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Tuesday, September 29, 2009



what fed governor fisher means by 'alacrity' is a bit uncertain -- after all, it would be hard to hold to the promise of tightening liquidity with a vigor "equal in speed and intensity to that with which we pursued monetary accommodation".

and yet, with particular improvement in house prices (however illusory it may prove), the fed might be on the warpath to withdraw easing more rapidly now -- and certainly it seems unlikely that they will extend nearly completed programs to purchase mortgage-backed securities and treasuries under the rubric of quantitative easing.

thinking forward the consequences of a suspension of QE, one has to first understand that up to 50% of recent treasury issuance at the long end of the curve has been soaked up by the central bank. much of the financing of the deficit and debt is being taken up at the shorter maturities, where there is less rate risk, shortening up the funding profile of the government and increasing its roll risk. dealers are highly unlikely to warehouse the kind of issuance in treasury bonds now making its way to market from the treasury, so it is not unreasonable to expect that the treasury curve may steepen. this would be contra the recent trend of lower yields in the long bond, which john jansen attributes to the hedging of more exotic bets in credit, as well as security in the belief that the open markets desk of the fed will not allow rates to rise. there's also been a move out of money market funds into the belly of the curve. but i imagine that a tick up in long rates to quash liquidity and multiplier expansion is exactly what inflation hawks would like to see, provided it doesn't run out of control.

if it does run out of control, we'll see a quick reprise of quantitative easing -- and then the debate over whether the united states is stuck on a hyperinflationary vortex, navigating between the scylla of deflationary collapse of keynesian demand management and charybdis of permanent quantitative easing, would really begin in earnest.

UPDATE: more from edward harrison.

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Friday, September 25, 2009


tim duy on liquidity withdrawal

following on today's earlier post, tim duy provides something of a window on the thinking behind these latest moves to threaten liquidity.

[G]iven the unemployment outlook is sad, wage growth continues to deteriorate, core inflation is falling, and we seem to lack an institutional arrangement to force higher prices, should they even emerge, into higher wages, what is the Fed thinking? Should they really be worried about winding down programs? Are they really confident enough that an inventory correction that will undoubtedly spike GDP numbers will also translate into sustainable growth? Even knowing full while that after the last recession, the US economy languished despite the inventory correction, only to be revived on the back of the housing bubble? In effect, the Fed looks to be putting much weight on the cyclical story playing out, while ignoring the structural story of the necessity of asset bubbles to fuel growth. Pondering this, a little noticed Bloomberg report jumped to mind:

Federal Reserve policy makers are concerned about making “a colossal policy error” leading to higher inflation if they don’t withdraw extraordinary monetary stimulus soon enough, said Laurence Meyer, vice chairman of Macroeconomic Advisers LLC and a former Fed governor.

“When you talk to committee members you see a little bit more angst than you’d expect,” Meyer said in an interview yesterday at the Kansas City Fed’s monetary policy conference in Jackson Hole, Wyoming. “In public they say they’re confident they’ll get it right, they’re confident they have the tools to get it right. But when you talk to them in private there’s some concern there.”

So, added to the Medley rumor, the pieces start to fall together. Internally, perhaps a wide range of FOMC members believe, in their hearts if not in the data, that they have gone so far that the balance of risks have shifted toward inflation. But this is troubling; the basis for the inflation story falls entirely on the Fed's expansion of its balance sheet. Just a meager $1.3 trillion expansion give or take in the wake of an over $11 trillion decline in household wealth? And the bulk of that expansion is sitting in excess bank reserves? Not really much of an inflation story. But why else are they so eager to withdraw? Just to prove to critics they can? With much fanfare, from Bloomberg today:

The Federal Reserve and U.S. Treasury said they’re scaling back emergency programs aimed at combating the financial crisis, reducing support for firms that now have an easier time getting funding.

The central bank today said it will further shrink auctions of cash loans to banks and Treasury securities to bond dealers, reducing the combined initiatives to $100 billion by January from $450 billion. The Treasury has “begun the process of exiting from some emergency programs,” the chief of the government’s $700 billion financial-rescue fund said separately.

Bottom Line. The Fed is moving toward the exit as they look toward the conclusion of their securities purchases programs. But it is not clear that such a move is justified by their own forecasts or the inflation/wage/employment data. There may be an internal fear they have gone too far, a fear that the hawks can exploit. To be sure, I see no reason to expect the Fed will raise rates for a long time. And the Fed maintains it has policy flexibility, claiming to be ready to revive asset purchases should economic or financial conditions justify. But I now suspect the bar for renewed expansion of Fed accommodation may be much higher than I had anticipated. And that the dominant push for expansion would have to come from financial market conditions, while they would be willing to tolerate persistently high unemployment rates so long as U. Michigan inflation expectations say elevated, regardless of the actual inflation data.

not only could we be seeing the popping of liquidity-fueled rallies in equity and credit; duy clearly fears this could be the onset of the second trough in an economic double dip. it should be said that the fed's alphabet soup has been unwinding for some time already, but has also been offset by quantitative easing in the form of mortgage-backed securities and treasury purchasing for the fed's portfolio. there's a strong implication here, however, that QE won't be expanded past the preset limits which the program will likely reach in the next week or two.

UPDATE: zero hedge forwards a bit more from moody's.

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Welcome back, GM--this whole issue goes back to the Fed being the Last Buyer. There is no one left to sell the Treasuries and MBS to--despite them being so confident a few months ago that the Treasury market was "liquid." Look at long Treasuries, for example. No real money buy-and-holders would buy a 3.5% ten-year or a 4.5% thirty-year coupon. The leveraged guys must have as much as they want--it's not so much that the spread is low, but that there is a lot of risk from short-end tightening and/or long end yield increases thanks to continued supply. The foreign central banks have stopped buying long Treasuries, opting instead for the one-night-stand T-bills.

Do the professors at the Fed really think that because they created Federal Reserve Notes and exchanged them for long Treasuries and MBS, some Wall Street sharpie is going to be willing to trade them back without making a substantial profit? The Fed was a big stupid buyer, and the only way out of that trade is to become even bigger and stupider or to find someone else who is. Good luck with that.

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all rests on liquidity

i caught this bit in ft alphaville yesterday, but pragmatic capitalist expanded on it marvelously.

Banks are in the business of lending, but an odd thing has occurred while bank earnings soared – they were doing no lending! Banks have been hoarding record amounts of cash as the government floods their balance sheets via various programs and bailouts. Many assume that the banks are either attempting to loan the money or simply letting it sit on their balance sheets earning nothing. But Moonraker’s analysis raises a more nefarious possibility – the banks are effectively creating a ponzi run stock market in which they use the bailout money to drive various market prices higher and thereby juice their own earnings. It’s quite brilliant when you think about it – until the music stops.

this is more or less exactly what is going on in not only the equity market but credit markets as well. and that makes it absolutely paramount for the individual stock market player to study the liquidity picture for the banks closely. as the spigot shuts, equity will likely be quick to suffer.

there's been a palpable change in the news flow around liquidity provisioning in the last week or two. as examples, bloomberg and the financial times among others have started reporting on federal reserve discussions with primary dealers and money market mutual funds on the use of reverse repos to mop up balance sheet cash.

The Federal Reserve has started talks with bond dealers about withdrawing the unprecedented amount of cash injected into the financial system the last two years, according to people with knowledge of the discussions.

Central bank officials are discussing plans to use so- called reverse repurchase agreements to drain some of the $1 trillion they pumped into the economy, said the people, who declined to be identified because the talks are private. ...

“To be effective, the Fed would have to drain several hundred billion dollars worth of funds through these reverse repos, between about $400 and $600 billion,” said Joseph Abate, a money market strategist in New York at Barclays Plc, a primary dealer. “You may have a dislocation in the repo markets due to the supply effect of the Fed injecting such a large amount of extra collateral into the marketplace.”

Bernanke [has written] that reverse repos could be done with counterparties beyond the Fed’s primary dealers, which serve as counterparties in open market operations and are required to bid on Treasury auctions.

More trading partners may be needed since primary dealers have been shrinking their balance sheets the past two years, and likely can’t absorb an additional $500 billion of securities, according to Abate at Barclays.

those additional counterparties are the money market mutual funds.

The central bank wants to use the deep-pocketed sector to refinance part of the giant portfolio of mortgage-backed securities and Treasuries acquired during the crisis, using a technique called "reverse repos".

This would involve the US central bank borrowing from money funds using some of its assets as collateral, thus draining liquidity from the financial system.

Such actions would neutralise the monetary consequences of the assets re-financed in this way, although the Fed would still hold the credit risk and mark-to-market risk on the portfolio.

The Fed has already talked of conducting reverse repos with primary dealers including the former Wall Street investment banks. But it does not believe that they have the balance sheet capacity to provide more than about $100bn (€68bn, £61bn) of finance.

This is not enough, given how much its balance sheet has swollen. The Fed is buying $1,450bn of MBS alone and has created roughly $800bn in additional bank reserves since the crisis began.

this hasn't happened yet, but other examples of liquidity provisioning are already being retracted. under the rubric of quantitative easing, the fed has gone into the market to buy outright hundreds of billions in treasuries and mortgage-backed securities. chairman bernanke has tried to differentiate what he's doing as "credit easing", but the net effect is to flush primary dealers with newly-minted cash. these programs have virtually reached their planned dollar targets and have not as yet been extended.

banks have also been funding extremely cheaply for nearly a year on the back of FDIC-based guarantees of their newly issued debt. banks utilized the program to issue more than $300bn in refinancing bonds that would otherwise have been extremely expensive if not impossible to float. the program is being allowed to expire, with the already-depleted FDIC on the hook for a pile of credit risk, and banks going forward are likely to be faced with continued significant regulatory pressure to shift their funding profiles away from constantly rolling short-term paper (which fostered so much trouble in 2008) into more stable (and more expensive) bonds. but the situation is far more complex than rolling out a new regulation. from the economist:

Unsurprisingly, regulators think that forcing banks to find more secure funding, along with more capital, will make the system safer. The Basel club of bank supervisors is considering new liquidity rules, as are many national regulators. New Zealand has already drawn up concrete rules. It is not clear how far this can go. There can be no return to an idealised past where only a dollar deposited in a bank would be loaned out. To force banks to rely only on deposits would require a big shrinkage of their balance-sheets, with devastating economic implications. Besides, not all deposits are sticky. The Bank of England reckons that $100 billion of Russian deposits were shipped out of Britain in the last quarter of 2008.

Far from improving, the funding profile of the Western banking system has been getting even sicker this year. Banks have been raising equity and long-term debt and gathering deposits, but in the grand scheme of things their efforts have made little difference. For America’s top eight commercial banks such higher-quality forms of funding have risen only slightly, from 78% to 80% of the total in the past six months. America’s two surviving investment banks, Goldman Sachs and Morgan Stanley, still depend on shorter-term borrowing, usually secured with collateral. This is fairly reliable but, as Bear Stearns showed, in a market meltdown it can dry up without central-bank support. In Britain, Lloyds Banking Group, a leading wholesale-funds junkie, still has half of its total funding maturing in under a year.

If the duration of funding has not changed much, its source has. In America, the euro zone and Britain, central-bank lending and public guarantees of bank bonds have reached about $2.7 trillion. That equates to about 9% of banks’ wholesale funding, using IMF estimates. Support is concentrated on the banks with the worst funding profiles. So Dexia in Belgium has €82 billion ($117 billion) of state funding, and Lloyds could have up to £100 billion ($162 billion).

The original idea was that state support could be withdrawn swiftly as the panic subsided. America’s main debt-guarantee scheme will close to new issuance next month (with those guarantees already issued expiring in 2012). Europe’s schemes are typically due to close by the end of the year, with guarantees expiring between 2012-14. The hope is that banks will not only be able to refinance debt on their own but also extend its maturity, cutting their dependence on fickle short-term funding.

Funding strains have eased. So far this year, Western banks have issued $645 billion of bonds without government guarantees, according to Dealogic, a research firm. But the idea that the banking system can improve its funding profile at the same time as it weans itself off explicit state guarantees looks wildly unrealistic. This partly reflects the sheer volumes of debt involved. As well as turning over existing short-term borrowings of some $18 trillion, Western banks have to refinance longer-term debts that are maturing at the rate of about $1.5 trillion a year. With securitisation markets damaged and confidence in banks battered, that will not be easy.

It is also unclear that the most needy banks can borrow freely yet. Lloyds issued an unguaranteed and unsecured ten-year bond on September 3rd at 193 basis points above government yields, about double what the safest British bank, HSBC, might pay. Not only is this rate “uneconomic”, according to one banker, but Lloyds only raised €1.5 billion, a drop in the ocean. In July Dexia sold a similar five-year bond at 160 basis points above government yields, but the issue size, at €1 billion, is also tiny relative to its needs.

central bankers have really provided two kinds of liquidity support for banks in these difficult times. the use of the federal reserve's balance sheet through repos pushed treasury bonds into the banks and less marketable debt into the fed. these t-bonds could then be used to raise cash on the asset side of the banks' balance sheets. the second form -- and the more important, in my eyes -- was the earnest support of commercial bank (and select other) liabilities through both the fed and the treasury by way of TARP. the alphabet soup of fed special programs in support of money markets, commercial paper, et al were all essentially aspects of this aim, as were FDIC bank debt guarantees. without them, a fast-motion replay of the banking system collapse of the 1930s was a mortal lock. the question, though, is really whether they can even yet be removed.

the economist points out the incredible scale of the funding profile problem that have accrued in the western banking system as a direct result of decades of current account deficits -- "As the Western banking system has expanded over the past two decades its assets have grown to about 2.5 times its deposits" -- "As well as turning over existing short-term borrowings of some $18 trillion, Western banks have to refinance longer-term debts that are maturing at the rate of about $1.5 trillion a year". these are absolutely boggling figures, and put into stark relief the practical limitations of the federal reserve in dealing with systemic funding difficulties in the intermediate term, though that the fed stemmed the tide last year is without question.

stability aside, the difficulty going forward is that wholesale funding, particularly if it is of longer duration, is relatively expensive. many deposit-poor banks may find themselves, without the help of the fed in procuring funding, in a position where the sensible thing will be to divest of assets and contract the balance sheet into something more in line with their deposit base. this means pressure on asset prices -- the opposite of what has been enabled over the last six months.

in summary, it looks very much like the government support of liquidity provisioning for the banking sector is waning in the aftermath of an inventory cycle in the economy and a massive liquidity-fueled rally in the tail end of the systemic capital structure. withdrawal of both liqudity-enhancing asset swaps and direct support of liabilities could have important ramifications for this rally.

UPDATE/ADDENDUM: it's also important to note that this is not exclusively a US story. as alphaville cites today, europe ex-germany is largely in the same position if not worse. the european central bank is there playing exactly the same role as the fed here, and are at a similar juncture.

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Thursday, September 24, 2009


bid-only credit markets

david goldman:

[S]ingle-A rated commercial mortgage backed securities ... have more than doubled in price....

These are securities that vaporize if losses on the underlying pools exceed 30% or so, depending on structure. With defaults rising on commercial real estate, the willingness of the market to buy the lower-to-middle part of the capital structure seems foolhardy.

Dealers tell me that markets have been bid only for the last couple of weeks: no-one has anything to sell, and financial institutions have a standing bid for anything with yield. Part of the explanation for the pendulum swing is the available of Public-Private Investment Partnership money to lever up these assets, but that cannot be the only cause. The fact is that the money management industry has no choice but to stampede in whichever direction the market is moving.

High-quality credit was stupid cheap at the beginning of the year. Now it’s stupid rich.



the illiquidity of mid-to-high-end housing

this factoid from mark hanson:

Let me frame this… in the bubble years existing sales $500k and over were common. In CA alone, from early 2005 to late 2007, the average house price was over $450k. Total sales were huge then too…over 700k nationally in many summer months.

In July 2009 there were only 460k single family (ex-condo) sales – by the way that was down from June’s 465k, but that got lost in the housing bottom headlines. Of the 460k houses sold, only 12k or roughly 2.5% had a purchase price over $500k. I don’t have inventory numbers on houses for sale over $500k but even at 5% of the total inventory that is 1.75 years of supply. Oh, and by the way in CA alone last month there was close to 12k NODs on props over $500k.

This 2.5% sales rate goes to underscore how insignificant (and ruined in many cases) the organic move-up/across buyer has become due to epidemic negative equity and absolute lack of affordability through exotic finance. Unless he can sell and re-buy he will remain gone.

But what really is negative equity? Unlike the bubble years when zero down or a 100% HELOC after the purchase in order to replenish savings was the norm, today’s buyer has to sell for enough to cover the Realtor cost and the 20% down needed to buy most mid-to-high end houses using new vintage loans. Most analysts look at the reported negative-equity figures as the tipping point — it’s not.

If homeowners can’t sell for enough to pay a Realtor 6%, extract the down on the new property, and pay for moving costs they are effectively in a negative equity position. Homeowners know this — a homeowner that has only 15% equity knows they are trapped in their house. We are still learning what this realization does to spending habits, as the focus for many becomes ‘how do I earn or save my way out of this’

When looking at neg-equity if you move the bar down to 90%, 80%, or even 74% (6% Realtor fee + 20% down) then it changes everything. The vast majority of homeowners in the nation become stuck (see chart below). Without these existing homeowners active in the real estate market, we will never find a true bottom.

hanson is painting a picture of a residential real estate market in a death spiral. with some states seeing a sizable majority of potential homebuyers frozen out of the housing market by negative equity, there will be effectively no (ie, net negative) move-up or organic homebuying. folks with less than 25% equity in a house that can be sold today cannot even move laterally, much less trade up, without adding capital that (for the most part) they don't have to spare. so mid- to high-end homes become completely illiquid assets at anything like current prices -- and illiquidity will drive prices further south as supply overwhelms demand. with prices declining further, banks will tighten lending standards further -- the era of the 30% down payment is already here in the blighted coastal states, and it figures to spread, moving the bar yet further away for the trapped. there is furthermore a demographic trend at work, as savings-light empty-nest baby boomers divest themselves of the grand houses that characterized their materialistic phase and move to downsize in an effort to raise capital and lower expenses in advance of old age. and so the vicious cycle perpetuates itself.

the end result will i think be a massive compression in price differentials between small and large homes. square footage, greatrooms, stainless-and-granite professional kitchens and fourth bedrooms were at a huge premium in the boom; in the bust the functional essence of a home, the roof it provides, will likely become the focal point to the relative devaluation of all extraneous components. it would not surprise me if, in the most afflicted markets, large houses actually exchange more cheaply than mid-size units, reflecting the significant differential in operating costs and taxes.

that may seem like great news if you're waiting out the housing bust from the sidelines and renting your way to, if not prosperity, at least smaller losses. but the effect of further significant declines in house prices on the properties to which the banks are perhaps most exposed has utterly no positive effect for credit quality and therefore the economy.

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have expectations for the economy got too high?

while a positive GDP print for the third quarter seems assured, numerous commentators have explored the nature of the economic rebound. one of the best among them is edward harrison of credit writedowns, who has pegged the uptick as an inventory correction cycle.

I have written about the present business cycle as the mother of all inventory corrections. Erroneously, I suggested we were going to see a re-stocking of inventories. That’s overstating the case. What I meant to say was that inventories were being purged so much in the first half of the year that it would lead to GDP growth even in the absence of re-stocking. This is something I stated correctly in May.

Thinking about production as opposed to sales again, you have to look at inventories. The NBER is not fooled by inventory builds because they look at both industrial production and retail sales. But, since GDP is a pure production statistic, inventory builds distort the picture. For example, say your economy produces $980 worth of stuff one quarter that gets sold. But it also sells a lot of stuff, $20 worth, out of inventory. If next quarter, you need to sell just as much stuff ($1000), guess what, GDP growth goes up automatically (Remember, we are not talking about GDP, but GDP growth). The inventory purge means you are producing less to meet demand than you would otherwise need to. So, when comparing one quarter to the next, unless you purge just as much stuff or unless demand goes down, you need to produce more. Therefore, you get an automatic uptick in GDP growth.

This is what is happening now. The positive impact that inventories is having on GDP growth has to do with the fact that GDP growth is a first derivative statistic where even subtracting a less negative number is positive.

inventory corrections often are an early feature in self-sustaining economic expansions. but in the final analysis, sustainable recovery will come only as a product of end demand pickup -- and that is where i want to focus. new deal democrat, one of the bulls of bonddad, has analyzed in multiple parts his expectations of a reversal in the employment trend. his latest installment integrates his previous analysis of real retail sales, industrial production and initial claims in a nascent model of unemployment, with real retail sales being the ultimate leader of the cycle turn. improving employment, as jobs are added to the economy, provide fuel for further retail sales gains.

this makes real retail sales perhaps the most important economic indicator to watch going forward. the month-ago report for august was really the first positive indication of retail sales growth since the start of the depression in late 2007. the september figure won't be release until mid-october.

does this uptick represent the start of sustainable consumer spending growth? this could be the all-important question.

the depression, as barry eichengreen and kevin o'rourke have made clearer to the world, must (much like its predecessors) be seen in its entirety as a global phenomena to be properly understood. so a look at retail sales trends in other countries might be instructive.


Canadian retailers unexpectedly posted lower sales in July, led by falling prices at gasoline stations, as consumers brought a two-month shopping spree to an end.

Sales dropped 0.6 percent from the prior month to C$34.2 billion ($32 billion), Statistics Canada said today in Ottawa. Economists expected a 0.7 percent increase in July, based on the median of 20 estimates compiled by Bloomberg. ...

This is a “horrible across-the-board report,” said Derek Holt, an economist at Scotia Capital in Toronto. “It may signal the release of pent-up demand from last fall is over with.”


French consumer spending fell in August when it had been expected to rise, as shoppers cut spending on clothes, shoes and cars, raising questions over the robustness of a nascent economic recovery.

Consumer spending, a key economic driver, fell 1.0 percent month-on-month in August, well below a consensus forecast for a 0.6 percent rise after a fall of 1.2 percent in July, national statistics office Insee said on Wednesday. ...

"In my opinion, it illustrates that difficult times are here for consumption," said Olivier Gasnier, an economist with Societe Generale.

"We are entering a period which is much more difficult for the labour market: prices are beginning to rise and the labour market is not on a good track."

new zealand:

New Zealand’s retail sales unexpectedly fell for a second month in July, adding to signs the economy faces a slow recovery from the worst recession in three decades. Sales dropped 0.5 percent from June when they declined a revised 0.1 percent, seasonally adjusted, Statistics New Zealand said in Wellington today. Core retail sales, which exclude car yards, fuel outlets and workshops, fell 0.5 percent.


U.K. retail sales unexpectedly stalled in August as shoppers bought less clothing, a sign consumers are cutting back on spending as unemployment rises. Sales were unchanged from July, when they climbed 0.2 percent, the Office for National Statistics said today in London. The median forecast was for a 0.1 percent increase, according to a Bloomberg News survey of 30 economists.


Japan’s retail sales fell for an 11th month in July, extending the longest losing streak since 2003, as poor weather and a worsening job market kept shoppers at home. Sales slid 2.5 percent from a year earlier, the Trade Ministry said today in Tokyo. The median estimate of 15 economists surveyed by Bloomberg was for a 3.5 percent drop. Consumers cut spending at the fastest pace in five months in July amid falling wages and a record-high jobless rate. The record 25 trillion yen ($266 billion) in stimulus spending that helped Japan’s economy expand for the first time in more than a year has failed to bolster sales at retailers. “Wages have been falling very steeply,” said Masayuki...


Retail sales in Germany rose for the first time in three months in July as lower prices boosted purchasing power and consumers grew more optimistic about the economic outlook. Sales, adjusted for inflation and seasonal swings, increased 0.7 percent from June, when they fell 1.3 percent, the Federal Statistics Office in Wiesbaden said today. The result was in line with the median estimate in a Bloomberg News survey of 26 economists. From a year earlier, sales decreased 1 percent.

one could also cite china's in-line retail sales, but like most i doubt there's much truth in chinese statistics.

the only unambiguously positive retail sales report in this cycle was the united states', augmented as it was by a huge rush to buy cars under the cash-for-clunkers program and a seasonal uptick in housing activity supported by expiring tax credits that has been powerful enough to overwhelm seasonal adjustments.

but the global picture here is one of disappointment -- retail sales are refusing thusfar to grow as hoped in spite of tremendous global stimulus, and given the relentless contraction of consumer credit that should perhaps not be surprising. western society -- and particularly america, britain and other current account deficit currency unions -- has spent thirty years calling forward future demand by leveraging the household, and with that trend reversed it's hard to expect a big retail sales recovery. this is also why inventory, though it has been cut significantly, is still as a function of sales very high -- and this is the most relevant measure to business profitability, as the modern business model prices for just-in-time delivery and takes losses more quickly on inventory than in times past. though the inventory cycle is pushing activity higher, businesses have the potential to be squeezed both by higher-than-normal inventories and profit margin compression as producer price increases remain difficult to pass on to the consumer. (updated PPI comparison here.)

retail sales measures over the coming weeks may be critical to divining how the inventory cycle plays out -- as a first stage to launching a broader consumer recovery, or as an uptick in a larger depressionary scenario that is simply taking time to play out.

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Thursday, September 17, 2009


south africa and HSAs

via physicians for a national health program -- a 2005 reference from the progressive newsmagazine new republic.



improving funding profiles will not be easy

the economist.

sorry for the lack of recent posting -- busy here and mostly just trying to bookmark things through twitter.

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Friday, September 11, 2009


corporate balance sheet repair

robert peston writing for the BBC -- what is true of the UK in this respect is also true of the united states.

t[T]he Bank of England's fear is that banks are being too averse to risk, that they don't want to lend even to businesses that are fundamentally viable.

And there is evidence that some legitimate requests for credit are being turned down.

But there is something else happening as well: many companies have recognised that their balance sheets are over-stretched, that their debt is too high relative to their devalued assets, and are choosing to repay debt.

Right now it is hard to find a substantial listed or private-equity financed business that actually wants to increase its debt - and many have programmes to reduce their borrowings.

There are, for example, a number of big companies which are technically insolvent: on a realistic valuation of their assets, and including the deficits in pension funds, their liabilities exceed the value of their assets.

They can keep going, because they are generating cash from operations. But although they won't admit it, for fear of panicking shareholders and creditors, they are in what is known as "workout" mode. They are concentrating on shrinking to pay down borrowings.

Paying down debt is rational for each individual business, but it collectively leads to lower investment, lower employment and lower demand in the economy as a whole - and therefore feeds back into worse conditions for business in aggregate and lower economic growth.

This pernicious trend of corporate debt reduction hobbled the Japanese economy for 15 years, according to the compelling analysis of Richard Koo (in his The Holy Grail of Macro Economics).

Corporate debt minimization can't do as much damage here because the debt of British businesses never reached the peaks of Japanese corporate indebtedness - and nor did our asset bubble become quite so egregiously pumped up as theirs.

But if it turns out to be the case that for an extended period, businesses will be choosing to repay debt rather than investing in growth, that will have significant implications for all of us.

It would imply that if households and government also chose simultaneously to cut spending to reduce their excessive debts - and on most analysis, the UK's indebtedness problem is concentrated on the household and public sectors rather than the corporate sector - then the incipient economic recovery could be snuffed out pretty fast.

Which explains why central bankers and finance ministers are only making plans to end their exception stimulus measures, rather than setting a precise date for the withdrawal of the prop.

as peston notes, this is exactly the dynamic of balance sheet recession that has been at work in japan for two decades.

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when will unemployment improve?

bonddad blog with the first of a multipart series -- but the answer might be sooner than you think.

... I believe that the economy will start to add jobs when the initial jobless claims rate drops past 550,000, and stays significantly under that number (about 530,000 or less) for three months, or else quickly drops under 500,000.

But of course, that begs the next question, which is, how can we tell if jobless claims are moving in that direction or not? There are several other data sets that help pinpoint this, and that's what I'll explore next week.

contributor new deal democrat also points to the moderation in inventory-to-sales as evidence that manufacturing might be priming for expansion. the three contributors are split on the viability of a consumer-led recovery.

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Tuesday, September 08, 2009


hiring plans

via naked capitalism.

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Friday, September 04, 2009


august jobs

via calculated risk.

i would reiterate from two months ago the point of bill gross as conveyed by edward harrison:

His basic point is this: no jobs and no wage growth equals no recovery.

We need to see incomes rise in order to get consumers to spend. If the Obama Administration wants recovery, they need to do more to increase incomes and worry less about bailing out the banks.

the aggregate weekly hours index (AWHI) continues to shrink at ever greater year-over-year rates, but the monthly seasonally adjusted rate of collapse has moderated significantly.

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soaring junk bond defaults

debt resolution is a messy thing sometimes.

The default rate is expected to rise to 13.9 percent by July 2010 and could reach as high as 18 percent if economic conditions are worse than expected, S&P said in a statement.

Default rates have surged from less than 1 percent in 2007 as an economic downturn squeezed corporate revenues and a global credit crunch dried up funding. A 13.9 percent default rate would be the highest since the Great Depression of the 1930s, when it hit 15.9 percent. ...

"Credit metrics in the U.S. show continued deterioration of credit quality and restricted lending conditions," S&P said.

In another sign of corporate distress, the rating agency has downgraded $2.9 trillion of company debt year to date, up from $1.9 trillion in the same period last year.

Just $73.6 billion of debt has been upgraded, though that is up from $35.8 billion in the same period last year.

"The bright spot for credit markets amid the current economic downturn is an increase in new issuance," S&P said. Junk-rated bond sales have grown to $73.6 billion through August from $35.8 billion in the same period last year. Investment-grade issuance has risen to $603 billion from $537 billion, according to S&P.

A reopening of the bond market following last year's credit freeze is allowing companies to refinance debt, keeping defaults lower than they otherwise would be.

so junk defaults have hit 10% on their way to 13-18% in spite of massive refinancing subsidies for troubles issuers fostered by huge liquidity injections by the federal reserve bank into the relevant markets and agents.

if that doesn't underscore just how massive the corporate junk bond problem is, i don't know what could. a lot of these companies are going to default eventually regardless of liquidity provisioning because smaller bank balance sheets are going to force them off the fringe on credit quality concerns, and they'll become a chapter of the history books written on our society's great deleveraging.

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FHA lines up for a bailout

via clusterstock -- this is very much expected and a product of congressional actions to keep bad mortgages afloat.

“FHA is designed to help stabilize the economy, operating within manageable, low-risk loans,” [Federal Housing Administration commissioner Brian] Montgomery said. “It is not designed to become the federal lender of last resort, a mega-agency to subsidize bad loans.

“We don’t want to dramatically enlarge FHA’s portfolio, with a substantial portion of the portfolio problematic, high risk loans that cost homeowners who were careful and bought homes within their means.”

and yet, in the emergent panic over the collapse of the housing bubble in 2007, FHA was asked to become exactly 'a mega-agency to subsidize bad loans' that did dramatically enlarge its portfolio with problematic, high-risk loans.

but the problems of the FHA are small beer compared to the troubles that will come down when FHLB system and GNMA -- the two federal agencies that were forced to stand in for GSEs fannie mae and freddie mac as the financing for each expired -- come a-knocking with the tremendous losses they've been busy booking since china began its great shift away from agency debt. it was long ago apparent that these institutions would have tremendous difficulty standing in for the failing GSE complex. i fear there's plenty more bailing where FHA, FNM and FRE came from -- particularly if, via calculated risk, john burns consulting has it right:

Based on the issues at the FHA, the end of the tax credit, and more supply coming on the market, Burns concluded that "housing could see another leg down later this year or early next year":

[W]atch the growing controversy regarding the FHA very carefully. The decisions made to allow the FHA to continue lending will have a huge impact on the housing market, particularly when so few entry-level buyers have a substantial down payment.

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Thursday, September 03, 2009


adjusted mutual fund cash

traders narrative in conjunction with jason goepfert analyze the inflation-adjusted mutual fund cash level.

The mutual fund cash level is no longer neutral. This new adjustment shows that on aggregate, mutual fund managers are holding about 1.5% less cash than the statistical model suggests. While that may seem a trifling difference, historically, it has been a tell for a topping market.

The data fits the market remarkably well. The only caveat is that as timing indicators go it is sloppy. The market may top now, a week from now or a bit longer. With the corollary that the amount of cash may decrease even further. But the message of this indicator is crystal clear: the market is top heavy.

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can china really become a consumer society?

that chinese households are deep repositories of savings has been taken at face value in the macroeconomic community for a long time. many around the world are counting on the chinese government to spur economic growth by utilizing those savings to boost domestic demand, correcting longstanding imbalances in trade that have been the fuel for the great leveraging of the last thirty years.

while china has certainly accumulated massive forex reserves as a result of maintaining its currency peg with the dollar, via paul kedrosky, this BBC radio documentary makes an extremely interesting case that these savings are not what they appear at all -- indeed, that there is essentially no prospect of pushing extant savings into consumer use even if economic conditions improve.

for ... poorer families living in the countryside, the idea that they've got money sitting around in bank accounts that they simply choose not to spend is a misunderstanding of what life is really like. for the Yu family, there are rarely choices about what to spend their money on. ... as Colin's parents explain, they spend almost all of their income on necessities.

expected healthcare expenses play a huge role in forcing savings, even among children expecting to care for their adults in old age, as rural chinese families are essentially self-insuring. young city dwellers have higher incomes and are often insured, but are also committed to saving in advance of caring for parents who in communist china made nothing like the amounts available to them today.

it very much seems to me that, in order for chinese households to transition to a more consumer-oriented society, they will likely need the aid of two things: a stronger currency, and a reliable social safety net. the first would increase purchasing power and domestic demand while decreasing reliance on exports; the second would remove the impetus to self-insure. these are both changes that will take a long while, once enjoined, to shift social expectations in china; as neither has been countenanced thusfar, i can see little prospect of either in the short run.

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People spend pretty much all of what they make. Outside of upper-upper-middle class and above, this is true the world over.

And I'm nervous about keeping my money in the bank here--who in their right mind would be OK with it in China (in large amounts)?

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The answer is NO.

Absolutely, totally NO.

Because a consumer society is an uniquely American invention.

No other country is that stupid.

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Tuesday, September 01, 2009


twenty years of the new normal

via ed harrison, bill gross' latest missive.

[T]here’s been a significant break in that growth pattern, because of delevering, deglobalization, and reregulation. All of those three in combination, to us at PIMCO, means that if you are a child of the bull market, it’s time to grow up and become a chastened adult; it’s time to recognize that things have changed and that they will continue to change for the next – yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.

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Mr. Gross, like many others, still cannot fathom that US consumers are spending less not because they are saving, but because they have less money and less ability to borrow it. Being a saver is like being thin--one does not suddenly begin doing it in middle age. Plenty of people go on diets, but most of them wind up gaining the weight back.

This is why the consensus view that we will become like Japan is mistaken--it presumes that people make "rational" economic choices (rational meaning choices that economists would make.)--that the baby boomers will begin saving money as they suddenly discover that they are getting old, that debtors will delever, etc. It is much more likely that someone who has made it into their fifties spending more money than they earned will realize that $50K or $100K isn't going to do squat for them in retirement.

I don't know what the future holds, but I'm willing to bet it will be unlike what happened in Japan.

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i don't know either, bwdik. i do think there will be a great panic push by the large segment of boomers who were saving on some level but overexposed to risk markets in 2007-9. they want to save and are accustomed to saving, but have sustained pretty severe balance sheet damage between risk markets and the housing collapse.

the segment that has never saved is likely relying on working until they drop dead. as it happens many of this lot are also in parlous employment and are being shed as industry downsizes to meet the new demand level. for my money, as of now these folks represent the belated return of the elderly poverty that SSA was supposed to wipe out. many face a future of household consolidation and reliance on children, et al.

i would postulate that households will almost always take whatever financial rope you give them to hang themselves with, in large part because they aren't very bright. so the bid is nearly always there; the huge leveraging of the household was a result of banks and shadow banks lowering their offering standards. now those standards have tightened, and households will be compelled to delever in an environment of bank balance sheet reduction. some will pay down debt; others will default.

it will be unlike japan, i agree. deposit-poor banks here are likely to be compelled to use earnings to delever as cheap wholesale funding dries up -- that never happened in the deposit-rich japan of zombie banking. japan's household savings position has gradually deteriorated throughout its corporate-leverage crisis; america has a household-leverage crisis and household savings efforts really cannot get much worse. so where delevering japan saw zero interest rates, zombie banks, a decline in household savings and increasing real domestic consumption -- the delevering US will likely see nonzero interest rates, forced (and perhaps rapid) downsizing of banks, increasing household savings and declining real domestic consumption. in other words, i think the US situation will probably be more traumatic, central bank machinations notwithstanding.

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I agree, GM, that your scenario would probably play out absent government action--but there's the rub, isn't it? What keeps the government from issuing debit cards to everyone which they can reload with money at will (done already for unemployment and the $200 back-to-school fiasco in NY). I mean, if we're going to run $2 trillion deficits each year (OK, we probably won't quite get there this FY) why not just give every adult in the country $10K to "keep them going until things improve" or some such rhetoric. I know it sounds far-fetched right now, but things really haven't gotten bad yet.

Currency debasement is also an option. Saying that the government can't create inflation is wrong--perhaps they can't create it through conventional means and the banking system, but they can create it. Of course, the cure would be worse than the disease, but desperate people don't always think long or even medium term.

The put it in the metaphor of Dune, we are approaching a nexus.

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still a depression, but watching industrial production

barry eichengreen and kevin o'rourke update their charts to note the nascent divergence of industrial production from the early 1930s trend.

This is a sharp divergence from experience in the Great Depression, when the decline in industrial production continued fully for three years. The question now is whether final demand for this increased production will materialise or whether consumer spending, especially in the US, will remain weak, causing the increase in production to go into inventories, leading firms to cut back subsequently, and resulting in a double dip recession.

interestingly, of all the country breakdowns of individual nation industrial production, only the united states is faring better than in the great depression to date. this is very likely due to the reversal of its role in this crisis, as the erstwhile great current account surplus nation (a role now shared by china, japan and germany) to the world's great current account deficit nation and provider of excess demand.

but end demand does not appear to be resuscitating as of yet, except where dramatically subsidized from the public checkbook, nor is retail credit in any expanding as banks continue to reduce balance sheet. as noted by pragmatic capitalist, retail data are still indicating contraction.

Are investors beginning to notice the weekly negative trends in retail? ICSC came in at -0.5% on the week and -0.7% year over year. Redbook came in -4.1%. The strong negative trend in consumer spending cannot be ignored forever. At some point this is going to take a grip on the economy and the stock market. This is a very bad sign for back to school sales….

this bloomberg piece citing the opinions of paul tudor jones and clarium capital's kevin harrington roughly corroborate the view that there's clearly a cyclical inventory restocking afoot, but it may be one limited by the trailing off of fiscal stimulus spending as the year runs out.

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cash savings

via barry ritholtz at big picture, mark warywoda of addenda capital on the state of the consumer.

So far, all we have had is a two-quarter bump up in personal savings rates — that is trivial related to the outstanding debt burden. The debt-to-income ratios have barely budged, given that income had fallen at the same time that spending had fallen.

How is it was possible that debt-to-income ratios hadn’t improved much when the savings rate had gone up to 5%? The short answer is it comes down to the simple equation: Savings = DPI – personal outlays.

A true savings rate should compare personal outlays to only the portion of personal income that’s actually spendable (ex supplemental benefits). A savings rate computed on that basis remains stubbornly very negative. And debt burdens remain atrociously high, at a time when incomes and asset values remain under pressure.

Until about 1970, personal outlays (dominated by Personal Consumption Expenditures (PCE) (96.6%), but also including interest payments and transfer payments) were consistently held under the amount of cash receipts — but not in recent decades.

While the official personal savings rate has always been positive, though trending down over time since 1982 until 2008, the unofficial personal savings rate has trended down since WWII, turning negative in the 1970s, and exceeding -10% for much of the 2000s . . .

Economic growth has increasingly relied on debt growth. The government is trying to preserve economic growth by levering up to fill the void left by private sector deleveraging. But will it be able to do so for as long as house-holds need to continue to delever? Consumers over-consumed for years (because they could — because of housing “wealth”, MEW and excessive leveraging). Leverage allowed consumers to, over the course of the decade, basically get a bonus year’s worth of spending relative to pre-2000 historical spending norms.

note how the cash savings rate went negative more or less exactly as the great leveraging began in the late 1970s. one is of course a function of the other.

this is hardly new news, but i think it gives a better look at the amount of balance sheet repair that stretches out before the american household looking forward. rebuilding the savings base of the country is going to be a difficult and painful job, no matter how it's handled.

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