eating away at markets.
Linde chief Wolfgang Reitzle caught the mood when he said: "I am fundamentally for the euro, but not at any price — above all not at the price of socializing the debts of other countries." I suspect that is the true voice of Germany, whatever the German ministers may say to please peers in Brussels.
Investors Fret at Costs if Rescues Are Needed
by Landon Thomas Jr. - New York Times
Ever since Lehman Brothers collapsed nearly three years ago, Europe’s leaders have repeatedly vowed to prevent any major European bank from failing. But as bank shares plummeted this week, the question on investors’ minds was not whether governments would rescue their banks if necessary. It was how much a bailout might cost them.
Whether it is Société Générale in France, UniCredit in Italy or Santander in Spain, the fear is that already indebted countries will find themselves in deeper trouble if they are forced to rescue some of their biggest banks.
By one measure, according to a recent report from the Peterson Institute for International Economics, 90 of Europe’s biggest banks hold 4.7 trillion euros ($6.7 trillion) in short-term loans that must be repaid over the next two years. That burden alone is more than half of the combined gross domestic product of the 17 nations that share the euro currency.
"This problem has become cancerous," said Stephen Jen, a former economist at the International Monetary Fund who runs a hedge fund in London. "France will not hesitate to fiscalize its banks — but it will be very expensive."
Shares of European bank stocks were volatile on Thursday. Société Générale, which has been the focus of the greatest fears, ended the day up 3.7 percent. But its stock price is still down 16 percent this week — and off almost 43 percent for the year. Shares of Santander climbed 3.2 percent and UniCredit rose 3.4 percent Thursday. But they, too, were rebounding slightly after big recent sell-offs.
In another danger signal, commercial bank reliance on the European Central Bank for short-term loans spiked to a three-month high on Wednesday. Banks borrowed 4 billion euros, or $5.7 billion, compared with 2 billion euros the day before, according to figures released on Thursday. That would indicate the banks are becoming wary of lending to one another, preferring to borrow from the central bank.
"What strikes me in the crisis of the last few weeks is the large content of self-fulfilling prophesies," said Paul De Grauwe, an economist in Brussels who advises the president of the European Commission, José Manuel Barroso. "The fear that something bad will happen increases the probability that the something bad occurs."
Heightening market anxiety is the realization that the banks that have promised to participate in the Greek debt restructuring may face larger losses than expected. Société Générale, which has one of the larger Greek exposures among major European banks, already announced a 268 million euro charge early this month.
What is more, Europe’s latest plan to address its bank problem — endowing its rescue fund, the European Financial Stability Facility, with the power to recapitalize banks — will take at least another month to become functional. Parliaments of the euro area countries must vote on the rescue fund’s new charter, and approval is by no means guaranteed.
Despite statements this week by Société Générale that it is in good condition, unconfirmed rumors have swirled through the markets that some of its lenders — including Singapore and the United States — were threatening to cut their exposure.
Addressing the issue head on, the governor of the French central bank, Christian Noyer, said on Thursday that the latest results of so-called stress tests on French banks demonstrated their health and that they had adequate capital to ride out any difficulties. "Recent stock market movements won’t affect the financial stability of the banks or the resilience they have shown since the beginning of the crisis," Mr. Noyer said.
And the agency that regulates French financial markets took pains to warn that "the dissemination of unfounded information is subject to sanction." The attacks on French banks began amid speculation that French government debt was about to lose its gilt-edged AAA credit rating.
France’s three largest banks — BNP Paribas, Société Générale, and Crédit Agricole — have bulging portfolios of French government bonds that represent substantial portions of their core capital. The latest worries, focused on the prospect of a lower rating for those bonds, could put pressure on the banks to raise more capital almost immediately if a downgrade occurred.
Even without a downgrade, worries about France’s finances have increased the risk profile of those bonds, making it more difficult for banks to use them as collateral for the short-term loans they still depend on to finance their operations. It becomes a vicious circle. If the French government had to inject cash into a failing bank, the additional debt burden could push the credit ratings agencies to downgrade France, making the European debt crisis worse.
Analysts point out that the top French banks report plenty of cash on hand: 150 billion euros in liquidity for BNP Paribas and 105 billion euros for Société Générale, according to a research report by Sanford C. Bernstein & Company. But analysts say unsettled investors are less concerned about the banks’ current positions and more focused on fears that their lenders will abandon them if their top-grade collateral is impaired.
In fact, most European banks, including France’s top institutions, appear to be in much better shape than their counterparts in Ireland and Britain were in 2007 and 2008 when they were forced into the arms of their governments. None of the banks are in the dire straits that pushed Ireland to take over Anglo Irish Bank or Britain to rescue the Royal Bank of Scotland.
Reinforcing that point, Alison Miller, head of European credit strategy in London for Nomura, said on Thursday that many people were misinterpreting money market indicators and falsely concluding that a crisis on the order of 2008 was in the making. For example, a spike in the so-called Euribor-OIS spread, a measure of the perceived riskiness of interbank lending, seems to be reminiscent of 2008.
But Ms. Miller said on a conference call that the widening spread reflected the extra cash that the European Central Bank was lending banks, rather than higher interest rates banks were demanding to lend to each other. She said the demand for central bank cash, while up sharply, was not at levels that would suggest a bank financing crisis. "It is not really signaling that there is major stress," she said.
Compared with 2008, Ms. Miller said, banks took advantage of favorable market conditions earlier this year to issue bonds and fill their coffers. In addition, European banks have vastly more money at the United States Federal Reserve than in 2008, making it less likely that banks will run out of dollars. "There is a lot of misinterpretation around some of the indicators," Ms. Miller said. "We are more sanguine."
At the root of Europe’s banking crisis is the pressing need of the biggest banks to raise large sums of money in a market environment that is very unforgiving. In a widely circulated research paper published last month by the Peterson Institute for International Economics in Washington on the debt burden of Europe’s 90 biggest banks, the authors, Peter Boone and Simon Johnson, suggest that the euro zone’s banking crisis was more than a short-term liquidity problem — that it might, in the worst case, require some banks to be bailed out by their governments, adding to the governments’ own debt woes.
"The bank troubles now are not about liquidity, but instead solvency," said Mr. Boone, a visiting economist at the London School of Economics. "Governments can solve solvency problems through capital injections and loan guarantees — but this just increases the potential liabilities of the government."
US postal Service proposes cutting 120,000 jobs, pulling out of health-care plan
by Joe Davidson - Washington Post
The financially strapped U.S. Postal Service is proposing to cut its workforce by 20 percent and to withdraw from the federal health and retirement plans because it believes it could provide benefits at a lower cost.
The layoffs would be achieved in part by breaking labor agreements, a proposal that drew swift fire from postal unions. The plan would require congressional approval but, if successful, could be precedent-setting, with possible ripple effects throughout government. It would also deliver a major blow to the nation’s labor movement.
In a notice informing employees of its proposals — with the headline "Financial crisis calls for significant actions" — the Postal Service said, "We will be insolvent next month due to significant declines in mail volume and retiree health benefit pre-funding costs imposed by Congress."
During the past four years, the service lost $20 billion, including $8.5 billion in fiscal 2010. Over that period, mail volume dropped by 20 percent. The USPS plan is described in two draft documents obtained by The Washington Post. A "Workforce Optimization" paper acknowledges its "extraordinary request" to break its labor contracts. "However, exceptional circumstances require exceptional remedies," the document says.
"The Postal Service is facing dire economic challenges that threaten its very existence. . . If the Postal Service was a private sector business, it would have filed for bankruptcy and utilized the reorganization process to restructure its labor agreements to reflect the new financial reality," the document continues.
In a white paper on health and retirement benefits, the USPS said it was imperative to rein in health benefit and pension costs, which are a third of its labor expenses. For health insurance plans, the paper said, the Postal Service wanted to withdraw its 480,000 pensioners and 600,000 active employees from the Federal Employees Health Benefits Program "and place them in a new, Postal Service administered" program.
Almost identical language is used for the Civil Service Retirement System and the Federal Employees Retirement System. The USPS said the programs do not meet "the private sector comparability standard," a statement that could be translated as meaning that government plans are too generous and too costly. "FEHB may exceed what the private sector does in certain areas," said Anthony J. Vegliante, USPS chief human resources officer and executive vice president. "It may not meet what the private sector does in other areas. So cost may be above the private sector, while value may be below the private sector."
Bills that would rein in employee benefits or have workers pay more for the benefits have been introduced in Congress and met with vigorous opposition from federal employee organizations. Intentionally or not, the Postal Service’s proposal provides support for such legislative initiatives. The proposals are the USPS’s latest money-saving effort in a series of moves, some as recent as a few weeks ago and others stretching over a decade.
The Postal Service has reduced its workforce by 212,000 positions in the past 10 years and recently announced it is considering the closing of 3,700 post offices. It also has asked Congress to allow it to deliver mail five days a week instead of six and to change a requirement that it pre-fund retiree health benefits.
The USPS said it needs to reduce its workforce by 120,000 career positions by 2015, from a total of about 563,400, on top of the 100,000 it expects by attrition. Some of the 120,000 could come through buyouts and other programs, but a significant number would probably result from layoffs if Congress allows the agency to circumvent union contracts.
"Unfortunately, the collective bargaining agreements between the Postal Service and our unionized employees contain layoff restrictions that make it impossible to reduce the size of our workforce by the amount required by 2015," according to the optimization document. "Therefore, a legislative change is needed to eliminate the layoff protections in our collective bargaining agreements."
The layoff protection, however, does not apply to employees with fewer than six years of service, which presumably would include thousands of workers. Postal union leaders quickly and sharply rejected the plans.
"The APWU will vehemently oppose any attempt to destroy the collective bargaining rights of postal employees or tamper with our recently negotiated contract — whether by postal management or members of Congress," American Postal Workers Union President Cliff Guffey said. "Our advisers are not encouraging us at all to even consider it," said National Rural Letter Carriers’ Association President Don Cantriel. "We are absolutely opposed" to the layoff proposal, he said. "We are opposed to pulling out of the Federal Employees Health Benefits plan."
National Association of Letter Carriers President Fredric V. Rolando said: "The issues of lay-off protection and health benefits are specifically covered by our contract. .?.?. The Congress of the United States does not engage in contract negotiations with unions, and we do not believe they are about to do so."
How Congress will respond to the proposals, however, remains to be seen. Many Republicans, including those who have sponsored legislation that labor considers anti-union, may support the plan. Some Democrats, for which organized labor is an ally, could back union opposition. But the Postal Service’s critical financial situation could make some Democrats have second thoughts.
Two members of Congress who have introduced separate postal reform bills were noncommittal on the USPS plan. A spokeswoman for Sen. Thomas R. Carper (D-Del.) said, "He is particularly interested in learning whether these proposals would be fair to employees and effective in reducing the Postal Service’s costs."
Rep. Darrell Issa (R-Calif.), chairman of the House Oversight and Government Reform Committee, said: "These new ideas from the Postal Service are worth exploring. Options for reform and cost savings that will protect taxpayers from paying for a bailout, now or in the future, need to be on the table."
Switzerland: Desperate Measures
by Bruce Krasting, My Take On Financial Events
After Bernanke capitulated on the Fed’s responsibility to balance it’s dual mandate and committed to keep ZIRP alive for another 24 months the Swiss Franc exploded in value. It was up 6% in just a few hours. That was the biggest one-day move in 30 years.
The Swiss National Bank is getting desperate. They responded by announcing new emergency measures. They are immediately increasing “sight deposits” by CHF 40B. This is the second increase in a week. The two actions together will increase liquidity in the banking system from CHF 30B to CHF 120b. A 400% increase.
We are confronted with huge numbers every day. What does an increase of CHF 90b really mean? It’s a very big deal. Swiss GDP is about CHF 500b. So the increase in liquidity is equal to 20% of GDP. Now think of US GDP at $15 Trillion. What the Swiss have done in just a week is equivalent to $3 trillion in a big economy like the USA. That is massive.
This is the language from the SNB yesterday:The massive overvaluation of the Swiss franc poses a threat to the development of the economy in Switzerland and has further increased the downside risks to price stability.
This was the sentence that caught my eye:To accelerate the increase in Swiss franc liquidity, the SNB will additionally conduct foreign exchange swap transactions. The foreign exchange swap is a monetary policy instrument which the SNB uses to create Swiss franc liquidity.
From this I conclude that not only is the SNB trying to push interest rates to zero, they intend to push the interbank swap rates for Swiss Francs to BELOW ZERO. This is a form of intervention that is intended to discourage speculative holders of SFR. This action by the SNB is working as of this morning. The CHF has backed off against all currency pairs.
One sees the evidence of the monetary intervention in the short date swaps. This morning the Spot Next and Spot a Week roll of CHF to dollars is being priced in the hole. This is the area of the market where speculative holdings of CHF are rolled over. The one week bid offer spread pricing this AM is:
-1.9 / -0.83
Note that both sides of the swap are negative. This implies that CHF interest rates are negative. The left side (the bid side) is the price one has to pay if they were long CHF versus dollars and wanted to hold onto a long position for a week. Some math:
The USDCHF spot rate is .7378. The cost of the one-week roll is .00018. The cost of rolling a long CHF position of 10,000,000 Francs comes to $3,307 per week. That may not seem like a big deal as the dollar equivalent of CHF 10mm is $13,550,000. But that is not how things work in this big casino.
Currency trading is done on very high margin. Many participants can play at the table with only 2% margin. Others have to come up with as much as 5%. What does $3,307 come to when the equity involved is only a fraction of the principal? For the 5% player it comes an annualized cost of holding the position of 23% of equity. For that big shot who plays with only 2% down the rollover cost comes to an annualized penalty of a whopping 63%.
From long experience in this business I can tell you that short-term currency traders HATE negative carry trades. A long CHF position now has a big cost to it. If a trader has a short Dollar/Swiss position of $100mm (a modest currency position for these folks) the cost of holding it is now $25,000 a week. This cost was zero two weeks ago. This squeeze on short date swaps is a very good reason to cut those short dollar positions. That is exactly what has happened so far today. The CHF has backed off (a bit) against all other currency pairs as of this morning. As of today, the SNB has achieved its objective of getting people out of the currency market.
This won’t last for long. There will be another tremble in the market that gets people scrambling for safety. The “go to” trade will still be to buy CHF when that happens. The cost of ownership be damned. What will happen as a result of the liquidity steps is that greater volatility in spot Swissie will occur.
The relative rate of the CHF versus Euros or Dollars is important to the SNB. But even more important is the rate of change. The short date squeeze by the SNB may result in a bit of retrenchment for a few days. But it will almost certainly result in increased volatility.
My take on the actions by the SNB is that they are trying to buy time and create a more orderly adjustment to a stronger CHF. I think the consequences will be that we will have violent intraday adjustments, but over the course of a month the Franc will be stronger anyway. The SNB is trying to buy time as measured in days. To me, that is no plan at all, just a desperate act by a desperate central bank.
How long is the list of Central Banks that are undertaking extreme measures to influence very short-term outcomes? The list is endless. Virtually every CB in the world is doing it today. As a result, extremely high volatility across all markets will prevail. Squeezing short dates often has a negative affect. Something always blows up as a result. Yet every central bank is attempting essentially the same thing. They are trying to buy time. They are the source of the volatility we are living through.
Desperate Swiss eye euro peg to repel safe-haven flood
by Ambrose Evans-Pritchard - Telegraph
Switzerland is mulling drastic measures to fend off safe-haven flows from Euroland and stop the relentless rise of the Swiss franc crippling large parts of the country's economic base.
The franc retreated against the euro in a wild-one day move on Thursday after top officials at the Swiss National Bank (SNB) floated ideas for a temporary euro peg, a once unthinkable move. "Nothing is excluded," said Jean-Pierre Danthine, a SNB board member. "The situation is extremely complex and difficult. There is no magic wand."
The Swiss franc has moved with gold over recent weeks, acting as a magnet for capital flight from the discredited debt currencies of West. The SNB said the franc is "massively overvalued" and has moved into dangerous territory over the past month. The hotel and restaurant lobby GastroSuisse said the 240,000 strong tourist sector was in an "extremely precarious" state, while the machine tool industry risks major lay-offs and loss of investment to foreign sites.
The SNB has already flooded the banking system with SwFr80bn (£65bn), a vast sum for a country of less than 8m people. This was overpowered by a wall of money on Wednesday after contagion hit French banks and the US Federal Reserve pledged to hold rates near zero until mid-2013. The SNB has since gone further, hinting at unlimited liquidity through swap transactions. Short-term rates have fallen below zero, leading to "negative carry" to deter hedge funds, but this may not be enough.
Kurt Schiltknecht, the SNB's former chief economist, said every measure used to curb inflows in a similar crisis in 1978 proved a "failure", including negative rates. Eventually the bank set a target against the Deutschmark (10pc above market levels) and pledged to buy foreign currency with printed francs for as long as it took. "It worked well. After some hesitation, the market became convinced," said Mr Schiltknecht. A euro peg would be similar.
Thomas Jordan, the SNB's vice-president, said a "temporary link with Europe's common currency" might be allowable under the bank's mandate so long as it did not compromise Switzerland's monetary independence.
Hans Redeker, currency chief at Morgan Stanley, said Swiss companies have been shielded so far by currency hedges taken out two years ago but these contracts are expiring. "They are running against the clock. The Swiss economy has been stable until now because exporters are still operating at the earlier exchange rate. There could be significant problems next year."
Denmark has avoided Switzerland's fate by pegging to the euro, though the model may be hard to replicate. "Nobody is speculating with the Danish krona. I think a euro peg could work if the SNB is willing to defend the level by creating as much liquidity as needed," said Mr Redeker.
The franc came within a whisker of parity against the euro this week before moving back to SwFr 1.08. It was trading above SwFr 1.65 to the euro before the credit crisis in 2008. Sterling has more than halved against the Swiss currency in just three years.
100% mortgages return to the British market
by Richard Evans - Telegraph
The 100pc mortgage is back. After becoming extinct in the wake of the credit crisis, one bank is now offering borrowers the chance to buy a property without a deposit.
Northern Bank, which operates in Northern Ireland, is offering the loans subject to affordability, although borrowers do not have to belong to a special group, such as professionals who can expect to earn high salaries in future, in order to be considered. The bank does not offer mortgages in other parts of the UK.
Previously, buyers without a deposit normally had to rely on help from parents via a guarantee. With "guarantor" mortgages, the home loan is effectively underwritten by the parents. So if you fell behind with monthly payments, this means that they would be obliged to pay.
The advantage of such schemes is that parents don’t have to stump up cash sums upfront and it can enable you to borrow more. But if you run into financial problems, this can affect your parents’ ability to get credit and potentially put their home at risk. Your parents would need to have sufficient income and/or equity in their home to be an effective guarantor, so not all first-time buyers would be able to obtain one of these mortgages.
If you have a deposit of less than 5pc – the minimum for almost all other mortgages – you could try a shared ownership scheme. Here housing associations allow you to buy 25pc of a property and pay rent to them on the rest. When you can afford it you make a further staged purchase. As you are only buying a slice of the property, the deposit needed will be significantly smaller.
King warns of harsh winds ahead as Bank cuts growth forecast
by Heather Stewart - Guardian
Sir Mervyn King warned that the headwinds facing Britain's fragile economic recovery were becoming "stronger by the day", as the Bank of England cut its growth forecasts.
City analysts predicted that interest rates would remain at their record low of 0.5% until 2013, after the governor used his quarterly inflation report briefing to warn that the UK could not be isolated from the turmoil in the global economy.
As George Osborne, the chancellor, prepared to address the House of Commons on Thursday on the risks for the UK from the mayhem in world financial markets, the Bank's nine-member monetary policy committee (MPC) downgraded its growth forecast to about 1.5% this year. That was down from 1.8% in its last report three months ago, and weaker than the 1.7% pencilled in by the Office for Budget Responsibility.
King warned that the Bank's number-crunchers had not included in their forecasts what he called "the unimaginable and the unmentionable" – risks impossible to quantify, such as a full-blown sovereign debt crisis in the eurozone. "It is very important that we do not see the development of a sovereign debt crisis."
For 2012, the Bank is now projecting growth of about 2%, against the OBR's 2.5%. It expects cash-strapped consumers, hit by tax rises and rapid increases in the cost of living, to continue tightening their belts. "The squeeze in households' real incomes is likely to continue to weigh on domestic demand, especially over the next year or so," the MPC said in the report. "But expansionary monetary policy, prospective growth in global demand and the current level of sterling should mean that, after some near-term weakness, GDP growth picks up."
King said that the drama in the markets reflected the fact that the imbalances built up in the global economy during the boom years had still not been resolved, and the Bank would be unable to cushion the UK from the fallout. "There's a limit to what monetary policy can do," he said. "There are significant adjustments that need to be made."
The governor made clear that a fresh round of "quantitative easing" – the injection of electronically created money into the economy – remains an option if the situation deteriorated further. Peter Dixon, UK economist at Commerzbank, said, "unsurprisingly, Sir Mervyn King maintained his long-standing view that the BoE still had some shots in its locker, including more asset purchases if necessary."
The governor rejected the idea that the Bank could follow the US Federal Reserve and make a long-term commitment to keep interest rates at current levels, however. In a bid to calm chaotic financial markets, the Fed suggested on Tuesday that borrowing costs would remain at their current exceptionally low levels until 2013. But King argued: "I think it's very dangerous to try to make a commitment. To lock in monetary policy now for two years does not seem to me to be particularly sensible." He added that financial markets in Britain already expected interest rates to be held for the foreseeable future.
George Buckley, chief UK economist at Deutsche Bank, noted that the Bank's forecasts suggested that without fresh monetary stimulus, such as a new round of quantitative easing, inflation would be below the MPC's 2% target in two years. "The Bank's signalling may be less obvious than that of the Fed, but in its own way it is telling us that rates are likely to remain low for a long period," added Buckley.
After King's bearish assessment, RBS joined other City banks in forecasting that there would be no rise in interest rates until 2013 at the earliest. The MPC expects inflation to peak later this year at about 5%, driven by soaring utilities bills, but to fall rapidly in 2012, as the effect of oil price rises and the VAT increase wear off. The MPC's analysis suggested the deep recession that followed the credit crunch has left lasting scars on the economy. "Output is likely to remain significantly below its pre-recession trend," it said, warning that even by 2014, GDP growth is only, "a little more likely to be above its historical average than below it".
Brendan Barber, TUC general secretary, said: "This recovery is already the slowest on record, and the Bank's assessment that it may take another three years for us just to recover lost ground shows that the pain is set to continue for some time." King said it was far too soon to say whether there was any connection between economic weakness and the riots. He stressed that the private sector had created many more jobs than had been lost through public-sector cuts over the past 12 months.
'The unimaginable and the unmentionable'
The risks too scary for the Bank of England to calculate:
- Eurozone break-up
As the continued sell-off in European markets makes clear, the future of the single currency looks alarmingly uncertain. Perhaps hard-hit Greece will decide it's had enough and leave – or maybe the entire 17-member bloc will be blown apart.
- Middle East conflagration
A worst-case scenario has the stand-off in Libya and the Syrian unrest spiral into a much wider conflict, sending world oil prices rocketing.
- 1930s-style protectionism
As Mervyn King said, creditors and debtors – east and west, China and the US – still have to work out how to share losses from the financial crisis. The pain could be evenly shared or end in a tit-for-tat trade war, with everyone worse off.
- Military conflict
The world economy is already perilously weak, and confidence is in tatters. Any sabre-rattling, from North Korea to the Caucasus, could be shattering.