Thursday, May 13, 2010

Capitalism Without Capital

Volatility is back and stocks have started zigzagging wildly again. This time the catalyst is Greece, but tomorrow it could be something else. The problem is there's too much leverage in the system, and that's generating uncertainty about the true condition of the economy. For a long time, leverage wasn't an issue, because there was enough liquidity to keep things bobbing along smoothly. But that changed when Lehman Bros. filed for bankruptcy and non-bank funding began to shut down. When the so-called "shadow banking" system crashed, liquidity dried up and the markets went into a nosedive. That's why Fed Chair Ben Bernanke stepped in and provided short-term loans to under-capitalized financial institutions. Bernanke's rescue operation revived the system, but it also transferred $1.7 trillion of illiquid assets and non-performing loans onto the Fed's balance sheet. So the problem really hasn't been fixed after all; the debts have just been moved from one balance sheet to another........

Nomi Prins explains it a bit differently in this month's The American Prospect. Here's an excerpt from her article "Shadow Banking":

"Between 2002 and early 2008, roughly $1.4 trillion worth of sub-prime loans were originated by now-fallen lenders like New Century Financial. If such loans were our only problem, the theoretical solution would have involved the government subsidizing these mortgages for the maximum cost of $1.4 trillion. However, according to Thomson Reuters, nearly $14 trillion worth of complex-securitized products were created, predominantly on top of them, precisely because leveraged funds abetted every step of their production and dispersion. Thus, at the height of federal payouts in July 2009, the government had put up $17.5 trillion to support Wall Street's pyramid Ponzi system, not $1.4 trillion. The destruction in the commercial lending market could spur the next implosion." ("Shadow Banking", Nomi Prins, The American Prospect)

This is a point that bears repeating: "...nearly $14 trillion worth of complex-securitized products were created" on top of just "$1.4 trillion" of subprime loans." No doubt, the investment bankers and hedge fund managers who inflated these monster balloons, knew that they were doomed from the get-go, but then, they must have also known that "I.B.G.-Y.B.G.", which in Wall Street parlance means, "I'll Be Gone and You'll Be Gone."(Read more)

Wednesday, May 12, 2010

Today's Links

1--EU imposes wage cuts on Spanish 'Protectorate', calls for budget primacy over sovereign parliaments UK Telegraph
2--Household Debt around the world--Paul Kedrosky
3--Was the euro saved by a call from Barack Obama? UK Independent
4--Shadow Banking Meltdown-- by PIMCO's McCulley
5--Eurozone's problem children-(graphs) Big Picture
6--The case for economic gloom and doom The New Republic (Today's "must read")

Quote: "Did the housing bubble cause the recession? Yes, in the same sense that a patient suffering from lung cancer finally dies as a result of pneumonia. The bursting of the bubble precipitated the recession, but the underlying condition, which made possible the financial chicanery of the last 15 years, was the global overcapacity in tradeable goods. With American firms no longer eagerly seeking funds for expansion, the banks and shadow banks had to look elsewhere for profitable outlets. And with the economy that produces tradeable goods not producing new jobs, a government that took its responsibility for maintaining employment had to look elsewhere to stimulate demand and growth. Ergo, two bubbles, and two recessions.".....

Brenner is not saying that the U.S. economy won’t “recover” from this or future recessions. What he is saying is that we and the rest of global capitalism will continue on the gradual downward slope that began in the 1970s. We will not be able to recreate the Golden Age of capitalism that lasted from 1945 to 1970 simply by applying the right mixture of spending, subsidies, re-regulation, and international negotiation. Instead, the world economy, and the U.S. economy, will resemble the post-bubble Japan of the 1990s—with its “L-shaped” recovery writ large.......And by Brenner’s logic, there is no lasting solution to global overcapacity and falling rates of profit short of the kind of depression that shook the world in the 1930s."

7--The EU's Dangerous Game NY Times Mark Weisbrot
8--Citigroup 2006: America - A Modern Day Plutonomy
9--The Community Reinvestment Act did NOT cause the subprime Meltdown Barry Ritholtz

Today's Links

1--Robust Economy, Back to Prerecession Levels, Forces Beijing Into a Balancing Act NY Times
2--The People vs. The Bankers Michael Hudson Counterpunch
3--The Second leg of the Great Depression was caused by European defaults Washington Blog
4--More Answers on Europe’s Debt Crisis NY Times
5--Banks Must Be Barred from Dealing Derivatives: It’s NOT a Normal Part of the Business of Banking: Rortybomb
6--Europe's 750 billion euro bazooka The Economist (details of Greek bailout)
7--A Primer on the Fed’s Swap Lines With Europe Wall Street Journal
8--Europe's Web of Debt NY Times (graphic)
9--"The People of Greece Are Fighting for the Whole of Europe” Democracy Now

Quote: "We have always known that heedless self-interest was bad morals; we know now that it is bad economics. Out of the collapse of a prosperity whose builders boasted their practicality has come the conviction that in the long run economic morality pays...

We are beginning to abandon our tolerance of the abuse of power by those who betray for profit the elementary decencies of life. In this process evil things formerly accepted will not be so easily condoned..." Franklin D Roosevelt, Second Inaugural Address, January 1937


Friday, May 7, 2010

Today's Links

1--U.S. Stocks Plunge Most in 14 Months as European Crisis Spreads

2--ECB to Intervene in Bond Market to Fight Euro Crisis

3--Sex & Drugs & the Spill, Paul Krugman, New York Times

Quote: "For years, the Minerals Management Service, the arm of the Interior Department that oversees drilling in the gulf, minimized the environmental risks of drilling. It failed to require a backup shutdown system that is standard in much of the rest of the world, even though its own staff declared such a system necessary. It exempted many offshore drillers from the requirement that they file plans to deal with major oil spills. And it specifically allowed BP to drill Deepwater Horizon without a detailed environmental analysis." (Summary analysis: Blame Bush)

4--Fed Hinting on Mortgage-Bond Sales Brings Bernanke Tightening Bloomberg

5--Roach Says Debt Crisis Raises Risk of ‘Double Dip’ Recession Bloomberg

Quote: "European efforts to stave off contagion will not be enough to prevent “significant” contractions in some of the affected countries, (Stephen) Roach said. Every “fix” is accompanied by “an adjustment in the real economy,” he said.

“We saw that in Asia in the late ‘90’s, we saw that in the U.S. in ‘08, ‘09, and we’re going to see that in Europe, certainly in the peripheral countries, with significant multiyear contractions in the years ahead.” Roach said the slump will probably “spill over” into the larger European countries.

6--E.U. Details $957 Billion Rescue Package New York Times

7--Some Thoughts Joe Saluzzi Themis Trading

Quote: "Not so long ago, if our markets experienced severe stress, and certainly a “fat finger”, human wisdom would intervene. Reasons for the stress would be ascertained, trading in affected stocks would be slowed or halted, stabilizing bids would be initiated as needed, and severe volatility would be dealt with in a calm and reasoned manner. Today, the human specialist model has been replaced by an automated market maker model. Our market structure has evolved. It has evolved, not by design,
or a well-thought and reasoned plan, but it has evolved to cater to masters of expensive technology, deployed unfettered by participants whose only concern is to squeeze out every last picosecond and fractional cent before they move on to other countries’ markets and asset classes. The for-profit exchange model at every chance sacrifices the protection of long term investor interests for the profitability of serving hyper-leveraged intraday speculators." Joe Saluzzi Themis Trading


In its effort to rescue the housing market, the Obama administration has created a Frankensystem which neither allows the market to clear nor solves the intractable social problems of lost equity and foreclosure. Obama needs to step back and take a look at the mess he's made by following the advice of financial industry reps and bank lobbyists. Housing is in a shambles. The market is presently stitched together with buyer-assistance programs, loan modifications programs, new homebuyer subsidies, foreclosure abatement programs, principal reduction programs, historic low interest rates, "easy-term" financing, and government-backed loans. It's a dog's breakfast of inducements, giveaways and bandaids all designed with one purpose in mind; to keep the banks from taking a bigger hit on their garbage mortgages. To get an idea of how desperate the situation really is; take a look at this article in the Wall Street Journal:

"The U.S. government's massive share of the nation's mortgage market grew even larger during the first quarter. Government-related entities backed 96.5 per cent of all home loans during the first quarter, up from 90 per cent in 2009, according to Inside Mortgage Finance. The increase was driven by a jump in the share of loans backed by Fannie Mae and Freddie Mac, the government-owned housing-finance giants....

“The collapse of the mortgage market in 2007 steered more business to the Federal Housing Administration, which insures loans, and Fannie and Freddie, which were taken over by the government in 2008 as rising losses wiped out thin capital reserves. Congress also increased the limits on the size of loans that Fannie, Freddie and the FHA can guarantee, raising the ceiling to as high as $729,750 in high-cost housing markets such as New York and California. ("U.S. Role in Mortgage Market Grows Even Larger" Nick Timiraos, Wall Street Journal)

There is no housing market in the U.S. apart from the government. The Potemkin banking system is still on the rocks, so Fannie and Freddie have been forced to pick up the slack. But if the government is going to put up all the financing, then it should have a bigger say-so on the way things are run. The emphasis should be on helping people, not on more handouts for the banks.

The first order of business should be the launching of a National Bank that would help support the privately-owned banking system. This would ensure the availability of credit for prospective homeowners and small businesses without putting more pressure on Fannie and Freddie. The National Bank would operate as a public utility run by government employees. That would help to control salaries, eliminate the problem of bloated executive compensation and incentives, and reduce the incidents of fraud.

Naturally, the banks will oppose the move tooth and nail, so it’s up to Obama to guide the legislation through the congress. This is matter of national security. The banks now pose a threat to the material well-being of everyone in the country. They're a menace. While a National Bank won't undo the massive damage that's already been done; it will put the economy on the road to recovery by creating a reliable source of credit for any future expansion without inflating another asset bubble.

As the WSJ's report reveals, the banks don't have the capital to function as banks. So, what good are they? They're merely wards of the state. Obama should bypass this sclerotic system of corruption-plagued institutions altogether and do what needs to be done while the economy is still weak. That way, the new National Bank will be up-and-running by the time economic activity begins to pick up again.

SHADOW INVENTORY--There's a 9-year backlog of distressed homes

Here's another stunner from the Wall Street Journal. The article is titled "Number of the Week: 103 Months to Clear Housing Inventory" by Mark Whitehouse. Here's an excerpt:

"How much should we worry about a new leg down in the housing market? If the number of foreclosed homes piling up at banks is any indication, there’s ample reason for concern. As of March, banks had an inventory of about 1.1 million foreclosed homes, up 20 per cent from a year earlier....

“Another 4.8 million mortgage holders were at least 60 days behind on their payments or in the foreclosure process, meaning their homes were well on their way to the inventory pile. That “shadow inventory” was up 30 per cent from a year earlier. Based on the rate at which banks have been selling those foreclosed homes over the past few months, all that inventory, real and shadow, would take 103 months to unload. That’s nearly nine years. Of course, banks could pick up the pace of sales, but the added supply of distressed homes would weigh heavily on prices — and thus boost their losses." ("Number of the Week: 103 Months to Clear Housing Inventory" Mark Whitehouse, Wall Street Journal)

Got that? There's a 9-year backlog of distressed homes. The banks are deliberately fudging the numbers to hide how bad things really are. The number of homes in late-stage foreclosure is not 1.1 million, but nearly 6 million--- 5X more than the banks are admitting. Housing will be in the doldrums for a decade or more. It's shameful that people can't get basic information like this to help them make their investment decisions. The banks couldn't pull off this type of information warfare without the help of government officials pulling strings from inside. Bernanke and Geithner must be involved.

So, what's the objective?

The banks are trying to keep prices artificially high to avoid writing-down millions of mortgages that would force them into bankruptcy. It's called "extend and pretend" and it’s poisonous for the broader economy because it distorts prices and keeps a broken banking system in place that can't perform its social purpose.

WSJ housing editor James R. Hagerty verifies Whitehouse's claims and fills in some of the blanks. Here's a clip from his article:

"To get a sense of how many more households will lose their homes to foreclosures or related actions, Barclays tallies what it calls a shadow inventory, consisting of homeowners 90 days or more overdue on mortgage payments or already in the foreclosure process. At the end of February, 4.6 million households were in that category.

Barclays expects 1.6 million "distressed sales" of homes—mainly foreclosures or sales of homes for less than the mortgage balance due—both this year and in 2011, then a slight decline to 1.5 million in 2012. Last year, Barclays estimates, such sales totaled 1.5 million. About 30 per cent of all home sales this year and next will be foreclosure-related, forecasts Robert Tayon, a mortgage analyst at Barclays, who says that would be only about 6 per cent in a normal housing market." ("Foreclosure Estimate Falls", James R. Hagerty, Wall Street Journal.)

Why would Barclays think that only 1.6 million "distressed" homes would be sold in 2010, when they openly admit that there's 4.6 million homes already in the foreclosure pipeline? What does Barclays know that the public is not supposed to know?

Clearly, the banks have worked out a deal with Geithner and Bernanke to sell distressed inventory in dribs and drabs rather than all at once. That keeps prices high and makes their losses more manageable. But isn't that collusion or, at the very least, price fixing? The government definitely HAS a role to play in helping people keep their homes or providing assistance when they lose them, but they have no right to scam the public by stealthily manipulating the market to save underwater financial institutions.

The problem is not housing. The problem is the banks. The banks do not have sufficient capital to fund the mortgage market, nor do they provide the bulk of the financing for auto loans, student loans, small business loans or credit card debt which is gathered into pools and chopped up into tranches for securities that are sold to investors. (Securitization generates wholesale funding for the credit markets.) Not only are the banks unable to fulfill their primary social purpose--which is extending credit--they're also increasingly dependent on revenue from high-risk speculation. A recent article in the Financial Times exposed the fraud behind the 12-month surge in equities pointing out that retail investors have largely stayed on the sidelines. Here's an excerpt:

"...surveys show that the usual investors in major rallies – pension funds, hedge funds and retail investors – have not been net buyers of equities…the most likely explanation for this anomaly in the biggest stock market rally since the 1930s is that major investment banks are the anxious buyers.

“Their buying would appear to be for one of two reasons. Firstly because they think the authorities will prevail in their (so far unsuccessful) efforts to inflate their way out of debt liquidation; or secondly because they are too big to fail and so can afford to take a huge gamble that enough buying will convince others to rush in and buy their inventory of risk assets at even higher prices." ("Equity Rally Not Driven by the Usual Investors", Financial Times.)

Many people already suspected that the soaring stock market had more to do with "easy money" and bubblenomics, than they did with "green shoots". Still, the FT article does help to underline the fact that the bank's business model is broken and badly in need of repair. But, what is to be done? The banks already own just about everyone on Capital Hill, and their lobbyists are now writing large sections of the reform legislation. So how can they be stopped?

The root of the problem is political, and that's the best place to start. The banks' lethal grip on government has to be broken. The rest will be easy.

Glitch in the System; Computer-driven mayhem on Wall Street

On Thursday, shares tumbled across all major indexes on fears that Greece's debt woes would spread to other vulnerable countries in the E.U.. What began as a down-day on Wall Street, quickly turned into a full-blown rout as blue chips, financials, techs and transports were all caught in a program-trading downdraft. The bloodletting was mind-numbingly swift. In one 15 minute period, stocks plunged more than 300 points (and nearly 1,000 points at their nadir) before bouncing off the bottom and clawing back some of the day's losses. For the big brokerage houses and investment banks, the massacre could not have happened at a worse time. Skittish retail investors have already been steering clear of Wall Street, convinced that the markets are rigged. Thursday's ructions are sure to keep them on the sidelines even longer.

From Reuters:

"During the sell-off, Procter & Gamble shares plummeted nearly 37 percent to $39.37... prompting the company to investigate whether any erroneous trades had occurred. The shares are listed on the New York Stock Exchange, but the significantly lower share price was recorded on a different electronic trading venue.

"We don't know what caused it," said Procter & Gamble spokeswoman Jennifer Chelune. "We know that that was an electronic trade ... and we're looking into it with Nasdaq and the other major electronic exchanges." Mathew Goldstein, Reuters)

When stocks nosedive, falling prices can trigger stop-loss orders which spark a selloff. Add high-frequency trading to the mix--which accounts for more than 70 per cent of daily volume--and a normal correction can quickly turn into a major crash. The high-speed computers make millions of trades in a flash without human intervention. The potential for a catastrophe like Thursday, is a near-certainty.


From the Wall Street Journal: "An electronic trading algorithm issued by an unknown trader caused a massive selloff in futures contracts tied to the S&P 500, according to a long-time electronic trader of the products. A mistaken order was issued to sell $16 billion, rather than $16 million, of e-mini S&P futures contracts, according to the person....

“Jay Suskind, a senior vice-president at Duncan-Williams Inc., said the combined string of negative news about Goldman Sachs Group Inc. (GS), the Greek debt crisis and the rise in Libor evoked memories of the uncertainties that plagued the markets in 2008. He said the most nervous investors on Thursday simply decided to sell, rather than wait for information.

"’It just felt like liquidation’ said Anton Schutz, manager of the Burnham Financial Services Fund. ‘This isn't profit-taking. This is guys getting taken out on stretchers.’" ("Financial Stocks Plunge On Broad Market Selloff", Wall Street Journal)

Thursday's panic reminded many of the darkest days of the financial crisis when trillions of dollars were pared from market-cap in 5 months of carnage. Now risk aversion is back; the yield on the 10-year Treasury is falling, the dollar is strengthening, Libor is on the rise, and the flight to safety is on. All of the upbeat data on manufacturing, retail sales, consumer spending and inventory restocking, won't allay the fears of jittery investors. When volatility is this extreme, animal spirits are curbed and people look for a place to hide.

Zero Hedge has railed against high-frequency trading for more than a year. Maybe now, someone will listen. Here's an excerpt from their website in 2009:

"What happens in a world where the very core of the capital markets system is gradually deleveraging to a point where maintaining a liquid and orderly market becomes impossible... When the quant deleveraging finally catches up with the market, the consequences will likely be unprecedented, with dramatic dislocations leading the market both higher and lower on record volatility... (and today) What happened today was no fat finger, it was no panic selling by one major account: it was simply the impact of everyone in the High-Frequency Trading (HFT) community going from port to starboard on the boat, at precisely the same time.....After today investors will have little if any faith left in the US stocks, assuming they had any to begin with." (zero hedge, The Day the Market Almost Died)

The Securities and Exchange Commission (SEC) knows that High-Frequency Trading (HFT) is fraught with danger, and that a drubbing like yesterday's can happen at any time. Apparently, that's a risk that SEC chair Mary Schapiro is willing to take in order to give the big financial institutions a leg-up on the little guys. But that's not the way to restore confidence or lure people back into the markets. For that, Schapiro's going to have to do her job and fix the system.

Today's Links

1--A Money Too Far Paul Krugman NY Times

2--Bloodbath Ahead for State Budgets CNN

3--It's Getting Worse: CDS Report

4--Bankers trot out tired, old arguments against financial overhaul LA Times

5--Market Plunge: What really happened Naked Capitalism

6--Deficit hawkery's harsh impact on education Wa Post

7--"What is Responsible Fiscal Policy" New economic Perspectives
Quote: A responsible government spending policy is not measured by some arbitrary accounting result called the deficit, but by the impact it has had on the real economy.

8--"A long and persistent middle-class squeeze" EPI

9--Are Freddie's Losses on Loans Purchased Since September 2008? Dean Baker blog

Quote: "... when Fannie and Freddie lose money, it means that they paid banks too much for the loans they purchased. If they paid too much for loans before they were taken over then this was preumably the result of bad business decisions. However, if they lose money on loans purchased after September of 2008, then the government is effectively subsidizing banks by paying too much money for their loans. This was the original intention of the TARP program.

Taxpayers have a right to know if Fannie and Freddie are bing used to subsidize banks by overpaying for their loans. The Post and other news outlets should be trying to answer this question." Dean Baker