Tuesday, November 30, 2010

November 30 2010: A little help from a friend

Dorothea Lange Dazey Boy October 1939
"Dazey farm, seventeen year old boy going to feed the pigs; Homedale district, Malheur County, Oregon"

Ilargi: First of all, apologies for the relative silence; Stoneleigh and I just came back tonight from a week-long whirlwind tour of England, and today alone was a 13-hour trip. With no internet access to boot. We have a lot of great people to thank, in Brighton, Oxford, Bristol, Chagford, London, Tunbridge Wells and more, for receiving us, lodging us and organizing conferences and interviews. We’ll certainly be back.

It’s of course a bit ironic that this very busy part of our tour coincided with some of the strongest economic turmoil for a while, but then what's the world without irony? In any case, I think many of our readers will recognize that we're still not all that wrong or off when it comes to what goes on in finance. By all means, though, judge for yourselves.

Other then stock markets that seem to be catching a bad flu, and the ongoing European tragi-comedy, the news item of the day is undoubtedly that WikiLeaks, after focusing mainly on governments and armed forces so far, is reported to be targeting private industries, in particular financial institutions. That may not be such a bad idea, since prosecutions and especially convictions to date in the mortgage and derivatives malaise are few and far between. It would seem that the US government could use some help.

Whether it’s such a good idea for Julian Assange himself remains to be seen. The world of finance has a way of dealing with threats to its hegemony that has little to do with taking prisoners.

The Irish situation serves as but one additional reminder where the true power in our societies resides: with the banks and their major stockholders. While the people of Ireland are not blameless when it comes to their predicaments, they are just one of multiple parties that should share the blame. And that’s not happening: the institutions that supplied the funds that enabled Irish housing prices to rise 10 or 15 fold in just a few years time are once again being made whole at the expense of an entire people, their social structures, their pension systems, and even their basic needs.

Every single bail-out we've witnessed since 2007 carries that same signature. And there is one thing besides the political power structure prevalent in the entire western world that people should take away from this. That is that the financial situation of the major banks, the same ones who have such a firm grip on power, is much worse than most realize.

That is to say that normal debt restructuring, the kind that has been de rigueur throughout modern history, and that many voices are presently clamoring for, can and will not be used today because it would directly and immediately mean the end of many if not most if not all of the main banking institutions.

More ominously, there is another aspect to this: it's not just the banks that are much poorer than we know or think. The same holds true for our governments, our insurance companies, our pension funds and last but not least for ourselves. If we would mark all assets to market, we ourselves would be marked down enormously, make no mistake. In a world where 95%+ of the money supply consists of credit, and where credit is seizing up, you don’t have to be a math genius to figure out what happens when it evaporatesalmost entirely.

The people of Ireland have been forced into a bail-out that's approximately $130 billion US large. There are 4.5 million people in Eire. $30,000 for every man woman and child has been added to Ireland's already monstrous debt levels at the stroke of a pen. Over which they will be forced to pay 5.8% in interest.

While Wall Street banks can still borrow money (well, make that credit) from the Federal Reserve at 0.25% or thereabouts. Nice job if you can get it.... Why not loan the "money" (let's not get into semantics) to Ireland at the 0.25% rate? Or to the American people themselves? Why do many Americans pay 10-20-30% interest on their credit card debt to the very same banks who at the very same time borrow at a rate that's some 100 times smaller? How mad is that? Why is that seen as somehow normal?

Is it because there is a moral idea that those who rack up debt deserve to pay dearly for doing so? Well, if such an idea exists, it's apparently applicable to some, but not to others. Because the one and only justification provided as the reason that Wall Street's finest have access to the ultra low rates, is that they racked up enormous debts.

In the present political environment, we will not be able to solve the absurd situation that money that belongs to a bankrupt people continues to be used, and in ever greater amounts, to paper over the fact that the banks it's given to are just as bankrupt as the people are, or even more so. It looks like it's not only the US government that can use some help, the American people need it at least as bad.

If Julian Assange can provide such help, that might not be such a bad thing.

WikiLeaks to go after US bank(s)
by Andy Greenberg - Forbes

These megaleaks, as you call them, we haven’t seen any of those from the private sector.
No, not at the same scale as for the military.

Will we?
Yes. We have one related to a bank coming up, that’s a megaleak. It’s not as big a scale as the Iraq material, but it’s either tens or hundreds of thousands of documents depending on how you define it.

Is it a U.S. bank?
Yes, it’s a U.S. bank.

One that still exists?
Yes, a big U.S. bank.

The biggest U.S. bank?
No comment.

When will it happen?
Early next year. I won’t say more.

[..] So do you have very high impact corporate stuff to release then?
I mean, it could take down a bank or two.[..]

What do you want to be the result of this release?
[Pauses] I’m not sure.

It will give a true and representative insight into how banks behave at the executive level in a way that will stimulate investigations and reforms, I presume.

Usually when you get leaks at this level, it’s about one particular case or one particular violation.  For this, there’s only one similar example. It’s like the Enron emails. Why were these so valuable? When Enron collapsed, through court processes, thousands and thousands of emails came out that were internal, and it provided a window into how the whole company was managed. It was all the little decisions that supported the flagrant violations.

This will be like that. Yes, there will be some flagrant violations, unethical practices that will be revealed, but it will also be all the supporting decision-making structures and the internal executive ethos that cames out, and that’s tremendously valuable. Like the Iraq War Logs, yes there were mass casualty incidents that were very newsworthy, but the great value is seeing the full spectrum of the war.

You could call it the ecosystem of corruption. But it’s also all the regular decision making that turns a blind eye to and supports unethical practices: the oversight that’s not done, the priorities of executives, how they think they’re fulfilling their own self-interest. The way they talk about it.


WikiLeaks Targeting Bank Of America? Interview Suggests Mega-Bank May Be Next
by Ryan McCarthy - Huffington Post

UPDATE: In a new blog post, Forbes writer Andy Greenberg stops short of ruling Bank of America out as the target of WikiLeaks' next major document dump -- and he says Assange told him that WikiLeaks has documents from "multiple finance firms." Greenberg also noted that whatever information Assange was referring to in 2009 Computer World interview, it is now roughly 14 months old.

ORIGINAL POST: The next target of WikiLeaks may be Bank of America, if comments made last year by the organization's editor-in-chief Julian Assange are any indication.

In an October 2009 interview with Computer World , Assange said that Wikileaks had acquired a large cache of information from Bank of America (hat tip to Raw Story.)

Here's Assange's 2009 interview:
"At the moment, for example, we are sitting on 5GB from Bank of America, one of the executive's hard drives," he said. "Now how do we present that? It's a difficult problem. We could just dump it all into one giant Zip file, but we know for a fact that has limited impact. To have impact, it needs to be easy for people to dive in and search it and get something out of it."

In a cover story interview with Forbes, Assange hinted that his organization's next focus will be on uncovering corporate America's secrets. While he declined to identify which bank he'd be targeting, Assange did comment on WikiLeaks' next move, which should come in a matter of weeks. Here's Assange on the material:
"You could call it the ecosystem of corruption," he says, refusing to characterize the coming release in more detail. "But it's also all the regular decision making that turns a blind eye to and supports unethical practices: the oversight that's not done, the priorities of executives, how they think they're fulfilling their own self-interest."

The added attention couldn't come at a worse time for Bank of America, which is currently embroiled in a federal racketeering lawsuit over its alleged use of "robo-signers" to process foreclosure documents. The bank is also facing battles over mortgage buybacks and new accusations that it routinely mishandled mortgage notes.

BofA Mortgage Morass Deepens After Employee Says Trustee Didn't Get Notes
by Prashant Gopal and Jody Shenn - Bloomberg

Testimony by a Bank of America Corp. employee in a New Jersey personal bankruptcy case may give more ammunition to homeowners and investors in their legal battles over defaulted mortgages. Linda DeMartini, a team leader in the company’s mortgage- litigation management division, said during a U.S. Bankruptcy Court hearing in Camden last year that it was routine for the lender to keep mortgage promissory notes even after loans were bundled by the thousands into bonds and sold to investors, according to a transcript. Contracts for such securitizations usually require the documents to be transferred to the trustee for mortgage bondholders.

In the case, U.S. Bankruptcy Judge Judith H. Wizmur on Nov. 16 rejected a claim on the home of John T. Kemp, ruling his mortgage company, now owned by Bank of America, had failed to deliver the note to the trustee. That could leave the trustee with no standing to take the property, and raises the question of whether other foreclosures could similarly be blocked.

Following the decision, the bank disavowed the statements by DeMartini, whom it had flown in from California to testify. It was the policy of Countrywide Financial Corp., acquired by Bank of America in July 2008, to deliver notes as called for in its securitization contracts, according to Larry Platt, an attorney at K&L Gates LLP in Washington designated by the bank to answer questions about the case. "This particular employee was mistaken in what she said," Platt said in a telephone interview.

Attorney Analysis
Wizmur’s ruling is being scrutinized by lawyers for borrowers seeking to stall repossessions as a way to press lenders to modify their debt. Attorneys for homeowners have already won cases by calling into doubt the legitimacy of affidavits used to take back properties. "If this is correct, many, many, many foreclosures already occurred in which this plaintiff didn’t have the note," said Bruce Levitt, the South Orange, New Jersey, attorney representing Kemp. "This could affect thousands or hundreds of thousands of loans."

Companies that service loans, including Bank of America, temporarily halted home seizures in the wake of disclosures that they relied on employees to sign thousands of affidavits without reading them, a practice that has become known as robo-signing. The attorneys general of all 50 states are jointly investigating foreclosure practices of servicers. Bank of America, based in Charlotte, North Carolina, is the largest U.S. mortgage servicer, overseeing $2.09 trillion of loans as of Sept. 30, according to industry newsletter Inside Mortgage Finance.

Investor Impact
The Kemp case is also being examined by lawyers for investors in mortgage-backed securities. Owners of the bonds have been cooperating in an effort to force sellers to take back loans, saying they were misled about their quality. The Wizmur ruling may give investors an additional opportunity to push for mortgage buybacks on grounds that the bonds weren’t created in keeping with securitization contracts. "It may mean investors who think they bought mortgage- backed securities bought securities that aren’t backed by anything," said Kurt Eggert, a professor at Chapman University School of Law in Orange, California.

The potential impact of DeMartini’s testimony may depend on the outcome of a broader dispute between homeowner and industry lawyers about whether missing or incomplete paperwork subsequently can be fixed, Eggert said. Wizmur, chief judge of the U.S. Bankruptcy Court for the District of New Jersey, said during hearings that the Countrywide securitization contract covering Kemp’s loan called for a trustee to take possession of the promissory notes, which represent the borrowers’ obligation to repay their loans.

The judge asked DeMartini whether the notes ever move to follow the transfer of ownership, according to the transcript of the August 2009 hearing. "I can’t say that they’re never moved because, I mean, with this many millions of loans as we have I wouldn’t presume to say that, but it is not customary for them to move," DeMartini said. "This is something that would concern investors," said Talcott Franklin, a Dallas-based lawyer whose firm is helping owners of more than $600 billion of mortgage bonds as they consider ways to limit their losses.

DeMartini held management and training positions since joining Countrywide Home Loans about a decade ago, according to her testimony. She said she has been involved in every aspect of servicing and "had to know about everything in order to do that."

Platt, the lawyer for Bank of America, said DeMartini was wrong, as was the bank’s local attorney in the case, who argued in court that notes weren’t moved in part because of the risk of losing them. The transfer of mortgage notes was outside the scope of DeMartini’s knowledge because she doesn’t deal with the sale of loans, Platt said. DeMartini, who at one point said she wasn’t "comfortable" testifying about the extent to which notes were transferred before continuing to do so, couldn’t be reached for comment. Jerry Dubrowski, a spokesman for the bank, said that she remains an employee.

Banks including JPMorgan Chase & Co. and Washington Mutual Inc. said in prospectuses for some mortgage-bond deals that they would hold onto notes for the trusts. They were empowered to act in custodial roles on behalf of trustees, according to the pooling and servicing agreements that govern the transactions.

Countrywide Deals
The securitization contracts related to the Kemp loan, and at least two other Countrywide mortgage-bond transactions, didn’t assign the company the additional role of document custodian for the trust. Countrywide, as the servicer, can take back the notes from the trustee when needed to manage foreclosure actions and mortgage payoffs, according to the contracts.

One risk to investors when notes remain with sellers acting as custodian is that an acquirer or creditor of those companies could walk in and take the notes, the banks that disclosed the practice in mortgage-bond prospectuses warned. Typically, trustees or custodians also are charged with checking that either all the necessary documents get delivered or letting sellers know about missing paperwork.

"If Countrywide had a special agreement to act as a stand- in for the trustee, given the inherent conflicts involved, one would have thought that would have been material and disclosed to investors," said Joshua Rosner, an analyst at New York-based Graham Fisher & Co. He said that the possibility that Countrywide retained documents raises questions about whether Bank of New York Mellon Corp., which serves as the trustee for the securitization of the Kemp loan, fulfilled its obligation to review loan files.

Stress-Tested System
"We have an established, clearly defined document review process," said Kevin Heine, a spokesman for New York-based BNY Mellon. "It is a controlled and well-documented system that has been stress-tested and audited. We are comfortable that it works well." Mortgage-bond contracts require that loan sellers deliver certain files to trustees, or other companies acting on their behalf, typically within a few months. "Material" missing paperwork can require sellers to take back loans for their full face value, according to the agreements.

"If the notes weren’t properly transferred to the trusts, then investors have the mother of all put-back claims," Adam J. Levitin, an associate professor at Georgetown University Law Center in Washington, wrote on a blog four days after citing the Wizmur ruling during a hearing by a House Financial Services subcommittee. Giving notes to the trustees after the fact isn’t a solution because the rules governing trusts, enforced by New York trust law, require that assets are in place by a specified closing date, said O. Max Gardner III, a Shelby, North Carolina, bankruptcy litigator. The notes also can’t be transferred to the trust without first being conveyed through a chain of interim entities, he said.

"If they do an end run and directly deliver it to the trust, that would violate all the documents they filed with the SEC under oath as to what they did," Gardner said.
Industry lawyers said trust law isn’t relevant in this instance. Based on other legal codes, loans have already been transferred into the mortgage-bond trusts, making a clean-up of paperwork permissible, they said.

Refuted Attack Strategies
"Those who seek to attack the integrity of securitizations have taken a number of approaches that have been refuted, so now they’re focusing on New York trust law," said Karen B. Gelernt, a lawyer in New York at Cadwalader, Wickersham & Taft LLP who works for banks. The part of the law they cite relates to "actions taken by the trustee after the trust is formed; it’s nonsensical to apply this provision to the creation of the trust," she said. "There doesn’t appear to be any case law that supports their interpretation."

Platt, the Bank of America lawyer, said that any bank that failed to initially deliver all the documents required in contracts may be required to refund investors only in cases in which foreclosures actually get blocked. "The judges may decide it’s better for the system to allow everyone to" send missing paperwork to trustees, said Rosner, the Graham Fisher analyst. "It’s too early to really answer question about the implications" if the Bank of America testimony is true.

Howard Davidowitz on the Economy: 2011 Will be Horrendous
by Aaron Task - Tech Ticker

The U.S. economy "is a complete disaster," Howard Davidowitz declared here in July, the most recent in a string of dire predictions from Tech Ticker's most entertaining guest. On the eve of Thanksgiving, I asked Davidowitz if he had any regrets, or was ready to throw in the towel given recent signs of economic revival.

Are you kidding me?

"Here are the numbers...we're broke," Davidowitz declares, noting the U.S. government goes $5 billion deeper into debt every day and is facing $1 trillion-plus annual deficits for the next decade. "In other words, we're bankrupt."

As with the economy, Davidowitz is unwaveringly consistent in his views on President Obama, calling him "deranged, dysfunctional and discredited." Results of the midterm election show "the people of this country think we are in a catastrophe," he says. "I'm with them."

"Obama is Toast", Davidowitz Says: U.S. to Face Dollar Crisis by 2012
by Peter Gorenstein - Tech Ticker

U.S. stocks are rallying today after Ireland announced a new $20 billion austerity package aimed at getting its debt crisis under control. The Irish government plans to cut spending and raise taxes over the next four years. The move helps the country meet requirements for a EU/IMF rescue package, which Irish Prime Minister Brian Cowen says will likely be around 85 billion euros.

Howard Davidowitz, a corporate restructuring professional, is encouraged by Ireland’s "positive action." The key in any restructuring, he says, is to "make hard decisions," which it looks like Ireland is prepared to do. Unfortunately for Europe, the crisis doesn’t end with Ireland. Interest rates in Spain, Portugal and Greece (already the recipient of bailout) are rising. Davidowitz says the situation in Spain is increasingly troublesome thanks to a 20% unemployment rate and housing crash.

Don’t be surprised to see the "PIIGS" announce more austerity measures in the future. The situation in Europe, and specifically Ireland, is very similar to what’s happened in the United States, Davidowitz notes. The only major difference is the U.S. can still borrow very cheaply. But, unlike Europe we’ve "done nothing! Nothing!" to get spending under control. He fears "the U.S. dollar is at risk" and could face a crisis "in the next two years," if we don’t start our own austerity plan.

Step one, he says: End quantitative easing and allow the Bush-Era tax cuts to expire. "I don't think we should cut taxes for anybody," says Davidowitz, noting we could have paid for the $3.8 trillion deficit-cutting plan the President's commission is recommending by not passing the Bush tax cuts in the first place.

Ireland's Debt Servitude
by Ambrose Evans-Pritchard - Telegraph

Stripped to its essentials, the €85bn package imposed on Ireland by the Eurogroup and the European Central Bank is a bail-out for improvident British, German, Dutch, and Belgian bankers and creditors. The Irish taxpayers carry the full burden, and deplete what remains of their reserve pension fund to cover a quarter of the cost.

This arrangement – I am not going to grace it with the term deal – was announced in Brussels before the elected Taoiseach of Ireland had been able to tell his own people what their fate would be. The Taoiseach said afterwards that Brussels had squelched any idea of haircuts for senior bondholders: a lack of "political and institutional" support in his polite words: or "they hit the roof", according to leaks.

One can see why the EU authorities reacted so vehemently. Such a move at this delicate juncture would have set off an even more dramatic chain reaction in the EMU debt markets than the one we are already seeing. It is harder to justify why the Irish should pay the entire price for upholding the European banking system, and why they should accept ruinous terms.

I might add that if it is really true that a haircut on the senior debt of Anglo Irish, et al, would bring down the entire financial edifice of Europe, then how did any of these European banks pass their stress tests this summer, and how did the EU authorities ever let the matter reach this point? Brussels cannot have it both ways. Ireland did not run large fiscal deficits or violate the Maastricht Treaty in the boom years. It ran a fiscal surplus, (as did Spain) and reduced its public debt to near zero. German finance minister Wolfgang Schauble keeps missing this basic point, but then we don’t want to disturb a comfortable – and convenient – German prejudice.

Patrick Honohan, the World Bank veteran brought in to clean house at the Irish Central Bank, wrote the definitive paper on the causes of this disaster from his perch at Trinity College Dublin in early 2009. Entitled "What Went Wrong In Ireland?", it recounts how the genuine tiger economy lost its way after the launch of the euro, and because of the euro. "Real interest rates from 1998 to 2007 averaged -1pc [compared with plus 7pc in the early 1990s]," he said.

A (positive) interest shock of this magnitude in a vibrant fast-growing economy was bound to stoke a massive credit and property bubble. "Eurozone membership certainly contributed to the property boom, and to the deteriorating drift in wage competitiveness. To be sure, all of these imbalances and misalignments could have happened outside EMU, but the policy antennae had not been retuned in Ireland. Warning signs were muted. Lacking these prompts, Irish policy-makers neglected the basics of public finance."

"Lengthy success lulled policy makers into a false sense of security. Captured by hubris, they neglected to ensure the basics, allowing a rogue bank’s reckless expansionism," he wrote.
Let me add that the ECB ran a monetary policy that was too loose even for the eurozone as a whole, holding rates at 2pc until well into the credit boom and allowing the M3 money supply to expand at 11pc (against a 4.5pc target). The ECB breached its own inflation ceiling every month for a decade.  It did this to help Germany through its mini-slump, and in doing so poured petrol on the bonfire of the PIGS. So please, NO MORE HYPOCRISY FROM BERLIN.

The truth is that the EMU venture is one of shared culpability. Yes, the Irish should have regulated their banks properly and restricted mortgages to a loan-to-value ratio of 80pc, 70pc, or 60pc, forcing it down as low as needed – as Hong Kong and Singapore do – to stop idiotic bubbles. But almost nobody understood the implications of monetary union:  in Dublin, in Berlin, in Brussels, and Frankfurt. They were almost all beguiled, (though I doubt that the ECB’s Axel Weber and Jurgen Stark ever were).

Given this, why should the  Irish people accept the current terms? As Citigroup said in a note today, the EU part of the package will come at around 7pc  — higher than the fee paid by Greece. This is pena By 2014, interest payments on Ireland’s public debt (then 120pc of GDP) will be €10bn, while tax revenues will be  €36bn. This ratio is well above the average default trigger of 22pc, as calculated in a  Moody’s study.

Nominal Irish GNP has contracted by 26pc since the peak. It is nominal, not real, that matters for debt dynamics. Ireland is in a classic debt-deflation trap , as described by Irving Fisher in his 1933 Economica paper. Yes, it has a very vibrant export sector, and can perhaps claw its way out of the trap – which Greece and Portugal cannot hope to do in time, in my view. In a way that makes the choice even harder.

The question is, should the Dail vote against the austerity budget on December 7, Pearl Harbour Day.  And should the next government –  with Sinn Fein in the coalition? – tell the EU to go to Hell, do an Iceland, wash its hands of the banks, and carry out a unilateral default on senior debt by refusing to extend the guarantee? The risks are huge, but then the provocations are also huge. And there is a score to settle. Did the EU not disregard the Irish `No’ to Lisbon, just as it disregarded the first Irish `No’ to Nice? Did it not trample all over Irish democracy?

It is not for a British newspaper to suggest which course to take. Both outcomes are ghastly, but as one Irish reader wrote to me: if  Eamon De Valera  could defy world opinion in 1945 by sending condolences to Germany for the death of the Fuhrer, today’s leaders need not worry too much about scandalizing those who made them swallow Lisbon. Compliance is traumatic. Default is traumatic. What the Irish have before them is a political choice about what they wish to be as a people, and a nation.

Let me finish with a few words by Dan O’Brien, the Economics Editor of the Irish Times, that caught my eye.

"Nothing quite symbolised this State’s loss of sovereignty than the press conference at which the ECB man spoke along with two IMF men and a European Commission official. It was held in the Government press centre beneath the Taoiseach’s office. I am a xenophile and cosmopolitan by nature, but to see foreign technocrats take over the very heart of the apparatus of this State to tell the media how the State will be run into the foreseeable future caused a sickening feeling in the pit of my stomach."

My sympathies.

Europe Sets Bailout Rules
by Marcus Walker and Charles Forelle - Wall Street Journal

Europe sealed a €67.5 billion bailout of Ireland Sunday and for the first time crafted a blueprint for rescues from 2013 on that could have private-sector creditors bearing some of the cost. The Irish bailout, equivalent to about $90 billion, is intended as a signal that the euro zone will come to the aid of its own. But the plan to share pain with banks and other private-sector lenders is a message that the munificence won't continue forever.

Ireland is the second euro-zone country, after Greece, to call for help paying its bills. Bond markets have all but cut Dublin off by demanding soaring interest rates. They have also become more wary of lending to Portugal and Spain, stoking fears of toppling dominoes along the euro-zone's weak perimeter. European finance ministers raced to reach an agreement before unsettled markets opened Monday.

The $90 billion deal for Ireland and the plan for future rescues "should decisively address the current nervousness in the financial markets," said Olli Rehn, the EU's economy commissioner. Under the compromise reached Sunday, the EU agreed to enact a new big bailout fund of undetermined size. It will replace, in 2013, the €440 billion fund created in May and now being used to help Ireland. Under the new fund's terms, creditors of countries that are deemed insolvent could be forced into a restructuring before the fund doles out any aid.

For Greece and now Ireland, European taxpayers and the taxpayer-backed International Monetary Fund have stepped into the breach with cash. For months, Germany has pushed to include bondholders among those who might bear the burden of a bailout. To Germans, the higher cost of borrowing that would result is an essential disincentive to the sort of profligate debt-accumulation that felled Greece this spring and triggered the crisis. But heavily indebted countries, such as Italy, fret that higher costs of borrowing to service their debt will further strain public purses. In addition, no one wants to shock already jittery debt markets.

Germany didn't get its way entirely: Both Jean-Claude Trichet, president of the European Central Bank, and Jean-Claude Juncker, the Luxembourg premier who heads the group of euro-zone countries, said that private-sector creditors would face restructuring on a "case-by-case" basis—and not automatically, as Germany had wished. The new system wouldn't affect creditors until mid-2013, and new "collective action clauses"—a regular feature of debt issued by certain emerging-market governments—that could smooth restructuring would only be inserted into euro-zone bonds issued from June 2013 onward.

Like the €110 billion bailout of Greece, the rescue funds that Ireland is slated to receive in coming weeks and months provide little more than time and space: Since debt relief is excluded before 2013, the country faces several years of mounting debt and budget austerity. The same can be said for Spain and, particularly, Portugal, whose low-growth economy is stung by government cutbacks demanded to shrink its deficit.

The Irish package includes €50 billion to prop up government finances and billions more for the country's ailing banks. The money is coming from two European Union funds and the IMF. Three countries outside the euro area—the U.K., Sweden and Denmark—also agreed to chip in. The bailout—widely expected for several days—is a blend of loans, some for as long as 10 years, and at an average interest rate of around 6%. It covers the Irish government's financing requirements for more than two years, gives the country more time to put in place deficit cuts and provides cash for banking troubles.

The extended timeframe for the loans makes clear just how long Europe is likely to be helping its weaker members; on Sunday, EU leaders suggested loans to Greece would be lengthened. Ireland committed to providing €17.5 billion of a possible €35 billion earmarked for its banks. Counting Ireland's own contribution, which is coming out of the state's treasury and its pension-reserve fund, the total package is €85 billion.

"Can Ireland do without this program? The answer is no," said Prime Minister Brian Cowen at a Dublin news conference Sunday evening. The package "provides Ireland with vital time and space to address the problems we've been dealing with since this global economic crisis began." After a decade-long boom in Ireland peaked in 2007, the Irish government saw its tax revenue plummet and a huge budget gap open up. Then Irish banks, saddled by poor property loans, began to sink, and the state stepped in with bailouts that total up to €50 billion.

The one-two punch has wrecked Irish public finances, driving the nation's government deficit to 32% of its gross domestic product, 10 times the euro-zone limit. The crisis became severe in recent weeks. Fearing that Irish banks wouldn't survive, depositors fled in droves. Banks were forced to seek huge amounts of liquidity from the European Central Bank, which signaled its discomfort. Under the deal reached Sunday, Ireland will try again what it has tried unsuccessfully for two years: adding more capital to banks to give investors and depositors more confidence in their solidity.

The deal contemplates an additional €10 billion of capital for the Irish banks; Ireland's central bank said €8 billion would come from fresh injections and the rest from the sale of "noncore" assets. Another €25 billion from the bailout package has been set aside in case needed for further bank aid. Mr. Cowen said Sunday that it is certain that Ireland will end up with "an increased level of public ownership of these institutions." After repeated government bailouts, Irish taxpayers already own more than one-third of Bank of Ireland and are poised to own more than 90% of Allied Irish Banks PLC. Anglo Irish Bank Corp. has been fully nationalized. European officials said senior creditors of the banks wouldn't be forced to take losses.

For much of the past two years, a grin-and-bear-it mood— leavened by anger at the banks—has prevailed in much of Ireland. But it has recently been replaced by frustration. While Ireland hasn't seen the violent riots that have gripped Athens, tens of thousands of protesters marched through Dublin Saturday. "I think [the government] should default on the bonds," said Valerie Whelan, a 58-year-old writer. "We are suffering so the bondholders don't suffer—it's capitalism gone mad."

Many called for the country to default on its debts—or at least on those of its now-nationalized banks—to spare the public the tough cuts and tax hikes needed to pay them off. Blowing whistles and chanting "burn the bondholders," marchers made their way to Dublin's General Post Office—the site of the 1916 Easter Rising that catalyzed Irish independence from Britain.

When Irish Eyes Are Crying
by Thomas G. Donlan - Barron’s

In rhetoric, an "irish bull" is a statement that is logically absurd but full of ironic meaning. One Irish scholar committed one by noting that "An Irish Bull is always pregnant." Here's the Irish Bull that best fits the current economic situation: "Why should we put ourselves out of our way to do anything for posterity? What has posterity ever done for us?" Posterity is not the problem in Ireland these days, nor is poverty the problem that it was a few decades ago. Instead, Irish prosperity is the problem—where it came from and where it went.

In every European country with the euro and palm trees—and yes, Ireland has palm trees, though they aren't native to the old sod—there was a decade and more of grandiose prosperity. Their banks and their citizens were able to borrow in euros as if they were as creditworthy as German banks and citizens. Now, because the palmy countries had no such Teutonic discipline, they have a banking crisis, a real-estate crisis, a leverage crisis and a solvency crisis—and these crises also threaten the countries north and east of the palmy zone. All European countries, even those that do not play with the single currency, face a euro crisis.

European Abattoir
If the crises are not fully acknowledged in every sunny clime, that's only a matter of time. For now, investors and speculators concentrate on Greece and Ireland, while keeping a wary eye on the other members of the infamous PIIGS—Portugal, Ireland, Italy, Greece and Spain. All the PIIGS used the credibility of the euro to borrow more than they could afford. The most prosperous euro countries were farmers after a fashion—they and their banks fed credit to the PIIGS and the other animals.

Now the PIIGS are going down like lambs to the slaughter, though not in letter order. The correct order seems to be Greece, Ireland, Portugal, Spain, Italy— followed by Everybody in Europe, or at least in the euro. Bailing out Greece was a desperation move, an attempt to stop the contagion before it hurt a big country. Bailing out Ireland is rooted in the same desperation, with different circumstances.

Greece is a chaotic country burdened by governments devoted to waste and mismanagement. Ireland is a well-run country with chaotic banks and a government trying to tame them by cutting its own expenditures. Until a couple of decades ago, austerity was Ireland's only choice. There was little money and few jobs, and Irish with ambition left the country. After signing up with the European Union as a poor country, deserving of agricultural subsidies and public works, Ireland began to prosper. It lowered taxes and welcomed foreigners, both their businesses and their vacationers.

Where in the 1960s there was a large piece of land with a grand view, with only a tumbledown cottage seemingly left vacant since the Famine, by the 1990s there could be a rebuilt cottage and four new ones besides, or a resort hotel, or a new town.

Indigestible Banks
Ireland would be worth saving, except that the government rashly guaranteed Irish banks' deposits, borrowings and loans. It turned out the mess was greater than the Irish government's assets. Irish Gross Domestic Product in 2009 was $227 billion on an exchange-rate basis, and $172 billion on purchasing power parity. If Irish banks owe German banks $139 billion and British banks $149 billion, as the Bank for International Settlements says, it hardly matters if the Irish government promises to support the Irish banks to its last euro.

Maybe the banks don't owe so much: As with American banks in the mortgage mess, nobody seems to know who owes what to whom, and most reports are fuzzy about which numbers represent hedged positions and which are the gross debts. In any case, these obligations are not equally distributed among all German and British banks, since all their banks were not equally profligate lenders. But this is not good news. Concentrating losses means that either the Irish get bailed out or some German and British banks get bailed out.

So, for example, the British government is borrowing $11 billion or so to lend to the Irish government, which will lend it to the Irish banks, which will pay back British banks that pay taxes to the British government, which will pay back its $11 billion loan obligation. If we called this a vicious circle of virtue, would that be an Irish Bull or a British Lion?

To Ireland's credit, so to speak, the government has tried to develop an austerity plan that won't destroy the fruits of years of foreign investment. The plan published last Wednesday leaves the corporate income tax at 12.5%. Instead, it hikes the value-added tax two points to 23%—which can be rebated on exports and sales to foreign visitors. On the other side of the ledger, the government is about to fall, and the estimated sum for the bailout by the EU and IMF keeps growing.

Moving Right Along
Portugal is next, of course. What holder of Portuguese debt, governmental or private, would not sell it, were it not for the reasonable expectation that the solvent countries of the EU and IMF would support Portugal as they support Greece and Ireland? "There is no need for help to Portugal," said the president of the European Union last week, echoing the protestations of soundness that lately were made for Ireland.

The denial all but assures the ultimate bailout of Portugal, another attempt to stop the contagion before it hurts a big country. But the first big country looms large: Cottages in Ireland are nothing compared with the castles in Spain that were built during the Spanish heyday of profligate banking.

Spain's economy, such as it is, is nearly twice as big as those of Greece, Ireland and Portugal combined. Already the market demands a record premium interest rate for lending to Spain and Spanish banks. And that's a record that can be broken easily. The Irish Bull for Spain is that it's too big to fail and too big to rescue. Sooner or later, the world's financial bureaucrats will compose their own Irish Bull: The place burned down because we put out all the fires. 

Germany faces its awful choice as Spain wobbles
by Ambrose Evans-Pritchard - Telegraph

Desperate moments call for desperate measures. In June 1940, the British War Cabinet led by Winston Churchill offered a total national merger to a shattered France. "France and Great Britain shall no longer be two nations, but one Franco-British union," read the declaration.

"The constitution of the Union will provide for joint organs of defence, foreign, financial and economic policies. Every citizen of France will enjoy immediately citizenship of Great Britain, every British subject will become a citizen of France." The text was drafted by Jean Monnet, the father of the European Project. If alive today, he would be pounding on the door of the Kanzleramt, exhorting Angela Merkel to offer a total fiscal union to all members of the eurozone before everything falls apart, and to be enshrined in EU treaty law forever.

"All debts of Greece, Cyprus, Italy, Spain, Portugal, and Ireland will be fused immediately with German debt; a single treasury will control spending, and issue euro-bonds for all Euroland," or some such formula.

This is the sort of game-changer that may now be required to save EMU and the Monnet dream. Germany must contemplate doing for Euroland what it has done for its own Volk in the East over the last 20 years – pay big transfers – or watch its strategic investment in the post-War order of Europe collapse with a bang, and in hideous acrimony. Tough call.

It is clear to those working in the bond markets that the debt crisis in the EMU periphery is nearing danger point, and risks spiralling out of control as quickly as the Lehman-AIG-Fannie-Freddie crisis in 2008.

Prof Willem Buiter, chief economist at Citigroup, said last week that Portugal is likely to need a rescue before the end of the year and that Spain will follow "soon after". Klaus Baader from Societe Generale issued a report the same day entitled "Eurozone sovereign debt crisis: next stop Spain". He suggests that the EU bail-out fund raises money to buy Spanish bonds pre-emptively. Nice idea, but what would the German constitutional court have to say about that?

At Deutsche Bank, Thomas Mayer said Spain might soon need a flexible credit from the IMF. Informed opinion has turned. Markets are already pricing a 23pc chance of default in Spain (34pc for Portugal, and 39pc for Ireland). If the country needs a rescue, it instantly exhausts the credible financial and political firepower of the EMU system.

The EU’s €440bn (£372bn) rescue fund "looks small, very small, too small", says Dr Buiter. Alleged plans for a double-up are circulating "en coulisses" in the Berlaymont, but Berlin squashed the idea as "completely over the top". In any case, we are beyond the point where escalating bluffs can achieve anything. Markets doubt that it makes sense to heap further debt on states that cannot service existing debt.

The EU strategy of hair-shirt austerity and 1930s debt-deflation for crippled economies has been tested in Ireland, and has led to the same doleful outcome as the 1930s. Tax revenues have collapsed. The deficit has hardly shrunk at all. The policy is based on mechanical theories of the "fiscal multiplier", and is patently self-defeating. Sinn Fein’s landslide victory in Donegal is a condign response to this academic hocus pocus.

Should the EU really impose a 6.7pc interest charge on Ireland’s bail-out loans, it should not be surprised if the new Irish government in January walks away from the whole stinking arrangement, and pulls the plug on Europe’s banking system. Many might cheer. However, it is Spain that determines EMU’s fate. Spanish premier Jose Luis Zapatero said there is "absolutely" no chance that his country would need a rescue. "Those investors shorting Spain are making a big mistake."

As Keynes once said, blaming economic crises on speculators is "not far removed, intellectually, from ascription of cattle disease to the "evil eye". Has Mr Zapatero read the IMF’s devastating Article IV report on his own country? It states that the government’s "gross financing needs" for 2011 will be €226bn, or 21pc of GDP. "Spain’s financing requirements are large and, retaining market confidence will be critical. Spain has exhausted its fiscal space. Targets should be made more credible."

Madrid must attract €226bn of good money from Spanish savers, German pension funds, French banks, Japanese life insurers, and China’s central bank, so that an incompetent government (this one happens to be socialist, but the Greek conservatives were worse) can continue to run budget deficits of 7pc to 8pc of GDP in 2011. Why should they lend a single pfennig, having already been told by EU leaders that they will face scalping if Spain ever needs a rescue?

"The economy is highly indebted and has one of the most negative international investment positions (IIP) among advanced countries," said the IMF. Its external accounts are under water by 80pc of GDP. Furthermore, Spanish banks will need to roll over €220bn in 2011 and 2012, according to Enrique Goñi, head of Banca Cívica. "We’re in the antechamber of a new liquidity crisis. We’re living through a financial pre-collapse," he said.

Now, before yet more Iberian brickbats fly my way, let me say that Spain’s public debt will be a modest 63pc of GDP this year (though total debt is over 270pc, which is what matters). The savings rate is high. The Banco de Espana has been heroic, but then it needed to be given that Spain no longer has control over its policy levers. The country had to contend with real interest rates of minus 2pc during the long boom, and cannot offset the horrendous bust with monetary stimulus or a properly valued peseta.

Spanish readers like to point out that British failings are comparable or worse. Whether or not that is true, it is irrelevant. Britain is not a prisoner of EMU. You might as well compare chalk and cheese.

We can argue whether the overhang of unsold properties in Spain will reach 1.5m, or six years’ supply, as claimed by Madrid consultants RR de Acuna, but there is little doubt that the "Cajas" and smaller banks have played a game of "extend and pretend" to disguise the true scale of losses on their property loans. This then is the headache facing Angela Merkel. By the time she inherited the EMU debacle, imbalances were already chronic, and she certainly does not have popular mandate for Churchillian gestures right now.

Even so, it is remarkable that Berlin is not even allowing the European Central Bank to pursue the first and obvious line of defence, which is to calm eurozone bond markets by using its financial stability powers to buy Irish, Portuguese, and Spanish debt on a nuclear scale. As the storm rages, the ECB is tightening monetary policy by draining liquidity (the Eonia rate is up from 0.4pc to 0.8pc since mid-year) and by signalling that they may soon shut the lending window that keeps Greek, Irish and Iberian banks alive.

Frankfurt is doing this even though the eurozone’s M3 money supply contracted on a month-to-month basis in both September and October, as did private credit. Is this just incompetence, or is somebody pushing PIGS into the slaughterhouse?

As for Britain’s offer in 1940, it is hard to see how such a union could ever have worked over time. It was rejected by the French cabinet, though premier Paul Reynaud pleaded in favour. One Gallic patriot said that utter destruction was better than becoming a "dominion of the British Empire". By the same token, today’s eurozone patriots might ask whether it is really worth giving up ancient sovereignty to keep a currency.

They Are Not Like Ireland. Really.
by Landon Thomas Jr. - New York Times

Last week Ireland joined Greece as the second country in the euro zone to get a bailout — to the grand sum of $100 billion. Now, attention has turned to other economies in the 16-member monetary union that are also burdened with high levels of debt, stagnant growth and rigid, overpriced labor markets. At the top of the list are Portugal and Spain.

To quell the anxiety and speculation, Europe’s leaders and its top thinkers have argued for the better part of this year that other countries would not follow in Greece and Ireland’s path. Given their past statements, however, they may not sound all that convincing.
  • "Italy is absolutely not in the same situation as Greece."
    Jean-Claude Trichet, head of the European Central Bank, April 9

  • "What the Portuguese government wants the world to know is simpler: Portugal is not Greece."
    The Economist magazine, April 22

  • "Portugal, Spain, Ireland or Italy are not in the same situation as Greece. And Belgium less yet."
    Guy Quaden, governor of the National Bank of Belgium, May 7

  • " ‘ Ireland is no Greece’ confirms latest economic forecast."
    Ernst and Young, in its Economic Eye Summer Forecast, June 2010

  • "Greece is not Ireland; it doesn’t have banking stability problems."
    George Papaconstantinou, finance minister of Greece, Nov. 8

  • "Our economy is very different from that of Greece or Ireland because our financial sector has benefited by the supervision and regulation of the Bank of Spain, which was missing in Ireland."
    Elena Salgado, the Spanish finance minister in an interview in the British newspaper The Independent, Nov. 25

  • Bank failures in Ireland had "nothing to do with Portugal."
    Ángel Gurría, secretary general of the Organization for Economic Cooperation and Development, in Bloomberg News, Nov. 22

  • "Portugal does not need any help, it is in a very different situation to Ireland."
    Herman Van Rompuy, the president of the European Council, Nov. 23

  • "Zapatero ‘gets it’ and Spain is taking its medicine pre-emptively. Certainly, Spain faces serious economic growth and labor market challenges as it works its way through a devastating real estate collapse in the coming quarters. But it has neither the debt stock of Greece, the bust banks of Ireland or the complacent government of Portugal."
    Jacob Funk Kirkegaard, research fellow at the Peterson Institute of International Economics in a CNBC guest blog post, Nov. 24

Roubini tells Portugal to seek bailout as markets slide
by Telegraph

Nouriel Roubini, the US economist, said Portugal should consider asking for a bailout before its financial plight worsens as the euro fell after the €85bn Ireland bailout failed to ease eurozone debt fears.

Mr Roubini, the economist who predicted the financial crisis, told daily paper Diario Economico it is "increasingly likely" Portugal will require international assistance. He said the country is approaching "a critical point" due to it high debt load and weak growth and there were ample funds to shore up Portugal, one of the eurozone's smaller countries which contributes less than 2pc to the 16-nation bloc's gross domestic product. However, he said neighboring Spain, Europe's fourth-largest economy, is "too big to bail out."

The euro, which rose about $1.33 on news of the Ireland deal after trading at $1.3181 in Asian trade - its lowest level since September 21, fell back below $1.32 in morning trading in Europe. "The impact on the euro was stark," said Mitul Kotecha of Credit Agricole, with the single currency "failing to hold its initial rally following the announcement".

The cost of insuring debt in Portugal, Spain, and Ireland continued to rise, while the cost of borrowing for the two southern Mediterranean nations also increased. Equity markets also fell across Europe, with Spain's Ibex index down more than 1pc. "The one to really watch is Spain, as the eurozone's fourth largest economy, bigger than Greece, Ireland and Portugal put together," said Nicholas Smith, director of equity research at MF Global in Tokyo. "The question is whether the Union has the capital firepower to rescue Spain in the way it has for Greece and Ireland."

Greece was the first recipient of a major EU-IMF bailout earlier this year. European Union finance ministers sealed the €85bn rescue deal for Ireland late on Sunday. Ireland's crippled banks, having invested heavily in a property boom that later collapsed, will immediately receive €10bn but will be subject to a "fundamental downsizing," the government said in Dublin.

While Irish Prime Minister Brian Cowen insisted he had got "the best deal available" for Ireland and its people, Irish press comment was scathing. "Sold down the swanny," headlined the Irish Daily Mail, adding in an editorial comment: "We are falling without a safety net. "They demand the emptying out of the national piggy bank, the only substantial money we had left. We have sold our birthright for a mess of pottage."

The Irish government has has agreed to contribute €17.5bn to the loan facility and will raid its National Pension Reserve Fund and other domestic cash resources. The Irish Sun said the deal "sentences us all to generations of horrific debt" and condemned the 5.8pc average annual interest rate on the loans as "fairly punitive." "It is pure fantasy to think the Irish people can afford to pay this bill. The taxpayer is being saddled with all the pain, while the bondholders get off scot free. It is scandal, pure scandal," it said.

The deal was nonetheless hailed by international finance officials. Bank of France governor Christian Noyer said he had "no doubt" that the initiative would be successful, while IMF chief Dominique Strauss-Kahn said he had no doubt Ireland would honor its end of the bargain. Non-euro countries Britain, Denmark and Sweden will provide bilateral loans totalling around €5bn. As part of the deal, Ireland was given an extra year, until 2015, to bring its 2010 deficit of 32pc of gross domestic product back within the permitted 3pc.

Ireland's coalition government unveiled a four-year plan last week that signalled spending cuts worth 10 billion euros and tax rises worth five billion euros, triggering the mass protests at the weekend. Cowen said he expected Ireland to pay an average interest rate of 5.8 percent a year on the loans, subject to market conditions. "Without these loans the necessary tax increases and spending cuts would be far more severe," Cowen insisted.

The EU ministers also drew up rules for future rescues that, under stringent IMF terms, would hit private investors who buy government bonds. They agreed that the private sector would share the burden in future bailouts after an existing eurozone emergency fund worth €440bn expires in 2013. "Rules will be adapted to provide for a case-by-case participation of private sector creditors, fully consistent with IMF policies," said a statement.

Debt crisis escalates in Europe; fears grow about Spain
by Anthony Faiola - Washington Post

The debt crisis in Europe escalated sharply Friday as investors dumped Spanish and Portuguese bonds in panicked selling, substantially heightening the prospect that one or both countries may need to join troubled Ireland and Greece in soliciting international bailouts.

The draining confidence in Western Europe's weakest economies threatened to upend bond markets, destabilize the euro and drag out the global economic recovery if it is not quickly contained. It also underscored the mounting problems facing countries that during the past decade have both over-borrowed and overspent, and are now in danger of losing investor faith in their ability to make good on their massive piles of debt.

The perceived risk of debt defaults in Portugal and Spain drove their borrowing costs to near-record highs Friday, with the interest rate demanded on Portuguese bonds at a point where it could effectively cut the Lisbon government off from raising fresh cash to run the country. As a result, Portugal was coming under pressure to immediately request a bailout from the European Union and International Monetary Fund. Officials in Lisbon responded by pushing through a painful round of budget cuts meant to reassure investors and rejected claims that they needed an emergency lifeline. Italian and Belgian borrowing costs also rose Friday.

The bigger fears, however, surrounded eroding confidence in Spain, whose faltering economy is more than twice the size of the Greek, Irish and Portuguese economies combined - meaning that a bailout there could run into the hundreds of billions of dollars. Coupled with the pending bailout for Ireland and possibly Portugal, analysts said, a Spanish rescue could severely deplete the $1 trillion stability fund set up by the E.U. and IMF this year to contain the crisis. That could complicate the E.U.'s ability to mount a defense if another member nation were to need assistance.

At the same time, it remained unclear whether the stronger members of the 16 euro countries - particularly Germany, the region's economic powerhouse - are willing to dig deeper into their pockets to help shore up their troubled neighbors. German officials were sending mixed signals. Axel Weber, president of Germany's central bank, suggested Thursday that the stability fund could be beefed up if needed. But on Friday, other German officials balked at the notion. Investors have also been rattled by a German proposal to have bond holders around the world - who have thus far effectively been guaranteed against losses - absorb some of the financial pain for future bailouts.

"There is neither a reason to consider [more funds] now, nor have there been any efforts by the European Union or by other parties to discuss this issue with the federal government," Steffen Seibert, spokesman for German Chancellor Angela Merkel, told reporters in Berlin. "This is a non-issue at the moment." Depending on the severity of the crisis, the fallout for the United States could be relatively limited. U.S. banks hold about $133 billion in debt from Ireland, Spain, Portugal and Greece, only slightly more than banks in tiny Belgium. By comparison, German banks are liable for $515 billion, and French banks for about $400 billion.

A greater danger is that a full-blown debt crisis in Europe could put new pressure on the region's banks, tightening credit and potentially slowing growth in one of the world's largest economic engines. It could also send the euro plunging against the dollar, making the greenback stronger on world markets and undermining the efforts of the Obama administration to boost U.S. exports overseas. "For now, the U.S. is kind of insulated," said Simon White, a partner at the London-based research firm Variant Perception. But whether it stays that way, he said, "depends on how deep the crisis goes."

Some analysts said investors might be overreacting to the risk in Spain. Spain's budget deficit is slightly less than those of the United States and Britain relative to the size of its economy. Overall Spanish government debt is below the European average, and Madrid has made surprising progress in cutting spending this year.

On Friday, Spain's Prime Minister Jose Luis Rodriguez Zapatero blamed speculators for the deepening crisis there. Predatory investors, he suggested, were placing financial bets against the country's ability to service its debt, causing an unwarranted market panic. However, the Bank of Spain asked lenders to publish more details of their exposure to the nation's hard-hit real estate market in an attempt to calm markets.

"I should warn those investors who are short-selling Spain that they are going to be wrong," Zapatero said in an interview on Spanish radio. He added that there was "absolutely" no possibility that the government would request a bailout. Later Friday, bonds from Spain and Portugal recovered slightly, but investors were still demanding significantly higher interest rates than those for debt issued by more stable countries, such as Germany.

Yet unlike in Portugal, where fears center on the country's ability to rein in runaway public spending, the crux of concern in Spain is that nation's huge banking sector. Like Ireland, which asked for an emergency bailout last Sunday, Spain is suffering from a real estate bust - and uncertainty about just how much that has damaged its banks' balance sheets. Any full-blown financial crisis would require massive new funds from the cash-strapped government to shore up the banks.

Though the financial system in Spain is still considered relatively sound, the shocking swiftness of the deterioration in Dublin's situation - with snowballing bad loans and a run on the banks in recent weeks - has spooked investors about a replay in Madrid. "What caught investors by surprise in Ireland was the speed with which pressures built up in the Irish banking sector," said Julian Callow, chief European economist at Barclay's Capital in London. "That now has forced investors to focus on the common elements" with Spain.

EU rescue costs start to threaten Germany itself
by Ambrose Evans-Pritchard - Telegraph

The escalating debt crisis on the eurozone periphery is starting to contaminate the creditworthiness of Germany and the core states of monetary union. Credit default swaps (CDS) measuring risk on German, French and Dutch bonds have surged over recent days, rising significantly above the levels of non-EMU states in Scandinavia.

"Germany cannot keep paying for bail-outs without going bankrupt itself," said Professor Wilhelm Hankel, of Frankfurt University. "This is frightening people. You cannot find a bank safe deposit box in Germany because every single one has already been taken and stuffed with gold and silver. It is like an underground Switzerland within our borders. People have terrible memories of 1948 and 1923 when they lost their savings."

The refrain was picked up this week by German finance minister Wolfgang Schäuble. "We're not swimming in money, we're drowning in debts," he told the Bundestag. While Germany's public and private debt is not extreme, it is very high for a country on the cusp of an acute ageing crisis. Adjusted for demographics, Germany is already one of the most indebted nations in the world.

Reports that EU officials are hatching plans to double the size of EU's €440bn (£373bn) rescue mechanism have inevitably caused outrage in Germany. Brussels has denied the claims, but the story has refused to die precisely because markets know the European Financial Stability Facility (EFSF) cannot cope with the all too possible event of a triple bail-out for Ireland, Portugal and Spain.

EU leaders hoped this moment would never come when they launched their "shock and awe" fund last May. The pledge alone was supposed to be enough. But EU proposals in late October for creditor "haircuts" have set off capital flight, or a "buyers' strike" in the words of Klaus Regling, head of the EFSF. Those at the coal-face of the bond markets are certain Portugal will need a rescue. Spain is in danger as yields on 10-year bonds punch to a post-EMU record of 5.2pc.

Axel Weber, Bundesbank chief, seemed to concede this week that Portugal and Spain would need bail-outs when he said that EMU governments may have to put up more money to bolster the fund. "€750bn should be enough. If not, we could increase it. The governments will do what is necessary," he said.

Whether governments will, in fact, write a fresh cheque is open to question. Chancellor Angela Merkel would risk popular fury if she had to raise fresh funds for eurozone debtors at a time of welfare cuts in Germany. She faces a string of regional elections where her Christian Democrats are struggling. Mr Weber rowed back on Thursday saying that a "worst-case scenario" of triple bail-outs would require a €140bn top-up for the fund. This assurance is unlikely to soothe investors already wondering how Italy could avoid contagion in such circumstances.

"Italy is in a lot of pain," said Stefano di Domizio, from Lombard Street Research. "Bond yields have been going up 10 basis points a day and spreads are now the highest since the launch of EMU. We're talking about €2 trillion of debt so Rome has to tap the market often, and that is the problem."

The great question is at what point Germany concludes that it cannot bear the mounting burden any longer. "I am worried that Germany's authorities are slowly losing sight of the European common good," said Jean-Claude Juncker, chair of Eurogroup finance ministers. Europe's fate may be decided soon by the German constitutional court as it rules on a clutch of cases challenging the legality of the Greek bail-out, the EFSF machinery, and ECB bond purchases.

"There has been a clear violation of the law and no judge can ignore that," said Prof Hankel, a co-author of one of the complaints. "I am convinced the court will forbid future payments." If he is right – we may learn in February – the EU debt crisis will take a dramatic new turn.

Europe Debt Fears Hit More Secure Countries
by Landon Thomas Jr.- New York Times

Fears among European bondholders spread Tuesday from the weakest members of the euro zone to other countries, including Italy and Belgium, spurring a stepped-up search for a solution to a crisis that is increasingly putting political as well as financial strain on Europe’s decade-old monetary union.

Reflecting those worries, the euro slipped to $1.3008 at midafternoon in the United States from $1.3125 late Monday. As recently as Nov. 5, the euro traded above $1.40.
Despite the commitment of 200 billion euros, or $260 billion, in bailout funds to Europe’s two most stricken nations — Greece and Ireland — institutional investors were unimpressed with the rescue effort this weekend of Ireland and continued to sell bond holdings in the weaker euro-zone economies.

But what is worse for the European Union and an increasingly stretched International Monetary Fund is that investors have begun to disgorge some of their positions in Belgium, Italy and even Germany. Even as the yields on the 10-year bonds of Greece, Ireland, Portugal and Spain ended trading Tuesday off their highs for the day, attention in Brussels turned to the rise on Italian sovereign debt to 4.64 percent, of Belgian bonds to 3.97 percent and the recent increase of German bonds, the European benchmark, which at 2.67 percent were down from Monday but well above the 2.1 percent of last summer. Rising yields reflect increased risk in the eyes of investors as well as inflationary expectations.

Not that anyone expects Germany, by far Europe’s most powerful economy, to come close to defaulting on its debt. And neither Italy nor Belgium is considered in the same boat as Greece, Ireland and Portugal, since their deficits are lower and they borrow primarily from domestic lenders. Instead, the fear is that Europe’s strategy so far — painfully drawn out step-by-step bailouts of Greece and Ireland — has failed to impress the markets and that the burden to finance even larger rescues for Spain and perhaps even Italy would be too much for Germany to bear, both financially and politically.

Some proposals, like a new European bond with fiscal conditions or the establishment of a European version of the International Monetary Fund, are considered more grandiose at the moment than practical. But others, especially those that come with a call for bondholders to share in the pain, are being examined in a new light, even though investors remain adamantly opposed to any such measures, while Europe’s debt-ridden economies are wary of any form of negotiated default.

One of the latest suggestions from outside specialists is for indebted European countries to consider something modeled on the so-called Brady plan that dealt with Latin American debtors in the 1980s and early 1990s. That could require bondholders to accept a write-down in exchange for a new, more liquid debt instrument. Others have suggested a so-called Abu Dhabi option under which the European Commission and the I.M.F. would promise rescue funds as long as private sector creditors shared the pain, in an echo of Abu Dhabi’s bailout of its fellow emirate Dubai late last year. But all such plans are difficult to consider in the current atmosphere.

The recent bond market attacks on Ireland and other weak European debtors set off as soon as the German chancellor, Angela Merkel, broached the idea of requiring bondholders to take a share of the loss. They gathered speed this week when it became clear that Ireland, as well as Greece, would have to pay a still-steep 5.87 percent interest rate on their loans — a tacit acknowledgement on Europe’s part, analysts say, that even with its bailout package Ireland remains a significant default risk.

"We have created more doubts than existed before," said Paul De Grauwe, an economist in Brussels who advises the president of the European Commission, José Manuel Barroso. "The interest rate now being charged for Ireland is a vote of no confidence for the package and it has obviously been inspired by a notion that we should punish our sinners. If we don’t succeed in containing this thing it could lead to a disaster in terms of the euro’s survival."

Mr. De Grauwe, unlike many economists who shout loudly of the euro’s inevitable demise, is no alarmist. He has been a longtime supporter of the European project, giving his views extra weight. He recently wrote a research paper that has drawn attention from investors, academics and officials in Brussels and London. In it, Mr. De Grauwe compares the current cycle of soaring bond yields among European economies to the series of competitive devaluations that led to the collapse in the early 1990s of the European Exchange Rate Mechanism, the precursor to today’s monetary union that binds the 16 nations in the euro zone.

Then it was investors betting on devaluations, most famously the one that led to the collapse of the British pound in 1992. Now, Mr. De Grauwe predicts, it will be bond investors zeroing in on the Europe’s weakest economies that, via a punishing cycle of soaring bond yields, could well lead the euro zone to implode — just as its precursor did — as one country after the next defaults on its rising debts.

Mr. De Grauwe proposes transforming Europe’s rescue facility into a European equivalent of the I.M.F., but other specialists say that Europe is not prepared to undertake the long and political challenging treaty revisions that would be required to bring it to life. Still others acknowledge that some form of restructuring is crucial.

Daniel Gros, the head of the Center for European Policy Studies in Brussels, said that just as investors of Dubai World were required to share the pain in return for a rescue by Abu Dhabi, so should bondholders in Irish banks. "It was not easy, but in the end all the creditors accepted it," Mr. Gros said.

Another idea that has gained some ground recently is a Brady plan for indebted European economies. The plan was recently put forward by a former Treasury secretary, Nicholas F. Brady, who led an effort in 1989 to help Mexico and other Latin American economies restructure their debt — requiring bondholders to take a loss of 30 percent in exchange for new, longer dated debt instruments that had lower rates and were backed by 30-year United States zero-coupon bonds. Much criticized at the time, the plan is now seen as the first step of Latin America’s recovery.

Mr. Brady presented the idea at an exclusive gathering of international financiers earlier this year that included the president of the European Central Bank, Jean-Claude Trichet. Mr. Brady does not pretend to be an expert on Europe, but he does recall from experience that for any such plan to gain acceptance, unified leadership is crucial. While Mrs. Merkel has offered her own ideas, they have run into a storm of criticism from other European leaders, including Mr. Trichet.

"The key was getting banks to write down their debt and accept a new security," Mr. Brady said during an interview. "Why don’t people get to work and get something done?"

Boom in Debt Buying Fuels Another Boom—in Lawsuits
by Jessica Silver-Greenberg - Wall Street Journal

Glynis Martin, a 56-year-old New York social worker, started struggling to keep up with her credit-card bills about five years ago as the mortgage on her Bronx apartment ate up most of her paycheck. Pretty soon debt-collection calls became routine for her, and in January, Midland Funding LLC sued Ms. Martin in Bronx County Civil Court for $4,524.84. "I just couldn't make ends meet and pay off those cards," she says. "I would have paid them what I could. It seems like they just went straight to court."

The strategy worked: Midland won a default judgment against her for $5,957.46 after Ms. Martin didn't show up for the first court date. She is paying $60 a month. On the same day the company sued Ms. Martin, it filed 109 other cases to recover delinquent debt in Bronx County Civil Court, part of the 4,279 cases filed there since the start of this year.

The average amount of money Midland sued to collect on one day was $2,069. None of the borrowers sued that day had lawyers, and only 10% showed up in court at all. Across the nation, there is a surge in lawsuits against people who aren't paying their bills, driven by the debt-buying industry that has boomed in the past three years as a sea of souring loans and credit-card obligations have become cheaper and cheaper to buy amid hard economic times.

Handing debt over to collectors is an important step in cleaning up the financial system, but the explosion in lawsuits—many for small sums—creates problems for the legal system. "There exists a real danger that the courts will be perceived as mere extensions of collection agencies," says Thomas Donnelly, an associate judge in Cook County, Ill. There are no nationwide figures available, but a survey of 20 judges across the nation by The Wall Street Journal yielded anecdotes of court calendars choked with debt-collection suits. For example, Judge Donnelly says he has heard as many as 400 cases a day, filed by debt buyers, debt collectors and their attorneys who have often lugged their filings to his courtroom in crates.

Midland, the company that sued Ms. Martin, is a unit of San Diego-based Encore Capital Group Inc., which buys distressed debt—loans on which borrowers have stopped making payments—for a few pennies on the dollar and often sues to collect. Encore says it filed 245,000 lawsuits last year, and nearly half its $487.8 million in gross collections came from legal actions. That is down from the 474,000 suits it filed in 2008, when the financial crisis created an explosion in bad debt. But Encore expects the number of lawsuits to climb this year because of the sluggish economy.

J. Brandon Black, chief executive of Encore, says suing is the only way his company can recover money in many collection cases. "We always prefer to speak with our consumers directly and work with them to create an arrangement that retires their account," he says. "Unfortunately, we rarely have the chance." Only 6% of Encore customers respond to a letter, and only 18% respond to a phone call, he adds.

In the 1990s and early 2000s, U.S. consumers went on a colossal spending binge, fueled by easy credit. Total debt outstanding on credit cards rose to $1.9 trillion in 2007 from $475 billion in 1993. When the economy began contracting three years ago, millions of Americans stopped making their loan payments. Lenders have written off $3.2 trillion in consumer debt of all type since September 2007, according to Mark Zandi, chief economist of Moody's Analytics. That tally includes home mortgages, auto loans and student loans in addition to credit-card debt.

More than 450 debt buyers scooped up an estimated $100 billion in distressed loans last year, according to the latest estimates by Kaulkin Ginsburg, a debt-collection industry adviser. Debt collectors used to harry nonpaying borrowers for months with letters and phone calls. But those tactics are less effective now that many more borrowers are deeply in debt. So the new breed of debt collectors turns much more quickly to court to squeeze money out of distressed paper.

Michelle Smith Scott, a small-claims court judge in Indianapolis who handles disputes of less than $6,000, imposed in October of last year a limit of 500 new debt-collection cases every two weeks on law firm Bowman, Heintz, Boscia & Vician, based in Merrillville, Ind. Roughly 60% of the law firm's business comes from debt buyers, including Encore, according to a partner at the law firm.

Just like the current flap over foreclosures, debt buyers have run into trouble with judges in several states for taking shortcuts with papers filed in collection cases. "Everyone is hysterical about the robo-signing" by a mortgage-company worker who testified that he signed foreclosure documents without reviewing details of each case, says Ira Rheingold, president of the National Association of Consumer Advocates. "What's overlooked is that…the scale in collection cases far exceeds what we're focused on now."

In some instances, the debt buyers' aggressive pursuit of debt may skirt state or federal laws limiting collectors. A patchwork of federal and state laws governs debt collection and litigation. On the national level, the Fair Debt Collection Practices Act limits how collectors pursue delinquent borrowers. Once debt buyers sue to retrieve debt, they are subject to state laws that impose a statute of limitations, often between five and seven years after the borrower stops making loan payments.

In 2007, CACV, a unit of debt collector SquareTwo Financial Corp., sued Timothy McCollough in state court in Montana to recover $3,800 on a credit card from J.P. Morgan Chase & Co., and another $5,500 in interest, collection costs and $480 in lawyer's fees. Mr. McCollough wrote to the court in March 2008, explaining that he had been living on Social Security income since suffering a head injury in 1990. He says that he hadn't made any payments or used the credit card for more than eight years, putting his account beyond the state's statute of limitations for debt collection. He asked the court to dismiss the suit, saying: "This is the third time they have brought me to court on this account. Do I have to sue them so I can live quietly in pain?"

In April 2009, a judge awarded damages of $310,000 plus $108,000 in legal fees and costs to Mr. McCollough. "CACV relies on its local attorneys to determine" whether debts exceed the statute of limitations, says Manuel Newburger, an outside counsel for CACV. "In this case it was brought to our attention that the case had not been handled in accordance with CACV's policies, and my client did the right thing by settling promptly with Mr. McCollough."

The big explosion in lawsuits is coming not from lenders but from firms who buy debt. The four largest publicly traded debt buyers—Encore, Asta Funding Inc., Asset Acceptance Capital Corp. and Portfolio Recovery Associates Inc.—purchased $19.6 billion in distressed debt last year. They typically recover three times what they spend buying debt, according to the Association of Credit and Collection Professionals, a trade group.

If the economy bounces back next year, profits at Encore and other debt buyers are likely to rise as collections improve, analysts say. "There's still a lot of distressed paper for sale, their collections are good and should only get better, so I'm expecting 2011 and beyond to be a good time for them," says Mark Hughes, an analyst with SunTrust Robinson Humphrey.

Wall Street has taken notice. J.C. Flowers & Co. LLC, the private-equity firm, has a 24% stake in Encore. BlackRock Inc. owns 6.9% of Portfolio Recovery Associates, a Norfolk, Va., company. In October, the company reported its highest quarterly revenue ever.

In 2006, One Equity Partners, the private-equity arm of J.P. Morgan Chase, purchased Pennsylvania-based NCO Group, which posted $1.56 billion in revenue last year, making it the largest debt-collection company. But J.P. Morgan is winding down the debt-buying side and will focus on debt collection, says Brian Callahan, a spokesman with the company.
Normally, a surge in buyers would push up prices of distressed debt, making the collections business less profitable.

But because of the financial crisis, the amount of distressed debt has surged, and the very opposite happened. Prices for fresh chargeoffs—loans that are sold after the lender gives up on collecting on them—shrank to 4% to 8% of face value in 2009 from 8% to 13% of face value in 2008. So far this year, pricing of distressed debt has begun to increase slightly, although it remains well below pre-crisis levels, according to Encore.

The savings-and-loan crisis gave birth to the modern debt-buying industry. Lawmakers established the Resolution Trust Corp. to shutter failed thrifts and auction other assets to buyers. By the mid-1990s, the RTC sold more than $450 billion in these assets. Over time, some buyers of such assets shifted to a new source of profit: charged-off credit-card debt and other consumer debt.

Encore, the largest publicly traded debt buyer by revenue, filed the most lawsuits last year. The San Diego company posted $33 million in profit last year, up 139% from 2008. While the Standard and Poor's 500-stock index rose 23.5% in 2009, Encore's stock soared 142%. Between 2007 and 2008, the company scooped up $20 billion in charged-off loans for $695.9 million. In order to wring more cash from debt, Encore increasingly has turned to the courts.

Lawsuits are filed by a network of outside law firms. Last year, Encore paid $112.6 million for legal collection, which brought in $233 million. Once Encore sues, it is virtually assured a win, says Mr. Black, the company's CEO. Roughly 94% of collection cases filed against borrowers result in default judgments in favor of the debt buyer, according to industry estimates. The majority of borrowers don't have a lawyer, some don't know they are even being sued, and others don't appear in court, say judges.

A growing number of cases brought by debt buyers are plagued by sloppy, incomplete or even false documentation of debts, according to the 20 judges around the country interviewed by the Journal. Mistakes might arise from the way that debt flows from the lender to the debt buyers. Bulk purchases of consumer debts sometimes include just a spreadsheet listing each person's name and the amount owed. Sales agreements usually limit how much additional information the buyer may request about the original debt.

Employees in Encore's Midland subsidiary work with outside law firms to file debt-collection suits. Midland has a proprietary computer system called "You've Got Claims" that generates unsigned affidavits. In these documents, which are signed and submitted to the court, employees attest that borrowers owe the amount of debt that Midland is suing to collect.

In a deposition filed as part of a civil lawsuit against Midland, employee Ivan Jimenez testified that he signs 200 to 400 affidavits a day. The percentage of documents checked for accuracy against other records is "very few and far between," he says. "As far as what I deal with, they just come from the printer as far as where we get them." U.S. District Judge David A. Katz ruled last year that the debt-collection company violated federal and Ohio laws by trying to collect $4,516.57 in credit-card debt using a phony affidavit. The company certified that the debt was genuine "based entirely" on the printout, rather than personal knowledge of the debtor, the judge concluded.

He refused a request to throw out the lawsuit, which won class-action status. Judge Katz wouldn't comment on specifics of the case, though he says it shows that lawyers for borrowers should "be more diligent in looking to the underlying documentation" for debts being pursued by collectors. Mr. Black of Encore, Midland's parent company, says he wouldn't comment on pending litigation. However, he emphasizes that "Midland had not misstated the amount of the debt."

BlackRock's Larry Fink predicts euro will fall to $1.20
by Telegraph

The boss of the world’s largest money manager predicts that the euro, which has been hit by fears that Ireland's financial woes could spread to Portugal and Spain, will fall 10pc to $1.20 against the dollar.

Mr Fink told the Financial Times: "The fundamental problem is most European sovereign credit is owned by the banking system. The banking system was supported by the regulators’ credit ratings of sovereign credit, so you could have bought Ireland and it had the same credit rating as Germany at one time ... that policy was clearly wrong."

On the huge amounts of government debt that European banks now hold, he added: "You have something that was freely understood and traded and people invested in it, to something that nobody wants." The crisis has led to euro-era highs in the cost of borrowing for Ireland, Spain and Portugal. And despite the US restarting QE, the dollar - which touched a nine-week high of $1.3199 against the euro on Friday - will "appreciate considerably", Mr Fink believes.

"The euro is probably going to go back down to $1.25 or $1.20 even with the Federal Reserve’s QE2 action ... so imagine if they [the Fed] weren’t doing this where dollar/euro would be," he added.

492 Days From Default to Foreclosure
by Mark Whitehouse- Wall Street Journal

492: The number of days since the average borrower in foreclosure last made a mortgage payment.

Banks can’t foreclose fast enough to keep up with all the people defaulting on their mortgage loans. That’s a problem, because it could make stiffing the bank even more attractive to struggling borrowers.
In recent months, the number of borrowers entering severe delinquency — meaning they missed their third monthly mortgage payment — has been on the decline, falling to about 700,000 in October, according to mortgage-data provider LPS Applied Analytics. But it’s still more than double the number of foreclosure processes started.

As a result, banks are taking progressively longer to foreclose. The average borrower in the foreclosure process hadn’t made a payment in 492 days as of the end of October, according to LPS. That compares to 382 days a year ago and a low of 244 days in August 2007.

In other words, people who default on their mortgages can reasonably expect, on average, to stay in their homes rent-free more than 16 months. In some states such as New York and Florida, the number is closer to 20 months.

That’s a meaningful incentive, and it’s likely to grow unless banks manage to boost their throughput. Speeding up the process won’t be easy, as demonstrated by the banks’ continuing legal troubles related to robo-signers, bank employees who signed foreclosure affidavits without properly checking the required loan documentation.

Millions of Americans still are paying their mortgages even though they owe more than their homes are worth. The more banks’ backlog grows, the more likely they are to join it, adding to the already giant pile of foreclosures weighing on the housing market

Taibbi Blames Greenspan: "The Biggest (Blank) in the Universe"
by by Aaron Task - Tech Ticker

In All the Devils Are Here, co-authors Joe Nocera and Bethany McLean, say the answer to the "who's to blame for the crisis?" question is everybody, as the title of the book implies. That's poppycock, according to Rolling Stone contributor Matt Taibbi, who'd probably use an unprintable expletive rather than "poppycock."

In his new book, Griftopia: Bubble Machines, Vampire Squids, and the Long Con That Is Breaking America, Taibbi lays the blame for the financial crisis largely at the feet of one man: Alan Greenspan. "He had this specific role as the Fed chief and created this psychological condition on the Street where everybody knew that every time they screwed up...he would come to their rescue," Taibbi says. "Daddy would bail everybody out with all this cheap money."

Commonly known as "the Greenspan Put," the belief system is a very specific form of moral hazard that came to dominate the financial landscape during Greenspan's tenure as Fed chairman. Beginning with the market's crash in October 1987 shortly after he became chairman, Greenspan faced a series of increasingly large financial crises - Orange County, Ca. and the Mexican pesos crisis in 1994, the 1997 ‘Asian Flu', the Russian debt default and implosion of Long Term Capital Management in 1998, the bursting of the dot.com bubble in 2000, the 9/11 terror attacks in 2001 and the beginning of the end of the housing/subprime bubble at the end of his tenure in 2006.

In almost every case his "solution" was to flood the system with money and bail out the speculators. Adding insult to injury, Taibbi notes, Greenspan professed to be a devotee of Ayn Rand's philosophy of objectivism, which abhors state involvement or interference in almost any aspect of society, most certainly the markets.

Greenspan pushed for Rand-style deregulation such as the repeal of Glass-Steagall, which helped give us the "too big to fail" banks, and opposed efforts to regulate derivatives, predatory mortgage lending and...just about anything else. "He represented this kind of contradiction," Taibbi says. "On the one hand, it's this 'arch-capitalist, government has no role anywhere, hands off everything' ideology and at the same time he was building this welfare state" for Wall Street.

For these reasons -- and his subsequent refusal to take any real responsibility for his actions -- Greenspan deserves outsized blame for the financial crisis and its aftermath, says Taibbi, who calls the former chairman the "the biggest [blank] in the universe" in his decidedly un-PC and highly entertaining new book.

Here's The Real Problem For The Stock Market
by Henry Blodget - Business Insider

Despite the recent pullback in the stock market, most people are still bullish.

The economy's finally recovering, they note. Jobless claims are finally improving, corporate profits are at record highs, and bond yields are so appallingly low that investors are almost forced into the market.And all that is true.

But unless "it's different this time" (the four most expensive words in the English language), stock returns over the next decade are likely to be far worse than average.

Why? Valuation.

Stocks appear reasonably valued when viewed against today's super-high profit margins. But in the past, every time profit margins have gotten so high (and they've only gotten this high once before), profit margins have reverted to the mean, taking stocks down with them.

Here's a chart from Northern Trust's Paul Kasriel. It shows corporate after-tax profit margins as a percent of GDP (with inventory adjustments) for the past half-century.

Corporate Profits

Image: Northern Trust

Note that only 5 times in the past 60 years have corporate profit margins approached the levels they're at today. And note what happened each time thereafter. (They regressed to--or beyond--the mean.)

When corporate profit margins are expanding, profits grow faster than revenue, and stock multiples usually expand (stocks track profits over the long haul).

When corporate profit margins are shrinking, profits grow more slowly than revenue, and stock multiples usually contract.

The most optimistic forecasts for GDP for the next several years (a proxy for corporate revenue) call for growth of 3%-4% per year.

If profit margins stay at today's high levels, this would mean earnings growth of about 3%-4% per year, which is below normal.

If profit margins begin to revert to the mean, meanwhile, profit growth will be even slower.

Yes, there is always a possibility that we're in a "new normal" in which profit margins will keep expanding for years, if not forever. (Well, okay, not forever. Even the biggest bull would be forced to agree that, at some point, profit margins have to stop expanding, or profits will get bigger than revenue.)

Based on the history of the past 60 years, however, this seems unlikely. At several points in the past 60 years, it looked like profit margins had hit a new normal, only to see them collapse to the mean. And the odds are that the same thing will happen this time.

What could bring profit margins down?

Any of a number of things:

  • Increasing commodity prices, which companies might not be able to pass through to end users

  • Higher taxes, as federal and local governments try to balance their budgets

  • Higher labor costs, as weak-dollar policies raise the cost of foreign manufacturing

  • Deflation, as companies are forced to compete by cutting prices because consumer demand remains weak

  • Recession. No one's talking about a double-dip now, but that doesn't mean we won't eventually get one. And have a look at what corporate profit margins have done in past recessions.

If corporate profit margins stay at today's high level for the next several years, the only way the stock market will deliver strong returns is if the market's P/E ratio expands. Again, it's possible that the PE ratio will do this, but as the chart below from Professor Robert Shiller shows, the PE ratio is already high.

Specifically, on cyclically adjusted earnings (more on this here), today's PE ratio is about 22X, versus a long-term average of 16X.

Robert Shiller CAPE

Blue line = cyclically adjusted PE; Red line = interest rates
Image: Robert Shiller

It's possible that the market's PE will stay elevated (or get even more elevated).  But it's more likely that the PE ratio will also regress to the mean.

In today's market, in other words, we have both extremely high profit margins and abnormally high PE ratios. In all previous history, both measures have tended to regress to--and beyond--the mean. So does this mean you should jettison your stocks? No.

Neither of these measures are useful for predicting what the market will do over the short- and intermediate-term (days, weeks, months, and even years). Over the long-term, however, they've shown a strong predictive ability.

So the combination of high profit margins and high PEs suggests that you should ratchet down your expectations for stock returns to well below the 10% long-term average.

And it also means that you should ask every bull to explain to you 1) why profit margins will keep expanding even though they're already near record highs, and 2) why PEs will keep expanding even though they're well above normal.

Whatever the bulls' answer is, be skeptical. Because what they're really saying is "it's different this time."

UK house prices fall sharply in October
by Norma Cohen - Financial Times

British house prices in October registered their biggest one-month drop since February 2009, according to an official index, which noted widespread price declines, falling in eight of 10 regions. The UK Land Registry House Price Index, which tends to lag trends flagged up by indices created by lenders, fell by 0.8 per cent in October, the second consecutive monthly decline after a 0.2 per cent drop in September. Year-on-year, prices are 3.4 per cent above 2009 levels.

Official Land Registry data track the declines in house prices that have been showing up for months in lenders’ indices and other private sector surveys. Uncertainty about employment prospects ahead of public sector job cuts and limited access to mortgage finance, particularly for first-time buyers, are weighing on demand for new homes, economists have said. The East of England and London were the only two regions to show firmer prices, rising by 1.0 and 0.3 per cent respectively. Yorkshire and Humberside showed the biggest one-month decline, with average prices falling by 1.8 per cent.

Among London boroughs, price movements varied widely, showing a four percentage point swing between the best and worst performing areas. While prices rose by 2.0 per cent in Camden, they fell by 1.8 per cent in Barking and Dagenham. Sales volumes, after hitting a high in July at 65,825, fell back in August to 58,783, the latest available figures. The drop in volumes is most acute among lower-priced properties, which are favoured by first-time buyers. The drop was sharpest among properties in the £100,001-£150,000 range where sales dropped 12 per cent from 2009 levels.

Alarm over U.S. debt creates 'window' for tough choices
by Richard Wolf, USA TODAY

If Americans aren't prepared for the hard choices needed to control the national debt, most voters here must have missed the memo. The local Republican congressman, Paul Ryan, campaigned for re-election by calling for reductions in the growth of Medicare and Social Security. He won with 68% of the vote.

Ryan's landslide in a southeastern Wisconsin district formerly held by Democrats may be a testament to the national mood when it comes to red ink, budget watchdogs and local business groups say. As President Obama and Congress turn their attention from energizing the economy to balancing the budget, even sacred items such as retirement programs will be fair game — something Ryan tells his constituents regularly. "They know that he talks straight," says Michael Kobylka, president of the Racine Area Manufacturers and Commerce, the local business coalition. "It's those third-rail issues that nobody has wanted to talk about that are part of the problem."

If the Tea Party movement that helped sweep Republicans to greater power this month is to have an impact in Washington, getting control of the national debt would be a logical place to start. A bipartisan presidential commission reports its findings Wednesday, Obama delivers his proposed 2012 budget early next year, and Congress must vote to raise the $14.3 trillion debt limit before it's breached next spring.

Cutting the deficit and debt is the preferred prescription for the economy among 39% of Americans, a USA TODAY/Gallup Poll conducted Nov. 19-21 shows. That tops other options, including raising taxes on the wealthy, cutting taxes and increasing stimulus spending. "We are in a unique, historic moment in American politics," says Pete Peterson, a former Commerce secretary under Richard Nixon who's investing millions of dollars in hopes of prodding politicians to act. Voters, he says, are saying: "Enough of the empty talk. Enough of the painless solutions at a time that clearly demands sacrifice. "I would ask both parties: Are you listening?"

For years, the debate in Washington has focused more on who's to blame than how to fix it. The Bush tax cuts, the 9/11 terrorist attacks, and the wars in Afghanistan and Iraq all contributed to rising deficits. Then came the recession, which sapped the government of tax revenue. Democrats' prescription for the recession — $814 billion in new spending — added to the deficit. The political upheaval that occurred Nov. 2 has left Obama weakened, Democrats clinging to a narrow Senate majority and Republicans firmly in control of the House, where most fiscal policy begins. Dick Armey, chairman of the conservative group FreedomWorks that has helped lead the Tea Party movement, says new GOP members will insist on dramatic spending cuts.

"This is about drawing a distinction with Obama," says Ohio Gov.-elect John Kasich, a Republican and former chairman of the House Budget Committee. "There's a window now for making changes and reducing the size and scope of government." That incentive extends to the Democrats as well. Erskine Bowles, co-chairman of the president's fiscal commission and former White House chief of staff to Bill Clinton, says "the era of deficit denial is over." "The only incentive for elected people doing this is, it has to be done," Bowles says.

'Show-me time' for Obama
Peterson's foundation and a cottage industry of groups advocating a frugal future back up their case with statistics:
  • The $13.7 trillion national debt is hurtling toward the size of the entire gross national product; it's gained nearly $1 trillion since the commission began its work in April.
  • Just the $220 billion interest on the debt equals government spending on veterans, homeland security, education and transportation combined. By 2020, annual interest on the debt could be nearing $1 trillion.
  • Baby Boomers will begin turning 65 in January. They're living longer and requiring more care, the costs of which are rising faster than inflation. Medicare's projected 75-year obligation, according to the Treasury Department: $38 trillion.

But where to make the cuts? During Obama's first two years, White House economic adviser Jason Furman notes, the president has proposed a three-year freeze on non-security spending and a law requiring Congress to keep new spending or tax cuts deficit-neutral. The health care law signed this year is projected to cut the deficit by $138 billion over the next decade.

Some leading economists argue cutting the deficit shouldn't even be a priority. For now, U.S. Treasury bonds remain a hot commodity on world markets. Lawrence Mishel of the liberal Economic Policy Institute is among those who favor more deficit-financed government stimulus to create jobs. Others say the rising debt is sure to fuel a crisis similar to those in Europe, in which rising costs of capital and hyperinflation leave the nation vulnerable. "It will be very swift and very dramatic, like in Greece or Ireland," says former Wyoming GOP senator Alan Simpson, co-chairman of the president's fiscal panel.

For Congress, target No. 1 is earmarks, the parochial programs and projects that lawmakers insert in spending bills for their states and districts. Wiping them all out, as Republicans have vowed to do this year, would save about $16 billion — less than half of 1% of the $3.8 trillion budget. On the flip side are bold proposals coming from outside government. The Bipartisan Policy Center, an independent group examining the debt, this month proposed nearly $6 trillion in savings over 10 years, with controversial ideas such as imposing a 6.5% national sales tax and capping Medicare's growth by giving beneficiaries vouchers to shop for less expensive coverage.

The leaders of Obama's fiscal commission suggested killing every tax break on the books, from the child tax credit to the mortgage interest deduction. Going after the sacrosanct home ownership tax break has failed in the past, in part because of the real estate lobby. The National Association of Realtors says losing the tax break would cut demand for home ownership, reducing home values an average of 15%.

Those proposals landed with a thud in Washington. Democratic House Speaker Nancy Pelosi called the chairmen's proposal "simply unacceptable" because of cuts to Social Security and Medicare. Republican Rep. Dave Camp, who will take over the House Ways and Means Committee next year, said, "The notion that we must raise taxes to solve our debt and deficit problems is just wrong."

The USA TODAY/Gallup Poll, however, shows most Americans are willing to consider both tax increases and benefit reductions to deal with the rising cost of entitlement programs. Nearly half favored a combination, while 30% wanted only tax increases and 19% wanted only cuts in benefits. Into the breach, leading budget watchdogs say, Obama must step. "You know, it's show-me time," says David Walker, the former head of the Government Accountability Office now leading the Comeback America Initiative, which focuses on fiscal solutions. "The president has to lead."

Future looks 'very scary'
The nation has tackled fiscal challenges before: In 1983, it extended the solvency of Social Security. In 1986, it transformed the tax code. In 1990, 1993 and 1997, it reduced deficits, helping to usher in four years of budget surpluses. What's different this time: The problem is much worse, and the nation is much more divided.

"The future looks very scary — in fact, more scary than it did in 1990 or '93 or '97," says Alice Rivlin, former head of both the White House and congressional budget offices and the only person on both the presidential and Bipartisan Policy Center panels. Her panels and others have laid down markers this month for the White House and Congress to follow. In the past, proposals such as freezing defense spending for five years, increasing Medicare copayments or raising the Social Security retirement age from 67, which it will reach in 2022, to 68 or 69 would have been political suicide. Now politicians such as Ryan are winning election in part on budget-cutting platforms.

"People are ready for an adult conversation, they're ready for the truth, they're ready for solutions no matter whether they agree on every detail or not," says Ryan, 40. His fiscal "Roadmap for America's Future" — which features dramatic changes that could boost Medicare costs and reduce Social Security benefits for Americans now under 55 — was endorsed by dozens of candidates in this year's elections. "This is no longer the third rail it was once thought to be."

Even so, the nation's capital is full of skeptics who have fought to reduce red ink for a generation. "Until you put down your sheet of paper with the items that you're going to cut on it, it's not real," says Robert Reischauer, president of the Urban Institute and former director of the Congressional Budget Office, who helped craft the 1990 and 1993 deficit-reduction deals. To help prod the politicians, groups led by the Peter G. Peterson Foundation are promoting fiscal rectitude with snappy ad campaigns. The latest TV ads from Peterson's "OweNo" campaign feature fictional presidential candidate Hugh Jidette (sounds like: huge debt), who promises more borrowing heaped on the backs of tomorrow's taxpayers.

Within hours of that campaign being unveiled Nov. 9, liberal activists fired up the opposition. Under the headline "Owe No You Don't," a coalition of labor unions and groups representing seniors, women and people with disabilities vowed to fight back. They began a petition drive on the Internet and set Tuesday as a day for people to call members of Congress urging them to protect Social Security and Medicare.

"There is a huge momentum now for those who say the deficit is the most important priority. That's a Washington momentum," says Roger Hickey, co-director of the liberal Campaign for America's Future, a member of the "Owe No You Don't" campaign. In its anti-Washington fervor, he says, "the public thought they were voting about jobs."

Mixed reviews in Racine
Jobs are needed in Racine, where the unemployment rate is 8.4%. Ditto Janesville, Ryan's hometown, where the rate is 9.5% — higher than Wisconsin's average of 7.8%, and just below the national 9.6% rate. It is a classic swing district: Democrat Les Aspin represented it for 22 years before leaving to become Bill Clinton's first Defense secretary, Obama carried it narrowly in 2008, and Ryan has swept to victory since 1998, never with less than 57% of the vote.

"Congressman Ryan has shown you can talk about entitlement reform and politically live," says native Brian Riedl, a budget expert at the conservative Heritage Foundation. Ryan's "roadmap," displayed in the window of his office here, was a hot commodity among GOP candidates this year, even though Republican leaders in Congress didn't endorse it. Several Republicans elected to the Senate, including Florida's Marco Rubio and Wisconsin's Ron Johnson, had kind words for it.

Not everyone buys Ryan's plan, least of all his Democratic opponent, John Heckenlively. The roadmap's cuts to Medicare and Social Security "was a topic that he actually preferred to avoid," Heckenlively says. Slashing Medicare and Social Security to save them isn't always popular on the streets and in the restaurants of Racine. "That just takes money out of my pocket," says Gordon Olson, 50, a disabled iron worker on Medicare, while waiting for his cheeseburger at the popular Kewpee restaurant downtown. He voted for Ryan's opponent.

As for Social Security's retirement age going to 69, as Bowles and Simpson have suggested, "When do you stop?" asks Jo Ann Hattix, 53, of Racine, associate publisher of Who's Who in Black Milwaukee, who also voted against Ryan. "Next time, you're going to hear we've got to work until we're 80." But Ryan's plan — sure to get a hearing in the House this year, since he will chair the Budget Committee — gets support from business leaders at the chamber's dinner one recent evening.

"I'd like to see more politicians talking honestly and specifically about it like Paul has," says Mark Patzke, president of Multi Products, a Racine company that produces gear motors. "If we aren't willing to make those decisions," says Thomas Mahoney, president of Johnson Bank in Racine, "we're not ready to make any tough decisions."