Wednesday, September 30, 2009

Germany Declares Economic War

Germany Declares Economic War

By Ambrose Evans-Pritchard, Telegraph.Co.Uk | 23 September 2009

Economics Last Updated: September 23rd, 2009

If there are any German readers of this blog, I would like to know what they think of the latest breath-taking provocations of German finance minister Peer Steinbrück.

Ill-informed belligerence: Peer Steinbrück
[[All he needs is a little more hair and a small mustache.: normxxx]]

Remember that Herr Steinbrück is not a journalist, pundit, or back-bench maverick. He speaks officially for the German government and for the German nation on the international stage. Every assertion that he made about Britain in his interview with Stern is either factually wrong, or such a serious distortion of events that it amounts to a smear. Furthermore, it was quite threatening.

What he said, in effect, is that Germany will 'marshal its forces' to ensure that a chunk of the British economy is shut down— whatever the social consequences. This is the closest thing I have seen to a declaration of economic warfare in Western Europe in my lifetime. "There is clearly a lobby in London that wants to defend its competitive advantage tooth and nail."

Stern said that he sees "dark powers at work" in Britain. He accused the UK government of "doing its best" to sabotage stricter financial regulation at the G20 in Pittsburgh. This resistance will be crushed. "We WILL effectively change the rules on the financial markets. Politics is sometimes like a locomotive which comes slowly up to full speed."

"The British financial industry gains 15 per cent of the gross domestic product, in Germany it is six per cent." Britain is out of step with the rest of Europe in trying to keep this "advantage going". It must "share the burden" of the financial crisis in the form of a tax on exchanges.

"The central question is who pays the bill? It cannot be that the citizens of Europe should carry the whole cost." Britain was having "an especially hard time, to put it politely", agreeing to tougher regulation of hedge funds.

Now, I understand that this Westphalian bully is fighting an election on Sunday, and may well be forced out of government. But let me state a few points.

1. Britain is not blocking the G20 deal on bonus caps for bankers. It broadly supports the idea. It backs the push for greater transparency.

2. Hedge funds had almost nothing to do with crisis as agreed by the Turner Report and the EU's Larosiere Report. They are already well regulated by the FSA in London (unlike New York, where they are not regulated). The FSA's hedge fund code is generally viewed as a model for others.

3. UK financial services are 7.8% of GDP, not 15%.

4. German Landesbanken and mortgage lenders got into trouble on their global ventures because they tried to extract extra profit and were badly regulated by BaFin, the Bundesbank, and Mr Steinbrück himself. Their use of Irish SIVs, etc, to conduct off-balance-sheet speculation is the direct result of bad rules (Basel, etc.) drawn up after earlier crises— a perfect example of how knee-jerk regulation by ignorant populists backfires.

5. Mr Steinbrück is the arch-cover-up artist himself. He has been resisting— "tooth and nail"— a transparent stress test of the German banks. This comes despite a string of criticisms from the IMF, OECD, and European Commission. It is blindingly obvious that he has swept the problems under the rug until after the election.

6. Britain is in considerable trouble right now— entirely of our own making, and caused by a decade of inept government, fiscal incontinence, and excess debt. Is that a moment to kick us in the teeth? One reason why the budget deficit has exploded to 13% of GDP is that the collapse of City profits has cut a huge hole in government revenues. There is already a brutal adjustment underway. What is the benefit of further contracting credit in the middle of severe downturn. The man is mad.

7. In terms of morality, I don't see much to choose between Germany's car industry (with its stress on high-powered engines that consume scarce resources, and pollute) and the 'City' of London. They are both core national industries, pillars of our respective economies.

8. Angela Merkel shares the British view that "binding powers" for the EU's new trio of super-regulators is a step too far, and a breach of Germany's constitution.

If a British Chancellor gave an interview on behalf of the British nation saying the German car industry should be shrunk massively, it would be viewed as a gross and gratuitous attack on Germany.

Need I add, yet again, that the banks did not cause this global crisis. Governments around the world caused the crisis by forcing down the price of credit (Greenspan, Bank of Japan, and ECB on short rates: China et al on long rates, by flooding the global bond market) far too low for many years, encouraging debt. Banks were the instruments, not the cause. That is an elementary point that many people— including Mr Steinbrück, obviously— still fail to understand.

The Westphalian bully likes taunting Britain. He made waves earlier this year mocking the "crass Keynesianism" of Gordon Brown at the most dangerous moment of the crisis. This prompted a formal protest by the British ambassdor in Berlin.

Mr Steinbrück subsequently engaged in a great deal of crass Keynesianism himself, as well as outright protectionism through the Deutschland Fund. [[A clear violation of EU rules!: normxxx]] If he remains in office, he will soon have to deal with the second leg of the German banking crisis that he has so artfully dodged until now. We must resist Schadenfreude when that moment comes.


German State To Lend Directly As 'Second Credit Crunch' Looms

By Ambrose Evans-Pritchard | 26 August 2009

Germany could directly intervene in the credit insurance and lending markets as soon as September, 2009 to head off a looming credit crunch, as it fears the economic recovery may soon falter as banks refuse to roll over loans. Tough action for tough times: the German government will be 'proactive' in heading off another credit crisis.

The finance minister, Peer Steinbrück, said broad sectors of the German economy are in trouble even if the country has avoided a full-blown lending crisis so far. "Conditions have become much tougher for some industries— electrical engineering, machine tools, suppliers, chemicals and shipbuilding. We have clear evidence from both small and large companies that lending is jammed. "The banks are not stepping up to their responsibility to provide credit," he told the German paper Handelsblatt.

"Some indicators have performed better, but… it is too early to say we have shaken off this crisis. There is still lots of risk and uncertainty, and no grounds for complacency. The fact that GDP proved better in the second quarter with 0.3% growth is somewhat reassuring, but let's not forget the economy has shrunk 7% from a year before."

Mr Steinbrück has now backed away from talk of forcing banks to lend, recognising they have to rebuild their capital, and shifted the focus to direct lending by the state. Among likely measures are use of the state-bank KFW to make "global loans" to industry on terms that pass on the full benefit of lower interest rates, as well state aid for credit insurance and trade finance. He said the bank rescue fund SoFFin still had €60bn left for support.

While some measures have been discussed before, there appears to be a new urgency. Decisions may be made by "early September". The comments are hard to reconcile with the a record surge in the IFO business confidence index, which jumped for a fifth month to 90.5 in August. Market sentiment is racing ahead of hard economic data.

Axel Weber, the Bundesbank chief and until recently the arch-hawk, last week spoke of a 'second wave' of the credit crisis as home-grown problems come to light, triggered by ratings downgrades that force banks to put aside more capital. "The first round of disruption in the bank balance sheets from structured credit products is behind us. Now we are threatened by stress from our domestic credit industry," he said.

"They are in panic," said Hans Redeker, currency chief at BNP Paribas. "They know the money supply and credit figures coming out are going to be awful". He added that Germany's stimulus measures have put off deep problems until after the election in September. The 'car scrappage scheme' has brought forward demand, implying a cliff-edge drop when the scheme expires. Kurzarbeit (short work) schemes that subsidise companies to keep idle workers on their books are slowly bleeding corporate balance sheets. "This has delayed the restructuring that needs to occur," he said.

Mr Steinbrück said markets are awash with liquidity again, but little is going into the real economy. "The banks evidently prefer to put their money into securities rather then granting new loans because they can get a higher return. After two years of financial crisis the gambler mentality is gaining the upper hand again."

The German authorities are deeply frustrated that so few banks have resorted to the 'rescue' scheme to rebuild their capital base. Critics say the Bundestag imposed such stringent conditions that lenders have opted instead to rein in lending. Mr Steinbrück said 'state lenders' pose a "systemic risk" to German finance. Few of the regional banks have a "viable" business model.

[[Sounds like a new new call for nationalizing (or, semi-nationalizing?) the banks! : normxxx]]

The Mortgage Machine Backfires

The Mortgage Machine Backfires

By Gretchen Morgenson | 26 September 2009

With the mortgage bust approaching Year Three, it is increasingly up to the nation's courts to examine the dubious practices that 'guided' the mania. A ruling that the Kansas Supreme Court issued last month has done precisely that. It has significant implications for both the mortgage industry and troubled borrowers.

The opinion spotlights a crucial but obscure cog in the nation's lending machinery: a privately owned loan tracking service known as the Mortgage Electronic Registration System (aka, MERS). This registry, created in 1997 to improve 'profits and efficiency' among lenders, 'eliminates' the need to record changes in property ownership in local land records[!?!] Dotting i's and crossing t's can be a costly bore, of course. And eliminating the need to record mortgage assignments locally helped keep the lending machine humming at hyperspeed during the boom.

But the MERS system also led to confusion. When MERS was involved, borrowers who hoped to work out their loans couldn't identify who they should turn to. And now, however, this 'clever' setup (for those 'clever' mortgage asset packagers) is coming under fire. Legal experts say the fact that the most recent assault comes out of Kansas, a state not known for radical jurists, makes the ruling even more meaningful.

Here's some background: For centuries, when a property changed hands, the transaction was submitted to county clerks who recorded it and filed it away. These records ensured that the history of a property's ownership was complete [[and 'freely' (notwithstanding minor administrative fees) and readily available to all: normxxx]] and that the priority of multiple liens placed on the property— a mortgage and a home equity loan, for example— was accurate. During the mortgage lending spree, however, home loans changed hands constantly [[and rapidly: normxxx]]. Those that ended up packaged inside of mortgage pools, for instance, were often involved in a dizzying series of transactions.

To avoid the costs and complexity of tracking all these exchanges, Fannie Mae, Freddie Mac and the mortgage industry set up MERS to record loan assignments electronically. This company didn't own the mortgages it registered, but it was listed in public records either as a nominee for the actual owner of the note or as the original mortgage holder. Cost savings to members who joined the registry were meaningful. In 2007, the organization calculated that it had saved the industry $1 billion during the previous decade. Some 60 million loans are registered in the name of MERS.

As long as real estate prices rose, this system ran smoothly. When that trajectory stopped, however, foreclosures brought against delinquent borrowers began flooding the nation's courts. MERS filed many of them.

"MERS is basically an electronic phone book for mortgages," said Kevin Byers, an expert on mortgage securities and a principal at Parkside Associates, a consulting firm in Atlanta. "To call this electronic registry a creditor in foreclosure and bankruptcy actions is legal pretzel logic, nothing more than an artifice constructed to save time, money and paperwork". As cases filed by MERS grew, lawyers representing troubled borrowers began questioning how an electronic registry with no ownership claims had the right to evict people.

April Charney, a consumer lawyer at Jacksonville Area Legal Aid in Florida, was among the first to argue that MERS, which didn't own the note or the mortgage, could not move against a borrower. Initially, judges rejected those arguments and allowed MERS foreclosures to proceed. Recently, however, MERS has begun losing some cases, and the Kansas ruling is a pivotal loss, experts say. While the matter before the Kansas Supreme Court didn't involve an action that MERS took against a borrower, the registry's legal standing is still central to the ruling.

The case involved a borrower named Boyd A. Kesler, who had taken out two mortgages from two different lenders on a property in Ford County, Kan. The first mortgage, for $50,000, was underwritten in 2004 by Landmark National Bank; the second, for $93,100, was issued by the Millennia Mortgage Corporation in 2005, but registered in MERS's name. It seems to have been transferred to Sovereign Bank, but Ford County records show no such assignment.

In April 2006, Mr. Kesler filed for bankruptcy. That July, Landmark National Bank foreclosed. It did not notify either MERS or Sovereign of the proceedings, and in October, the court overseeing the matter ordered the property sold. It fetched $87,000 and Landmark received what it was owed. Mr. Kesler kept the rest; Sovereign received nothing.

Days later, Sovereign asked the court to rescind the sale, arguing that it had an interest in the property and should have received some of the proceeds. It told the court that it hadn't been alerted to the deal because its nominee, MERS, wasn't named in the proceedings. The court was unsympathetic. In January 2007, it found that Sovereign's failure to register its interest with the county clerk barred it from asserting rights to the mortgage after the judgment had been entered.

The court also said that even though MERS was named as mortgagee on the second loan, it didn't have an interest in the underlying property. By letting the sale stand and by rejecting Sovereign's argument, the lower court, in essence, rejected MERS's business model. Although the Kansas court's ruling applies only to cases in its jurisdiction, foreclosure experts said it could encourage judges elsewhere to question MERS's standing in their cases.

"It's as if there is this massive edifice of pretense with respect to how mortgage loans have been recorded all across the country and that edifice is creaking and groaning," said Christopher L. Peterson, a law professor at the University of Utah. "If courts are willing to say MERS doesn't have any ownership interest in mortgage loans, that may eventually call into question the priority of liens recorded in MERS's name, and there are millions and millions of them". In other words, banks holding second mortgages could find themselves in the same pair of unlucky shoes that Sovereign found itself wearing in Kansas.

Asked about the ruling, Karmela Lejarde, a spokeswoman for MERS, contested the court's reasoning. "We believe the Kansas Supreme Court used an erroneous standard of review; this is not the end of the judicial process," she said. "The mortgages on which MERS is the mortgagee will remain binding contracts."

But Patrick A. Randolph, a law professor at the University of Missouri, Kansas City, who describes himself as "a friend of MERS", described the recent decision as unsettling. "This opinion is hostile to the notion of MERS as nominee and could lead to problems for it in foreclosing," he said. "The entire structure of MERS as a recorded nominee could collapse in Kansas, and that could lead to a patch-up job where they would have to run around and re-record the mortgages."

If so, MERS would be hoisted on its own petard. And it would be a rare case of poetic justice in this long-running mortgage mess. [[Well, maybe not so poetic, as the eventual 'stuckees' for those mortgages will actually be the buyers of most of those ABSs— pension funds, retirement funds, insurance companies, municipalities, private individuals— even foreign cities.: normxxx]]

Tuesday, September 29, 2009

Money Figures Show There's Trouble Ahead

Money Figures Show There's Trouble Ahead

By Ambrose Evans-Pritchard | 29 September 2009

Private credit is contracting on both sides of the Atlantic. The M3 money data is flashing early warning signals of a deflation crisis next year in nearly half the world economy. Emergency schemes that have propped up spending are being withdrawn, gently or otherwise.

Unemployment benefits have masked social hardship until now but these are starting to expire with cliff-edge effects.The jobless army in Spain will be reduced to €100 a week; in Estonia to €15. Whoever wins today's elections in Germany [[Merkel and the 'right wing': normxxx]]will face the reckoning so deftly dodged before. Kurzarbeit, that subsidises firms for not firing workers, is running out. The cash-for-clunkers scheme ended this month. It certainly "worked".

Car sales were up 28% in August, but only by stealing from the future. The Center for Automotive Research says sales will fall by a million next year: "It will be the largest downturn ever suffered by the German car industry". Fiat's Sergio Marchionne warns of "disaster" for Italy unless Rome renews its car scrappage subsidies. Chrysler too will see some "harsh reality" following the expiry of America's scheme this month. Some expect US car sales to slump 40% in September.

Weaker US data is starting to trickle in. Shipments of capital goods fell by 1.9% in August. New house sales are stuck near 430,000— down 70% from their peak— despite an $8,000 tax credit for first-time buyers. It expires in November.

We are moving into a phase when most OECD states must retrench to head off debt-compound traps. Britain faces the broad sword; Spain has told ministries to slash 8% of discretionary spending; the IMF says Japan risks a funding crisis. If you look at the sheer scale of global stimulus this year, what shocks is how little has been achieved.

China's exports were down 23% in August; Japan's were down 36%. Industrial production has dropped by 23% in Japan, 18% in Italy, 17% in Germany, 13% in France and Russia and 11% in the US. Call this a "V-shaped" recovery if you want. Markets are pricing in economic growth that is not occurring.

The overwhelming fact is that private spending has slumped in the deficit countries of the Anglosphere, Club Med, and East Europe, but has not risen enough in the surplus countries (East Asia and Germany) to compensate. Excess capacity remains near post-war highs across the world. Yet inflation hawks are already stamping feet at key central banks. Are they about to repeat the errors made in early 2007, and then again in the summer of 2008, when they tightened— or made hawkish noises— even as the underlying credit system fell apart?

Fed chairman Ben Bernanke spoke in April 2008 of "a return to growth in the second half of this year", and again in July 2008 that growth would "pick up gradually over the next two years". He could only have thought such a thing if he was ignoring the money data. Key aggregates had been in free-fall for months.

I cited monetarists in July 2008 warning that the lifeblood of the Western credit was "draining away". For whatever reason (the lockhold of 'New' Keynesian ideology?) the Fed missed the signal. So did the European Central Bank when it raised rates weeks before the Lehman collapse, blathering about a "1970s inflation spiral". [[which only they were able to see! : normxxx]]

Yes, the money entrails can mislead. The gurus squabble like Trotskyists. But you ignore the data at your peril.

Tim Congdon from International Monetary Research says that US bank loans have been falling at an annual pace of almost 14% since early Summer: "There has been nothing like this in the USA since the 1930s." M3 money has been falling at a 5% rate; M2 fell by 12% in August; the Commercial Paper market has shrunk from $1.6 trillion to $1.2 trillion since late May; the Monetary Multiplier at the St Louis Fed is below zero (0.925). In Europe, M3 money has been contracting at a 1% rate since April.

Private loans have fallen by €111bn since January. Whether you see a credit crunch in Euroland depends where you sit. It is already garrotting Spain. Germany's Mittelstand says it is "a reality", even if not for big companies that issue bonds. The German Economy Ministry is drawing up plans for €250bn in state credit, knowing smaller firms will be unable to roll over debts.

Bundesbank chief Axel Weber sees no crunch now, yet fears a 'second pulse' of the crisis this winter. "We are threatened by stress from our domestic credit industry through the rise in the insolvency of firms and households," he says. Draw your own conclusion. Western central banks will have to "monetize" deficits on a huge scale to stave off debt deflation. The longer they think otherwise, the worse it will be.

Sunday, September 27, 2009

My Trading Philosophy

…are you saying that the markets are not likely to see any gross movement 24 hours after either an attack by Israel or Iran, or say, any movement, over the next 7 days, 1 month, 3 months, that it'd all happen in the 1st hour or so?

Clearly you are in need of 'boning up' on the "Efficient Market Hypothesis" (AKA, EMH)! There is a "hard" form and a "soft" form.

The hard form says that all public information/knowledge is immediately factored into market prices, so that whatever you do, once you take the risks into account, you are no better off than you were before such knowledge was made public! Despite its non-intuitive nature, this form actually was able to survive for many years (before it was proved to be technically) false. What that means, is that for all intents and purposes, you would need to be a Wall Street 'quant' in order to "take advantage of" any 'breaking' news.

This is more or less easily refuted (nowadays), since using a 'reductio ad absurdum' you can prove that the hard EMH will predict that since the market is 'always at or near equilibrium', little or no trading takes place (especially as all of that news will most probably cancel itself out)! Or that such trading as does take place is correlated to the amount of news breaking at any given time (but how does one measure that?) and is entirely random as to net market effects. It also assumes the 'absence' (improbability) of any large anomalies, so that it is constitutionally unable to come up with a reasonable explanation for something like the October 19, 1987 25% stock market crash! (The EMH explanation is that such an event is perfectly predictable as a very, very low probability event way out on the tail of the gaussian distribution, ie, a "once in the lifetime of the universe event"! Unfortunately, such events seem to be happening rather more frequently (sometimes within hours of each other— much to the surprise and chagrin of the 'quants'.)

The soft form allows that stock market prices may not immediately reflect the news, but on the average over the long run, you would do no better than chance (ie, your net gain would be zero) by trying to beat the effects of the news (sometimes the effects will go one way, sometimes the other)! A terrific example of this is what happened to the Wall Street 'quants' in summer of 2007. For almost 5 years, the 'quants' had seemingly beaten the averages by using incredibly obstruse mathematical algorithms (which no one on Wall street understood except them), super-computers, "flash trading", and similar techiques to take advantage of very, very minor "anomalies" in stock market prices that appeared only briefly (before traders such as the quants erased them). Then in the space of days, they lost all of the money they had gained— and then some— when the market 'perversely' turned against their models, causing the stocks they had shorted to go up and the stocks they held long to go down! A double whammy which was due to the fact that their models had assumed no correlation among prices but, in fact, the very (similar) models the quants created produced exactly such a correlation! Moral: the market is not infinite, is not gaussian, and is prone to (correlated) panic! (P.S. The crashes of 2008 and March, 2009 improved their education still further!)

I do not hold with EMH (insofar as I have any overriding philosophy of the market, I am a behavioral finance theorist); however, I have never been able to refute the 'soft' version of EMH (nor, to my knowledge has anyone else). So, I adhere to the principle that long term investing and avoiding "running with the pack", aka, "MOMO" investing, is best. That is, I use a "contrary", 'informed' investing approach that will produce positive results in the long run, because most investors are quite short term oriented and heavily influenced by what others are doing! (So, I am taking advantage of an "anomaly" which most other traders are not willing to exploit.)

However, I very strongly do not believe in the 'Buy and Hold' investing approach, much favored by Wall Street for 'naive' investors, especially as I very strongly believe that the market is cyclical in nature— though as with all things involving people, hardly perfectly so. As various people can attest, I have been predicting something close to financial Armageddon from 2001 on (though I was a little late; I expected it to occur around 2008/9… and not 2007/8…). This was largely because of the state of the financial markets (it was clear already in 2001 for anyone willing to see that we were absolutely in "melt up mode" financially that made the twenties look tame by comparison and could only have ended the same way!) and because the market has a very strong tendency to "echo" itself every forty years or so (2009 is 80 years after 1929 and the horrible markets of the '30s, and 40 years after 1969 and the horrible markets of the '70s)! Indeed, the horrendous bear market of 2000-2002 merely echoed the bear market of 1920-21. And, yes, 1960 was a (mild) recession year.

For my serious money, I prefer to use Sy Harding's STS timing approach… Check it out. I have been aware of the 'seasonal effect' in the stock market for over 40 years; but that effect was too marginal to use for trading, until Sy added his 'tweak'.

Saturday, September 26, 2009

Equity Market Est Tres Expensif

Equity Market Est Tres Expensif

By David Rosenberg | 26 September 2009
Chief Economist And Strategist, Gluskin Sheff & Associates.

The S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings and history shows that at these high valuation levels, the market declines in the coming year 60% of the time.

All we know is that we have a trailing P/E multiple (operating earnings) on the S&P 500 of 26.5x— a record expansion of eight multiple points from the low over a mere six-month span. Take note that this is the highest P/E multiple since March 2002, which is right around the time that the bear market rally at that time (also premised on post-crisis "V-shaped" recovery hopes) began to roll over. It took a good year for the fundamental bottom in the market to be put in, and that was heresy back then too.

The P/E multiple on non- "scrubbed reported earnings" [[ie, the stuff we need to report to the IRS or land in the clinker: normxxx]] has soared 60 points since March to 184x. Which is not only a record, but five times more expensive than what we saw during the peak of the dotcom bubble a decade ago (oh, but we forgot— write-downs don't matter, especially if you've been "bailed out"!). Going back over the last six decades, we know that the market typically faces serious valuation constraints once it breaches the 25x P/E multiple threshold.

The mean total return, thereafter, on the S&P 500 a year out, is -0.3% and the median is -6.2%. And that total return is negative 60% of the time, so when we say that there is too much growth and too much risk embedded in the equity market right now, we like to think that we have history on our side. As for valuation, well let's consider that from our lens, the S&P 500 is now priced for $83 in 'operating' EPS (we come to that conclusion by backing out the earnings yield that would match the current inflation-adjusted Baa corporate bond yield).

That is nearly a double from the most recent four-quarter trend. Not only that, but the current 'top-down' (analysts') estimates on operating EPS, are $48.00 for 2009; $52.60 for 2010; $62.50 for 2011; and $81.00 for 2012. The 'bottoms-up' (analysts') consensus forecasts only go to 2010 and even for this usually bullish bunch operating EPS is seen at only $73 for 2010, which means that $83 is likely a 2012 story according to them. Either way, the market is basically discounting an earnings stream that even the usually overly optimistic consensus does not see for another two to three years. This is more than just a 'fully' priced market at this point.

The S&P 500 is, in fact, deeply overvalued at this juncture. Imagine that, a mere six months after record depressed lows we have a situation where:

• The trailing price-earnings ratio on operating EPS is 26.5x.

• The trailing price-earnings ratio on reported EPS is

• The price-to-dividend ratio is
53x, where it was at the 2007 highs. Again, the market is trading as if it were at a peak for the cycle, not any longer near a trough.

• The price-to-book ratio is
2.3x. If you want undervalued, try August 1982— the onset of an 18-year secular bull market— when the S&P 500 bottomed after trading at a discount to book value.

Friday, September 25, 2009

Spain Tips Into Depression

Spain Tips Into Depression

By Ambrose Evans-Pritchard | 24 September 2009

Spain is sliding into a full-blown economic depression akin to that seen in the 1930s, with unemployment approaching levels not seen since the Second Republic of the 1930s and little chance of recovery until well into the next decade, according to a clutch of reports over recent days. The Madrid research group RR de Acuña & Asociados said the collapse of Spain's building industry will cause the economy to contract for the next three years, with a peak to trough loss of over 11% of GDP. The grim forecast is starkly at odds with claims by premier Jose Luis Zapatero, who still says Spain's recession will be milder than elsewhere in Europe.

RR de Acuña said the overhang of unsold properties on the market, or still being built, has reached 1,623,000. This dwarfs annual demand of 218,000, and will take six or seven years to clear. The group said Spain's unemployment will peak at around 25%, comparable to the worst chapter of the Great Depression.

Spanish workers typically receive 50% to 60% of their former pay for eighteen months after losing their job. Then the guillotine falls. Spain's parliament has rushed through a law guaranteeing €420 a month for long-term unemployed, but this will not prevent a social crisis if the slump drags on. Separately, UBS said unemployment will reach 4.8m and may go as high as 5.4m if the job purge in the service sector gathers pace. There is the growing risk of a "Lost Decade" akin to Japan's malaise after the Nikkei bubble.

Roberto Ruiz, the bank's Spain strategist, said salaries must fall by 10% in real terms to regain lost competitiveness, replicating the sort of wage squeeze seen in Germany after reunification. There is no sign yet that either Spanish trade unions or the Zapatero government are ready for such draconian measures. Talks between the unions and Spain's industry federation (CEOE) broke down in acrimony in July.

Mr Ruiz said the construction sector will shrink from 18% of GDP at the peak of the boom to around 5%, making it unlikely that there will be any significant recovery before 2012. Even then growth will be "slow, weak, and fragile". The Spanish government can do little to cushion the downturn. "The room for manouvre in fiscal policy has been exhausted," said Mr Ruiz.

The rocketing cost of jobless benefits has added 3% of GDP to the budget deficit. Mr Zapatero has ordered all ministries to cut 8% of discretionary spending to help plug the gap left by collapsing tax revenues. The axe is likely to fall on research and big projects such as high-speed railways.

The root cause of Spain's trouble is that it joined monetary union before its economy was ready. EMU halved Spanish interest rates almost overnight. Real rates were minus 2% for much of this decade. Combined private and corporate debt reached 230% of GDP, funded by French and German savings.

The credit boom masked a steady decline in productivity over the last decade. Spain's unit labour costs have risen by about 30% compared to Germany. The Bank of Spain made heroic efforts to counter the effects of the bubble by forcing banks to put aside extra reserves, known as 'dynamic provisioning', but the sheer scale of the problem has washed over the defences. Spain no longer has the escape valve of devaluation to claw back market share.

It cannot resort to emergency monetary stimulus— as Switzerland, Britain, the US, and Japan are doing to prevent the onset of debt deflation. Prices are already falling at a rate of 1.2%. Jamie Dannhauser from Lombard Street Research said Spain is bearing the full brunt of the European Central Bank's restrictive monetary policy, which has caused private sector credit in the eurozone to shrink over the last six months. The latest ECB data shows that 60% of Spanish firms have seen access to credit fall so far this year. Most say they have been denied their full request for loans or credit lines.

Mr Dannhauser said Spain faces the same sort of boom-bust headache as Britain. The big difference is that Spain cannot let the exchange rate take the strain. "It is going to be very hard for them to sort this out in a currency union."

For the time being, an odd calm prevails across the Iberian peninsular. There are no street riots, even though youth unemployment has reached 38%. It is hard to imagine anything like the bloody uprising by Asturian miners in 1934, the last time so many people were without jobs.

Local communities have started to issue scrip currency known as "moneda social", based on reflation experiments tried by Austrian cantons in 1932 and more recently by Argentina. Yet few blame the crisis on the effects of the euro. There is a near total backing for EMU, in contrast to France and Germany where a small but vocal minority has never accepted the wisdom of Europe's one-size-fits-all system. Membership in the EU and the euro is inextricably linked in Spain's collective mind to the country's re-emergence as a modern, dynamic European power after the stultifying isolation of the Franco dictatorship. It would take a major trauma to test that bond.

See also Spain: The Hole In Europe's Balance Sheet

Thursday, September 24, 2009

Did The Fed Just Kill The Bull Market?

Did The Fed Just Kill The Bull Market?

By Anthony Mirhaydari | 24 September 2009

Well, that was interesting. After the Federal Reserve announced on Wednesday it would leave interest rates unchanged, stocks initially bounded higher before abruptly shifting direction and screaming lower. The bulls gunned the Dow Industrial Average achingly close to the 10,000 level before things fell apart.

At issue wasn't the Fed's target policy rate, which affects short-term interest rates. Instead, traders were apparently concerned that Fed chairman Ben Bernanke and his cohorts failed to expand its direct purchases of mortgages and government debt. This will likely result in higher long-term rates.

You see, the Federal Reserve has been engaging in unorthodox monetary policy over the past 9 months via "Permanent Open Market Operations," or POMO. Fed traders were authorized in March to spend some $300 billion to buy U.S. Treasury debt and $1.45 trillion to buy mortgage-backed securities and debt from government-controlled housing lenders Fannie Mae and Freddie Mac. With the original budget on the Treasury allocation nearly exhausted, many wondered if the Fed will let the program expire, or renew it. Today we got our answer and Wall Street didn't like it.

This is important since not only did these purchases help the federal government continue its simulative deficit spending over the cries of budget hawks in Congress, it helped keep a lid on borrowing rates throughout the economy. Thus, we had a unique situation where stocks were rising without a concurrent and ultimately self-defeating rise in Treasury yields. To use an analogy, this is akin to enjoying a daily slice of chocolate cheesecake without an expansion in your waistline.

Despite a 57% rise in the S&P 500 since March, the yield on 5-Year Treasuries has advanced only 0.4%. During the early stages of the 2003 bull market, interest rates jumped more than 1.1%. While the difference may seem miniscule, it has a huge affect on the internal return calculations performed by corporate financial officers and trading managers. Anecdotal evidence suggests private traders enjoyed buying financial assets alongside Bernanke & Co.

On Monday, the Fed announced it had purchased $4 billion worth of mostly five-year Treasury notes. The announcement came at 10:15 am, which was the same time that stocks hit their intraday low before moving higher. The effort has also helped weaken the U.S. dollar, which the stock market likes as well since it boosts the competitiveness of U.S. exports, adding to GDP growth.

In an ideal world, the Fed would continue these efforts. There is still plenty of excess capacity in the economy as unemployment remains high, wage growth is stagnant, energy prices remain relatively low, and factories remain shuttered. But with the G20 powwow about to start, the Fed probably worried about the vocal opposition to these direct purchases voiced by our foreign creditors in China, Russia, and elsewhere.

They also feared the market's reaction to an expansion of POMO, which would require yet further increases in the money supply. The obvious results would have been further weakening of the dollar and an increase in inflation expectations— both of which would have increased long-term interest rates and cancelled out the benefits of increased POMO. Now, the equity market must operate in a more normal environment where rising stock prices result in higher interest rates. The question is: Can the economy, with its nascent recovery, handle more expensive credit?

Wednesday, September 23, 2009

From Bear To Bull

From Bear To Bull
James Grant Argues The Latest Gloomy Forecasts Ignore An Important Lesson Of History: The Deeper The Slump, The Zippier The Recovery.

Click here for a link to ORIGINAL article:

By James Grant | 23 September 2009

As if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless. But they don't know, and can't. The future is unfathomable.

Not famously a glass half-full kind of fellow, I am about to propose that the recovery will be a bit of a barn burner. Not that I can really know, either, the future being what it is. However, though I can't predict, I can guess. No, not "guess." Let us say infer.

The very best investors don't even try to forecast the future. Rather, they seize such opportunities as the present affords them. Henry Singleton, chief executive officer of Teledyne Inc. from the 1960s through the 1980s, was one of these enlightened opportunists. The best plan, he believed, was no plan. Better to approach an uncertain world with an open mind.

"I know a lot of people have very strong and definite plans that they've worked out on all kinds of things," Singleton once remarked at a Teledyne annual meeting, "but we're subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible." Then how many influences, outside and inside, must bear on the U.S. economy?

Though we can't see into the future, we can observe how people are preparing to meet it. Depleted inventories, bloated jobless rolls and rock-bottom interest rates suggest that people are preparing for to meet it from the inside of a bomb shelter. [[And Wall Street insanely bullish once more, as at the top in 2007? And housing foreclosures and unemployment still climbing, and consumers (involuntarily?) increasing savings up to 7%? Where are those recovery $$$s to come from?: normxxx]]

The 'Great Recession' destroyed confidence as much as it did jobs and wealth. Here was a slump out of central casting. From the peak, inflation-adjusted gross domestic product has fallen by 3.9%. The 'meek and mild' downturns of 1990-91 and 2001 (each, coincidentally, just eight months long, hardly worth the bother), brought losses to the real GDP of just 1.4% and 0.3%, respectively.

That recession that sunk its hooks into the U.S. economy in the fourth quarter of 2007 has set unwanted records [[,eg,: normxxx]] in such vital statistical categories as manufacturing and trade inventories (the steepest decline since 1949), capacity utilization (lowest since at least 1967) and industrial production (sharpest fall since 1946). And it isn't just every postwar disturbance that sends Citigroup Inc. (founded in 1812) into the arms of the [Fed] or has General Electric Co. (triple-A rated from 1956 to just this past March) 'borrowing' under the wing of the Federal Deposit Insurance Corp. Neither does every recession feature zero percent Treasury bill yields, a coast-to-coast bear market in residential real estate or a Federal Reserve balance sheet beginning to resemble that of the Reserve Bank of Zimbabwe. Yet these things have come to pass.

Americans are blessedly out of practice at bearing up under this sort of economic adversity. Individuals take their knocks, always, as do companies and communities. But it has been a generation since a business cycle downturn exacted the collective pain that this one has done. Knocked for a loop, we forget a truism.

With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery. To quote a dissenter from the forecasting consensus, Michael T. Darda, chief economist of MKM Partners, Greenwich, Conn.: "[T]he most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period."

Growth snapped back sharply following the depressions of 1893-94[!?!] 1907-08, 1920-21 and 1929-33 [[yes, indeed, from 1933 to 1936. But what of the depressions of 1837 (6 years), 1857 (5 years), and 1893, the depression that inspired "Coxey's Army," that lasted by most accounts for 4 years.: normxxx]] If ugly downturns made for torpid recoveries, as today's economists suggest, the economic history of this country would have to be rewritten. Amity Shlaes, in her "The Forgotten Man," a history of the Depression, shows what the New Deal failed to achieve in the way of long-term economic stimulus.

However, in the first full year of the administration of Franklin D. Roosevelt (and the first full year of recovery from the Great Depression), inflation-adjusted gross national product spurted by 17.3%. Many were caught short. Among his first acts in office, Roosevelt had closed the banks. He had excoriated the bankers, devalued the dollar, called in the people's gold and instituted, through the National Industrial Recovery Act, a program of coerced reflation.

"At the business trough in 1933," Mr. Darda points out, "the unemployment rate stood at 25% .(if there had been a 'U6' version of labor underutilization then, it likely would have been about 44% vs. 16.8% today… [[industrial (non-farm?) unemployment stood at 35%: normxxx]]. At the same time, the consumption share of GDP was above 80% in 1933 and the household savings rate was negative. [[So, is this 1930 or 1933!?!: normxxx]] Yet, in the four years that followed, the economy expanded at a 9.5% annual average rate while the unemployment rate dropped 10.6 percentage points." Not even this mighty leap restored the 27% leap of 1929 GNP that the Depression had devoured.

But the economy's lurch to the upside in the [economically and] politically inhospitable mid-1930s should serve to blunt the force of the line of argument that the 2009-10 recovery is doomed because private enterprise is no longer practiced in the 50 states.

To the English economist Arthur C. Pigou is credited a bon mot that exactly frames the issue. "The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant". So it is today. Paul A. Volcker, Warren Buffett, Ben S. Bernanke and economists too numerous to mention are on record talking down the recovery before it fairly gets started.

They collectively paint the picture of an economy that got drunk, fell down a flight of stairs, broke a leg and deserves to be lying flat on its back in the hospital contemplating the wages of sin. Among economists polled by Bloomberg News, the median 2010 GDP forecast is for 2.4% growth. It would be a unusually flat rebound from a full-bodied downturn. Our recession, though [[as yet: normxxx]] a mere 'inconvenience' compared to some of the cyclical snows of [early] yesteryear, does bear comparison with the slump of 1981-82. In the worst quarter of that contraction, the first three months of 1982, real GDP shrank at an annual rate of 6.4%, matching the steepest drop of the current recession, which was registered in the first quarter of 2009.

Yet the Reagan recovery, starting in the first quarter of 1983, rushed along at quarterly growth rates (expressed as annual rates of change) over the next six quarters of 5.1%, 9.3%, 8.1%, 8.5%, 8.0% and 7.1%. Not until the third quarter of 1984 did real quarterly GDP growth drop below 5%. One may observe that Ronald Reagan stood for enterprise, free trade and low taxes, whereas Barack Obama stands for other things.

President Obama's economic policies seem almost as far removed from Roosevelt's as they are from Reagan's. (Not for Obama, at least not yet, is a new National Recovery Administration [[or cutting government spending to make good on his campaign promise of 'balancing the budget': normxxx]]). Certainly, Roosevelt never attempted anything like the fiscal and monetary resuscitation organized over the past 12 months.

In the post World War II era, the government has attacked recessions with an average fiscal stimulus of 2.6% of GDP and an average monetary stimulus of 0.3% of GDP, for a combined countercyclical lift of 2.9%. (Fiscal stimulus I define as the cumulative change in the federal budget, monetary stimulus as the cumulative change in the Fed's balance sheet, both measured from the peak of the boom to the trough of the bust.) This time out, the fiscal stimulus is likely to measure 10% of GDP, monetary stimulus 9.5% of GDP, for a combined pick-me-up equivalent to 19.5% of GDP. Our Great Recession would be marked for greatness if for no other reason than by the outpouring of federal dollars to repress it.

What did we do before Timothy Geithner and Ben Bernanke? In the day, it was the self-regenerative power of markets that lifted us off the rocks. The brutality of the depression of the early 1920s [[as also the '30s fiasco: normxxx]] could not have been far from the mind of President Harry S Truman as he signed into law the 1946 act to make it the government's business to maintain the economy at full employment. That 1920-21 crackup featured a deflationary collapse— wholesale prices plunged by 37%— and, by 21st century lights, a highly unconventional set of government measures to set things right.

"The fall in market prices raised the public's stock of real [money] balances above the desired amount, just as if the Federal Reserve had increased base money at a constant price level," monetary historian Allan H. Meltzer relates in his "A History of the Federal Reserve". And so ended the 1921 depression! But [in reaction to] the 1921 downturn, the Fed had raised, not lowered, interest rates and Congress had balanced the budget— indeed, ran a surplus. Yet the depression ended.

How, exactly, did it end? Falling prices opened wallets, Meltzer explains. Finding bargains, consumers and investors snapped them up.After falling by 4.4% in 1920 and by 8.7% in 1921, inflation-adjusted GNP shot up by 15.8% in 1922 and by 12.1% in 1923. Bargain-hunting is the balm of recovery even today, dead set against low prices the Federal Reserve might be.

Detroit is a living laboratory in many things, including the so-called real balance effect. As Marshall Mandall, a RE/MAX agent in that city, tells the story, house prices are still falling at the high end of the market, though they have stabilized at the low end [[$8000 stimulus, anyone?: normxxx]]. Transaction volumes are rising. Speculators are on the prowl, but so, too, are ordinary home buyers.

It seems— who'd have guessed it?— that value sells. "They can buy something for half of what they could three years ago," Mr. Mandall says. "Everybody perceives bargains in their house-hunting". At the end of the second quarter, according to the Detroit Free Press, the supply of unsold houses was equivalent to 8.5 months' sales, down 39% from the year before.

Through the first six months of 2009, the Case-Shiller 10-City Composite index of house prices fell by 5.5% compared to year-end 2008. However, the rate of decline has been slowing and, indeed, the index recorded month-to-month appreciation in May and June. It may just be that the Fed's assumption of a 14% decline in prices this year (built into the base case of its bank stress test) is unrealistically bearish. [[We are just entering into the second peaking of the ARMs resets… and, of course, unemployment is still growing: normxxx]].

The Fed's voice is among the saddest in the lugubrious choir of bearish forecasters, and for good reason. By instigating a debt boom, the Bank of Bernanke (and of his predecessor, Alan Greenspan) was instrumental in causing our troubles. You might have thought that it would therefore see them coming. Not at all. Belatedly grasping how bad was bad, it has thrown the kitchen sink at them.

And it maintains this stance of radical ease lest it get the blame for a relapse. However, by driving money market interest rates to zero and by setting all-time American records in money-printing ($1.2 trillion conjured in the past 12 months), the Fed is putting the value of the dollar at risk. Its wide-open policy all but begs our foreign creditors to ask the fatal question, What is the dollar, anyway? Why, the dollar is a scrap of paper, or an electronic impulse, the value of which is anchored by the analytical acuity of the monetary bureaucracy that failed to predict the greatest financial crackup since the 1930s.

The Fed may be worried about something else. By sitting on interest rates, it is distorting every business and investment decision. If mispriced debt was the root cause of the narrowly-averted destruction of global finance, the Fed is well on its way to setting the stage for some distant (let us hope) Act II. In the meantime, ultra-low interest rates have lit a fire under the stock and debt markets.

By rallying, equities and corporate bonds not only anticipate recovery, but they also help to bring it to fruition. By opening their arms wide to such previously unfinanceable businesses as AMR Corp., parent of American Airlines, and Delta Air Lines Inc., [[and those "too big to fail banks"; never forget them: normxxx]] the newly confident credit markets are implementing their own stimulus program. "Reflexivity" is the three-dollar word coined by the speculator George Soros to describe the dual effect of market oscillations.

Not only does the rise and fall of the averages reflect economic reality, but it also changes it. One year ago, the Wall Street liquidation stopped world commerce in its tracks. Today's bull markets are helping to revive it. I promised to be bullish , and I am (for once)— bullish on the prospects for unscripted strength in business activity. So, too, is the Economic Cycle Research Institute, New York, which was founded by the late Geoffrey Moore and can trace its intellectual heritage back to the great business-cycle theorist Wesley C. Mitchell.

The institute's long leading index of the U.S. economy, along with supporting sub-indices, are making 26-year highs and point to the strongest bounce-back since 1983. A second nonconformist, the previously cited Mr. Darda, notes that the last time a recession ravaged the labor market as badly as this one has— the years were 1957-58— payrolls climbed by a hefty 4.5% in the first year of an ensuing 24-month expansion [[but that was before the wholesale replacement of workers by automation and when the laid off workers were largely blue collar: normxxx]] . Which is not to say, he cautions, that growth this time will match that pace, only that growth is likely to surprise by its strength, not weakness.

And that is my case, too. The world is positioned for disappointment. But, in economic and financial matters, the world rarely gets what it expects. Pigou had humanity's number. The "error of pessimism" is born the size of a full-grown man— the size of the average adult economist, for example.

[ Normxxx Here:  Strong (above expected) recovery yes! But beware that DOUBLE dip!  ]

James Grant is the editor of Grant's Interest Rate Observer. Among his books is "The Trouble with Prosperity."

Tuesday, September 22, 2009

Does The EU Club Have A Future?

Does The EU Club Have A Future?
The Economic Crisis Has Transformed The Global Economic Landscape… The Dreams Of A Decade Ago Now Seem Grandiose… Strasbourg's Babel House Has No Unifying Language Or Political Culture…

By Ambrose Evans-Pritchard. | 22 September 2009

Broadly speaking, the world is run at the outset of the 21st Century by the United States and China together in uneasy condominium. This is the surprising reality of our era. The pattern is unlikely to change much until India takes its full place, perhaps in 40 years.

The baton passed from Europe's tired hands at London's G20 summit in April, where the only meeting that mattered was the tete-a-tete between Barack Obama and Hu Jintao. The two Pacific superpowers are meshed together by their "dollar-yuan" currency and de facto debt union, and by their 'Strategic Economic Dialogue'. Let's just call it G2 for short. China's return to great power status is well known, but some may be surprised to learn that America's share of global GDP has scarcely changed in 30 years, falling slightly to 20 per cent depending how you measure it.

Greater Europe has slipped relentlessly. The Western part is still rich, but counts ever less in world affairs as ageing takes it toll. The United Nations expects America to add 100 million people by 2050: Germany will contract from 82 million to 70 million. Italy will shrink. Eastern Europe faces implosion.

This is not fertile demography for hi-tech invention. "What is at risk in the medium to long run is nothing less than the sustainability of the society Europe has built and the viability of its civilisation," admitted an internal EU report by former Dutch premier Wim Kok in 2004. Nothing has changed since.

The Great Recession of 2008-2009 may have humiliated Anglo-Saxon capitalism but the German and Italian economies have shrunk by almost twice as much as the US from peak to trough. As will become clear, they also lack the labour market springs of quick recovery. The Bundesbank fears it will take until 2013 for Germany to regain its former output. Will Italy ever do so?

Europe's triumphalism a year ago was badly misjudged. A new report by the Brussels think tank Breugel says the EU itself may be the biggest casualty since the traumatic events have led to revival of the nation state— each defending its own industry "bec et ongles", each pressuring its banks to come home. Berlin even created a €115 billion "German Fund", and EU competition rules be damned.

The G20 has emerged as the forum that counts. EU big shot states prefer to play on that stage. EU summits in Brussels have slipped to backwater status. "The crisis risks calling into question the very legitimacy of the European Union. Confidence in the effectiveness of the EU economic policy system has been severely hurt by the crisis." it said.

Breugel fears the "return of mass unemployment", a "depression-deep crisis" in parts of Eastern Europe, and a bond crisis as spendthrift states struggle to roll over their public debts. (It was too polite to name Italy and Greece but both are— or will be— caught in debt compound traps.) [[With Spain perhaps the first to go!?!: normxxx]] How far it seems from the heady optimism a decade ago when EU leaders launched the euro and talked of Europe's rise to economic hegemony by 2010.

By then they were endowing the EU with the apparatus of full-blown state. A "foreign office" (High Rep), with its own intelligence cell and military staff with nine generals and 57 colonels; a Euro-army ('rapid reaction force'), backed by 100,000 troops, 400 aircraft, and 100 ships to project power across the globe; a proto-FBI (Europol); a satellite system (Galileo); they even created a Directorate of Justice and Home Affairs… Home Affairs!?!

They launched a "Philadelphia Convention" to draft Europe's Constitution— "the Treaty to end all Treaties"— which I had the task of covering. Launched at Laeken, allegedly to bring Europe 'closer to the citizens' after a spate of anti-EU riots and "No" votes, it was hijacked by insiders hell bent on forging a Super-Etat, in perpetuity. Few in Europe's talking shops had a serious thought then for China, let alone India, or Vietnam. The world was seen in bipolar, almost Manichean terms: Europe against America, a "friendly" rivalry like those poisonous football matches between the Celtics and Rangers, or Barcelona and Madrid.

As Europe subsides into its new role as a museum piece, Britons who are instinctively Euro-sceptic or simply have more natural affinity with the English-speaking world— or indeed, like my 19-year-old son, with China— can justifiably ask how far this country should contort itself to take part in the EU project. For years we believed— or were scared into believing— that the strategic and economic price of jumping off the integrationist conveyor belt would be too high. It may be time to turn this argument on its head.

How worthwhile is it to remain a member of an inward-looking club when the locus of creative dynamism is elsewhere? This has become a piquant question as Brussels seizes on the banking crisis to extend control over the City and our finance industry, worth 8 per cent of GDP and generating £50 billion a year surplus on the current account. Simon Tilford from the Centre for European Reform says British Euro-sceptics like to have their cake and eat it: "Euro-sceptics appear to believe that a Britain outside the EU would remain part of the single market, but that it would be freed from the need to abide by EU regulation. In short, Britain could enjoy all the benefits of access to the single market but none of the costs. This is incoherent. A retreat would achieve nothing but impotence."

Mr Tilford is right. There is a lack of rigour and often a defeatist assumption that Britain never gets its way in Europe, never has allies, and is forever at the mercy of Franco-German villainy. It looks [exactly] otherwise to French and German journalists in Brussels. But then, each of Europe's fractious tribes thinks that somebody else is in charge. That is the elemental flaw in the project.

Psychologists call this an "ownership" problem. The owners are the 28,000 fonctionaires on high-paid EU tenure. And Paris has reason to gripe.

English has displaced French as the lingua franca, with all the subtle advantages that brings. British and Irish officials are ubiquitous in the upper reaches of the directorates that count most: Competition, Single Market, Trade. The last two secretary-generals of the Commission have been Irish, a far cry from Emile Noel, who ran it as a replica of the French civil service for 30 years. It is why the Commission became for a while an engine of free market reform.

Let us be honest: UK withdrawal would be traumatic, altering the political chemistry of Europe in unpredictable ways. While it is possible that a cluster of like-minded states on the Atlantic and Nordic rim would eventually retreat with us into a free-trade bloc, it would be rash statecraft to bet on it. Those that tend to align with Britain inside the EU as a counterweight to Rhineland domination— Scandinavians, Dutch, Balts, Slavs, and Spain (on-off)— would have to trim, tucking in obediently behind Paris and Berlin.

Britain would risk creating the sort of monolithic Habsburg Europe we wish to avoid, violating the balancing principle of our diplomacy in Europe since Elizabeth I. (One wonders how that shrewd, equivocating, steely queen would have played the EU.) Yet to accept that exit would be a high-risk gamble does not settle the argument. Ultra-federalists might scream, hurl abuse, and attempt to shut Perfidious Albion from EU markets, but the Dutch, Danes, Swedes and others would want to heal the rift.

If Brussels pushed too hard for Carthaginian terms, it would risk setting off unstable combustion in the residual EU. As Breugel says, the legitimacy of the EU is already badly eroded. This great question might have been best left unresolved, finessed by English pragmatism, had the EU not taken a dangerously authoritarian course by ramming through the European Constitution— renamed 'Lisbon'— after it had been rejected by voters in France and Holland in 2005, and would have been rejected by half Europe had the fiasco continued.

This manoeuvre is altogether different from the euro-creep tactics of EU father Jean Monnet, who handled democratic sensibilities with greater care. Clearly it never occurred to those behind this heavy-handed move— Angela Merkel and Nicolas Sarkozy— that Irish voters would then reject the text in the one country allowed to vote. Perhaps the Irish can be cajoled in their weakened state into voting "Yes" next month.

But a delicate line has been crossed. The EU project is usurping power, even if the forms of parliamentary ratification have been preserved. Critics call the Lisbon Treaty a "federalist blueprint". That muddies the issue. It in fact concentrates power in a unitary state, giving the European Court jurisdiction for the first time over the whole gamut of EU affairs (all three pillars, in EU jargon— the Community pillar, the common foreign and security policy pillar, and the pillar devoted to police and judicial cooperation in criminal matters). It will adjudicate over the Charter of Rights.

Euro-judges will have power to reshape British society by court ruling if they so wish, just as the activist Warren Court reshaped America. By creating a full-time EU president and by giving Euro-MPs the power of the purse, it mimics nationhood. Yet it should be obvious that Europe cannot ape the institutions of the historic nation states in this way. Shifting power from London, Madrid, or Copenhagen to the EU core does not transfer democratic accountability: it rather breaks the lines of accountability.

Strasbourg's Babel house has no unifying history, language or political culture. It answers to no coherent demos, and cannot do so because none exists at a European level. Italians read Italian newspapers about Italian politics, just as we read British newspapers about British politics. It is surreal that this should be happening when the EU is in crisis [[but there it is: normxxx]].

We are confronted by a venture that is using anti-democratic means to establish an anti-democratic power structure, to no useful end for the people of these isles. It fair to say that this breaches the Burkean principle of "settled practice", dear to readers of The Daily Telegraph. Since this unwelcome revolution is being forced upon us, perhaps it is time to end the long taboo and ask whether we must inevitably go along with it.

Monday, September 21, 2009

Housing Tsunami's Second Wave

The Housing Tsunami's Second Wave

By Richard Benson | 17 September 2009

Spokesmen for the Obama Administration and the Wall Street establishment refer to the slight up tic in lower-priced housing prices and existing home sales as a positive sign that we're close to a bottom. Why is it, then, that housing prices in the mid to high-end range are still crashing? Indeed, if you close your eyes and listen to the happy talk, you could be swayed into believing that the massive credit losses from housing are coming to an end and economic recovery is finally here. But before singing the chorus to "happy days are here again", you'll need to open your eyes and take a look at some facts and their relationship to mortgage defaults.

The first wave of the mortgage credit tsunami (which actually began around 2005 when loan underwriting started to unravel) was caused by hundreds of billions of dollars of sub-prime mortgages that defaulted. These loans were made to unqualified borrowers who couldn't really afford the monthly payments, even if they had had a job at the time the loan was made. Because there was so little warning of the approaching tsunami[!?!] it took a few more years for the storm to develop but when it did, it bankrupted Bear Stearns and Lehman Brothers and caused the nationalization of Fannie Mae, Freddie Mac, GM and Chrysler.

Moreover, the fall in housing prices and the end of consumer refinancing kicked the legs out from under consumer spending, fueling unemployment and a now grim job market. Unfortunately for all, the sub-prime disaster was not the end of the credit crisis in home mortgages, but just the first wave.

The next tidal wave of losses on home mortgages is testament to a failed housing experiment designed by the Federal Reserve under the false pretense of 'universal' home ownership. In [long] past years, mortgages were issued to responsible homeowners who took pride in home ownership and paid their mortgage on time. But when so many risky mortgage products, such as option ARMS, interest-only loans, cash out REFI's, no money down, etc., became available to practically anyone looking to buy a house, regardless of income, these products became the rage (a 20 percent down payment to bind an owner to a property was 'so yesterday') and home equity literally vanished. [[And— thanks to 'costs', option ARMs, Refis— quickly went negative. : normxxx]]

The assumption that people will continue paying a mortgage without an equity stake in a property worth less than they paid was a false hope. Mortgage losses from sub-prime loans have now spread to Alt-A, Option ARM, and standard prime mortgages. Practically every town, city, and state has been affected in some way by the 16 million homeowners living in homes with negative equity (a home worth less than the mortgage). Buyers of property who experimented and gambled with other people's money have been caught up in an American Dream that has now become their worst nightmare.

Analysts at Deutsch Bank have forecast that the 30 percent of underwater mortgages today could rise to 48 percent by 2011, so you won't have to look too far to see what will happen to foreclosures and mortgage losses when the number rises to 20 million people. A study done on $1.7 trillion mortgages by Fitch Ratings lays out the cold facts in black and white on how people treat their mortgages:

From 2000 through 2006 when homeowners actually had equity in their homes, and prices were rising, mortgages were paid on time. In this time frame, the mortgage "cure rate" was 19.4 percent on sub-prime loans, 30.2 percent on Alt–A loans, and 45 percent on standard prime loans.

In 2009, when housing prices had crashed and home mortgages were under water, the
"cure rate" for prime loans is a pathetic
6.6 percent (barely above the "cure rates of sub-prime at 5.3 percent, and Alt-A at 4.3 percent). No wonder over 50 percent of foreclosures are now on prime mortgages!

The plan by Fannie Mae & and Freddie Mac to refinance loans up to 125 percent LTV is a failure. Very few underwater homeowners are falling for the 'loan modification' government scheme. Even the FHA, which is now making well over 25 percent of all new home loans and will take as little as 3.5 percent as a down payment, has seen late and foreclosed loans jump from about 5 percent last year, to 8 percent today. FHA borrowers generally have lower credit scores, wages, and job skills. Since initial unemployment claims are still averaging 550,000 a week, many of these FHA borrowers will lose their jobs, causing an FHA loan default rate of well over 10 percent.

In today's world, homeowners motivated by cold hard economics and common sense are not stupid. When you don't have any real equity in your house or are underwater and out of work, it's time to mail the house keys back to the government or the bank! Foreclosures are picking up not only because mortgage holders are walking away, but when many people stop paying their mortgage, they also stop paying their property taxes.

Local governments everywhere are strapped for cash and are willing to quickly sell tax liens on properties with delinquent taxes due. The buyer of a tax lien has rights to the property that come before that of the mortgage holder so if the mortgage holder doesn't pay the tax lien, they could be wiped out when the holder of the tax lien files to get clear title of the property. So how big is the next wave in the housing mortgage disaster? [[FWIW, ARMS will be resetting clear out to 2011. : normxxx]]

Currently, one out of eight mortgages is in foreclosure or paying late, and with unemployment averaging over 9 percent for 2009 and 2010 and not really expeted to peak until 2011, it's likely that one in five mortgages could ultimately default. Moreover, we have seen that less than 7 percent of those mortgages that are late will get 'cured' and stay out of foreclosure. Over the last six months, notices of home foreclosures have been running about 350,000 a month, which is over 4 million a year. A lot of homes are headed to the auction block with their mortgages headed for the shredder.

For mortgage losses we should recognize that prime mortgages on average are significantly larger than sub-prime, and it only stands to reason that the larger the house and mortgage, the bigger the loss. With over 50 percent of mortgages failing coming from prime loans, bigger loan losses for the lenders lie ahead. The total losses to come is anyone's guess, but the $11 trillion in outstanding home mortgages could easily produce over $2 trillion in defaulted mortgages, and another $600 billion of credit losses! So, until this wave has crashed on the shore, I would recommend staying away from the water!

Wednesday, September 16, 2009

Prepare For A Lower Dow To Gold Ratio?

Prepare For A Lower Dow To Gold Ratio?

By Moses Kim | 2 September 2009

Assets are continually revalued against one another in an ongoing process to determine proper valuations. Investor preferences move in big waves, from paper assets to hard assets. The decades of the 80's and 90's were clearly periods when paper assets such as stocks, bonds, and derivatives performed exceptionally well. That era of paper wealth is gone for now, as evidenced by the mass failure of financial institutions last fall, and we have entered into a period when hard assets are in vogue.

The Dow to Gold ratio is a useful tool to track this process of asset reallocation, since gold is the ultimate hard asset. Usually, when hard assets enter into a bull market, the Dow to Gold ratio goes to under 5. For example, the ratio hit 1 in 1896, 2 in 1932, 3 in 1974, and 1 again in 1980. The current bull market in gold has brought the ratio from a high of 44 in 1999, to its current reading of 10. [[On the other hand, it was as low as 7 on March 6 of this year.: normxxx]]

In addition, there seems to be a tendency for the ratio to "overshoot" on the downside based on how overextended the ratio becomes. For example, an 18 Dow:Gold ratio eventually fell to 2 in 1932, and a 27 Dow:Gold ratio eventually fell to 1 in 1980. Considering that the Dow:Gold ratio was at 44 prior to this move, it looks like we may yet have a ways to go on the downside.

The decade-long move in gold may seem overextended, but there are still several bullish factors working in gold's favor. First, gold has been able to trade above 900 since the supposed recovery in the economy and massive rally in stocks beginning in March. A similar consolidation pattern in gold in 2006 preceded a 50% surge in prices. Anyone familiar with fractals is eying this pattern and its potential completion.

Second, gold has been able to rise along with the dollar index, which is usually a bullish signal. Third, we are moving into a historically bullish season for gold. [[Gold tends to be very seasonally strong in September.: normxxx]] With stocks overpriced at around 129 times reported earnings, a decent-sized pullback is in order. [[While earnings can be expected to increase sharply in Q3, especially for the banks (whose 'smoke and mirrors' accounting is being aided and abettted by the Fed and the GAAP), it is hardly likely to bring that P/E ratio back down to normal— around the mid teens.: normxxx]] Therefore, I expect the Dow to Gold ratio to decrease in the coming months and years. Keep an eye on the Dow to Gold ratio as an indicator of the "smart" investor sentiment and relative valuation of asset classes.

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For more info, see Fred's Intelligent Bear Site

To quote from that source:
The long term trend of the ratio is up at a rate of 1.25% per year. This should be expected as the process of mining gold becomes more efficient and cheaper due to advances in machinery, energy, exploration technology, chemicals, etc. In fact, the advances in mining probably match the efficiency gains seen in the economy in general…

The Dow/Gold Ratio chart shows that we could be witnessing the end of an era for equities. Stocks had an 18 year bull market where buy and hold was the guaranteed way to make money. Unfortunately for the stock market bulls, asset classes go in and out of favor, and the next great asset class may very well be gold. The chart shows that it would be logical to expect the ratio to return to a value around 6. Perhaps a ratio of 6 would be gold 1200, Dow 7200.

Note: the effect of inflation should be nil, since the act of taking the ratio would cancel it out— unless either gold or stocks tended to inflate more than the other over time, of which there is no indication.

For a completely alternative view, see:
How the World's Best Investors See the Market
By Porter Stansberry, Thursday, September 17, 2009