"Wife of rehabilitation client. Jackson County, Ohio." Farm Security Administration
Ilargi: 747. That’s the -very appropriate- highest level I saw the Italian 10-year rate achieve in the early morning. Skyrocketing, baby. For all we know, Italy may plead with Berlusconi to come back even before he's left if this goes on.
Just to be clear: this rate puts Italy in urgent need of a bailout. Even the 2-year yield soared above 7%. There is supposed to be a €5 billion bond sale tomorrow; it could be ominous. Looking at the trouble Europe has dealing with Greece, one has to wonder what Italy's drama will bring to the EU. The ECB is certainly buying Italian debt as we speak, which makes one wonder where the yield would stand if it didn't.
50%. That’s how much Cao Jianhai of the 'prestigious' Chinese Academy of Social Sciences sees home prices falling in China -perhaps even within the next year- if and when the government continues its current policies of "economic cooling", i.e. lending restrictions and capital requirements for banks. This will lead to even more power for loan sharks, and to cut-off fingers, bankruptcies and down the line inevitably to mass social unrest.
China as an economist's wet dream is over.
50% is also the threshold that Diana Olick at CNBC says America's underwater mortgages have passed. She quotes analyst Mark Hanson:
Half of US Mortgages Are Effectively UnderwaterOn US totals, if you figure average house prices use conforming loan balances, then a repeat buyer has to have roughly 10% down to buy in addition to the 6% Realtor fee to sell.
Thus, the effective negative equity target would be 85%. You also have to factor in secondary financing, which most measures leave out.
Based on that, over 50% of all mortgaged households in the US are effectively underwater — unable to sell for enough to pay a Realtor and put a down payment on a new purchase without coming out of pocket.
Because repeat buyers have always carried the market as the foundation, this is why demand has not come back. It's as if half the potential buyers in America died over a two-year period of time.
Ilargi: Laugh all you want at the Greek and Italian antics, America, your turn will come, and it won't be long now. Numbers like these are certain to push home prices down further. A lot. The housing market is effectively dead, and it won't come back until prices are back where they become affordable. Which is at a far lower level than they are now. And that leads straight to the next number:
$7.8 billion Which is what Fannie Mae has asked the US government for as a next bailout. No end in sight.
$112 billion Is what Fannie Mae has cost the taxpayer so far.
$169 billion The tally for Fannie Mae and Freddie Mac combined to date.
$220 billion The number the US government claims baling out the pair may cost you by 2014. Here's thinking that's still off by a factor or so (be creative).
And here's what Michael Williams, Fannie's president and CEO, has to say about the situation: "Despite these challenges, we are making solid progress." Yeah; some progress, alright.
But let's get back to Europe. What we see happening there lately is that politics starts trumping economics, i.e. numbers. This makes a lot of sense; the numbers are so bad that the power hungry among us need to try a different tack. And they have plenty of that.
Hence the difficulties Greece has in forming a new government, national unity or not. The frontrunner for prime minister until this morning, but no longer -or so it seems-, is/was Lucas Papademos. Ol' Luke is one of the boys: Harvard, Columbia, Boston Fed and ECB are on his proud resume. He's what we call a technocrat. Someone all too eager to follow the directions "offered" by the financial status quo. They wanted him in order to be sure all austerity and budget cut measures would be save.
But some Greek politicians refuse to play along. And Papandreou is probably all too glad that he can leave, and not carry the blame for what is to come, and which will be much worse, however it plays out, than what has already happened. (Note: I just read that parliament speaker Petsalnikos has been put forward, and a cabinet has been formed. I’ll give it till Christmas, and that's just because I’m in a generous mood.)
Italy after Berlusconi -he's still there, mind you- is a similar story. the technocrat pushed forward in Rome is Mario Monti. Resume: Yale, European Commission, Trilateral Commission, Bilderberg Group, Spinelli Group. Neoliberal, technocrat. Not everyone in Italy will love him as a prime minister, to put it mildly. It’ll be quite the fight. But then, that’s what Italy is up for anyway.
An utterly corrupt political system has been simmering for years in quests for power while Berlusconi tightened his grip and issued bonds like confetti. He’ll soon be gone, the debt will not. And Italy may well go the way of Belgium: a fast succession of short-lived cabinets, followed by a Mexican stand-off stalemate that can last for years, while Rome is burning. Italian private debt is low, but that only means taxes will rise through the roof, as the various governments will see no other way than to claim the wealth of their citizens.
The citizens of Europe are just the last link in a chain in which every higher link tries to crush the lower ones into submission. The result will be something akin to the Balkanization of Europe.
Merkel and Sarkozy try to crush the Greeks into submission, and they'll soon do the same with Italy. Then Sarkozy, if he lasts that long -which is a big question mark-, will find Germany -with Holland, Finland etc.- trying to make him bend over.
Meanwhile, Ambrose Evans Pritchard hollers that China and the US should crush Germany into submission. Meaning Berlin should fund the ECB with trillions of euros of its taxpayers' money and fork it all over to Greece, Italy, Spain, you know the drill by now.
Germany will undoubtedly already have told Obama and Wen Jiabao that in its view, it's not the ECB that should do the next round, but the IMF. That way the US can pay its fair share of the bailout. Merkel will argue that it's very much in the American interest to save Europe's banks and countries, and American banks are responsible for a large part of the EU crisis. So pay up, guys!
All these leaders are watching what happens to Papandreou and Berlusconi and thinking: what's going to happen at my own next election? Will I even last that long? What if the big boys want me out?
In Europe, daily power has now shifted to the Frankfurt group, in which the core leaders (Merkel, Sarkozy, European Commission, ECB) try to take the decisions without having to listen to parliaments and such. Even as Merkel's own courts have recently ordered all major financial decisions to go through the Bundestag. This will not go well. It's hard to say where and when exactly such a chaotic system will snap, but snap it will.
Once politics takes over, it's very hard to make it take a step back. There are age-old issues in every nook and cranny of Europe that are set to rise up once again like so many zombies. Perhaps that's simply the inevitable consequence of an economic system based on and held together by zombie money. It won't be pretty. It makes me think of what George Monbiot once wrote about limits to cheap energy: we’ll end up fighting like cats in a sack.
To see where the sack is likely to located, here's a Société Générale graph courtesy of the Guardian's Nils Pratley (If you think Italy is bad....):
Italian Bonds Sink As LCH.Clearnet Ups Margin Calls
by Neelabh Chaturvedi - Dow Jones Newswires
Italian bonds capitulated Wednesday, with yields soaring across the curve to hit euro- era highs after clearing house LCH.Clearnet SA made it more expensive to trade the country's bonds, blunting initial optimism that followed Prime Minister Silvio Berlusconi's decision to step down.
The yield on the benchmark 10-year bond soared by 45 basis points to 7.12%, according to Tradeweb, above the psychological 7% mark that prompted Greece, Ireland, and Portugal to seek external assistance as funding costs became unsustainable.
More alarmingly, shorter-dated yields rose at an even faster clip, with the two-year yield climbing 96 basis points to 7.11%. The yield on treasury bills due in a year's time breached 6%, an ominous sign ahead of Italy's EUR5 billion sale Thursday. The flight to safety helped core bonds recover, with the December bund futures contract rising 26 ticks to 138.29, bouncing over a point off session lows.
The sense of panic in the Italian bond markets spread quickly to foreign-exchange, with the euro falling fast across the board and other currencies deemed risky, growth-sensitive bets, such as the Australian dollar, also sinking. The euro dropped by 0.5% as European trading hours got underway to hit a low of $1.3730.
Europe's emerging-market currencies also felt the pain, as nervous investors shoved the Hungarian forint to its lowest levels against the euro since March 2009. The Polish zloty and Czech koruna also fell sharply.
Clearing house LCH.Clearnet SA said Wednesday it had raised initial margin calls on Italian bonds across a range of maturities. The margin call on bonds due between seven and 10 years was raised by five percentage points to 11.65%, for bonds due between 10 years and 15 years it was raised by five percentage points to 11.80%, while for bonds that mature in 15 years and 30 years the margin call was raised by five percentage points to 20%.
The changes come into effect Nov. 9 and will have an impact on margin calls from Nov. 10, the French arm of LCH.Clearnet said. "An increase in margin requirements will exacerbate an already well entrenched negative feedback loop, just as it did in case of Greece, Portugal, and Ireland," said Richard McGuire, senior fixed income strategist at Rabobank International.
A rise in margin requirements would make it costlier for dealers to trade the country's bonds and market participants noted that traders had begun to liquidate holdings. Thin trading conditions magnified the move. "People are just getting out of their positions and hitting crazy levels," a trader in London said. "The European Central Bank might buy bonds but it is unlikely to be aggressive until there is more clarity on the political front in Italy," the trader said.
The brutal sell-off was in contrast to initial trading, where assets perceived to be risky had gained after Berlusconi stated his intention to resign once the parliament approves the latest reform measures. Investors have questioned the Italian government's willingness to push through tough austerity steps and news of Berlusconi's possible departure had rekindled hopes that whoever replaces him might do what is needed to pare the country's bulging debt pile.
If you thought Italy was bad...
by Nils Pratley - Guardian
Italy's finances look shaky but some of its neighbours in the eurozone – and the UK – might be even worse off
Italy's finances look shaky – a debt-to-GDP ratio of 118%, a heavy proportion of debt to be rolled over and growth almost at a standstill. On the other hand, the level of household debt is much lower that of most other large European countries.
Nor does the government have the same size of unfunded pension and other liabilities as some other European countries.
This chart and caption, published a couple of weeks ago by Société Générale analysts, is alarming.
Why Cash Is A Great Place To Be Right Now
by Simon Black, Sovereign Man
Last week, I sent my 4th Pillar subscribers an issue warning them of a sharp rally in the US dollar. Since then, the euro has fallen from above 1.40 to 1.379. The pound weakened from 1.6165 to 1.603. And the currency we watch most closely in the 4th Pillar, the Aussie dollar, dipped from above 1.06 to 1.0375.
I issued this warning because it is becoming abundantly clear to me that we’re in for another prolonged bout of deleveraging in global financial markets. You’ve heard this term "deleveraging" before, no doubt. But, let’s step back discuss in simple terms what it actually means.
The way the modern banking system works is that banks use their depositors’ funds to make loans or purchase securities. Regulators require them to hold a certain amount of capital against these "assets," and the amount is known as the "Capital Adequacy Ratio." The idea is to ensure that the bank will still have money on hand if its asset portfolio goes bad.
Now, things are fairly predictable in the day-to-day course of banking business. Money is lent out, paid back, deposited, and withdrawn. To guard against fluctuations in activity and imbalances that arise in the normal course of business, the bank keeps a certain amount of liquid cash (and near-cash instruments) on hand as a buffer.
When sudden volatility strikes, the amount of liquidity banks wish to hold goes up… sometimes dramatically. With all the turmoil in Europe’s debt markets right now, and the collapse of the global futures broker MF Global last week, we’re in a heavy period of volatility right now. Banks are all scrambling to get their hands on cash in order to have larger buffers against system shocks.
Moreover, longer-term factors are at play beneath the surface, which reinforce this trend. Capital adequacy ratios are complex calculations, but the basic idea is that the riskier the loan made, or security purchased, the more capital a bank should set aside against it.
However, in their wisdom, the bureaucrats at the Bank for International Settlements (BIS), which sets global capital adequacy standards for the banking industry, deemed ALL bonds issued by ANY Eurozone governments to be "risk free." You don’t need to be Einstein to see the problem here. The government bonds of Ireland, Portugal, Spain, Italy, not to mention Greece, have ALL fallen dramatically in value. In the case of Greece, an official write down has already been agreed to.
As a result, banks around the world– most notably the German, French, and Italian banks– are going to see huge holes appear in their balance sheets FOR WHICH THEY WERE NOT REQUIRED TO SET ASIDE ANY CAPITAL.
These losses are very real, however, and they will have to be paid for out of banks’ capital. As a result, to maintain their mandated capital adequacy ratios (risk-weighted assets/capital), the banks need to do one of two things.
- Raise fresh capital (increase the size of the denominator).
- Shrink their at-risk assets (reduce the size of the numerator).
Right now, most banks either cannot raise fresh capital, or do not want to do so at current depressed share prices (as it dilutes the stakes of the guys who make these decisions). That means option 1 above is largely off the table.
So instead, they are all going to try and tackle the problem from the other side of the coin and shrink their assets instead. That means they are calling in loans, selling securities, dumping collateral that they’ve seized, and so on. All of this is draining liquidity from the financial system and setting off a huge scramble for cash.
It won’t work. Since the banks are all trying to unload assets at the same time, the price for those assets will plunge, which in turn means they will have to take losses. And losses are just hits against capital. Which puts them back to square one. It’s a vicious circle.
And that’s why I believe that right now, the best place for you to have the bulk of your investment capital is in CASH. That’s the asset in greatest demand in the global financial system right now. Its value is going up. And the value of most stocks, bonds, and other securitized debt is going down. The 4th Pillar Model Portfolio (which I manage) is 65% in cash (half in US$, half in A$) at the moment.
Ironically, government bonds of the USA, Japan, and the UK, which are all heavily indebted, and either being downgraded, or on watch to be downgraded, are all still considered "risk-free" in the computation of banks’ capital adequacy ratios. So they will probably also benefit from the scramble for safety and liquidity… for now, at least.
The next shoe to drop will be when these other sovereign bonds issuers go the way of the PIIGS. I don’t expect that to happen any time soon. But, one by one, the "risk free" instruments in which the global investment herd can park its money are being eliminated. When this does, you can plan on a triple-digit silver price and five-digit gold price.
The emergence of the Frankfurt Group has turned back the democratic clock
by Larry Elliott - Guardian
Electorates are being bypassed as increasing austerity pushes Europe's weaker countries into an economic death spiral
Financial markets rallied last week when the Greek prime minister, George Papandreou, announced he was dropping plans for a referendum on the terms of his country's bailout. Bond dealers liked the idea that the government in Athens could soon be headed by Lucas Papademos, a former vice-president of the European Central Bank. Angela Merkel and Nicolas Sarkozy think Papademos is the sort of hard-line technocrat with whom they can do business.
Silvio Berlusconi's long-predicted departure as Italy's prime minister will no doubt be greeted in the same way, particularly if he is replaced by a government of national unity headed by another technocrat, Mario Monti. A former Brussels commissioner, he is seen as someone who could be relied upon to push through the European Union's austerity programme during the next 12 months, watched over by Christine Lagarde's team of officials from the International Monetary Fund.
From the perspective of the financial markets, this makes perfect sense. Papandreou could no longer be relied upon, and his decision to hold a plebiscite threw Europe into turmoil last week, blighting the Cannes G20 summit. He had to go.
In Italy, Berlusconi is seen as entirely the wrong man to cope with his country's deepening crisis; bond yields are above 6.5%, a level that eventually resulted in bailouts for Greece, Ireland and Portugal. He, too, has to go in the interests not just of financial and political stability but to prevent the eurozone from imploding.
The European Union has always had problems with democracy, a messy process that can interfere with the grand designs of people at the top who know best. When Ireland voted no to the Nice Treaty, it was told to come up with the right result in a second ballot. The European Central Bank wields immense power, but nobody knows how the unelected members of its governing council vote because no minutes of meetings are published.
That said, the latest phase of Europe's sovereign debt crisis has exposed the quite flagrant contempt for voters, the people who are going to bear the full weight of the austerity programmes being cooked up by the political elites.
Here's how things work. The real decisions in Europe are now taken by the Frankfurt Group, an unelected cabal made of up eight people: Lagarde; Merkel; Sarkozy; Mario Draghi, the new president of the ECB; José Manuel Barroso, the president of the European Commission; Jean-Claude Juncker, chairman of the Eurogroup; Herman van Rompuy, the president of the European Council; and Olli Rehn, Europe's economic and monetary affairs commissioner.
This group, which is accountable to no one, calls the shots in Europe. The cabal decides whether Greece should be allowed to hold a referendum and if and when Athens should get the next tranche of its bailout cash. What matters to this group is what the financial markets think not what voters might want.
To the extent that governments had any power, it has been removed and placed in the hands of the European Commission, the European Central Bank and the IMF. It is as if the democratic clock has been turned back to the days when France was ruled by the Bourbons.
In the circumstances, it is hardly surprising that electorates have resorted to general strikes and street protests to have their say. Governments come and go but the policies remain the same, creating a glaring democratic deficit. This would be deeply troubling even if it could be shown that the Frankfurt Group's economic remedies were working, which they are not.
Instead, the insistence on ever more austerity is pushing Europe's weaker countries into an economic death spiral while their voters are being bypassed. That is a dangerous mixture.
Eurozone: A new 'politburo' forms
by Paul Taylor - Reuters
Europe has a new informal leadership directorate intent on finding a solution to the euro zone's debt crisis, but it has yet to prove its ability to come up with a lasting formula. Forged in the fire of a bond market inferno, the shadowy so-called Frankfurt Group has grabbed the helm of the 17-nation currency area in a few short weeks.
The inner circle comprises the leaders of Germany and France, the presidents of the executive European Commission and of the European Council of EU leaders, the heads of the European Central Bank and the International Monetary Fund, the chairman of euro zone finance ministers, and the European Commissioner for economic and financial affairs.
Europe's new politburo met four times on the sidelines of last week's Group of 20 summit in Cannes, issuing an ultimatum to Greece that it would not get a cent more aid until it met its European commitments, and arm-twisting Italy to carry out long delayed economic reforms and let the IMF monitor them. In a tell-tale recognition of the new ad hoc power centre, members wore lapel badges marked "Groupe de Francfort".
U.S. President Barack Obama attended one of the meetings, getting what he joked was a "crash course" in the complexity of Europe's laborious decision-making processes and institutions. "He proved to be a quick learner," one participant said. Two people familiar with the discussion said he argued for the euro zone to make its financial backstop more credible by harnessing the resources of the ECB, but German Chancellor Angela Merkel and ECB President Mario Draghi resisted.
Obama also supported a proposal to pool euro zone countries' rights to borrow from the IMF to help bolster a firewall against contagion from the Greek debt crisis, but Germany's central bank opposed this too, the sources said. The president referred obliquely to the debate at a news conference the next day, saying: "European leaders understand that ultimately what the markets are looking for is a strong signal from Europe that they're standing behind the euro."
Hours earlier, a television camera in the Cannes summit conference room caught Obama and British Prime Minister David Cameron discussing the issue while waiting for the start of the final working session. Cameron, whose country is not in the euro, has called publicly for the ECB to act as the lender of last resort for the euro zone, as the Federal Reserve does for the United States, and the Bank of England for Britain.
When Merkel entered the room, Obama pulled her aside for a private conversation. An open microphone caught his opening words: "I guess you guys have to be creative here." The Frankfurt Group came about on the hoof to try to fashion a crisis response in something closer to the short timespan of frantic financial markets.
It seems destined to endure, not least because the growing imbalance between a stronger Germany and a weaker France means other players are needed to broker decisions. Crucially, it aims to bridge the ideological gulf between northern and southern Europe, and between supporters of the orthodox German focus on fiscal discipline and an independent central bank with the sole task of fighting inflation, and advocates of a more integrated and expansive economic and monetary union.
The presence of IMF Managing Director Christine Lagarde gives the group greater credibility in the markets, as well as providing a reality check on what international lenders expect and the limits to their willingness to support the euro zone.
It all began with a blazing row at the Old Opera House in Frankfurt on Oct. 19 that spoiled Jean-Claude Trichet's farewell party after eight years as president of the ECB.
As the fallout from Greece's debt crisis singed European banks and panicky investors dumped euro zone government bonds, French President Nicolas Sarkozy, who had snubbed the ceremony in honour of Trichet, flew in at the last minute to meet a visibly irritated Merkel. Sarkozy himself said that day that France and Germany were at odds over how to leverage the euro zone's financial rescue fund. The French wanted to let the European Financial Stability Facility operate as a bank and borrow money from the ECB.
"In Germany, the coalition is divided on this issue. It is not just Angela Merkel whom we need to convince," Sarkozy told lawmakers, according to Charles de Courson, who was present.
At the Frankfurt meeting, described by one participant as "explosive", Merkel and Trichet firmly opposed the idea, which they said would violate the European Union's treaty prohibition on the central bank financing governments. Germany insisted on that clause when the ECB was created because of its own history of fiscal abuse of the central bank that fuelled hyperinflation in the 1920s and funded the Nazis' massive rearmament in the run up to World War Two.
As French officials tell it, Merkel is not so hostile to the proposal as her finance minister, Wolfgang Schaeuble, and the head of the German Bundesbank, Jens Weidmann. The French are convinced that Merkel understands the ECB will have to be more centrally involved in fighting bond market contagion, but she cannot get it through her divided coalition for now. They see the ECB as the main centre of resistance.
After hearing a chorus of Obama, Cameron and the leaders of India, Canada and Australia at the G20, Merkel acknowledged that the rest of the world found it hard to understand that the ECB was not allowed to play the role of lender of last resort. But the crisis may have to get still worse before the Germans and the ECB relent, if they ever do.
The Frankfurt Group has already had an impact in euro zone crisis management but like all informal core groups it has begun to stir resentment among those who are excluded, and it has yet to prove its ability to craft a convincing longer-term solution. North European creditor countries such as the Netherlands, Slovakia and Finland, where public hostility to further euro zone bailouts is fierce, are already grumbling about decisions being taken behind their backs.
In Greece and Italy, there has been strong criticism of the perceived arrogance of "Merkozy", as the Franco-German duumvirate are increasingly nicknamed, in summoning their prime ministers to receive ultimatums. German and French officials shrug off such complaints as inevitable, noting that EU partners are even more unhappy when France and Germany do not agree, since that paralyses Europe.
"There is always a trade-off between legitimacy and efficacy," said an EU official involved in the Frankfurt Group. "The euro area institutions were not designed for crisis management so we need innovative solutions. "In an emergency like this, we have to have a structure that works," he said, adding that the presence of the European Commission and of European Council President Herman Van Rompuy guaranteed that the interests of smaller member states would be taken into account.
EU officials had held conference calls with the 15 other euro zone states during the Cannes summit "to keep them in the loop". The head of the EFSF, Klaus Regling, was secretly flown to Cannes to brief the leaders on the state of accelerated preparations to leverage the rescue fund, one source said. Merkel long resisted French pressure to create more of an "economic government" in the euro zone, not least because she did not want Germany to be in a minority on issues such as bailouts, free trade or the EU budget.
She also did not want to alienate German allies and neighbours such as Denmark, Poland and the Czech Republic, which are not in the euro zone. But recent problems in smaller countries that aggravated market turmoil -- Finland's demand for collateral on loans to Greece and Slovakia's parliamentary wrangling over increasing the EFSF's powers -- convinced her of the need for stronger leadership to impose order.
Whether the Frankfurt Group will be the forum that finally convinces Germany to accept a bigger crisis-fighting role for the ECB, or the creation of jointly issued euro zone bonds, remains to be seen.
A crisis? Call the F-team
by Charlemagne - Economist
The euro's Frankfurt Group
Some European delegates walking around the G20 summit in Cannes can be seen sporting an unusual badge: Groupe de Francfort.
The Frankfurt Group, or GdF for short, is the latest addition to the proliferation of international political groups, the G7, G8 and the G20, among many. Consisting of the leaders of Germany, France, the Eurogroup of finance ministers, the European Central Bank, the European Commission and the International Monetary Fund, the F-team has quickly established itself as the cluster managing the euro’s crisis. It has no legal structure or secretariat, but it is now the core within Europe’s core.
It was born by unhappy coincidence at Frankfurt’s old opera house on October 19th, on the occasion of a farewell party for Jean-Claude Trichet, the former president of the European Central Bank (ECB). This was meant to be a grand sending-off, with a farewell concert, drinks reception and laudatory speeches from Europe’s political elite. Angela Merkel, the German chancellor, was among those in the front row.
But soon the atmosphere soured. Wheeled on to the stage, Helmut Schmidt, the former West German chancellor, indignantly told the audience that the failure of the current generation of politicians was a far greater threat to the future of Europe "than the indebtedness of individual states." Then came news that Nicolas Sarkozy, the French president, would fly in even as his wife was in hospital, about to give birth to their daughter, Giulia.
While the orchestra conducted by Claudio Abbado struck up its performance of Mozart, the leaders gathered in a backroom of the opera house to prepare for the upcoming European summit on October 23rd that was meant to resolve the crisis once and for all. But the debate soon turned rancorous. Mrs Merkel rejected Mr Sarkozy’s push to boost the euro zone’s bail-out fund by allowing it to borrow money from the ECB.
Mr Trichet was, if anything, even more vehemently opposed to the idea. By treaty, the ECB is forbidden from lending money to governments. The ECB president, it is said, abandoned his customary English for his native French, the better to argue with Mr Sarkozy.
The incoming ECB president, Mario Draghi, quickly returned to the main event to listen to the concert. Two hours later, Mrs Merkel slipped out of a side door. Mr Sarkozy stormed out the front, with key aides running to keep up with him. "I was surprised by the depth of disagreement," said one participant.
Plainly the summit would be unable to reach a deal. But instead of cancelling it, euro-zone leaders decided instead to call a second one three days later. Each summit, moreover, was split into two gatherings: one for the EU’s 27 leaders, followed by a smaller meeting of the 17 euro-zone members. If only multiplying the power of the EFSF were as easy as multiplying meetings—and political acronyms.
But somehow, around 4am on October 27th, European leaders finally announced a "comprehensive set of additional measures reflecting our strong determination to do whatever is required to overcome the present difficulties". The deal, however, was full of holes that must now be filled quickly, given the political chaos in Greece (see my earlier post and column) and the prospect that it might default in the coming weeks.
The Frankfurt Group is steering the effort to complete the new firewall "at an accelerated pace". It is not as unwieldy as the 17-strong Eurogroup of finance minister, but more legitimate the duumvirate of Germany and France. Sometimes the F-team summons others for a dressing down, as happened with the Greek prime minister, George Papandreou, on November 2nd. Sometimes outsiders are invited to assist, such as the American president, Barack Obama, who joined discussions the following evening.
That stamp of approval will ensure that GdF is here to stay.
America and China must crush Germany into submission
by Ambrose Evans-Pritchard - Telegraph
As we watch Italy's 10-year bond yields near 7.5pc and threaten to detonate the explosive charge on €1.9 trillion of debt, it is time for the world to reimpose order. You cannot allow the biggest bankruptcy in history to run its course – with calamitous domino implications – before all options have been exhausted.
One can only guess what is happening in the great global centres of power, but it would not surprise me if US President Barack Obama and China's Hu Jintao start to intervene very soon, in unison and with massive diplomatic force. One can imagine joint telephone calls to Chancellor Angela Merkel more or less ordering her country to face up to the implications of the monetary union that Germany itself created and ran (badly).
Yes, this means mobilizing the full-firepower of the ECB – with a pledge to change EU Treaty law and the bank's mandate – and perhaps some form of quantum leap towards a fiscal and debt union. Germany will of course try to say no. But it will pay a catastrophic diplomatic and political price, and will fail to save its economy anyway if it does so.
Having followed the German political scene closely for the last five months, it is clear to me that almost the entire German political establishment is out of its depth, ideological, sometimes smug, apt to view the EMU debt-crisis as a Calvinist morality tale, and lacking in deep understanding of what it has got itself into.
One can understand German worries about money printing – and especially the loss of fiscal sovereignty and democratic control – but matters have already moved on. It is too late for that.
As for the EU authorities with their mad contractionary fiscal and monetary policies in an accelerating slump, they seem to have achieved little by toppling two elected governments in one week. In Italy they have already made matters worse. I doubt that much will change with "technocratic governments" in either Greece and Italy, yet immense damage has been done to democratic accountability.
The EU Project has become both dangerous and insane.
Europe's banks retreat into 'mini-crunch'
by Patrick Collinson and Jill Treanor - Guardian
Europe's banks are withdrawing from foreign lending in an echo of 1930s beggar-thy-neighbour economics
Crisis-hit banks in Europe have begun retreating into beggar-thy-neighbour lending policies in an echo of the protectionism that scarred Europe in the 1930s depression.
Commerzbank, Germany's second largest bank, is to start refusing any loans that do not help Germany or Poland, sending a shudder through other Eastern European countries where the bank used to be a major lender. Its chief financial officer, Eric Strutz, said: "We have to focus on supporting the German economy as other banks pull out."
On Tuesday, Lloyds Banking Group admitted it had pulled back its exposure to banking groups in the eurozone, while City analysts warned political and financial pressure would force European banks to retreat to domestic markets.
Stuart Gulliver, chief executive of HSBC, said he was concerned Asia could suffer if European banks came under further pressure in what is being called the "mini credit crunch". "We need to be careful to monitor the risk of a sharp withdrawal of credit by European banks as a result of events at home," he said.
BNP Paribas and Société Générale, two of the French banks most under pressure, have revealed plans to offload €150bn (£93bn) in assets, with Soc Gen planning sweeping cuts to its networks in Russia, Romania, the Czech Republic and Egypt. Italy's Banco Popolare has put its Hungarian operations up for sale, but has yet to find a buyer.
Lloyds, which acquired HBOS in 2008, is closing down and writing off billions of pounds in loans it made to Ireland in a near-complete withdrawal from the country. Lloyds said its core capital ratio, a key measure of its financial strength, had risen to 10.3% from 10.1% in the last three months.
Evolution Securities head of banking research Ian Gordon said: "Did Lloyds raise capital? No. Is it able to take capital from profits? No. It is raising its capital ratio by shrinking its assets, which fell from £383bn to £372bn. It's clear the focus of banks such as Lloyds is on shrinking the balance sheet, so it's inevitable that if they prioritise lending through Project Merlin, then they will have a reduced appetite for lending outside of the UK."
The retreat to home turf marks a U-turn from the early years of the euro, when cross-border mergers were common and Brussels envisaged a single pool of capital and liquidity to match the single currency. But already the syndicated loans market, in which banks make joint cross-border loans to corporate borrowers, is shrinking rapidly.
John Beck, international bond manager at Franklin Templeton, which manages $300bn in bonds globally, warned of a return to the autarky – or economic self-sufficiency – of the 1930s, when countries came off the gold standard and each tried to devalue their currency against the other.
"Project Merlin has been put in place to ensure UK banks carry on lending to British businesses, but at the same time the aim of government is for banks to become safer – so the way out is to reduce their lending to companies outside the UK. Already Commerzbank won't lend outside its home territory, so what we may be seeing here is the start of banking autarky."
The effective closure of wholesale lending markets also means banks across Europe are much more dependent on raising money from domestic savers and corporates through their home branch networks rather than relying on interbank borrowing within the eurozone.
"When resources are tight you shrink back to your strongest footprint. Other banks face similar choices," said Matthew Clark, analyst with City broker Keefe Bruyette & Woods. Banks across the EU are under instruction from the European regulator to amass capital to withstand further losses from the eurozone. But the European banking authority last week admitted the outcome could be for banks to withdraw loans, cut dividends and reduce bonuses.
The shrinking of loan books – or "deleveraging" – would be a prolonged dampener on economic activity across Europe, said Gordon. "Several years of shrinkage are now inevitable."
European Banks Selling Sovereign Bonds May Worsen Debt Crisis
by Aaron Kirchfeld and Fabio Benedetti-Valentini - Bloomberg
BNP Paribas SA and Commerzbank AG are unloading sovereign bonds at a loss, leading European lenders in a government-debt flight that threatens to exacerbate the region’s crisis.
BNP Paribas, France’s biggest bank, booked a loss of 812 million euros ($1 billion) in the past four months from reducing its holdings of European sovereign debt, while Commerzbank took losses as it cut its Greek, Irish, Italian, Portuguese and Spanish bonds by 22 percent to 13 billion euros this year.
Banks are selling debt of southern European nations as investors punish companies with large holdings and regulators demand higher reserves to shoulder possible losses. The European Banking Authority is requiring lenders to boost capital by 106 billion euros after marking their government debt to market values. The trend may undermine European leaders’ efforts to lower borrowing costs for countries such as Greece and Italy while generating larger writedowns and capital shortfalls.
"European regulators and leaders are shooting themselves in the foot because a big investor group for sovereign bonds has been taken out of the market," said Otto Dichtl, a London-based credit analyst for financial companies at Knight Capital Europe Ltd. "The downward spiral will continue until policy makers find a back-up solution for the sovereigns."
European banks cut their foreign lending to the Greek public sector to $37 billion as of June 30 from $52 billion at the end of 2010, according to the most recent data from the Bank for International Settlements. European banks’ lending to the Irish, Portuguese and Spanish public sectors also fell, according to Basel, Switzerland-based BIS. Financial companies can reduce risk through writedowns, sales and hedges, as well as by letting bonds mature.
Barclays Plc, the U.K.’s second-largest bank by assets, said on Oct. 31 that it cut sovereign-debt holdings of Spain, Italy, Portugal, Ireland and Greece by 31 percent in three months. Royal Bank of Scotland Group Plc, Britain’s biggest state-controlled bank, said on Nov. 4 that it reduced central- and local-government debt of those countries to 1.1 billion pounds ($1.8 billion) from 4.6 billion pounds at year-end.
Italian Yields Climb
Greek bonds have dropped 42 percent since July, the most among 26 sovereign-debt markets tracked by Bloomberg/European Federation of Financial Analysts Societies indexes. Italian debt declined 8 percent and Portuguese securities 5 percent, the indexes show.
Italian benchmark yields climbed to a euro-era record yesterday on concern that the region’s third-largest economy will struggle to manage its debt as growth stagnates.
European leaders are demanding that banks raise capital to increase their resilience after firms represented by the Institute of International Finance agreed last month to accept a 50 percent loss on Greek sovereign holdings to help tackle the debt crisis. Policy makers also announced plans to boost the region’s rescue fund to 1 trillion euros.
The EBA examined how much capital the region’s biggest lenders would need to reach a core Tier 1 ratio of 9 percent by the middle of next year after marking their sovereign holdings to market, an exercise omitted during bank stress tests in July. Most major European countries’ sovereign debt was considered risk-free in the past.
"The recapitalization of European banks is also turning out to be a damp squib," according to a Nov. 6 note from CreditSights Inc. "This does nothing to fix the main problem of restoring sovereigns’ risk-free status."
Forcing Europe’s lenders to boost capital based on sovereign markdowns "will cause a number of serious problems," the IIF, a Washington-based group representing more than 450 financial firms, warned in a letter to French President Nicolas Sarkozy before last week’s Group of 20 summit in Cannes, France.
"The market value of the debt of the countries most under scrutiny is likely to decline further as banks unload sovereign bonds," according to the letter, signed by Managing Director Charles Dallara. "This is contrary to the goal of stabilizing and underpinning the outlook for sovereign debt in Europe."
The losses on Greek bonds and efforts to reduce sovereign- debt holdings have hurt banks’ third-quarter earnings. Commerzbank, Germany’s second-biggest lender, reported a 687 million-euro loss on Nov. 4 after writing down the value of its Greek government debt and selling securities of southern European nations at a loss. Chief Financial Officer Eric Strutz said the Frankfurt-based firm booked a "three-digit-million" euro loss on Italian bond sales, without elaborating.
Strutz, on a conference call with analysts that day, blamed regulators for worsening the situation by including mark-to- market rules in the stress tests, effectively encouraging banks to sell sovereign bonds.
"It’s a little bit strange to see that the regulators are actually fueling the whole debate by going into the other direction of creating more supply in the market," said Strutz. "If you have a mark-to-market, all banks will further sell down their sovereign bonds, because in the end, you need -- whether implicit or explicit -- you need higher capital for that."
While Commerzbank doesn’t want "a fire sale," it’s willing to take "a small loss" to free up capital as the lender further reduces sovereign holdings, he said.
Reiner Rossmann, a Commerzbank spokesman, declined to comment beyond Strutz’s statements.
Losses on Debt
Third-quarter profit at BNP Paribas fell 72 percent because of a 2.26 billion-euro writedown on Greek sovereign debt and losses from selling European government bonds, the Paris-based bank said on Nov. 3.
BNP Paribas, the largest foreign holder of Italy’s bonds, reduced that nation’s debt in its banking book by 8.3 billion euros between the end of June and the end of October, according to a Nov. 3 presentation. Chief Executive Officer Baudouin Prot said on a conference call with reporters the same day that the Italian bonds were "sold in full on the markets" and not to the European Central Bank.
BNP Paribas said it cut the total sovereign debt in its banking book by 23 percent to 81.5 billion euros. "We very much reduced our exposure to sovereign debt," Prot said in a Nov. 3 Bloomberg Television interview. "We incurred losses for that." Isabelle Wolff, a spokeswoman for BNP Paribas, declined to elaborate.
"You can’t really blame BNP or other European banks for selling sovereign debt," said Christophe Nijdam, an AlphaValue bank analyst in Paris. "The European rescue fund hasn’t enough financial firepower, we still don’t have a rescue fund equipped to make sizeable purchases on the secondary market. As a banker, you don’t want to wait to see what happens for Italy and Spain."
While it’s difficult to determine who’s buying the bonds, Knight Capital’s Dichtl said that beyond purchases by the ECB, some Greek government bonds may be bought by hedge funds or distressed-asset investors and Italian debt is still being purchased by asset managers and pension funds.
Of about 355 billion euros in outstanding Greek debt, about 127 billion euros is held by the European Union, the International Monetary Fund and the ECB, while about 90 billion euros is held by European banks, led by Greek lenders, according to estimates by Open Europe, a research group based in London and Brussels. About 80 billion euros is held by foreign non- banks such as hedge funds and insurers. Data is scarce, making estimates difficult, according to Raoul Ruparel, an economic analyst at Open Europe.
'Disentangle the Links'
In the past, domestic banks in countries such as Greece and Ireland "filled the gap" when foreign demand for their nations’ bonds slipped, said Alberto Gallo, head of European credit strategy at Edinburgh-based RBS.
"The question is how to disentangle the link between banks and sovereigns," said Gallo, who described the situation as a Catch-22, referring to Joseph Heller’s 1961 novel that describes the no-win situation faced by a World War II pilot trying to avoid duty. "If you do, you have a risk of accelerated de- leveraging. If you don’t, you end up with a bank system very correlated with sovereign bonds and vulnerable to shocks."
Exit From Italian Debt Spurs Fears
by Marcus Walker and Charles Forelle - Wall Street Journal
The investor exodus from Italian bonds, sparked by the dual political crises in Italy and Greece, raises the most dangerous scenario yet in the euro zone's two-year-old debt crisis.
Yields on 10-year Italian bonds rose as high as 6.73% on Tuesday, a high for the euro era, in the latest sign that investors are fast losing faith in the world's third-biggest sovereign-bond market. Yields might have risen far higher in the past week but for heavy bond-buying by the European Central Bank, economists say. Reversing the capital flight could require both political change in Italy and massive international assistance.
The first event came closer Tuesday evening when Italy's scandal-hit Prime Minister Silvio Berlusconi said he would resign once Parliament passes next year's budget. But it wasn't clear yet whether the announcement meant his final departure from a political scene he has dominated for nearly two decades—or what policy changes a successor might impose.
Italy may yet need financial aid if the mere announcement of a new government doesn't stop the capital outflow. The funds potentially available to Italy from Europe and the International Monetary Fund are unlikely to meet Rome's needs, however. Failure to halt the crisis could lead, in the worst case, to an Italian debt default that cripples Europe's banks, plunges the region into a slump and roils the global financial system.
With €1.9 trillion ($2.6 trillion) in government debt, Italy accounts for nearly one-quarter of all euro-zone public debt, and could prove too big for other European governments to save.
Italy has long relied on the fact that its debt level, although high at 120% of gross domestic product, isn't rising much, thanks to Rome's relatively small budget deficit. But the country still needs to borrow hundreds of billions of euros a year to repay its debts falling due.
Next year, Italy must borrow enough money to repay more than €300 billion in maturing debts and cover a targeted budget deficit of up to €25 billion. If investors aren't willing to lend Italy such sums, Europe will have to prop up the country with all the money it can muster—with help from the IMF—or risk a global financial crash.
A failure by Italy to honor its debts on time is currently considered a remote prospect, precisely because its impact on Europe's banking system and other government bond markets would be so disastrous, economists say.
"An Italian debt restructuring would be calamitous for the euro-zone economy," says Julian Callow, European economist at Barclays Capital in London. "It would plunge it back into a severe recession and generate global instability."
European policy makers are rushing to draw up contingency plans for an event that seemed unthinkable only six months ago: A bailout in case Italy can't attract enough private capital. So far, Italy has been able to attract buyers for its debt, albeit at rising cost. When Italy launched a new 10-year bond in August, it paid buyers a yield of 5.22%. When it sold more of the same bond in October, the yield demanded was 6.06%.
A short-term spike in borrowing costs is a manageable problem for Italy, since only a small part of its debts need to be refinanced at a given time. The Bank of Italy estimates that the country could bring down its overall debts next year even if its interest rates for new borrowing are 2.5 percentage points higher than currently expected.
The problem, however, isn't yields, but investors' appetite for holding Italian debt at all. Many investors now fear that Italian bonds will lose further value, inflicting losses on them. That can lead to a self-fulfilling process of investors pulling out of Italian debt, leaving Rome with too few buyers of new bonds.
Some analysts say that is already happening. "Italian yields would have skyrocketed if the ECB hadn't intervened in the Italian bond market," says Jacques Cailloux, economist at the Royal Bank of Scotland in London. "It's already evident that private-sector demand for Italian bonds has died out."
The apparent end to the Berlusconi era could prove to be the first step toward restoring confidence in Italy, but it won't be enough on its own, analysts say. A technocrat-led government with a reputation for seriousness "would clearly be a step in the right direction," Mr. Cailloux says. "But it wouldn't in itself resolve the Italian economy's structural problems," he says.
Euro-zone authorities are starting to believe that even reforms probably won't be enough, and external financial aid may be needed to tide Italy over until its domestic changes convince financial markets.
At the Group of 20 global economic summit in Cannes, France, last week, European leaders including German Chancellor Angela Merkel and French President Nicolas Sarkozy pushed Mr. Berlusconi to launch deep fiscal and structural overhauls, and to accept outside financial assistance led by the IMF, euro-zone officials say. He agreed only to a limited IMF monitoring role. He told reporters he had turned down an IMF loan.
The challenge for other European governments is that their bailout fund, the European Financial Stability Facility, isn't nearly big enough to meet Italy's borrowing needs for more than a few months. Italy's bond repayments of €64 billion in the first quarter of 2012 are nearly equal to the entire bailout provided to Ireland over three years.
Euro-zone policy makers have already given up hope of using the EFSF directly to lend to Italy. Instead, the plan is to use the remaining money in the fund as a carrot to entice private investors to keep lending. Under two schemes being considered, EFSF money would be put up to absorb a part of any losses that bond buyers might suffer by lending to Italy.
European officials say the approach could work well if investors think the risk of loss is limited. But if investors fear steep writedowns, the little carrot won't help. While a new Italian government might be more open to IMF support than Mr. Berlusconi was, the fund's available global resources total €280 billion—and Italy would only be entitled to tap a fraction of that. Proposals to boost the IMF's resources have so far been shot down by the U.S. and other countries that would have to pay the bill.
That leaves the one institution with theoretically unlimited firepower: the ECB, which can create and lend new euros. But although the bank has been busy buying the bonds of crisis-hit governments—totalling €9.5 billion last week alone—it has repeatedly said its intervention will be limited in scope and duration.
New ECB President Mario Draghi said last week that the bank won't act as a lender of last resort to euro-zone governments, affirming the bank's stance that its mandate under the European Union treaty is limited to fighting inflation.
However, many observers believe the ECB would help Italy more energetically if Italy did more to help itself. Restoring financial-market confidence will require a combination of fiscal and broader economic reforms by Italy's post-Berlusconi leaders, plus aid and advice from the IMF and European authorities, says Mr. Callow. "Under such conditions the ECB could feel justified in accelerating its debt purchases" to allay fears of falling bond prices and lure back private-sector investors, he says.
Half of US Mortgages Are Effectively Underwater
by Diana Olick - CNBC
A new report on still-falling home prices today highlights the fact that the lower those prices go, the more American borrowers fall into an negative equity position; that is, they owe more on their mortgages than their homes are worth.
Most analysts will tell you that negative equity is the number one problem in the housing market today, even worse than foreclosures, because it causes foreclosures, stymies consumer spending and traps potential home buyers and sellers in place.
Negative equity rose to 28.6 percent of single-family homes with mortgages in the third quarter of this year, according to Zillow. That's up from 26.8 percent in the second quarter. In real terms, that's 14.6 million borrowers.
Many of those borrowers are already behind on their mortgage payments, and some are likely already in the foreclosure process. The rest of them are in danger of defaulting, not because they can't pay their mortgages, but because they either won't want to (seeing as they will never see any real appreciation in their investment) or because any change in their economic or personal situation might force them into default (change of job, divorce).
While 14.6 million might seem like a lot, it's not the real number when you consider negative equity in housing's recovery. That's because it doesn't factor in "effective" negative equity, which is borrowers who have so little equity in their homes that they cannot afford to move.
Consider the following from mortgage analyst Mark Hanson:On US totals, if you figure average house prices use conforming loan balances, then a repeat buyer has to have roughly 10 percent down to buy in addition to the 6 percent Realtor fee to sell.
Thus, the effective negative equity target would be 85%. You also have to factor in secondary financing, which most measures leave out.
Based on that, over 50 percent of all mortgaged households in the US are effectively underwater — unable to sell for enough to pay a Realtor and put a down payment on a new purchase without coming out of pocket. Because repeat buyers have always carried the market as the foundation, this is why demand has not come back. It's as if half the potential buyers in America died over a two-year period of time.
The foreclosure crisis grabs most of the media attention these days, but in order for housing to recover, the market needs to see activity.
It's as simple as buying and selling. Negative and effective negative equity are causing stagnation, which may in the end be far more detrimental than foreclosures. The argument to solve this problem is principal forgiveness, and it is gaining traction politically and somewhat less in the banking sector.
Principal forgiveness, or lowering the balance of a large chunk of the nation's mortgages, would be costly at best but could be catastrophic at worst. "Those thinking principal reductions are a panacea have never originated a loan, done the street level research, and do not really know the borrowers behind their data," argues Hanson. "More than likely it would create a far greater number of new strategic defaulters than the number it would legitimately save from Foreclosure."
Fannie Mae Wants Another Bailout After Another Shockingly Huge Quarterly Loss
by Derek Kravitz - AP
Mortgage giant Fannie Mae is asking the federal government for $7.8 billion in aid to cover its losses in the July-September quarter.
The government-controlled company said Tuesday that it lost $7.6 billion in the third quarter. Low mortgage rates reduced profits and declining home prices caused more defaults on loans it had guaranteed. The government rescued Fannie Mae and sibling company Freddie Mac in September 2008 to cover their losses on soured mortgage loans. Since then, a federal regulator has controlled their financial decisions.
Taxpayers have spent about $169 billion to rescue Fannie and Freddie, the most expensive bailout of the 2008 financial crisis. The government estimates that figure could reach up $220 billion to support the companies through 2014 after subtracting dividend payments. Fannie has received $112.6 billion so far from the Treasury Department, the most expensive bailout of a single company.
Michael Williams, Fannie's president and CEO, said Fannie's losses are increasing for two reasons: Some homeowners are paying less interest after refinancing at historically low mortgage rates; others are defaulting on their mortgages. "Despite these challenges, we are making solid progress," he said. For example, Fannie's rate of homeowners who are late on their monthly mortgage payments by 90 days or more has decreased each quarter since the beginning of 2010, he said.
When property values drop, homeowners default, either because they are unable to afford the payments or because they owe more than the property is worth. Because of the guarantees, Fannie and Freddie must pay for the losses. Fannie said lower mortgage rates contributed to $4.5 billion in quarterly losses. While those losses are large, they are temporary and should ease in future earnings reports, said Mahesh Swaminathan, mortgage strategist at Credit Suisse. "They are accounting losses on their books rather than economic losses," he said.
Fannie's July-September loss attributable to common shareholders works out to $1.32 per share. It takes into account $2.5 billion in dividend payments to the government. That compares with a loss of $3.5 billion, or 61 cents per share, in the third quarter of 2010. Last week, Freddie requested $6 billion in extra aid — the largest request since April 2010 — after it reported losing $6 billion in the third quarter.
Washington-based Fannie and McLean, Va.-based Freddie own or guarantee about half of all mortgages in the U.S., or nearly 31 million home loans. Along with other federal agencies, they backed nearly 90 percent of new mortgages over the past year.
Fannie and Freddie buy home loans from banks and other lenders, package them with bonds with a guarantee against default and sell them to investors around the world. The companies nearly folded three years ago because of big losses on risky mortgages they purchased.
The Obama administration unveiled a plan earlier this year to slowly dissolve the two mortgage giants. The aim is to shrink the government's role in the mortgage system, remaking decades of federal policy aimed at getting Americans to buy homes. It would also probably make home loans more expensive. Exactly how far the government's role in mortgage lending would be reduced was left to Congress to decide. But all three options the administration presented would create a housing finance system that relies far more on private money.
Property Prices Collapse in China. Is This a Crash?
by Gordon G. Chang - Forbes
Residential property prices are in freefall in China as developers race to meet revenue targets for the year in a quickly deteriorating market.
The country’s largest builders began discounting homes in Shanghai, Beijing, and Shenzhen in recent weeks, and the trend has now spread to second- and third-tier cities such as Hangzhou, Hefei, and Chongqing. In Chongqing, for instance, Hong Kong-based Hutchison Whampoa cut asking prices 32% at its Cape Coral project. "The price war has begun," said Alan Chiang Sheung-lai of property consultant DTZ to the South China Morning Post.
What started slowly in September turned into a rout by the middle of last month—normally a good period for sales—when Shanghai developers started to slash asking prices. Analysts then expected falling property values to move Premier Wen Jiabao to relax tightening measures, such as increases in mortgage rates and prohibitions on second-home purchases, intended to cool the market.
They were wrong. After a State Council meeting on October 29, Mr. Wen affirmed his policy, stating that local authorities should continue to "strictly implement the central government’s real estate policies in the coming months to let citizens see the results of the curbs." Then, the selling began in earnest as "desperate" developers competed among themselves to unload inventory. One builder—Excellence Group—even said it would sell flats in Huizhou at its development cost.
Citi’s Oscar Choi believes prices will decline another 10% next year, but that’s a conservative estimate. Even state-funded experts are more pessimistic.
For example, Cao Jianhai of the prestigious Chinese Academy of Social Sciences sees price cuts of 50% on homes if the government continues its cooling measures.
When Beijing’s pet analysts are saying prices could halve in a few months, we can be sure they are thinking the eventual sell-off will be worse. In any event, the markets are bracing for trouble. Investors are dumping both the bonds and the shares of Chinese developers, and legendary bear Jim Chanos, citing the property market, late last month said he is still not covering his short positions on China.
One does not have to agree that China will be "Dubai times 1,000—or worse"—Chanos’s memorable phrase—to understand that the unwinding of "the biggest housing bubble ever created" will be especially painful.
Analysts have great confidence in Beijing’s technocrats because they managed to continue to manufacture growth through the global downturn, but most of us seem to forget that the Chinese, through massive stimulus, created even bigger challenges for themselves. At the moment, Beijing has yet to resolve two intractable problems: persistent inflation and artificially high property prices.
The dominant narrative at the moment is that China’s economic managers will skillfully deflate the property bubble and land the economy softly. As Time observes, "Many observers say a sharp economic decline won’t be permitted to happen before the change of leadership in 2012."
Won’t be permitted? It is true that Beijing’s technocrats have had the advantage of working in a semi-closed system that has allowed them to use the considerable resources of the state to achieve outcomes not possible in freer economies. Nonetheless, they can continue to do so—in other words, defy economic principles—only as long as market participants—in this case builders, local officials, and homeowners—cooperate.
The last four weeks, however, must have been a sobering period for Premier Wen, and not only because developers began to lose their nerve. For one thing, recent purchasers have taken to the streets because they had suffered losses even before taking possession of their homes.
A crowd of about 300 people in Shanghai smashed windows at the sales office of Longfor Properties on October 22, two days after the builder had ended a sales promotion on a project. The protestors had bought properties in earlier phases of the same project at prices as much as 30% higher than the discounted ones.
And then, on the 23rd, a smaller crowd—on the same street—demonstrated against another developer, Greenland Group. Protesters were injured in Shanghai at another demonstration, this time against a unit of China Overseas Holdings. There were also protests against builders in Beijing and in other cities, Hangzhou and Nanjing.
The cities of Hangzhou and Hefei have reportedly told developers to limit discounts to 20% to avoid unrest, but the attempt to establish fiat prices will not work for long because many builders face insolvency.
Moreover, Premier Wen has to be concerned that sometimes he cannot control his own cities, which have flouted his decrees by removing curbs on property ownership. Nanjing defied Beijing and relaxed mortgage rules, as did Anhui province. At least in Foshan, a city in Guangdong, central authorities apparently convinced local leaders to rescind their earlier decision to scrap centrally mandated curbs.
The overriding reality is that, because of Beijing’s stimulus spending, there are too many properties and not enough buyers at this time. The market will have to arrive at equilibrium at some point, but what is surprising is the rapidity at which this is now happening. In common parlance, it’s called a crash.
China Housing Prices Decline
by Dinny Mcmahon, Esther Fung And James T. Areddy - Wall Street Journal
Accelerating Fall in Sector Signals Government Efforts Are Working, but Raises Fears About Growth
A decline in China's property prices is picking up steam, suggesting Beijing has had some success in taming housing costs, while also raising concerns that prices could drop too far and fast when the rest of the world is relying on the country as an engine of growth.
House prices were flat or falling in a majority of China's top cities, weekly data released Monday show. The weekly data, though volatile, add to evidence that housing prices are headed downward after years of consistent increases. Beijing has been trying to calm property prices for about two years in an effort to make housing more affordable and douse a possible catalyst for social unrest. Steps by regulators include tightening lending and putting tougher restrictions on buying homes.
An unanswered question is whether China can gently let the air out of its real-estate bubble or whether the bubble will burst, undermining economic growth. With the European Union and U.S. struggling to kick-start their own economies, global growth depends increasingly on the health of the Chinese economy, the world's second-largest.
Beijing's top officials say they plan to stay the course. "I will especially stress that there won't be the slightest wavering in China's property-tightening measures—our target is for prices to return to reasonable levels," Premier Wen Jiabao said in a speech on Sunday in Russia.
Real estate is a major driver of growth in China and a big source of demand for steel and cement, as well as of domestic demand for manufactured goods such as furniture. As much as 25% of the Chinese economy may be tied up in real estate and related industries, according to analysts. Ordinary Chinese frequently invest in real estate, so a sharp downturn could batter their savings.
Prices in the major southern cities of Shanghai and Guangzhou are down from their levels at the start of the year, according to data released by the China Real Estate Index System. Prices fell by 0.23% nationally in October compared with September, faster than the 0.03% drop posted in September from August, according to data from the same index.
In Shanghai, China's business capital, average prices for new residential real estate in many parts of the city are under asking prices for existing homes, according to Shanghai Urban Real Estate Surveyors-Appraisal Co., a consulting firm. Steeper declines may lie ahead. "The correction is not over; it has just started," J.P. Morgan said in a note Friday. "However, the likelihood of a nationwide collapse is very small…. Bursting the bubble is clearly not part of the policy objective."
J.P. Morgan analysts forecast that prices nationally could fall 5% to 10% over the next 12 to 18 months, and as much as 20% in some major cities. Real-estate developers are having greater problems finding financing to complete projects or start new ones. Trust-investment vehicles—a key part of China's shadow lending system—have become a major source of funding for developers, after bank lending all but dried up this year.
New financing provided by trust companies to property developers fell 17% in the third quarter from the second, after regulators stepped in to curtail trust lending to the sector, according to data issued Friday. China's trust companies provided 113.9 billion yuan ($18 billion) of funding to property developers in the three months ended September, according to data on the China Trustee Association website, down from 136.7 billion yuan in April through June. In the first quarter, they provided 71.1 billion yuan in funding.
Trust companies don't take on the risk of an investment themselves, but funnel funds from companies and wealthy individuals into a wide range of investments, including private equity, loans, direct stakes in property development, and even bonds and stocks.
For the Chinese public, complaints still focus largely on housing affordability. But the price drops have also prompted some outcry. In late October, more than 40 people gathered at the showroom of developer Greenland Group in Shanghai amid heavy security to express frustration that properties had been discounted after they had made their purchases.
A real-estate agent with the company said discounts for 28% were on offer. "I bought an apartment here in September and now I've lost more than 400,000 yuan($63,000)," said a businesswoman in her 40s. "That is my hard-earned money, how can the developer be so ruthless?" Greenland Group said Monday that the protests have died down, but didn't provide other details.
Property developers have long held back from cutting prices on new developments, hoping the government would blink first and relax restrictions on purchases. Instead, authorities have continued to increase pressure. The southern city of Zhuhai last week implemented a cap on the prices developers can charge for new housing, a temporary move that emphasizes the pressures officials face to cool the housing market.
On Monday, Hangzhou-based property developer Greentown China Holdings Ltd. said it is considering disposing of some of its property projects to boost its cash flow, rather than cut prices. "Selling the projects is a better option than offering large discounts, which would tarnish our image with our end-customers," Chief Financial Officer Simon Fung said. He said disposing of projects outright is also faster than selling individual units at discounted prices.
China's banking regulator asked trust companies in September to report their exposure to Greentown, amid concerns about how some developers have funded their projects. Greentown executives say the company remains strong.
Politicans and Business Close Ranks Against Berlusconi
by Fiona Ehlers - Spiegel
Things are getting lonely at the top for Silvio Berlusconi. After members of his own party distanced themselves from the Italian prime minister, business owners are now calling for his resignation.
Enrico Frare has been working hard for 12 hours, and now it's time to go home. "The last one turns off the lights," he says, "and I'm always the last one." It's the middle of the night in Veneto, the model northern Italian province with its creative small- and mid-sized businesses. He talks on his car phone in the parking lot of his company, fielding calls from Italian expatriates from Japan and Argentina. They are calling to congratulate him.
And it's not Frare's birthday that they're calling about, it's his birthday suit: All of Italy now knows what he looks like naked. Frare, 36, is a textile manufacturer from Treviso, and has been the head of a winter sportswear company since January. Last week he took out a full-page ad in Italy's largest newspaper, Corriere della Sera, in which he posed naked. The ominous caption next to the photo read: "Every day in Italy a businessman risks losing his underpants."
Why did he do it?
Enrico Frare, 36, runs a winter sportswear company. Last week he posed naked for an ad in Italy's largest newspaper, Corriere della Sera. "Every day in Italy a businessman risks losing his underpants," read the caption -- a protest against Italian leadership during the euro crisis.
For months, Frare says, he hasn't managed to get start-up capital from Italian banks. He's short €700,000 ($960,000). He has money to keep production going and secure the jobs of his 18 employees until the end of the year. He says that he wants to grow in Italy, "the country that I love, and the country that allowed me to become big and bold." Frare also wants to stay in the country, which means not manufacturing abroad and not moving his capital across the border, as his friends are doing. What does he expect from the government in Rome? "I want it to wake up and do something, and to finally bring about reforms, even in the face of resistance."
Growing, trusting and staying are three things that have become almost impossible in Italy these days, as one emergency summit follows another, and the sell-off of Italian government bonds generates a sense of alarm. The leader of the Democratic Party says the country is in worse shape than ever since the end of World War II.
"The crisis and government question are two problems that have to be resolved together," says Pier Ferdinando Casini, chairman of the Unione di Centro (Union of the Center, or UdC) Party, and many people in Rome seem to agree: Even members of Silvio Berlusconi's own party are now distancing themselves from the prime minister. Last Wednesday, six of them wrote him a letter and demanded a new government. Two other party members defected for the UdC.
On Monday, Berlusconi denied rumorsof his imminent resignation. But prominent businessmen have also started to leave his side. Diego Della Valle, owner of the legendary leather goods company Tod's, also ran an ad. But instead of a photo, the ad featured the words: "Politicians, basta! Your time is up. We won't tolerate your spectacles anymore. We demand competent politicians who think about the country, and not just themselves."
Ferrari Chairman Luca di Montezemolo was even more direct, demanding Berlusconi's resignation. "We need to open a new page," he said. Opinion polls show that about 60 percent of Italians would support Montezemolo as a politician.
Montezemolo has a restructuring plan that he believes will protect Italy from bankruptcy. He is calling for a nonpartisan "government for the public good," which would tax wealthy Italians and radically cut government costs by substantially reducing the roughly 1,000 senators and members of parliament, as well as the number of provinces. "If Berlusconi had just remained a businessman, we wouldn't have as many problems," says Enrico Frare.
More and more family-owned businesses, the real engine of the Italian economy, are moving their capital abroad, which has led to tighter controls at the border with Switzerland. Italians are showing up in Tirol and Carinthia, the two Austrian provinces bordering northern Italy, to investigate the requirements for opening private bank accounts. A group of businessmen from the Friuli region traveled to Slovenia to invest their money in banks there instead of Italian government bonds.
The investment climate has deteriorated dramatically. Italy lost its allure for foreign investors some time ago. According to a survey of German entrepreneurs in Italy, the country is far less attractive for foreign investment than France, Spain and Portugal, because of such factors as high taxes, high ancillary wage costs, unreliable payment of debt and political instability.
The results of the World Economic Forum's most recent Global Competitiveness Report are also devastating for Italy. The country ranked 123rd in labor market efficiency -- just below Mozambique. The reasons for its poor showing include rigid protections against termination, the absurdly lengthy duration of legal proceedings and the increasingly restrictive commercial lending practices of Italian banks, a problem which has also beset textile executive Frare.
At the G-20 summit in Cannes, Berlusconi faced demands for solutions. Pressure mounts daily to implement an austerity plan that has been announced several times. Meanwhile the markups on Italian government bonds continue to hit new records. On a single day -- the Friday before last -- the interest on those bonds amounted to about €479 million. Although Berlusconi hurried to deliver his report, wearing an expensive flannel coat as he walked up the red carpet, he arrived empty-handed.
Placating the Markets?
He did not come with urgent decrees, as expected, but merely with announcements, including a so-called expansion of the stability law and a sort of miniature growth plan, but no drastic measures. They were thrown out by the president, who insisted that such extensive proposals could not be implemented through an emergency order.
Either way, Berlusconi's measures would not be enough to placate the markets. In fact, it is questionable whether the measures would make it through the Italian parliament. It seems clear that he wants to push through his anti-crisis plan with a 52nd confidence vote, either this week or next. He won the last confidence vote only three weeks ago -- by one vote. Now the outlook is even worse, and it seems likely that Berlusconi, an escape artist who has emerged strengthened from past crises, will not survive this one. As of last week, the country has been under special observation by the International Monetary Fund in Washington.
And while Berlusconi vied for confidence at various EU summits, the Italian president was busy in Rome, assessing politicians for their post-Berlusconi potential, knowing that he has to be prepared for the imminent end of the current administration.
Giorgio Napolitano, 86, had summoned them one after another, representatives of the opposition and the shaky governing majority. His question was: Who can bring the reforms that are so urgently needed? It might be a transitional government headed, for example, by former EU Competition Commissioner Mario Monti. German Chancellor Angela Merkel has reportedly discussed the question of a possible successor with the president, who may be the only politician in Italy at the moment keeping a cool head.
So far, the response has consistently sounded like the usual Italian cacophony, which is detrimental in times of crisis, and not just for Italy. There are rumors of efforts to stab Berlusconi in the back by renegades from his own party, and of the stubborn Northern League leader Umberto Bossi, who is giving the finger to pension reform. And then there is the toothless opposition, which says: We're ready, but only if Berlusconi resigns.
And then there is the sharp dispute with Finance Minister Giulio Tremonti, who is berated as a traitor because he angrily walked out of a crisis meeting with Berlusconi, allegedly saying: It isn't Italy's economy that is the problem, "it's you." Only a day later, Tremonti and Berlusconi, in a publicity move, were photographed sitting at a conference table together and poring over documents.
Italy is currently showing its ugliest side: a crippled, ridiculous country stuck somewhere between Greek tragedy and opera buffa. According to Corriere della Sera, Berlusconi will not be brought down in the next few days, and yet his end will come -- if not tomorrow, then in a few weeks. A functional government hasn't existed for some time, and yet has managed to retain power, partly because the premier has latched onto the office like a drowning man.
This is understandable. When Berlusconi is no longer prime minister, he will lose the privileges that protect him from the courts. The four cases currently pending against him would suddenly become dangerous. In the Rubygate trial, Berlusconi could face between three and 12 years in prison. The other three cases, in which he is accused of bribery, tax evasion and accounting fraud, also threaten the existence of his corporate empire.
At least there was one bit of good news at the end of a turbulent week: Berlusconi's long-planned CD of love songs will be available just in time for the Christmas season. It will be called "Il vero amore," or "True Love."
Run For Your Lives
by Alexander Jung, Alexander Neubacher, Christoph Pauly, Christian Reiemann, Michael Sauga, Hans-Jürgen Schlamp and Anne Seith - Spiegel
Euro Zone Considers Solution of Last Resort
The ink on the most recent European Union summit agreement was hardly dry before it became clear that it was insufficient. With investors now increasingly wary of Italy, the consensus is growing that the European Central Bank -- and the IMF -- will have to play an even greater role. But will it be enough?
When government heads from Germany and the US get together, protocol usually calls for as much pomp as possible: honor guards, hymns, flag parades and the like. But the tone was decidedly more businesslike at the G-20 summit in Cannes last Thursday. German Chancellor Angela Merkel and US President Barack Obama, together with US Treasury Secretary Timothy Geithner and German Finance Minister Wolfgang Schäuble, met in a mundane conference room at the five-star Intercontinental Carlton Hotel. The group had serious issues to discuss.
Merkel reported on the results of a meeting held a day earlier -- during which she and French President Nicolas Sarkozy had told Greek Prime Minister Georgios Papandreou exactly what they thought about his (now cancelled) plans to hold a national referendum on the euro bailout package. Obama and Geithner, however, were not impressed. The euro crisis continues to worsen, the pair grumbled. It is time, they said, for Europe to finally take decisive action. The decisions taken at the European Union summit in late October were not enough, they complained.
In response, Merkel and Schäuble recited the long list of measures the Europeans had recently initiated. But in reality, they had little to offer in reply to Washington's analysis. The euro crisis, Obama warned, now threatens the global economy.
Too little, too late. That has been the global public's assessment of European efforts to rescue its currency -- for the last one and a half years. And there is every indication that it will remain that way, even after the most recent G-20 meeting.
Indeed, concurrent to the meeting in Cannes, the euro zone experienced what was likely the most ridiculous week of events since the crisis began: a Greek referendum announced on Monday, a reversal on Thursday, a national unity coalition promised in Athens on Friday and Papandreou's resignation on Sunday. Things changed almost by the hour, it seemed. And there is still little reason for optimism.
Half-Hearted and Half-Baked
Greece will keep the euro for the time being -- that much is certain. But it also seems clear that this is neither a guarantee of economic health in Greece nor a secure future for the common currency. On the contrary, there were growing doubts on financial markets last week as to whether the resolutions reached at the late-October European summit would be sufficient.
At that meeting, European leaders leveraged their bailout fund to more than a trillion euros. But what was celebrated a week ago as a "tour de force" and a "breakthrough" is now viewed as half-hearted and half-baked. Hardly a politician or economic expert believes that Greece can be rehabilitated under the more current plan from Brussels. And now there are also growing concerns about Italy.
Interest rates for Italian treasury bonds reached a new record high last week, and the managers of the European Financial Stability Facility (EFSF) were unwilling to risk tapping the global financial markets. The planned issue of a new EFSF bond was cancelled at the last minute.
Not surprisingly, the mood was grim among the leaders gathered on the French Riviera last week for the G-20 summit. The conclusion, after countless discussions about the crisis, was that much more radical measures are needed.
The International Monetary Fund (IMF) and the European Central Bank (ECB) are to take over the management of the debt crisis in the future, and Germany's currency reserves are no longer off limits. Last week Germany's central bank, the Bundesbank, narrowly managed to prevent portions of those reserves from being used to fill the IMF coffers.
Can the "big bazooka" that US politicians, in particular, like to invoke actually save the euro? Many economists are skeptical, because it is primarily economic imbalances that are creating ever-widening rifts between countries in the European currency area. The economic divide between the north, with its strong export economies, and the south, with its high consumption, has grown even further. At the same time, citizens are losing confidence in Europe's ability to manage the crisis.
'Run For Your Lives'
"Run for your lives" is the new motto in Europe, and not just among banks and insurance companies, which are selling off southern European bonds as quickly as they can, but also among ordinary holders of savings accounts. Banks and regulatory agencies are noticing that anxious citizens throughout Europe are trying to bring their money to safety. The flight of capital from Italy, Spain and Greece is in full swing.
Since the beginning of the crisis, ordinary Greeks have withdrawn about €50 billion ($69 billion) from their accounts, or a fifth of total deposits. In May, when the first rumors about a possible withdrawal from the euro zone were making the rounds, the Greeks withdrew €1.5 billion from their accounts within 48 hours.
And it is no longer just the rich who are moving their money to a safe place. A Greek nun recently closed her convent's bank account, telling the bank employee that she needed the €700,000 in the account for renovations. But when pressed by the bank employee, she finally admitted that she was worried about her order's assets.
Switzerland is a popular safe haven. The Greeks have reportedly deposited about €280 billion in Swiss banks. At the airport in Athens, passengers are often caught leaving the country with upwards of €100,000 in cash, well in excess of the €10,000 limit.
This capital flight has triggered a boom in the European real estate market, especially in Berlin and London, where wealthy Greeks are buying second homes. Knight Frank, a real estate firm, estimates that about €290 million from Greece was invested in London in 2010 alone.
Lack of Confidence
The Italians are also getting nervous. Figures compiled by the German Bundesbank and the Banca d'Italia, Italy's central bank, suggest that more than €80 billion in capital was moved out of Italy in August and September by Italians concerned about the growing risk of a government insolvency.
Unfortunately, investors' lack of confidence in southern European economies is only too warranted, as a still unpublished study by the Munich-based Ifo Institute for Economic Research shows. The study's authors examined changes in the prices of domestically produced goods and services in the Mediterranean countries before the crisis began. Their figures reveal how the countries systematically ruined their competitiveness.
According to the study, prices of goods produced in Greece went up by an average of 67 percent between 1995 and 2008, a record increase for the euro zone. The average price of domestically produced goods went up by 56 percent in Spain, 47 percent in Portugal and 41 percent in Italy. By contrast, prices went up in Germany by only 9 percent in the same period.
Wage and social policy was a key reason for the differences. While German workers had to make do with modest collective bargaining results and tough reforms, the Mediterranean countries were spending money hand over fist. As a result, the goods they produce are now much too expensive internationally.
The real reason why the common currency has come under so much pressure lies in these divergences. It also explains why the nighttime decisions reached at the last EU summit in Brussels do not offer a lasting solution for the euro crisis.
The Next Domino?
"Do the experts in the foreign currency markets seriously believe that the governments' latest 'comprehensive bailout package' for the euro will last more than a few months?" wonders Kenneth Rogoff, an economist at Harvard University and a leading expert on sovereign debt crises. In fact, says Rogoff, he is surprised at how positively the markets reacted initially to the results of the summit.
Rogoff is sharply critical of the Brussels plan, saying that it "relies on a questionable mix of dubious financial-engineering gimmicks and vague promises of modest Asian funding."
Indeed, there are now growing doubts as to whether the agreement is capable of making the bailout fund more effective and giving the Greeks and all of Europe a new outlook.
For example, European leaders decided to reduce Greece's total debt from the current level of more than 160 percent of economic output to about 120 percent by 2020. It's an ambitious goal, but even if it were attained, the Greeks would not be out of the woods by a long shot. A debt-to-GDP ratio of 120 percent would place them at the level at which the ailing Italians are at the moment.
A much lower ratio is needed if a country hopes to be reasonably efficient. In a study of government borrowing in past centuries Rogoff, together with his colleague Carmen Reinhart, have demonstrated that a debt-to-GDP ratio of 90 percent or more cripples growth and increases the risk of insolvency.
Far Too Small
Just as questionable as the restructuring plan for Greece is the idea of boosting the impact of the bailout fund to the trillion-euro level. The problem is that EFSF members are only willing to come up with a portion of the loans to ailing debtor nations, while large private investors like banks and investment funds, as well as emerging economies with large amounts of surplus capital, like China and Brazil, would contribute the rest.
But if the major players in the global financial industry could hardly be convinced to buy the bonds of ailing countries last year, why would they do it today, at a time when risk is even more unpredictable and the credibility of a guarantor nation like France is being called into question?
Even if the EFSF reached the desired dimensions, it would still be far too small to rescue Italy, the country that is now the greatest cause for concern for many in Brussels, Berlin and Paris. Amid growing mistrust, the country was forced to offer yields of more than 6 percent last week just to find buyers for a 10-year bond issue, much higher than Germany has to pay for a similar bond.
The levels meant that yields were back to where they had been in early August, says Andrew Bosomworth, head of the German investment management arm of the world's largest bond trader, PIMCO, and responsible for €138 billon in investor funds. That was when the ECB first began buying up Italian bonds in order to keep the interest rate on those bonds manageable.
Bosomworth also noted that the central bankers were "active in the market every day" last week. According to PIMCO estimates, by Thursday the ECB had bought about €10 billion in government bonds -- most of them Italian, Bosomworth suspects.
Aside from the ECB, there are no longer many buyers of Italian treasury bonds. It is clear that most investors are trying to reduce their inventories -- if they can find someone to take the paper off their hands. It is almost as if buyers were boycotting Italian bonds.
Unwilling and Unable
But Italy will have to place €30 billion worth of bonds in the coming weeks. The country's financing requirements will increase to more than €600 billion within three years. Then the government will have to replace the money it once borrowed at low rates with new, more costly bonds. Each additional percentage point costs the Italian government an additional €20 billion in the medium term.
Italy already spends about 5 percent of its total gross domestic product to pay the interest on its government bonds. If that percentage increases, it will become increasingly difficult for Rome to shoulder its enormous burden of debt. At that point, tough austerity measures will be the only way to keep the government's finances under control.
But that is something that Prime Minister Silvio Berlusconi is either unwilling or unable to do.
The government did approve a few measures last week, such as the sale of government-owned real estate. However, the program, dubbed a "mini-plan" by the business newspaper Il Sole 24 Ore, is unlikely to achieve much. And even its implementation is uncertain, since Berlusconi would presumably have trouble cobbling together a parliamentary majority to enact the measures. The coalition government is in chaos, writes the paper.
As long as Italy remains politically unreliable, there will continue to be growing concerns that the third-largest economy in the euro zone could turn into a second Greece. And the leaders of the world's major industrialized nations are also worried, as evidenced by their rough treatment of the Italians at last week's G-20 summit.
On Thursday morning, German Finance Minister Schäuble and his French counterpart François Baroin tried to convince their French colleague Giulio Tremonti to implement additional austerity measures. The group reconvened at noon.
This time US Treasury Secretary Geithner joined the meeting, and the trio demanded that Italy agree to allow both its reforms and its national budget to be monitored by the IMF -- the kind of measure normally reserved for developing nations dependent on IMF funding. Tremonti was outraged and rejected the idea.
All the More Critical
Nevertheless, the French and the Germans stood their ground. They are, after all, suspicious of the European Commission's monitoring role. They suspect that Commission President José Manuel Barroso is willing to bend the rules a little when it comes to monitoring Italy's fiscal and economic policy, given that his native Portugal is also in economic hot water. Supervision by an independent organization like the IMF, argue France and Germany, is thus all the more critical.
In the evening, Merkel, Sarkozy, Obama and Berlusconi addressed the issue. First they decided that the IMF could issue a new credit line to countries faced with the threat of financing difficulties. It would be issued quickly and without significant conditions to countries with short-term liquidity bottlenecks, like Spain and Italy. The size of the credit line would be based on a given country's share of IMF capital. Spain could expect a maximum of €23 billion in support, while Italy would qualify for €45 billion.
In the end Merkel, Sarkozy and Obama -- a somewhat surprising addition to the German-French euro duo -- prevailed upon Berlusconi to agree to announce further austerity measures. After hours of wavering, Berlusconi finally came around. Nevertheless, there is still much skepticism, and not just among the leaders gathered in Cannes -- over the value of such pronouncements given the country's deep political crisis.
Printing Money with the IMF
Obama, at any rate, felt that they would have little value. Instead, he confronted the Germans in Cannes with a suggestion so radical that it alarmed both Merkel and Schäuble. To save the common currency, Obama proposed that the Europeans follow the example of the American Federal Reserve, which buys up almost unlimited amounts of US treasury bonds when necessary.
The Germans pointed out feebly that the ECB operates within a completely different tradition than the Fed, and that it also pursues a different mission. But it is becoming increasingly clear to Merkel and her finance minister that, in the end, only the ECB will be able to save the euro if the crisis continues to escalate. It is the only European fiscal policy institution capable of taking action, and it also comes equipped with unlimited firepower. It can never run out of money, because it can simply print new money when needed.
This is an approach Germany's representatives in the ECB council have strongly resisted. Former Bundesbank President Axel Weber and former ECB chief economist Jürgen Stark resigned from their posts in the dispute over ECB purchases of Greek and Portuguese bonds. Jens Weidmann, the new Bundesbank president, is likewise strictly opposed to funding government deficits by printing money.
This position is understandable, given that the Germans have, twice in the last century, seen how this sort of monetary policy can end in hyperinflation and national bankruptcy. But how long can the Germans resist the pressure from other members?
Most European leaders have nothing against using the central bank's reserves as a source of financing, as became evident at the Cannes summit. Important politicians like European Council President Herman Van Rompuy and French President Sarkozy proposed making IMF "special drawing rights" available -- a move which would enable the funding of major bailout packages in Europe. The US also supported the idea.
Another Open Flank
But Bundesbank President Weidmann was deeply troubled and made his concerns known to the chancellor. Special drawing rights, he argued, as well as gold and foreign currency, are part of the currency reserves that the Bundesbank is required by law to safeguard.
The Bundesbank fears that issuing the special drawing rights would open yet another door to monetary state-financing. Special drawing rights, the bank notes, are akin to an artificial currency against which foreign currencies can be borrowed at the IMF. Making them available, Germany worries, would be tantamount to opening up yet another flank to the crisis.
Following Weidmann's intervention, Merkel informed her counterparts that the autonomous Bundesbank would not participate in the release the special drawing rights. A battle had been won but not the war itself, as officials at the Bundesbank fear. At the Cannes summit, Van Rompuy spoke of a "trust" at the IMF that could be fed with artificial money from the special drawing rights.
It appears that the euro crisis is approaching its endgame. Many promises made when the common currency was introduced have already been broken. The initial stipulation that only stable countries be allowed in, for example, quickly proved illusory once Italy and Greece were accepted.
German taxpayers were also promised that they would never be held liable for the debts of other countries in the euro zone. But then came the first and second bailout packages for Greece and the European bailout fund.
And now another breach of confidence is on the horizon, with the Germans being expected to accept the notion that the ECB will be available to ailing euro countries as an almost unlimited reserve fund.
The question the German government now faces is whether to preserve the monetary union or have a stable currency. The decision can no longer be put off for long. "To stabilize the situation," says former US Treasury Secretary Lawrence Summers, the bailout measures would have "to go well beyond the measures proposed to date."
Allies intensify pressure on Berlusconi
by Guy Dinmore and Alex Barker - FT
Senior members of Silvio Berlusconi’s centre-right coalition have questioned the prime minister’s assertion that he still has a majority in parliament following defections from his party, raising questions over how much longer he can stay in office.
Italy’s bond yields hit new euro-era highs on Monday, reflecting market concerns that Italy risks becoming rudderless without an effective government able to implement reforms it has promised to the international community.
The spread between Italy’s benchmark 10-year bonds and German Bunds hit a record 490 points in morning trading, with the Italian yield jumping to 6.66 per cent from 6.38 per cent at Friday’s close. Traders reported intervention by the European Central Bank to buy Italian bonds, but this only slightly eased yields and the spread.
Italy’s plight has eclipsed the ongoing crisis in Greece, where a new prime minister is expected to be appointed on Monday. Mr Berlusconi insisted on Sunday that his coalition still had the numbers in parliament to go on despite defections by party dissidents to the opposition. The latest to go was Gabriella Carlucci, a former television presenter and long-time Berlusconi loyalist. However Robert Maroni, interior minister, and Renato Brunetta, minister for civil service reforms, both questioned whether the government could continue.
The first major test in parliament will come on Tuesday when the lower house is due to vote to ratify the 2010 accounts. The opposition Democratic party is also threatening to call a vote of no-confidence in the government.
Mr Berlusconi left Rome on Monday morning to go to his residence in Milan, but he was expected to return to the capital in the evening. The 75-year-old prime minister, weakened by court cases and sex scandals, insists that if the government falls then Italy will hold elections. But it is also possible that he could be replaced as prime minister by someone from his People of Liberty party, or by a caretaker from outside parliament.
The crisis within his party raises serious questions over the government’s ability to respond to EU pressure to move ahead with economic reforms pledged by Mr Berlusconi to a eurozone summit in Brussels last month.
A European Commission monitoring team is due to visit Rome this week. EU sources in Brussels said that in advance of the mission, Olli Rehn, commissioner for economic affairs, had written to Giulio Tremonti, finance minister, with a detailed questionnaire covering some 40 budget related issues, which Italian officials have until the end of the week to answer.
In Brussels there is scarcely-concealed dismay with the Berlusconi administration’s overall handling of the fiscal crisis, with the Commission sceptical that austerity measures passed by Italy in September will achieve their targets. Such a questionnaire is standard practice during intrusive EU and IMF assessments of bail-out countries, but is unusual in that Italy is not yet the recipient of any bail-out loans.
Greek banks in €6.4 billion bond switch
by Tracy Alloway - FT
Three of Greece’s biggest banks have issued €6.4bn ($8.8bn) of government-guaranteed bonds likely to be used as security to obtain financing from central banks, a move that points to worsening market conditions amid talk of a disorderly Greek default.
Alpha Bank, EFG and Piraeus on Friday issued the floating-rate notes, which analysts say will probably be used as part of a new €30bn liquidity facility created for cash-strapped Greek banks earlier this year. Under the scheme, Greek banks can issue bonds guaranteed by the government, which can then be used as collateral to receive funding from central banks.
Greek lenders have two sources of central bank liquidity support: the European Central Bank, as well as the so-called Emergency Liquidity Assistance, or ELA, provided by Greece’s own central bank.
"Greek banks had not thus far made full use of a facility to issue an additional €30bn of government-guaranteed bonds, almost surely because the ECB was not prepared to accept them as collateral," JPMorgan analysts wrote. Friday’s "issuance suggests a softening of that stance", they said, noting it was the first Greek government-guaranteed bank bond issuance since the summer.
In July the International Monetary Fund urged the ECB to approve a new €30bn liquidity package to keep Greek banks afloat in case of a default. The ECB had authorised Greek bank bonds for use as collateral on a tranche-by-tranche basis since 2010, but had failed to do so with the new package.
"Wholesale funding markets remain closed, and exceptional ECB liquidity support has grown," the IMF said that month. "Contrary to programme expectations, the ECB governing council has not taken a decision on whether to accept as eligible collateral the proposed new €30bn tranche of government-guaranteed bank bonds."
Market participants are on alert for signs of fresh strain in the Greek financial system after George Papandreou, Greek prime minister, rattled investors last week by first saying the country would hold a referendum on a second bail-out package, only to scrap the plan later.
Deposits in Greek banks have fallen in recent months, according to central bank data, and lenders’ access to normal market means of financing remains practically non-existent.
EFG said in its prospectus for the new bonds that the debt would be held in a manner that would make them eligible to be used as central bank collateral. However, they would still need to satisfy eligibility requirements to be used as security for central bank financing. The potential softening of the ECB’s stance "could point to a deterioration in Greek bank funding conditions, such as further deposit outflows", the JPMorgan analysts said.
Merkel and Sarkozy Have Lost Credibility
by Simon Nixon - Wall Street Journal
"Six weeks to save the euro," European leaders promised the world in September. That deadline passed at last week's Cannes G-20 summit with the goal looking further away then ever. Nothing of substance was agreed on the French Riviera to aid the cause of euro survival, but one giant decision was taken that could hasten its demise. Angela Merkel and Nicolas Sarkozy's announcement that Greece is free to leave the euro has transformed the nature of the euro.
The United States fought a bloody civil war in the nineteenth century to stop states seceding from the union. Yet the German and French leaders have decided the euro zone will be a voluntary union, not because of an attachment to the principle of national self-determination but to protect the principle that euro-zone countries should not become liable for each other's debts.
The significance of Ms. Merkel and Mr. Sarkozy's Cannes declaration is immense. At a stroke, they have introduced foreign-exchange risk into a sovereign-debt market still grappling with the realization that euro-zone government bonds contain unexpected credit risk. Worse, throughout the crisis, the two leaders said they will do whatever it takes to save the euro.
Yet the assurances they've given haven't been worth the paper they were written on: First, there were to be no sovereign defaults; then the first Greek haircut was a "unique situation;" the second Greek haircut followed 12 weeks later; now euro-zone exits are possible. No wonder the markets won't lend and China won't invest in Europe's bailout funds. Nothing these leaders say any longer carries any credibility.
All that can end Europe's debt crisis now is evidence that debt burdens are actually falling. Instead, the evidence suggests the euro-zone economy is disappearing down a sink-hole. Without any mechanism for fiscal transfers, the weakest economies are being forced to tackle their debt problems through ever greater austerity, leading to a downward spiral.
Meanwhile the disarray in government bond markets has triggered a full-scale institutional run on euro-zone banks, which have been shut out of key funding markers. So not only are the weakest countries trapped in an uncompetitive exchange rate but they also face higher borrowing costs too as banks cut back lending, adding to their competitiveness challenge.
In desperation, the euro zone appears determined to force out the Prime Ministers of Greece and Italy, hoping they might be replaced by new governments willing to speed up the pace of reform and boost competitiveness. George Papandreou and Silvio Berlusconi both chose to pander to their political bases rather than undertake serious structural reform, destroying any hope either country might reduce their burden of debt.
Both governments have persistently dragged their feet on reform commitments given to the euro zone in return for financial support, in Italy's case via European Central Bank purchases of its bonds. But it is hard to be confident that removing two leaders in command of parliamentary majorities will deliver more effective government.
In Greece, the best hope is that a coalition will emerge able to survive long enough to ratify the Oct. 26 debt deal, thereby securing the next tranche of its bailout money and avoiding a disorderly default next month. But even if the euro zone survives this hurdle, a general election is likely to quickly follow. Perhaps the threat of national bankruptcy will force all major parties to pledge to support the debt deal, even though opinion polls show 60% of voters oppose it.
But it's hard to imagine how a deal that requires Greece to hand over economic sovereignty while leaving it with a debt pile many suspect remains unsustainable cannot become an election issue. In recent European elections extremist parties have made substantial gains. And whatever new government emerges in Athens, it must still deliver on the bailout conditions, so the threat of disorderly default will remain.
In Italy, the hope is that Mr. Berlusconi can be forced out and replaced by a technocratic government appointed by the President which would take the radical measures needed to restore confidence. After all, Italy is a rich country—its northern provinces have the highest income per capita in Europe. There's talk of a wealth tax to rapidly cut the country's debt to GDP ratio. But even if this result can be engineered—installing a technocratic government still requires the parliament's consent—Italy is unlikely to rapidly regain bond-market access.
A string of European banks last week saw their stock prices bounce after they revealed they dumped holdings of Italian bonds in the previous quarter. The prospect of the euro zone's bailout fund offering insurance that will cap their losses at 80% of the nominal value is unlikely to entice too many buyers in the market.
The best that Italy can expect is that a change of government provides cover for further ECB bond-buying. But this may not be panacea many imagine. New president Mario Draghi last week reiterated the ECB line that its bond buying program is temporary and limited. Despite ECB bond buying, Italian 10-year bond yields rose above 6.3% last week. The ECB is also helping fund Italian banks.
There's a limit to how much Italian exposure the ECB will be comfortable taking before it insists Rome seeks external liquidity support, as it did with Greece, Portugal and Ireland. And as in Greece, Italy cannot postpone its date with the voters for ever—political uncertainty will continue to sap investor confidence.
What started as a financial crisis is now a full-blown political crisis in two euro-zone states. If the euro zone is to survive, it is now clear it will only do so by increasing its democratic deficit. The economic policies of Southern Europe will in future be dictated by a Brussels-based technocratic elite, which voters will be asked to rubber-stamp on pain of economic ruin.
What is also clear is that the one thing that has always seemed vital to any lasting solution to the crisis—large-scale fiscal transfers from Germany to the periphery and a willingness to underwrite future debt—looks less likely than ever. The euro will outlive its six-week deadline, but its long-term survival remains in serious doubt.
France cuts frantically as Italy nears debt spiral
by Ambrose Evans-Pritchard - Telegraph
France has unveiled the toughest austerity measures since World War Two despite the looming danger of a double-dip recession, vowing to slash borrowing by €65bn over the next five years in a last-ditch effort to save the country's AAA rating.
"We wish to protect the French against the grave problems facing other European countries. Bankruptcy is not an abstract word," said premier Francois Fillon. The belt-tightening plan -- the second package since August, taking total cuts to €112bn -- include a 5pc super-tax on big firms, a rise in VAT on restaurants and construction, and cuts on pensions, schools, health, and welfare. It is the latest squeeze in a relentless campaign of fiscal tightening across the eurozone.
"It is like the 1930s: imposing austerity on countries already in recession is the way into a death spiral," said Danny Blanchflower, a former UK rate-setter.
Left-wing critics have evoked grim parallels with the "deflation decrees" of Pierre Laval in 1935 when France had to take ever harsher measures to preserve the country's viability on the Gold Standard, a gamble that ultimately set off violent street protests.
France's move came amid a further blizzard of grim data from Europe, confirming that most of the region is already on the cusp of recession. Growth has reached a "virtual standstill", said EU commissioner Olli Rehn. Eurozone retail sales fell 0.7pc in September from the month before. German industrial output plunged 2.7pc, the steepest drop since the depths of the crisis in January 2009. Factory orders fell 12pc.
Mr Fillon said the country must accept sacrifice to "avoid the day where policies are imposed upon us by others," insisting that France would meet its "untouchable" deficit target of 4.5pc of GDP next year -- down from 5.7pc this year. The austerity plan seems aimed at insulating France from the unfolding disaster in Italy, where a deepening slump and the final agonies of Silvio Berlusconi's government sent debt markets into a tail-spin on Monday.
Rome was a seething cauldron of rumours, plots, and threats all day long as Mr Berlusconi furiously denied claims by insiders that he was about to resign and ordered "traitors" in his own party to look him in the eyes. He faces a confidence vote on Tuesday
Yield spreads on 10-year Italian bonds spiked to a post-EMU record of 491 basis points over German Bunds. Crucially, they reached 424 points over the benchmark AAA basket used by LCH Clearnet to fix margin requirements. The exchange has in the past raised the bar once spreads reach 450 and stayed there for a few days. "The markets will price in financial systemic risk once we get to this level," said Andrew Roberts from RBS.
The escalating crisis threatens the rest of Europe through bank exposure. Mediobanca said Europe's 20 biggest banks hold €186bn of Italian sovereign debt, led by Intesa SanPaolo (€64bn), Unicredit (€39bn), BNP Paribas (€23bn), Dexia (€13bn), Commerzbank (€9bn), and Crèdit Agricole (€8bn).
Goldman Sachs warned that Italy might start to take "unilateral decisions" such as seizing banks or clamping down on the bond market (effectively holding investors captive) if the political climate deteriorates further and authorities feel boxed in. It said the crisis has set off a "self-fulfilling dynamic" that may ultimately make it impossible for Italy to roll over debt.
The EU's bail-out fund (EFSF) does not yet have the firepower to halt the crisis by purchasing Italy's bonds. The fund itself struggled to raise money in a €3bn auction on Monday, paying 177 points over Bunds -- up from 51 in June. "The EFSF is basically doomed to be worthless," said professor Giuseppe Ragusa from Rome's Luiss Guido Carli University. Investors are wary of its shifting mandate. There is suspicion for EU plans to leverage the fund to €1 trillion as a "first loss" insurer of bonds, which concentrates risk.
Mr Ragusa said surging yields already imply an extra €7.6bn in extra debt payments. Rome must raise €260bn next year. "The European Central Bank is the only answer. If Berlusconi goes and there is a technocrat government, the ECB may be willing to step in and save Italy," he said.
The ECB was undoubtely a buyer yesterday but held back from overwhelming action, risking a deadly metastasis of the crisis. Board member José Manuel González-Páramo issued a blunt warning that Italy can expect no white knight. "The ECB is not a lender of last resort. It does not have a magic wand."
Joachim Fels from Morgan Stanley said Europe's leaders may themselves have invited disaster by suggesting for the first time that a country -- Greece -- may be pushed out of EMU. This shatters the stated orthodoxy until now that the euro is inviolable and eternal. "They may have set in motion a sequence of events which could potentially lead to runs on sovereigns and banks in peripheral countries that make everything we have seen so far in this crisis look benign," he said.
The Perfect Storm: Eight Reasons To Be Bullish On The US Dollar
by Mike "Mish" Shedlock - Global Economic Trend Analysis
One of my much appreciated contacts is Steen Jakobsen, chief economist for Saxo Bank in Copenhagen, Denmark. Today he passed on an "internal note" that he gave permission to share.
Steen Writes ...
One of my main themes over the last quarter has been a “relative outperformance” of the US economy relative to consensus. This has materialized and our call was almost entirely driven by Consumer Metric data which over the last three years has outperformed any other relevant predictor. This is now slowing down slightly, but still elevated. Meanwhile Europe start election cycle where Spain goes to the election in less than two weeks, while Sarkozy starts his re-election campaign when he is done playing Napoleon in European politics.
The outlook for 2012 is a “Perfect Storm” with increased austerity, higher unemployment, and weaker global growth (read: China).
My colleague Peter Garnry was kind enough to quickly program a small excel thing which can track changes to growth by consensus using the ECST function on Bloomberg. This is the result.
European consensus growth by market consensus
European growth coming off hard and has been in almost free fall since end of July.
US consensus growth by market consensus
US growth has seen a low and looks higher, but there is a number of issues ahead:
- The Super Committee needs to finalize its work by this weekend in order to secure proper processing Congress. WSJ journal this morning says sources say some progress is being made and main points for now are: A. Limiting tax deductions replacing tax hikes. B. Getting permanent Bush tax as payment and most importantly for FX markets: C. Republicans seems fighting for repatriating capital back to the US at tax rate of 5.25% vs. presently 35% - this topic has even been on 60 Minutes, so to me it looks like “deal to be done shortly” as it plays nicely to create “Job creating program.
- The headwind from fiscal tightening will equal negative 1.00 percent of GDP – this is federal, state and local communities trying to cut back, but also investment will remain meek.
Long-Term Up-Cycle for US Dollar
A long life has taught me that everything “mean-reverts”.
When I moved back from the US in 2000, the EURUSD was trading below 0.8400 – since then the US has pursued a policy a “benign neglect” and succeeded in making the US extremely weak by all definitions.
Clearly the US has debt issues on their own, but currencies are relative trades. To me we are entering long-term up cycle for the US dollar. The final QE/Printing of money will come in Q1 of 2012 and could cement the low, but I am willing to start overweighting US dollar relative to Europe, not Japan, and further down the road to go full in.
I suggest the EUR/USD is out of touch with relative rates, funding needs, and relative dynamics of the economies.
Four Reasons to be Bullish on the US Dollar
- The EU debt crisis – when ECB becomes lender-of-last-resort we will see 10 figure move lower.
- Relative growth differences – The US is more dynamic and with only “one master” . – i.e. Congress vs. Europeans 27 members and lacking fiscal union.
- Competitiveness. US will able to compete on labor costs with close to 20 pc real unemployment and incoming tax incentives.
- HIA – Homeland investment Act – as stated above the Super Committee is trying to get a reduced tax of 5.25% in place.
My bullishness is relative, but the biggest contributors to long-term wealth tends to be your choice of currency. I have a target of 100 in DXY for next year, so a 25% rise in the US dollar during 2012 – and in EURUSD terms the expected move is changed range from 1.30/1.40 now to 1.20/1.30 on ECB rolling over, another 5-6 figures on interest rates, and then HIA II we end around 1.10-1.15 for 2012 end target.
That said, I will, as always, add, my own believe in me being able to predict anything remains 0.001 percent.
I do not share Steen's bullishness on the Yen, but otherwise I am in general agreement with his prognosis.
I do not have specific targets, but I too expect the US dollar to strengthen. That is not what Bernanke wants.
However, 58% of the US dollar index is the Euro, and the Euro is a basket case. European banks are in worse shape than their US counterparts, and a breakup of the Eurozone that I expect will certainly exacerbate the problem.
For a discussion and timing of a Eurozone breakup, please see History Suggests Greece Will Freeze Bank Deposits, Exit Euro by Christmas; Spain and Portugal to Follow Next Year; What's the Rational Thing to Do?
Moreover, in conjunction with the upcoming regime change in China, I expect a significant slowdown in China coupled with a shift from huge infrastructure projects to a more consumer-driven model of growth.
When that happens China's demand for commodities will plunge, so will its exports, and a plunge in commodity prices will be good for the US dollar. A plunge in commodity prices will also be bad for the "hard asset" currencies, especially Australia and Canada.
Thus, to Steen's four reasons, we can add
- Breakup of the Eurozone
- China regime change and shift to consumption model slowing Chinese exports
- Falling commodity prices
- Weakening of "hard currencies"
Since little of the above scenario is widely believed (either Steen's or mine), and since a strengthening of the US dollar is not likely to be good for equities in general, not only will this scenario be good for the US dollar, it will help contribute to the "Perfect Storm" of deflation.
Eurozone ministers fail to create €1 trillion bail-out fund
by Louise Armitstead - Telegraph
Eurozone finance ministers have failed to sanction measures to create the bloc's crucial €1 trillion bail-out fund – despite warnings that Europe is dangerously ill-equipped to cope with the financial and economic crisis enveloping Italy.
Despite publishing a more detailed mandate following a summit in Brussels, the Eurogroup delayed agreeing specifics on how to leverage the €440bn European Financial Stability Facility (EFSF), risking further market turmoil ahead of votes on Tuesday that could topple Silvio Berlusconi's government.
The EFSF also pushed ahead with a 10-year bond auction which it had put off from last week because of lack of demand. The fund, which is supposed to be the eurozone's key weapon against the debt crisis, managed to raise €3bn but only after having to pay record returns to entice investors.
Joachim Fels of Morgan Stanley said: "The leveraged EFSF may still turn into a bazooka but so far it looks more like a water pistol." The fund is hampered by uncertainty over Greece's bail-out and eurozone membership. The country is expected to announce the new head of its interim Government on Tuesday.
Italian government bond yields hit 14-year highs, crossing the threshold economists say is unsustainable for the country's €1.9 trillion debt pile. The yield on 10-year bonds soared to 6.68pc at one point, leading to frantic speculation that Italy will require an international bail-out.
The Italian parliament will vote today to ratify the 2010 state accounts and a raft of austerity measures which will also serve as a vote of confidence in Mr Berlusconi. The Italian premier denied reports he was set to resign. However, rumours of his departure pushed the Milan stockmarket up more than 2pc and pulled bond yields down. Analysts said Italy has a "Berlusconi problem, not a financing problem".
After a choppy day on European bourses, the Italian market closed up 1.3pc while the Germany's DAX and France's CAC each fell 0.6pc. In London the FTSE 100 ended off 0.3pc. Wolfgang Schauble, Germany's finance minister, said it was vital Rome approved mooted austerity measures. He told reporters: "Italy has to stick to what has been announced. If Italy will deliver, will reduce its debt, there is no problem."
Christine Lagarde warned the crisis was in a "dangerous" phase that is threatening the wider global economy. Speaking in Moscow, the International Monetary Fund chief said: "The economy in general is in a dangerous and uncertain phase. There is clearly a darkening outlook, rising risks. If the storm strengthens further in the euro area, emerging Europe as its closest neighbour would be severely hit."
Prime Minister David Cameron insisted Britain would not become embroiled in the bail-outs. He told the House of Commons the G20 had a clear message: "Sort yourselves out and then we will help, not the other way round." But a document prepared for the Eurogroup suggested the European Investment Bank (EIB) could provide up to €74bn of lending support over two years to continental banks. The UK is the EIB's biggest shareholder.
In addition, Fathom Consulting warned a disorderly default in the eurozone would trigger a recession requiring an extra £1 trillion of additional quantitative easing in the UK to keep to inflation targets. George Osborne attended a meeting of "euro-outs" last night. The Chancellor is trying to drum up opposition to the financial transaction tax that Germany plans to push in today's meeting of EU finance ministers. The Eurogroup set another meeting for November 17. Failure to produce decisions may result in another G20 summit before Christmas.
Thomas Jefferson Warned The Nation To Beware The Power Of The Banks
by Robert Lenzner - Forbes
Before there was John Kenneth Galbraith or Joe Stiglitz or Nouriel Roubini, or Simon Johnson or Niall Ferguson or Occupy Wall Street– there was one of the Founding Fathers, Thomas Jefferson giving an advance warning of 2008 some 200 years ago. An awesome foreboding it was, too.
"I believe that banking institutions are more dangerous to our liberties than standing armies," Jefferson wrote. " If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around(these banks) will deprive the people of all property until their children wake up homeless on the continent their fathers conquered."
" The issuing power of currency shall be taken from the banks and restored to the people, to whom it properly belongs."
We should all meditate on that amazing prediction of things to come that are not necessarily beneficial to the 99%– but only to the 1%.
Goldman, Others Face MF Global-Type Threat: Roubini
by Dan Freed - TheStreet
Goldman Sachs, Morgan Stanley, Jefferies & Co. and Barclays could all suffer the same fate as MF Global, according to "tweets" by Nouriel Roubini, the bearish economist and New York University professor who gained fame as one of a small number of experts credited with predicting the 2008 financial crisis.
"What happened to MF Global could happen to Jefferies, Barclays, Goldman Sachs & Morgan Stanley.Leverage & maturity mismatch can lead to runs," Roubini wrote using the abbreviations and misspellings typical of Twitter Monday morning. He had no immediate response to an email message or a phone call, and spokespersons for Morgan Stanley and Goldman declined to comment. Email messages to spokespersons at Jefferies and Barclays produced no immediate response.
MF Global filed for bankruptcy last week just days after a ratings downgrade sparked by the company's disclosure that it had more than $6 billion in exposure to European debt. Though the company's positions had not fallen significantly in value, its disclosure sparked a crisis of confidence in MF Global, which saw its shares lose 66% over four days leading up to its bankruptcy filing.
Morgan Stanley and Goldman Sachs, along with other large securities dealers like Lehman Brothers, Merrill Lynch, and Bear Stearns, all saw their shares plunge drastically in 2008 on investor concerns that they did not have sufficient access to cash to keep their doors open in a crisis. While Morgan Stanley and Goldman have since registered as bank holding companies and beefed up their balance sheets, Roubini argued Monday that those efforts were not sufficient.
"Broker dealers still very levered a lil less than before, & have a huge maturity mismatch: so a large loss reduces capital & leads to a run," Roubini tweeted. Roubini argued in another tweet that JPMorgan Chase, Bank of America and Citigroup are "less at risk to a run only because insured deposits of retail bank subsidize the BK presumably the brokerage unit. Huge moral hazard unsolved." Spokespeople for those banks had no immediate response.
Roubini wrote other tweets Monday morning voicing his concern about the fragility of the banking system, a view that contradicts that of many industry analysts and CEOs who say large financial institutions have done more than enough to shore up their balance sheets in the wake of the 2008 crisis.
Reacting to comments by Citigroup chief Vikram Pandit at the annual SIFMA conference in New York Monday, Roubini wrote: "Selfserving nonsense of the day:Pandit sayin that markets will see riskier banks & impose discipline so no need for capital surcharge." Citigroup also had no immediate response.
Goldman: Property Tax Receipts Are Going Negative, And Local Finances Will Be A "Renewed" Source Of Weakness
by Joe Weisenthal - Business Insider
One argument made by a lot of municipal finance bears is that the big source of local tax revenue, property taxes, hadn't even begun to reflect the housing collapse, since new assessments of home prices aren't taken that often.
Well, we we're here on that
In a note out last night, Goldman warns of a slowdown in state and local tax revenue, and it included this chart, which shows that finally, in 2011, property tax receipts are negative YOY.
Between this, and other tax trends, it would appear that the state & local bloodletting -- a drag on growth and jobs -- will continue longer than you'd hope.
While the combination of these trends implies that activity at the state and local level might become a renewed source of weakness, there are mitigating factors.
Most importantly, the state and local sectors are of similar sizes (state governments make up about 45% of state and local expenditures, local governments make up about 55%) but the weakening in local government finances from the unwinding of inflated property tax revenues is likely to be more gradual than the sharp decline in income and sales tax revenues that states experienced in late 2008 and 2009.
In order to preserve municipal services, many localities are also considering property tax increases that could put a floor under tax receipts. However, while this might maintain spending at a higher level than it would otherwise be, it would nevertheless constitute fiscal restraint in another form. Property taxes account for only about one-third of total state and local revenue, so it would take quite a large decline to offset revenue growth from other sources, even if property taxes did decline sharply.
That said, as shown in the bottom chart below, property taxes have just started to unwind the increase of the last several years.
US poverty measure paints bleaker picture
by Robin Harding - FT
Poverty in the US is even worse than previously thought, according to a new official measure that takes better account of the cost of living. In 2010, 16 per cent of Americans lived in poverty according to a supplemental measure published by the Census Bureau for the first time on Monday, compared with the official figure of 15.1 per cent. That suggests an additional 2.5m Americans are poor: 49.1m rather than 46.6m by the official definition.
The supplementary figure illustrates how rising costs for health and childcare have added to poverty and paints a different picture of which Americans are poor. It may influence the current debate in Washington about how to reduce the US budget deficit by showing the role that programmes such as income tax credits and food stamps play to control poverty.
The official measure, introduced in the 1960s, compares income before tax to a threshold of three times the cost of a basic diet of food. In 2010, for a family of two adults and two children, that threshold was $22,113. But the official measure takes no account of changes to tax and benefits that affect after-tax income, costs that have increased in time, such as medical care or the higher cost of living in some parts of the US.
Adjusting for these factors increases the average poverty threshold to $24,343 and suggests that the demographics of US poverty are different. The adjustments suggest a lower rate of child poverty than the official number – 18.2 per cent, rather than 22.5 per cent. But they also suggest greater poverty among the elderly – a rate of 15.9 rather than 9 per cent; partly because the alternative measure does not set a lower poverty threshold for older households.
Compared with the official measure, the alternative finds higher poverty among homeowners relative to renters; among urbanites relative to rural dwellers; and among Americans on the two coasts relative to those who live in the interior. That largely reflects differences in housing costs.
The factors that lead to the biggest increase in poverty are healthcare costs, for which inflation has been high for decades and which add 3.3 percentage points to the poverty rate, work-related expenses such as transport and child care which have also suffered disproportionately high inflation, and payroll taxes which fall heavily on low incomes.
By contrast, the biggest factors to reduce the poverty rate by the alternative measure are the Earned Income Tax Credit, which helps low-income workers with children and lowers the poverty rate by 2 percentage points, and the food-stamps programme which subtracts 1.7 percentage points from the poverty rate.
Federal borrowing mounts while household debt shrinks
by Dennis Cauchon, USA TODAY
The sharp rise in federal borrowing is overwhelming efforts of consumers to reduce debt, leaving the economy deeper in debt than when the recession began in December 2007, a USA TODAY analysis finds.
The substitution of government debt for consumer debt helped end the recession and start a recovery, economists say, but it leaves the nation's long-term economic health in peril.
Households have reduced debt by $549 billion since 2007, mostly by cutting mortgages through defaults and paying down credit cards. During that time, the federal government has added more than $4 trillion in debt, pushing the country's total borrowing to a record $36.5 trillion, excluding the financial industry, according to the Federal Reserve.
"Government will eventually need to reduce the deficit," says Susan Lund, research director at McKinsey Global Institute, part of the business consulting firm. "But it's a very difficult balancing act to avoid withdrawing stimulus too soon while stopping before you borrow too much."
Lund, who studied 45 financial crises since 1930, says a familiar pattern is underway: Private borrowers reduce debt quickly, government borrows more, a period of government austerity follows — a process that can take five to seven years for an economy to repair itself.
"Is the debt level we have today going to be the death of us? No," says Martin Regalia, chief economist for the U.S. Chamber of Commerce. "It's the trajectory that could do us in. We know we're headed in the wrong direction." Regalia says the recommendations of a special congressional deficit-reduction committee are crucial. The panel reports Nov. 23.
How the USA's debt picture has changed:
- Consumers. Households have cut mortgage debt by 10.6% since the mid-2008 peak, after adjusting for inflation. Credit card balances and auto loans outstanding are down 9.6%.
- Government. Federal debt has risen from 36.9% of the nation's gross domestic product when the recession began to 67.5% on Sept. 30.
The shift of debt from individual borrowers to all taxpayers will shuffle who pays it off. Younger people will face extra burdens, says North Carolina State economist Nora Traum. But the political outcome of deficit negotiations will determine how the rest is distributed among income levels, age groups, professions and regions. "With such uncertainty, it's hard to say who will be winners and losers," she says.
Lagarde Says Eastern Europe Faces Risk of Liquidity Squeeze
by Henry Meyer and Boris Groendahl - Bloomberg
International Monetary Fund Managing Director Christine Lagarde warned that eastern Europe may face a credit squeeze as western European banks mired in the euro-area debt crisis withdraw liquidity from the region.
"Big fault lines" remain in the former communist bloc’s financial systems, adding to its high dependence on exports to western Europe, Lagarde said today in speech at Moscow’s State University of the Ministry of Finance after meeting President Dmitry Medvedev. The risks include a high share of external debt and loans in foreign currencies, both funded by western banks, she said.
"If the storm strengthens further in the euro area, emerging Europe as its closest neighbor would be severely hit," Lagarde said. "This time around, western parent banks, which have been instrumental in keeping those economies afloat, would no longer necessarily be here to sustain growth and the health of those countries."
Lenders that bankrolled eastern Europe’s boom before the 2008 credit crunch are being squeezed by deteriorating loan quality and slowing economic growth. The region was the world’s worst-hit in the aftermath of the collapse of Lehman Brothers Holdings Inc. three years ago and may face the threat of another sharp slowdown as the euro area’s troubles spread.
'Issue of Availability'
"The issue of availability of liquidity may very well come back as we see some of those western banks withdraw, reduce their activities, reduce their exposure," Lagarde said, diverging from the text of the speech released by the IMF.
Lagarde’s remarks echoed the European Bank for Reconstruction and Development, which warned last month that regulatory pressure on euro-area banks to raise capital ratios may result in less support to local units. About three-quarters of eastern Europe’s banking industry is owned by western lenders such as Italy’s UniCredit SpA (UCG), Austria’s Erste Group Bank AG (EBS) and France’s Societe Generale (GLE) SA.
A possible withdrawal of funds by west European banks from Russia is among the country’s "significant vulnerabilities," Lagarde said, urging the government of the world’s biggest energy exporter to "rebuild fiscal buffers while oil prices are still high."
Russian units of foreign banks including UniCredit and Societe Generale have started lending excess liquidity to their parents since the middle of the year amid the debt crisis, using "central bank liquidity" and funds from their Russian operations, Deputy Economy Minister Andrei Klepach said Oct. 27. Foreign banks "facilitated" capital flight three years ago during the country’s record economic slump, Prime Minister Vladimir Putin has said.
Russia, the only one of the so-called BRIC countries without capital controls, may see $70 billion leave the country this year, more than double last year’s $33.6 billion of outflows, the central bank estimates.
"There is no decoupling" between advanced and emerging economies, Lagarde said. "There is close dependency, strong connectedness between economies." While eastern European economies have reined in the current-account deficits that plagued them in the runup to the 2008 crisis, their fiscal leeway to counter a downturn has narrowed, Lagarde said.
"Back then, because they had sown in good times, countries were able to reap in bad times, letting public demand expand to partly cushion the decline in private demand," she said. "That option is no longer on the table."
The IMF and the EBRD were among the orchestrators of an accord known as the "Vienna Initiative" in 2008 and 2009 that combined emergency loans from public institutions for countries including Hungary, Latvia, Romania, or Ukraine, with pledges by the western banks to roll over financing for their units and recapitalize them as necessary.
That accord has been called into question by banks including UniCredit and Erste, which said they will be more selective in their investments and less reliant on passing on scarce liquidity to their subsidiaries. Western regulators are encouraging those strategies.
Banks in eastern Europe should "lend what is possible based on local refinancing," the Austrian central bank’s head of banking supervision, Andreas Ittner, said last week. "I consider this a crucial element of a sustainable business model," he added.
U.S. Banks Pull Back on Europe Lending
by Alan Zibel and Jeffrey Sparshott - Wall Street Journal
U.S. banks tightened their standards for loans to European banks and fewer relaxed lending standards to businesses in the third quarter, the Federal Reserve said Monday.
The Fed's quarterly senior-loan-officer survey, based on 51 domestic banks and 22 U.S. branches of foreign banks, showed that about two-thirds of banks that make loans to their European counterparts had tightened standards for those loans in the July-to-September quarter, reflecting growing uncertainty in financial markets over Europe's sovereign-debt crisis.
"Many domestic banks indicated that the tightening was considerable," the Fed said about lending to European banks. The central bank added a set of special questions about lending to Europe to the survey, conducted in early October. About half of the domestic banks in the survey said they make loans or extend credit lines to European banks.
Banks can impose tighter standards on businesses and consumers by limiting the size of loans, demanding more collateral or higher down payments and charging higher fees.
The report "underscores the fallout from the heightened economic uncertainty that prevailed during the late summer months when concerns about a second economic recession was pervasive," wrote Millan Mulraine, an economist with TD Securities, in a note to clients.
The Fed survey, taken in early October, showed fewer banks continued to relax their business-lending standards in the third quarter, compared with a broader trend of such easing in previous quarters.
The slower pace of a loosening in standards reflected a more uncertain economic outlook, the Fed said. In a reversal from recent quarters, reports of weaker demand for business loans outnumbered reports of stronger demand, the central bank said. That trend was especially pronounced among midsize and larger firms.
Many banks, especially smaller ones, say they have yet to see a rebound in demand for loans due to the weak economy. "We are ready to lend. We've never shut off the faucet, but I can't create loan demand," said Sal Marranca, chief executive officer of Cattaraugus County Bank in Little Valley, N.Y.
While credit conditions are slowly returning to normal, they remain much tighter than before the financial crisis of 2008. Fed policy makers reiterated last week that U.S. short-term interest rates are likely to remain close to zero at least through mid-2013, a move first announced Aug. 9.
The central bank will also continue to increase its holdings of long-term Treasurys, a step unveiled Sep. 21 in an effort to push down long-term interest rates. Both moves are aimed at boosting a persistently weak economy by getting consumers and companies to borrow and spend more.
Still, banks appear cautious. In particular, standards for home loans remain tight, leading many in the real-estate industry to complain that overly restrictive standards are hurting the housing market.
The Fed survey found more banks reporting stronger demand for new mortgage loans to purchase homes amid the lowest mortgage rates in decades. However, the report said few banks relaxed their lending standards to make it easier for consumers to buy a home.
Italy Nears Tipping Point as Its Bond Yields Climb
by Tom Lauricella, Matt Wirz and Stephen L. Bernard - Wall Street Journal
With Italian bond yields surging higher, analysts said Italy is at the brink of being unable to afford to borrow in the public markets.
Less than two weeks after European leaders unveiled an agreement that was designed to bolster confidence in the region, the yield on Italy's 10-year debt drew close to the 7% mark, a line in the sand of both practical and psychological importance to the market.
Psychologically, 7% has become a beacon due to the fact that Greece, Portugal and Ireland each sought bailouts soon after their debt reached these levels. While analysts said it is too simplistic to say that Italy will be forced to ask for support if its 10-year debt yields 7%, they said the recent selloff is taking the country to the tipping point.
"I don't know if 7% is the upper limit, or if it's 6.9% or 7.25%, but I do know [Italy] can't go on for very long having these kinds of bond yields," said Gabriel Stein, director at Lombard Street Research in London.
In a practical sense, yields at these levels could force traders to post more collateral when borrowing against Italian bonds, because they are perceived as more risky. That potentially makes Italian bonds less attractive for banks, which historically have been among the biggest buyers of European government debt. This creates a vicious circle, in which higher yields lead to more selling, which in turn scares off buyers.
And with €1.9 trillion in debt ($2.62 trillion) and €200 billion of debt coming due next year, Italy can ill afford to see rates remain at these high levels.
Analysts said European officials will be hard-pressed to reverse the selling without a concrete plan to support Italy. Such a plan would need to be in the magnitude of the European Central Bank committing unlimited resources to guaranteeing member countries' debt, they said.
Yields on Italian debt have been rising steadily, with prices falling, for weeks, but Monday's selloff was particularly steep, according to Tradeweb data. The yield on the 10-year note jumped to 6.56% from 6.31% on Friday. That is up from 5.91% two weeks ago and 5.5% at the end of September. Bond yields move inversely to prices.
The picture is even worse for Italy judged by the Italian bond due in March 2022. The yield on that issue hit 6.88% Monday, up from 5.29% when it was sold at the end of August. "At 7%, these really are extremely stressed levels," said Moyeen Islam a director for fixed-income strategy at Barclays Capital in London.
Sohail Malik, lead portfolio manager for special situations credit at European Credit Management, estimated Italy is paying about 3.42% on bonds coming due next year. Mr. Malik estimated that if that debt was all rolled over into new 10-year debt at 7%, it would create an extra €43 billion of interest costs over the life of the debt. "Imagine doing that for two to three years of maturities at the same level," Mr. Malik said. "Unsustainable."
Market participants said the selling pressure came from long-term investors, such as pension funds, banks and insurers. They said Italian investors, who traditionally have been big buyers of Italian government debt, have stepped back from the market, contributing to the vacuum in which prices have fallen. "The pace of the move tells you that there are no buyers," said Mark Schofield, global head of rate strategy at Citigroup in London.
Monday's surge in bond yields widened the gap between Italian and German 10-year bond yields to a euro-zone era record of 4.75 percentage points, up from 4.48 percentage points Friday. In some ways, the widening of that spread has caused a vicious selling cycle thanks to rules that govern the use of government debt as collateral for borrowing money, otherwise known as repurchase, or repo, agreements.
Analysts point to the rules set by LCH.Clearnet Group Ltd., the main clearinghouse for repurchase agreements. LCH.Clearnet requires higher collateral for repo trades involving government bonds that yield 4.5% more than a basket of triple-A-rated European sovereign bonds for five consecutive days. Market watchers said Italy is on the cusp of falling into that riskier bucket. LCH.Clearnet didn't respond to requests for comment.
Should the collateral requirements be triggered, it would make Italian debt less attractive for banks and investors who use their holdings as a cheap way to borrow money. Some market watchers said there has been selling of Italian debt in anticipation of the stricter guidelines.
The bigger issue, analysts said, is the damage to Italy's finances. Italy's debts are larger than the country's gross domestic product, and with an economy that is barely expanding, analysts said it could be impossible for Italy to make its way out of debt on its own. "The fact that rates are close to 6.5% or 7% makes it very difficult for Italy to repay its debt in the long run," said Pavan Wadhwa, head of global interest rate strategy at J.P. Morgan.
The Most Positive Possible Outcome Of The Current Financial Crisis In Europe
by Charles Hugh Smith - Of Two Minds
I was recently challenged by a contributor to write something positive, and so I decided to write about the single most positive outcome of the current financial crisis in Europe: the complete collapse of the corrupt, predatory, pathological global banking sector and its dealers, the central banks.
Exploring why this is so reveals the insurmountable internal conflicts in our current financial system, and also illuminates the systemic political propaganda which is deployed daily to prop up a parasitic, corrupting, pathologically destructive financial system.
Our first stop is modern finance itself. Modern financial "products" and "instruments" are often highly complex and abstract, but the entire edifice can be distilled down to this: the system is based on the assumption that all risk can be hedged, and the difference between the initial position’s yield/gain (i..e. placement of capital at risk for a gain) and the cost of hedging the risk of the wager to zero can be skimmed from the system risk-free.
That is the entire system in a nutshell, and we can immediately see the advantages of this system over traditional Capitalism, where risk can be hedged but never to zero, and the return is correlated to the risk taken on.
In modern finance, high-risk "investments" (wagers) with high returns can be taken on without worry because any and all risk can be hedged to zero, even in super high-risk wagers.
And since even high-risk positions can be seamlessly hedged to zero, then there is no reason not to borrow money to increase the size of your wagers: since you can’t lose, then why not? Wagering in risk-free skimming with borrowed or leveraged money is simply rational.
Put these together and we see how a system based on risk-free skimming eventually leverages itself to the point that the slightest disruption can bring down the entire over-leveraged, over-extended system.
Why is this so? Every hedge has a counterparty who is supposed to pay off if the initial wager blows up. A system based on risk-free hedging is ultimately a self-organizing system which maximizes return by increasing bet sizes, leveraging/borrowing to near infinity and hedging every hedge as well as every wager.
This creates long chains of hedges and counterparties. Here’s an example based on an asset we all understand, a house. Let’s say someone buys a house for $1,000 down, something that was common in the housing bubble. That $1,000 is leveraged up to buy a $200,000 house via a $200,000 mortgage.
The "owner" of the house then buys a hedge to protect himself from the house losing value, so the risk is reduced to zero: if the value rises, the owner reaps the gain and if it declines, then he collects the payoff of the hedge from the counterparty, for example, a Wall Street investment firm.
The counterparty calculated the risk of real estate declining and then priced the hedge accordingly. There is some small risk that the loss will exceed the cost of the hedge, so the issuer of that hedge bundles similar bets and then buys a hedge or "insurance" from another player, who makes the same calculations of risk and return.
Meanwhile, the mortgage has been tranched (sliced into principal and interest and into various pools of risk) and bundled with other "low-risk" mortgages and sold to investors, who also buy a hedge against any loss in the tranch, for example, a credit default swap (CDS) which pays out if a borrower defaults. Those hedges are sold or "insured" with another hedges.
All of this debt and all of these hedges are based on a mere $1,000 of actual capital. The players who originated each hedge are similarly leveraged, because since risk can be lowered to zero, who needs capital?
So what happens when one counterparty (issuer of a hedge) somewhere in the chain runs into trouble? The entire chain collapses. With razor-thin capital to cover any losses, then each link in the chain dissolves into insolvency if their counterparty fails to pay off.
This is how we get hundreds of trillions of dollars in "notational" derivatives: every hedged is hedged with another "instrument," "products" are bundled and insured, and so on. The system is based on the principle that risk can be reduced to zero, and so there is no need for capital.
Unfortunately, that premise is demonstrably false. Benoit Mandelbrot dismantled the notion that risk can be reduced to zero in his prescient masterpiece, The (Mis)behavior of Markets. The founder of fractal geometry showed that markets are fractal in nature, and are thus intrinsically prone to unpredictable disruptions. Simply put, risk cannot be massaged away.
Thus the fundamental premise of all modern finance is flat-out wrong, and this explains why systemic risk, rather than being eliminated, actually rises with every ratchet up in debt, leverage and counterparty hedging.
The entire global financial system is thus based on the equivalent of a perpetual motion machine: money can be borrowed or leveraged into existence in essentially unlimited quantities, and then deployed in risk-free skimming operations to harvest unlimited wealth.
What does this promise of using leveraged capital to skim risk-free fortunes do to the "real economy" of production and investment in plant and technology? It guts it.
The risk of industrial Capitalism is real and cannot be hedged away; high-risk investments may blow up or they may return high yields. It literally makes no sense to risk real capital in productive Capitalism when a zero-risk skimming operation can be developed that essentially needs near-zero capital.
Thus financial capital has come to completely dominate industrial or productive capital. The pernicious consequences of this dominance have poisoned the economy and culture on multiple levels.
In the political sphere, the aggregation of hundreds of billions of dollars in skimmed profits gave Wall Street and the banking sector unlimited budgets to buy political influence. This created a monstrously pathological feedback loop: the more political influence Wall Street bought, the higher their returns on financialization skimming.
Consider housing as an example. Housing was once a simple, barely profitable long-term investment for both the buyer, who had to place substantial capital at risk (20% down payment) and the holders of mortgages, who took a modest yield for 30 years in trade for low risk.
Wall Street and the banks financialized housing via political influence. opening up a vast new territory to be exploited via skimming. Since capital wasn’t necessary in no-risk skimming, then down payments were dispensed with to increase the pool of debtors, as they are the foundation of all skimming operations.
The cost of servicing that debt was manipulated via "teaser rates" and "interest only" loans, further leveraging up American home buyers’ modest income streams. Mortgages were bundled, tranched and hedged, and the mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) were sold to trusting investors aroudn the world.
It was a bonanza of unprecedented wealth creation from financial skimming. $1,000 down and a few hundred dollars a month for a "teaser rate" interest-only loan was leveraged into a global chain of "products" and counterparties that could be skimmed all along the chain.
That deepened the political corruption that fed the skimming operation, and introduced the "no risk" pathology into Mainstream America. Since real estate never went down in value, then buying a second, third or fourth home on leverage was simply rational; in a Federal Reserve-controlled world of near-zero yields on cash, it was irrational not to.
But there were two intrinsic flaws in the skimming operation: while the Wall Street players were hedged (or so they reckoned), the average Americans buying homes with near-infinite leverage were not hedged. That meant that when their razor-thin capital went to zero, they were insolvent. Once they defaulted, then the income stream feeding the chain of skimming went away and the chain collapsed.
Once one counterparty failed in the chain, the entire chain collapsed as well. As Mandelbroit explained, such disruptions were an intrinsic feature of the system; though the timing of a systemic disruption could not be predicted, the fact that disruptions would occur on a regular basis could be predicted.
Some players knew this, of course, but that led to another pathology: those investment players who avoided the "no risk" skimming casino could not generate the yields being "earned" by the leveraged skimmers with legitimate investing, and so their investors abandoned them for the fully rational reason that "no risk" yields were higher elsewhere.
This too created a feedback loop, where the capital available to be leveraged grew rapidly, while the pool of capital available for "patient" risky investments in actual productive assets declined. Capital available for productive investment thus became costly and scarce, while capital available for leveraged skimming became cheap and abundant.
The Federal Reserve bankrolled the skimming to the hilt. Indeed, the entire pathology of low-interest, unlimited leverage skimming was based on the Federal Reserve’s manipulation and intervention. That remains true today.
What happens when the whole chain blows up and the foundation of debt is impaired? Since the whole system is based on the debt and the income streams devoted to servicing it, the entire edifice collapses when the debt is impaired–debtors default and the system clogs with bad debt, i.e. uncollectable debt.
In a transparent Capitalist system, the debt would be written down and all the insolvent borrowers, lenders and counterparties would be wiped out. But the political corruption that enabled modern finance to poison the American economy and culture has stopped that cleansing from occurring.
Such a systemic writedown of bad debt in a system with only razor-thin capital to support a mighty edifice of leverage and debt would wipe out Wall Street and the banks and reveal the skimming operation of modern finance as an impossible perpetual motion machine rigged to enrich a thin crust of citizenry at the expense of the rest.
And since they skim enough money to buy political protection, Capitalism has been strangled and tossed in a shallow grave lest it disupt the skimming and the political corruption that keeps the machine running. What we end up with is artificial valuations, endless propaganda and a zombie economy.
When borrowers are left dangling in default and the assets left on the books at full value, you end up with zombie debtors, zombie lenders, a zombie government that only has one lever to pull to keep the whole corrupt pathology going–borrow and squander more money– and ultimately a zombie economy, drifting and decaying in a fetid pool of lies, shadow banking, ceaseless official propaganda, jury-rigged "fixes," manipulated statistics, corruption, predation, exploitation and pathology.
That’s the U.S. economy, and indeed, the economies of the E.U., China and Japan in a nutshell.
The only way to clear a zombie economy is to write off uncollectable debt and liquidate all the assets, loans and hedges. That would collapse our financial system, but since it is the cause of our political and economic dysfunction, that would be the highest possible good and extremely positive.
There is a great final irony in the scare-mongering threats of the skimmers and their political toadies. If the taxpayers don’t bail out the skimmers, then we’ll have martial law by the weekend, the smouldering fires of Europe will rekindle into open warfare, and so on.
The irony is the propping up of a deeply, intrinsically pathological and destructive financial system is not saving the economy, it’s the reason the economy is imploding. The Big Lie technique of propaganda is to reverse the polarity of reality: we are told up is down until we believe it.
We are told that liquidating the overhang of bad debt, leverage and hedges would "destroy the world as we know it." The truth is that keeping the zombie system from expiring and covering up the corruption with propaganda is what’s actually destroying the world as we know it.
Thus the collapse of the current financial system of central banks, pathological Wall Street and insolvent banks would be the greatest possible good and the greatest possible positive for the global economy and its participants.
ECB stymied on debt crisis without fiscal union
by Ambrose Evans-Pritchard - Telegraph
Germany's top banker has vehemently rejected demands from David Cameron and other world leaders for drastic action by the European Central Bank to stop the eurozone crisis spiralling out of control.
Jens Weidmann, head of the Bundesbank and the ECB's dominant governor, said that any move to leverage Europe's €440bn rescue fund through central bank financing would be a "clear violation" of the ECB's legal mandate. He said Article 123 of the EU Treaty imposed a legal "prohibition on monetary financing", implying that the ECB cannot attempt to shore up the debt markets of Italy and Spain for covert fiscal support.
Mr Weidmann said Germany learned the bitter lesson under the Weimar Republic that funding public debt "via the money printing press" leads to hyperinflation and disaster. The comments came a day after Britain's Prime Minister said it was "difficult to understand" why the ECB was not "doing more" to halt contagion, a view shared in Washington, Beijing and Tokyo.
Asia's creditor states are scornful of requests to help rescue Europe when the ECB itself refuses to take on the role of lender of last resort. However, there is some dispute over whether the ECB is technically able to take on that role even if it dares bend the law any further. "The ECB is not indemnified by a eurozone treasury, because there is no such treasury," said Julian Callow from Barclays Capital.
The Bank of England and the US Federal Reserve have explicit guarantees from national treasuries that any losses stemming from bond purchases will be compensated, giving them the "credibility halo" of sovereign states.
The picture is entirely different in Euroland where the ECB has very little money of its own and shares key powers with the national central banks. There is no fiscal union to back up monetary union, and no sovereign entity underpinning the project. There is instead a Babel of conflicting sovereign voices.
The ECB's paper losses are already becoming an issue. Simon Ward from Henderson Global Investors said the ECB system has accumulated almost €200bn in Greek exposure alone. The bank holds an estimated €45bn of Greek bonds. As of late August, it had provided €110bn in support to Greek banks through its normal lending window as well as through "emergency liquidity assistance" (ELA) against weak collateral. This bank support may since have mushroomed to €150bn.
Mr Ward said it is unclear whether the ECB has taken on similar sorts of "back-door" ELA liabilities in Italy and Spain because the data has been delayed. The stated level of ECB intervention is €587bn for eurozone banks and €184bn in bond purchases. "We think there is a lot more going on quietly," he said.
Hans-Werner Sinn from Germany's IfO Institute said the Bundesbank's exposure to eurozone liabilities through so-called "TARGET" credit has ballooned to €450bn, with the Banca D'Italia making the biggest demands by far in September. In effect, this is a lending operation by the Bundesbank to EMU's weaker central banks. Dr Sinn said it is "not legally clear" what happens if any country defaults or leaves EMU.
Kenneth Rogoff, a Harvard professor and the IMF's former chief economist, said the ECB may have to "going crawling on hands and knees" to eurozone governments for more money. "If the ECB has bought a lot of junk debt and lost money it will have to asked to be recapitalised," he said. "Ultimately, Europe will have to change the whole constitutional structure of the eurozone, because this crisis is not a temporary liquidity problem."
The urgency was clear again on Tuesday as yield spreads on Italy's 10-year bond over German Bunds spiked to 497 basis points, driven by news that premier Silvio Berlusconi had survived a key budget vote. He later pledged to resign, but it is unclear whether the chaos of elections will make it any easier to govern Italy. "We cannot keep going for long with a spread of 500 points," said Emma Marcegaglia, head of Italy's industry lobby Confindustria. "Such a spread means an enormous credit crunch and unsustainable public finances."
The ECB has bought almost €90bn of Italian debt since August but has done so in a fitful fashion, turning the spigot on and off as a pressure tool to force reforms and political changes. It is far from clear that the ECB is imposing the right fiscal medicine on Italy by demanding a balanced budget by 2013, just as the country crashes back into deep recession.
Chiara Manenti from Banca SaoPaolo said the greatest risk for Italy's debt dynamics is a sharp slowdown in the economy itself. "That would be far more dangerous," she said. The IMF warned it is latest report on Italy that fiscal belt-tightening should be "at the right speed". These words of wisdom seem to have been ignored entirely in the EU's Calvinist dash for austerity.
Greek default within the euro is the only real option
by Robert Jenkins - FT
It was a possibility feared but unspoken – until last week. Suddenly a Greek exit from the euro was on the table. "Are you in or are you out?" Many Europeans no longer care. They should. Their leaders do. Here is why.
Greece will restructure. It can do so "within the euro" or it can do so "outside the euro". The difference is crucial. If you already understand the distinction, stop reading here. If not, you may soon wish you had. For here is how an exit of Greece from the eurozone would play out:
1: The Greek cabinet decides an exit. Rumours begin to circulate. Greek citizens withdraw their euro deposits while they are still euros and not drachmas; supplies of banknotes run short; businesses shift their euro balances abroad. Foreign lenders to Greek businesses cancel credit lines. Banks close their doors.
2. Following an emergency cabinet meeting, the Greek government announces the new drachma. Capital controls are imposed and border patrols dispatched to enforce them. Public sector debt is redenominated in local currency. The value of the drachma plunges. Greek inflation soars.
3. Disputes erupt over private sector debt (for example a German bank’s loan to the Greek subsidiary of a multinational such as BMW). Is the obligation still a euro loan or is it now drachma-denominated? If it is a drachma loan then the German bank has a problem – a drachma asset worth a fraction of its euro book value. If, on the other hand, the obligation remains in euros then both bank and company have a problem as the Greek borrower now has a euro loan which it must service from depreciating drachma income.
4. Contagion commences. Portuguese citizens worry that it might happen there. Portuguese depositors begin to withdraw euros for fear they will soon be escudos. Companies in Portugal transfer funds abroad as a precaution. Banks close. Soon, similar scenes occur in Ireland with echoes elsewhere along the Mediterranean. Banks cease dealings with their "peripheral" counterparts.
5. Confusion mounts over the magnitude of European bank exposure to the private sector of the periphery. Trading with and between Europe’s banks stops. Bank stocks crater and haven assets rise. In response to an inward flood of capital Switzerland imposes punitive negative interest rates on non-resident deposits.
6. Bank lending across the EU ceases. Economic activity halts.
I could go on but you get the point. It is not a pretty picture. Let me just add the fact that European banking exposure to the private sector (corporations and households) of the "peripherals" is a multiple of that to the public sector (government debt) of the area. These numbers are not secret. They have appeared in the Financial Times.
The associated risks are what used to be called cross-border risks – a term well known to US bankers of a certain age who once recklessly lent dollars and pesos to the Mexican public and private sector – only to discover that sovereign risk involved not only the risk that the sovereign might not pay but also that the private sector might be prevented by law or currency changes from doing so.
Banks in Europe can be forgiven for making this mistake. The advent of the eurozone was to have abolished the notion of cross-border risk, n’est-ce pas? Was not a Munich bank lending to BMW Athens now akin to a New York bank lending to General Motors in San Francisco? That was the idea. Seemed sound, right? It is, if the eurozone hangs together.
A number of senior officials understood this early on. Others have taken time for the implications to sink in – so focused has been everyone’s attention on sovereign bond-related exposures. This explains the slow but predictable shift in rhetoric: from no default to "orderly default", from default to "default within the euro" and more recently, "we will defend the euro at all costs".
Yes, the European leadership has grasped the gory details. They must now share them with their constituents. The peoples of northern Europe need to understand that their interests lie not in hounding the Greeks out but in keeping them in.
And referendum or no, the Greek government must explain the consequences that a Greek exit from the euro would have for the Greek economy and its citizens. A Greek default within the euro is manageable and will be managed. Greek default outside the euro involves risks to a different order of magnitude.
This issue has been the elephant in the room – visible for all to see should anyone care to look. For a long time no one cared to. No one wanted to. Now they must.
Robert Jenkins is an external member of the interim financial policy committee of the Bank of England. He writes in a private capacity
Once Greece goes, the whole euro project will unravel
by Jeremy Warner - Telegraph
Robert Jenkins, a member of the Bank of England's Financial Policy Committee, does a good job in setting out the potentially disastrous economic and financial consequences for Greece and the wider European Union if Greece is allowed to default via exiting the eurozone in this morning's FT (£).
That possibility was admitted for the first time by eurozone leaders at the Cannes summit last week. Obey or leave the club was their message. But, as Mr Jenkins explains, the consequences, not just for Greece but everyone else in the eurozone, would be potentially catastrophic. Once Greece goes, the other PIGS would sit there like ducks in a row, waiting to be picked off one by one, or perhaps all in one go.
However, there are two problems with the implication of his analysis, which is that Greece must be restructured within the single currency, since the economic consequences for all of it exiting are too awful to contemplate.
One is that the realpolitik of the eurozone is preventing the application of sensible policy to ease the plight of the periphery and allow the resumption of reasonable economic growth. It cannot be right to accept inappropriate economic policy simply because you fear the alternative might be even worse.
The other, related, criticism is that though the short term consequences of a break-up may be extraordinarily traumatic, the long term costs of staying together look pretty unappetising too.
Far from promoting growth and political solidarity, which is what the single currency was supposed to do, the euro is in fact achieving the opposite effect, by condemning the eurozone to long term recession and now extreme political infighting. Again, it cannot be right to persist with something which is achieving the opposite of what it was meant to simply because the alternatives are thought to be worse.
By suggesting that there will be no support for Italian bond markets until Italy reforms itself, the European Central Bank is playing god in a way which is almost certain to end badly.
Whatever Silvio Berlusconi's faults, which are undoubtedly many, since when was it thought acceptable for the central bank to effectively decide on what the government in Italy should be?
The now repeated imposition of supra-national policy by an unelected elite on the citizens of the eurozone has got to be ultimately unusustainable. The dangers of extreme populist backlash followed in short order by Balkanisation are all too obvious. If the euro goes, so does the European Union, Angela Merkel keeps saying. Actually, it is the other way around.
Persistence with the euro is straining the whole EU to the breaking point.
Investing in a Stranger's Retirement
by Leslie Scism and Michael Corkery - Wall Street Journal
Last month, some financial advisers passed around to potential investors a spreadsheet with information about future pension payments for 93 people, including retired civil servants and military veterans.
The advisers' pitch: For a lump-sum amount, investors could purchase pieces of the pensions—offered up by pensioners wanting instant cash in exchange for their future monthly checks—that could yield them 6% or 7% a year. The retiree would sign a contract pledging to hand over part of each month's check for a specific number of years.
The burgeoning business of investing in someone else's pension has never been easier—or more controversial and risky. For pensioners who are eager to sell, websites beckon with names such as BuyYourPension.com and pension4cash.com. Financial middlemen then bundle the information from pensioners into spreadsheets that are supplied to financial advisers for their clients.
In addition to the yield paid to investors, the transactions aim to reward an array of transaction facilitators. Fees are spread among the website operators, firms that pull together transactions, distributors and financial advisers who land individual investors.
No one keeps track of how many pensions are turned into instant cash, and the number for now is believed to be small. But in recent months, websites have proliferated, and obscure middlemen far from Wall Street have ramped up efforts to win over financial advisers to the concept. They are finding some acceptance among those who favor alternative investments as part of an overall diversified portfolio.
"It's becoming more of a staple part of our business," said Daniel Cordoba, founder of Asset Exchange Strategies LLC, a Leander, Texas, financial-advisory firm that has sold a handful of pension-payment deals to clients in recent weeks. "There's a starvation for yield" with most bonds paying little interest, and clients are scared of the volatile stock markets, he added.
For some pension recipients, the deals seem like the way out of a financial crisis. Joseph Serina, a metal-fabrication worker who spent 21 years in the Navy, received $57,450 three years ago from a group of investors in return for promising them $125,280 in pension payments over eight years. The difference of $67,830 is paid to investors as interest payments and as fees to the financial arrangers.
"Even though it seemed kind of high, I felt I had no other choice," said Mr. Serina, 49 years old, who lives in Virginia Beach, Va. Mr. Serina said he was struggling to keep up with his mortgage payments and wanted his daughter to continue sleeping in a familiar place. He also faced overdue bills from a billiards-supply business.
In general, pension deals thread the needle of federal law that discourages the assignment of pensions for public policy reasons, according to court rulings. In a preliminary ruling in August, a California state-court judge said that military-pension transactions by Structured Investments Co., which has been in business since the 1990s, are "prohibited and unenforceable."
Brett Rubin, a lawyer for Structured, said the firm believes its transactions are proper. Over the years, its agreements have been enforced by other courts, including a U.S. bankruptcy court, according to court filings. Structured is contesting an order in May from California's Corporations Commissioner to "desist and refrain" from misrepresentations or omissions of key facts to potential investors.
Regulators said past omissions included a 1994 bank-fraud conviction of a company official and the deals' riskiness. "Structured looks forward to vindicating itself," said Stanley Morris, another lawyer for the firm.
The biggest risk for investors is that pension recipients renege on their promises to turn over monthly checks to the investor. Mr. Serina decided to stop forwarding his pension checks after learning of the California lawsuits and concluding his deal terms with Structured Investments were "outrageous"—he was paying the equivalent of more than 20% annual interest on the lump sum he received. With the litigation still pending, "I didn't see why I should keep sending payments," he said.
Mark Cortazzo, a senior partner with financial-advisory firm Macro Consulting Group in Parsippany, N.J., said he refuses to pitch pension deals to his clients. "If these don't work out as expected, you've got a lot of headaches," he said.
Several buyers of pension payments who were interviewed by The Wall Street Journal declined to be identified because they didn't want to be seen as profiting from anyone's financial desperation. "I had misgivings at first," said an investor in Philadelphia who this summer bought seven years of pension payments from a retired sailor. She forwarded $50,000, to be repaid in monthly installments that includes 6% annual interest.
As part of the deal, the woman got some information about the seller, including that he needed the money to escape foreclosure. The retired sailor's "distress" bothered her, she said, but she "concluded this would help him save the house."
The pensions detailed in the October spreadsheet came from recent work by Voyager Financial Group LLC, based in Little Rock, Ark. Company officials started zeroing in on pensions about a year ago, said Jonathan Sheets, Voyager's general counsel. Voyager looked to build on its expertise in the secondary market for structured settlements, or awards to accident victims and other plaintiffs that are paid out over years.
Voyager officials helped set up websites that bring in leads, Mr. Sheets said. The company regularly updates a spreadsheet with details about available pension deals. Mr. Sheets said Voyager arranges transactions "within the parameters of the law," and encourages concerned financial advisers "to seek their own independent" legal counsel.
The spreadsheet that circulated in October included deals with a total of $8.2 million in future income. Of the 93 pensions for sale, a former New Jersey cop had $72,000 up for grabs, and a retired California civil servant offered a total of $299,598. Forty-four military veterans were on the list. Among the smallest was $454.75 a month for five years from a retired Ford Motor Co. worker. The largest: $396,000 in Marine Corps payments, or $2,200 a month for 15 years, according to a copy of the spreadsheet reviewed by the Journal.
Voyager said it asks sellers to provide information on their financial situation, and Mr. Sheets said the company won't participate in deals if it becomes apparent a seller "will be incapable of supporting" himself. The spreadsheet also noted how much insurance was in place on each seller's life. That coverage is important because it protects the investor if the pension recipient dies, ending monthly payments.
Buyers and sellers don't meet, but they do learn each other's name and address, said Mr. Sheets. Buyers get a credit report about the seller-and a copy of a photo ID.